Project-Specific Insurance Advisory:
Recent Problematic Trends In Project-Specific Professional Liability Insurance Programs
By David J. Hatem, PC

For the last three decades project owners, design professionals, project grantors (federal and state), construction lenders, design-builders and others have all recognized the benefits of a well-designed and structured project-specific professional liability insurance program (P-S PLI program), especially in connection with insuring, mitigating and managing professional liability risk, and in a) aligning professional accountability with adequate insurance coverage and b) expediting the cost-effective resolution of professional liability claims, especially on projects involving substantial risk and construction values.

Recently, however, some project owners as part of their owner-controlled insurance programs (OCIPs) are developing and procuring ill-conceived P-S PLI programs that significantly undermine and erode virtually all of the salutary characteristics and benefits of such programs, cost more (whether measured in insurance premium dollars, required self-insured funding obligations and/or the cost of delays and inefficiencies in claims resolution) and render dysfunctional the operation and realization of the principal intended benefits of such programs. When these problematic P-S PLI programs are implemented on public-sector projects – especially when implemented on megaprojects – the public ends up paying significantly more for a relatively useless and dysfunctional insurance program and the interests of private-sector project participants insured under such programs are disserved. In addition, there are more subtle, but real and negative consequences of such problematic programs in the public-sector context, including diminution in accountability of private-sector project participants to the public owner and potentially inappropriate (in perception or actuality) use of public dollars to fund self-insured (SIR) obligations (triggered by claims or findings of breach of professional duty of design professionals insured under the P-S PLI program).

Background: Project-Specific PLI Programs

P-S PLI programs are a mechanism to provide professional liability insurance coverage for design professional breach of professional duty (e.g. negligence) in connection with services performed by those professionals on a specific project. The coverage is dedicated to, and for, the specific project and professional liability claims arising therefrom, and is guaranteed for a specified duration (i.e. the policy period), and for an additional extended reporting (or so-called discovery) period. Project-specific policies have relatively substantial SIR obligations (somewhat like a deductible) that typically are funded by the various design professionals who are insured under the policy. Many of these policies are underwritten with mandatory joint defense provisions under which the various design professional insureds are obligated to jointly defend and settle claims asserted against one or more of them. This joint defense approach is reinforced by "insured versus insured" exclusions which preclude coverage for professional liability claims asserted by one design professional insured against another. These programs are intended to maximize the availability of coverage for indemnity payments for claims by rendering more efficient, focused and expedited the resolution of professional liability claims against the design professional insureds. Most project owners who purchase project-specific professional liability insurance as part of an OCIP recognize these benefits and often reference them as considerations motivating and underlying their decision to procure such programs. As such, when structured in the traditional manner outlined in this section, project-specific professional liability insurance programs provide an acknowledged benefit to project owners.

On public projects – especially megaprojects – P-S PLI programs provide a mechanism for facilitating design professional accountability for deficient service performance by aligning project owner “consultant performance evaluation” (also known as cost recovery) programs with the coverage terms and program functioning of the P-S PLI program. Federal grantors (e.g. Federal Transit Authority and Federal Highway Administration) and oversight and regulatory agencies recognize and support the procurement of OCIP programs that include project-specific professional liability insurance programs. However, these federal agencies typically need and expect reasonable assurance (especially because the public owner pays the premium and will likely be reimbursed for a portion by federal grant funds) that design professionals (who are insured under the program) remain accountable for deficient performance (notwithstanding the procurement of a P-S PLI program) and have significant financial stake in the adequacy of their performance – i.e. are responsible for the funding and payment of the self-insured retention obligation(s). These considerations are also areas of concern to state auditors, inspectors general and attorneys general, as well as other specific project overseers, regulators, and funding and appropriation sources. These are legitimate and warranted concerns that should be anticipated and addressed in the development and implementation of a well-conceived P-S PLI program.

