On new build properties and conversions, structural defects can appear months or years after completion due to poor design, workmanship or materials.
Inherent Defects Insurance (IDI), also known as Latent Defects Insurance (LDI), can help to cover the cost of repairs or rebuilding if structural damage appears months or years after the practical completion a new-build or conversion project.
This type of damage can be hugely disruptive, costly and complicated, and could have a serious impact on your business. That’s why it can make good commercial sense to mitigate the risk with building defects insurance – in some cases it can be essential for property developers, funders, and owners or tenants.
IDI originates from the French Decennial Liability, which is a form of strict liability arising from the French Civil Code. The French system is compulsory and requires for both first party insurance (Dommages Ouvrages) for the owner, and third party insurance (Decennial Liability) for the contractors, designers and architects. This system was designed to provide the building owner with effective protection against major damage may occur, or come to light, in the decade that follows completion of the building.
WHY IS IDI PURCHASED?
Property policies generally exclude latent defects for newly completed buildings or civil projects. IDI covers defects in the design, workmanship or materials of a new building which have not been discovered at the date of practical completion but which come to light as a result of physical damage at a later stage. Coverage under IDI begins at practical completion (though ingress of water is excluded for the first 12 months) and typically lasts for 10-12 years.
IDI is taken out by the principal or contractor to cover the costs associated with the potential collapse of the building after completion. The insurance is compulsory in a few countries such as France and Egypt. In other countries, such as Qatar, strict liability exists for defects post construction and it is left for clients to decide whether they should insure or not. Despite not being a strict requirement, the coverage is prominent in the United Kingdom. A significant reason for this is due to the fact that the Council of Mortgage Lenders insists on IDI (or similar warranty) for any project involving new residential units, before allowing any purchase.
The Impact of Regulatory Changes in India
“In 2016, the Real Estate (Regulation and Development) Act (the Act) introduced a 5 year period of liability on the developers of residential dwellings in India. The Act seeks to protect home-buyers while simultaneously boosting investments in the real estate industry.”
India is currently subject to strict liability regulations however many developers are considering the global approach to reducing the increased uncertainty introduced by the legislative change. Like their UK counterparts many developers have begun investigating how insurance and IDI policies may provide some level of protection.
Indeed Tier 1 developers may be able to uses IDI to distinguish themselves from others in the residential market in India. By providing prospective buyers with a structural guarantee for a period of 5 years post construction, they make their developments more attractive to potential buyers.
A lot of work is currently underway to create a product which meets the needs of the local market.
As a first party insurance product, IDI allows the building to be reinstated faster than pursuing the contractor or design team contractually. Alternatively, if the contractor is in liquidation, no longer exists or the warranty period has expired, IDI offers protection in the place of unenforceable warranties.
KEY ADVANTAGES OF IDI
IDI means there's no need to establish who is at fault or to prove negligence - and no need for often slow, complex litigation before repairs can be done. There are no restrictions on the number of assignments meaning the coverage can pass on to future owners. In the event of a claim immediate access to repair funds can minimise business interruption or cover the loss in rental income if tenant(s) cannot occupy the premise and exercise a rent cessor.
IDI can provide a high-performance alternative to collateral warranties, although they often work hand-in-hand. Collateral warranties are agreements which are associated with another 'primary' contract. They provide for a duty of care to be extended by one of the contracting parties to a third party who is not party to the original contract.
Collateral warranties can only be actioned if the professional indemnity policy (to which they are usually appended) is still in place and all parties are still trading, and therefore do not provide adequate protection in the event of contractor insolvency. In addition negligence on the part of the construction team, also needs to be proven which can be very difficult. IDI covers you even if parties cease trading without the need to prove negligence; one of the key benefits of first party coverage.
IDI is not an answer for all defects as coverage is triggered by physical damage to the structure. It is important to still consider the importance of professional indemnity insurance (which covers a defect in design) and warranties for defects which don’t cause damage.
HOW IS THE PRODUCT DEVELOPING?
Recently there has been increased interest in IDI in non-traditional territories such as Malaysia, India, China, Turkey and the USA. Each new region brings with it a slightly different interpretation regarding what can, or should, be covered under the policy. While historically IDI has been placed to provide additional protection for building construction much consideration is being given to the protection it can provide in relation to civil projects such as bridges, tunnels or rail structures.
Not only are companies considering new ways established insurance products can be used to transfer risks insurers have an appetite to support the product development and are working with specialist brokers to develop tailored solutions.
CONSIDERING IDI FOR CIVIL PROJECTS
Appetite and solutions also exist for civil projects such as tunnels, bridges and structures relating to metro and rail projects. At a basic level the cover is the same. It provides first party coverage for damage to the structure which is the result of a latent defect – one that comes to light after practical completion of the project. For mega projects the application of first loss limits can still make the cover viable, and protect the contractors and developers from the majority of worst case scenarios.
Like any IDI policy cover needs to be arranged and terms agreed before the start of construction. Insurers will require evidence that a technical inspection company has been employed to monitor the construction and sign it off at practical completion. At that time, cover can then commence for a period of up to 10 years.
Developing a First Party Solution for the USA
There is an array of insurances which address defects in the USA: professional liability, sub contractor default and general liability. None however consider defects from a first party perspective, meaning from the point of view of owners, developers or contractors who continue to have an interest in the property post completion.
While what constitutes damage and/or an occurrence under the insurance policy can vary significantly with jurisdictions and between states there is an opportunity for the introduction of IDI.
Construction Risk Partners, a JLT group company, were pioneers of IDI in the country. They successfully arranged IDI coverage on a Public Private Partnership (P3) building project in California. Not only did the insurance satisfy unusual contractual requirements, more importantly it helped the client receive a better credit rating for the project which ultimately led to better lending rate.
“There is a great potential for IDI on both commercial and residential developments, especially when the advantages of the first party coverage structure meaning there is no need to prove liability, negligence or default of the contractors and/or sub contractors - or incur the legal costs to do so.
(Joseph Charczenko, Director of Construction Risk Partners a JLT Group company)”