Latent defects insurance is often presented as a better way of providing protection against defects, rather than the time and paperwork involved in procuring collateral warranties from multiple parties. There appears to be an increase in popularity for it in the current economic climate, given the potentially significant benefit of the protection continuing even if the contractor or a consultant is insolvent.
However, is it really a substitute for collateral warranties? What are the pros and cons of latent defects insurance?
What is latent defects insurance?
Latent defects insurance provides cover in the event of a defect in design, workmanship or materials becoming apparent after completion, typically for a 10 or 12 year period. It is generally taken out by the developer at the start of the project, and gives protection against damage occurring as a result of a structural defect. The insured can be any party with an interest in the project. In the event of a defect causing damage, the policy will cover the cost of remedying the defect.
What are the benefits?
- Once damage occurs, there is no need to prove fault on the part of a particular party, whereas claims under a collateral warranty require the beneficiary to establish that a breach of contract has occurred and may require actions to be raised against a number of parties;
- The policy is taken out at the start of the project and does not need to be renewed. It is therefore unaffected by the subsequent insolvency of any member of the construction team, whereas professional indemnity insurance (which the construction team would generally be required to maintain in terms of a collateral warranty) has to be renewed annually, and will provide no protection if it has not been renewed at the point a claim is made.
What are the drawbacks?
- The policies limit claims in a number of ways: they generally do not cover economic losses arising from the damage, but only the cost of repair or reinstatement and will only cover defects in structural parts of the building (for example, defects in relation to M&E equipment and installations are generally not covered);
- Claims will be subject to an excess, which may be significant;
- Cover will be subject to a maximum sum insured. In addition, latent defects policies will often penalise under-insurance by calculating the amount by which the building was under-insured and reduce the amount of any payout proportionately.
Other points to note
- The insurer will generally appoint a surveyor at the outset to visit the works and certify them on completion. The cost of doing so will be passed on to the insured;
- The insured should not do anything after the insurance certificate has been issued which would affect the insurer raising a claim against any third party in relation to the damage. The insured will also require to notify the insurer of any subsequent fit out works or other modification carried out;
- There are different products on the market and, if considering taking out a latent defects policy, these should be investigated and any policy tailored to the particular requirements of the development in order to maximise the benefit from the policy. For example, it is possible to obtain cover which includes M&E installations, or where loss of rent is an optional extra.
Latent defects insurance can be useful as additional protection against contractor or consultant insolvency, or to fill the gap if collateral warranties simply are not available. It should not, however, be seen as a straightforward substitute for collateral warranties.