Recent Problematic Trends

Recently, a trend appears to be emerging in connection with the development and procuring of project-specific professional liability insurance programs that undermines and eradicates most of the salutary characteristics and benefits of such programs. In part, this trend appears to be motivated by at least two independent and, in some instances, combined factors:

• A desire of project owners to reduce insurance premium cost by significantly increasing the SIR obligations (to amounts such as $5 million to $10 million on a per claim basis).
• The desire of some professional liability insurers to significantly reduce professional liability insured risk by providing coverage only above significantly and abnormally high SIR obligation(s) (again $5 million or more) on a per claim basis.

These factors appear to be congruent and confluent; however, their combination is neither in the best interest of project owners (especially public owners), nor design professionals (and potentially others) who will be insured under such programs.

In general, these ill-conceived programs typically are procured with per-claim SIR levels of between $5 million to $10 million (and perhaps higher). While the coverage terms nominally include a joint defense provision and an insured versus insured exclusion, for reasons discussed below, these coverage terms in practice and reality are rendered ineffective and, in all probability, legally (and ethically) inoperative and unenforceable by virtue of the unusually high amounts of the per claim SIR obligations.

Some project owners may attempt to mitigate the significant per claim SIR funding obligations of the design professional insureds by agreeing to pay all or a significant portion of the SIR obligations. However, that act or offer of compromise will create actual and perceived conflict of interest and legitimate accountability concerns for public owners, and these concerns, in all probability, will be raised by project overseers, regulators and grantors at both the state and federal levels. Essentially, the issue will be that project owners should not, in effect, release or limit the liability of the design professional by funding all or part of the SIR obligations in circumstances in which, by definition, the project owner has made or established a claim (or claims) against the design professional based on the latter’s deficient service performance that triggers the SIR obligations. In substance, the project owner will be absorbing or paying for the design professional's negligence that has resulted in the unnecessary expenditure of public funds. In addition, some project owners who contribute to the funding of the per claim SIR obligations may assert that they are entitled - by virtue of that funding - to control the defense and settlement of claims that they make against the design professional insureds. While this type of assertion logically makes no sense and poses ethical issues, that has not detracted some project owners from asserting such entitlement positions.

For the design professional insured, how can such significant and multiple SIR obligations be funded? For most projects, including megaprojects, this contingent (but very real and substantial) financial exposure can erode all profit for such firms, even when functioning as a joint venture and sharing risk with other firms.

Will corporate or practice (practice) professional liability insurance of design professionals fill the coverage gaps created by such abnormally and unreasonably high SIR levels? Probably not. Even were a practice professional liability insurer to fill the gaps, it would and should want to control the defense and resolution of claims against the design professional insureds (within the gaps) and, most likely, the gaps would need to be filled by multiple practice professional liability insurers, each of which rightfully so will insist on controlling the defense and resolution of claims against their respective design professional insureds within the practice levels of coverage. In addition, in this scenario, each design professional whose practice insurer will participate in providing coverage for the "gaps" will impose a separate deductible or self-insured retention obligation on the design professional. All of this practice insurer participation - even assuming hypothetically that such insurers would be willing to fill the gaps (which is a remote proposition, at best) - will render inoperative the joint defense and insured versus insured provisions of the project-specific professional liability insurance coverage. In addition, even were such practice insurers willing to provide such coverage, typically any such commitment would be co-terminous with the period of practice coverage - typically only one year. If the particular project were to gain a reputation as "problematic" or suffer a similar stigma (in the professional liability insurance underwriting world) practice insurers would probably decline in future years to provide coverage for the gaps, which is exactly what occurred on the Central Artery/Tunnel Project in Boston.

However, the more likely scenario is that practice insurers, in the first instance (and independent of any adverse project claims experience) will decline any invitation or request to provide coverage for the gaps. This would be a sensible and understandable decision.

Regardless of whether design professionals or their practice insurance were responsible for funding the significant gap exposures created by abnormally high SIR obligations, design professionals should be allowed to assert claims against each other within such significant SIR obligations, and their practice insurers should be entitled to assert subrogation claims against other design professionals who are insured under the project-specific professional liability insurance program with respect to recovery of defense costs, indemnification and other payments made within the practice insurer "gaps" layer.

