A spate of high profile new builds with structural defects highlights the need for specialist construction insurance
On Christmas Eve 2018, a wave of panic engulfed the exclusive Opal Tower development in Sydney, Australia, when 300 residents fled from their apartments. They had been forced to evacuate their homes after ominous “creaking sounds” were heard coming from within the building’s structure.
The noise was caused by fissures zig-zagging alarmingly through the concrete walls and ceilings of the gleaming 34-storey development, which overlooks Sydney Olympic Park.
As fears heightened, fire crews shut off the Opal Tower’s water and gas supplies and took the building off the power grid; 51 units in the apartment block were declared unsafe by engineers. A further 3,000 people were evacuated from nearby buildings.
Some residents were allowed to return home early on Christmas Day, but many families had to spend the holiday period in temporary accommodation.
The incident has not only affected the families who forced from their homes. The developer (and its insurers) will bear the cost of repairs. Reputational damage has resulted, caused in part by social media campaigns. And property values have dropped, both in the Opal Tower itself and in the buildings surrounding it.
Why structural defects are a hot topic
High profile buildings are making the headlines, but for the wrong reasons. Defects are putting property developers – and their insurers - on high alert.
The Opal Tower evacuation was one of a series of recent notable issues affecting well-known developments.
In this, our second blog inspired by MIPIM 2019’s theme, “Engaging the Future”, we examine other incidents of this type and consider the current risk environment, along with the tools available to developers to mitigate against such risks.
Discover how developer's insurance claims of the past are impacting the current risk landscape in The Construction Insurance Claim Still Costing Property Developers Today
What developers need to know about latent defects and safety
Safety concerns relating to residential property have increased in prominence in recent years, driven partially by the Grenfell Tower tragedy, in west London, on 14 June 2017.
Other recent structural failure-related events include:
- Cracking to steel beams: The San Francisco Salesforce Transit Center, California
In September 2018, San Francisco’s transportation hub closed less than two months after opening, when a large crack was discovered in one of its steel beams, generating concerns about the building’s safety. The flaw was spotted by a construction worker installing ceiling panels on the building’s third-floor bus deck. Once touted as the Grand Central of the West Coast, where travellers could relax, dine and shop before heading off to their destinations, the building has not yet been scheduled to reopen.
- Sinking and tilting: The 301 Mission Street Millennium Tower, San Francisco
The tallest residential building in San Francisco, this 58-storey skyscraper has sunk downwards by 17 inches and leaned a full 14 inches to the northwest since its opening in 2009. A cause for the movement of the building has not been discovered, and investigators insist the structure is sound. However, this has not prevented a weakening of home values. Accusations of fraud have ensued, as well as years of legal battles. Millennium Tower homeowners have also complained of mysterious odours, bubbling floors, cracked walls and a giant fissure in a 36th floor window.
The possibility of structural defects – and their consequences - should form a key part of all construction risk management strategies for developers and owners.
How should building owners deal with structural defects?
The standard buildings insurance cover offered to property owners and developers will not reimburse for losses arising from defects inherent in the construction or its design.
The owner is left to exercise their rights against the contractor under the building contract. But this raises further questions such as:
- Can the owner demonstrate that the contractor is liable?
- Is the contractor still solvent? Do they have the wherewithal to meet a massive repair bill plus the ancillary business interruption costs?
- If not, does the contractor have the correct suite of insurances in place to provide the capital to meet its contractual responsibilities?
Therefore, latent defects can be extremely problematic. They can cause considerable disruption to a variety of parties, and can be highly expensive to correct.
How building owners are mitigating against inherent defects
As we have seen from the Carillion collapse in 2018, size is not necessarily a reliable indicator of financial stability. A latent defects insurance (LDI) policy can reduce the concerns and fears of owners, developers and tenants alike by providing them with a first party insurance solution.
LDI provides cover for the cost of remedying and rectifying damage arising out of a latent or inherent defect, whether it is in a commercial, residential or mixed use development.
Latent defects are normally defined as faults in the design, workmanship, materials, supervision, construction, installation or site preparation of a new building. These faults remain undiscovered at the date of practical completion, but come to light afterwards by virtue of physical damage.
How is an LDI policy underwritten?
The LDI policy is incepted at the start of the project and does not need to be renewed, the cost being agreed up-front, prior to the start of construction. The majority of the premium (typically 85-90%) is paid upon practical completion in one instalment, subject to the final sum insured being confirmed. Purchasers have a window of time (usually a month or so) to take up the cover once practical completion has been achieved.
A latent defect auditing process is conducted throughout the construction phase by the insurer’s surveyor. Its purpose is to reassure warranty providers that the building project complies with building regulations and any other specific warranty requirements. A latent defects audit service generally consists of a design assessment, plus a range of site inspections that take place at key stages throughout a development.
When does the policy period start?
The typical 10-12 year period of insurance runs from the date of practical completion. Normally LDI is procured prior to the commencement of construction. However, some recently completed projects have had cover arranged for both part completed and completed schemes, applying to developers, tenants and lenders with the policy being freely assignable.
Additional extensions can be purchased which include loss of rent, damage to mechanical and electrical services, alternative accommodation, loss of gross profit or revenue, increased cost of working from alternative premises and mechanical/component failure cover.
Find out why more developers are taking out structural warranties in our blog Latent Defects Insurance is on the Increase.
How inherent defects insurance increases a developer’s or an owner’s business edge
Internationally, there has been a significant increase in the uptake of commercial LDI during the past few years.
While lenders often insist on LDI cover for residential developments, many commercial lenders now see it as an added form of protection.
In the wake of the Carillion collapse, and because of the well-publicised difficulties faced by several major UK contractors, LDI is gaining a reputation as a solid protection against future issues.
Private rental sector developers are now looking for a commercial-to-residential product as a form of protection if they decide to sell off units individually at a later date.
Appetite for cover is also driven by the recognition of the value that it brings to a project. Structural defects insurance can provide valuable risk transfer and is a key commercial issue for many developments.
Increasingly, tenants taking on long-term leases (especially full repair and insure leases) are insisting on having a latent defects insurance policy in place.
Developers are responding by ensuring they tick all of the boxes they can for prospective tenants to increase unit marketability in the current competitive environment. As the LDI policy is also freely assignable to future tenants or purchasers, it can help to smooth the process of a sale or tenancy agreement.
How to find the most effective LDI coverage
When purchasing LDI, developers and owners have various construction insurance options. They include operating on the instruction of their lenders or investors and working with an insurance broker.
LDI comes with a complex range of risk and insurance issues. If an insurer has not been specified by financiers, developers should work with a specialist construction insurance broker who has the market expertise and industry knowledge to tailor policies to suit their individual needs.
For further information please contact Will Bromfield, JLT Construction, Global Projects Team on +44 (0)20 8108 9325 or book an appointment at MIPIM here.