In this context, given the substantial SIR exposures, joint defense and insured versus insured provisions under the P-S PLI program are likely to be legally unenforceable. However, if the insured violates the joint defense and insured versus insured requirements of the project policy, it will sacrifice coverage under the project-specific professional liability insurance policy, which is neither good for the design professional insured, nor for the project owner who paid the premium for that coverage.

The dysfunctionality of the claim defense and resolution process with such significantly high SIR layers will lead to lack of coordination in defense and settlement of claims, increased defense costs (legal and expert), delayed claim resolution, reduced insurance limits (due to substantial erosion of available coverage by payment of defense and expert fees). For the project owner this will mean less coverage available to pay claims and a more contentious, protracted and expensive claims resolution process.

Because of all of these issues, reinsurance and excess participation in such ill-conceived P-S PLI programs should and will be both problematic and expensive, even if available.

For the design professional insured, these problematic programs represent increased corporate dollar exposure and increased corporate insurance costs, and the potential for significant professional liability coverage gaps and non-insured professional liability exposure (if, as predicted, practice insurers prudently will not provide coverage for the SIR gaps).

A further trend in this problematic approach arises in the design-build project context and involves exclusion of coverage for the design professional subconsultants of the design-builder. The exclusion of that coverage renders dysfunctional any joint defense between the design-builder and its design professional subconsultants and requires the latter to attempt to obtain professional liability insurance coverage from its practice insurers.

Finally, another problematic trend involves the procurement by the project owner (OPPI) or constructor/design-builder (CPPI) of professional protective insurance policies. These policies provide coverage only to the procurer – i.e., either the project owner, constructor or design-builder - and not the design professionals. Although these policies generally are not an adequate substitute for a well-conceived P-S PLI program, they may have value in certain limited applications (e.g., in circumstances in which a particular project does not require proactive risk management during construction or coordinated claims management and resolution programmatic features). Although not excess in nature, coverage under these policies is triggered once the underlying practice coverage limits of the design professionals (or a defined sub-limit thereof) have been exhausted. The existence of these professional protective policies often is not disclosed to the design professionals. The OPPI or CPPI insurer also may reserve rights to subrogate against the design professionals.

The very existence of these protective policies typically leads to “downstream” pressure by the procurer or the protective insured (i.e., project owner, constructor or design-builder) upon the design professional (and its practice insurer) to pay out practice limits (whether justified or not by the reasonable claim value) in order to trigger the protective coverage. For these reasons, professional protective policies instigate and propel needless tension and adversity among the design professionals and other primary project participants (the latter of whom are covered under the protective policy), which can be extremely disruptive and undermine partnering and positive project relationships, especially when claims arise on an on-going construction project. These protective policies provide no meaningful opportunity for proactive risk management programs, such as those provided under certain well-designed P-S PLI programs, or for the joint and coordinated management, defense and resolution of claims, as the practice or underlying insurers and the OPPI/CPPI insurer have no relationship, and owe obligations to different insureds with conflicting interests. In the more “macro” perspective, these protective policies undermine the longer-term and larger-picture relationships among primary project participants, and promote more conflict and adversity among them during the progress of the project, complicate and protract the claim resolution process, and thereby jeopardize the important overall objectives of on time and budget project completion.

Recommendations and Conclusion

These problematic trends should be arrested. Project owners should be aware of the serious insurability concerns, and coverage depletion and claims resolution disadvantages - especially on public projects - posed by these trends.

Design professionals (and other insureds) under proposed project-specific professional liability insurance policies containing these problematic trends should request their own firm or corporate insurance broker to review the proposed program and how it would function relative to the corporate or practice coverage of the design professional, with particular attention to the probability of coverage gaps and the creation of uninsured liability by such programs. The design professional insured should recognize that the project owner's OCIP broker does not represent the interests of the design professionals who are insured under the program.

Project owners and design professionals should be on the alert for the problematic trends in project-specific professional liability insurance discussed in this advisory and take appropriate and timely action.

David J. Hatem is a Founding Partner of the Boston-based law firm, Donovan Hatem LLP. He leads the firm's Professional Practices Group, which represents engineers, architects and construction management professionals. Hatem is nationally recognized for his expertise in law related to the design and construction industry.