Insuring the project
a few of the fundamentals
Concerns of Project Managers
Jon M. Wickwire
Editor's Note: Techniques of project management, by necessity, involve the assessment and management of risk. Insurance policies are one device to distribute risk and make provision for contingencies. The complex, and at times arcane, world of insurance can obscure the meaning and operation of insurance provisions. The following article outlines some of the fundamentals involved in three of the most common types of commercial insurance for project related risks: the Commercial General Liability policy; the Builder's Risk policy; and the Architect/Engineer Liability policy. In addition, the article addresses one of the trends in the procurement of insurance policies, the concept of Wrap-Up Coverage.
In the game of blackjack, “insurance” is a form of bet used to hedge against the risk that the dealer has blackjack. Many players call the bet a losing proposition. Although some may feel that buying commercial insurance is little more than playing blackjack, few businesses do without the aid of commercial insurance. Indeed, insurance has become an integral part of both private and public contracts. Standard contract provisions require parties to procure and maintain appropriate liability and casualty insurance. Thus, insurance is a basic component of project management. Understanding fundamental concepts of insurance is crucial to the successful incorporation of insurance into the management of the project.
INSURANCE V. INDEMNIFICATION
Although the concepts are frequently interchanged, insurance and indemnification are different and distinct concepts. Insurance is a specific form of contractual agreement, typically regulated by state statutes, under which the insurer agrees to defend the insured against certain claims and/or pay certain losses. In the case of liability policies, such losses are those incurred by third parties. Consequently, liability coverage is frequently referred to as third-party coverage. In the case of casualty insurance, the losses are those incurred by the insured. Thus, casualty coverage is frequently referred to as first-party coverage. In either case, however, the contract of insurance is an obligation by a third party who does not control or participate in the risk being insured. Indemnification, on the other hand, is typically a contractual provision between parties whose conduct or agreement create the risk being indemnified. For example, in a sales contract, the agreement might provide for the seller to indemnify the purchasers against certain fees or costs assessed against the purchaser. Likewise, in construction contracts, the contractor may be required by an indemnification clause to indemnify the owner for losses incurred by the owner as a result of the negligence of the contractor or its subcontractors. Thus, in cases of indemnification, the parties to the indemnification agreement typically create, control, or are subject to the risk of loss.
The distinction between insurance and indemnification agreements is critical since many jurisdictions restrict the ability of parties to seek indemnification for their own negligence. In such jurisdictions, indemnification agreements are strictly and narrowly construed to preclude a party from obtaining indemnification for its own negligence. In those jurisdictions, the operation and effect of insurance becomes more critical as away of distributing risk resulting from a party's own conduct.
AGREEMENTS TO PROCURE INSURANCE
In part due to the problems associated with indemnification provisions, many public and private contracts require the contractor to obtain insurance. Such provisions are commonly employed as a risk allocation technique. They are frequently used either in conjunction with or in substitution for indemnification provisions. The provisions may specify both the type of insurance coverage as well as the dollar limits of coverage. In addition, the provisions may require that the government or the owner be named as an additional named insured under the policies. Some forms of these provisions may allocate responsibility for procurement of insurance depending upon whether the insurance is liability insurance or casualty insurance. These provisions may place the principal responsibility upon the owner or the government for the procurement of casualty insurance but place the responsibility upon the contractor for the procurement of liability insurance. These variations attempt to place the relative responsibility with the party who is in the best position to obtain the type of insurance economically and efficiently. Likewise, the agreements may provide that one party has the initial responsibility to procure the relevant insurance, but if it fails to do so, the other party may obtain the insurance at the cost of the first party. Agreements to procure insurance, therefore, can be employed not only to ensure that adequate and appropriate insurance is obtained for the project, but also to procure the insurance as efficiently and as practically as possible.
Commercial General Liability (CGL) insurance policies are the most common form of commercial insurance. Both public and private contracts routinely require the party performing work to maintain CGL coverage in designated amounts. The obvious purpose is to ensure that the party performing work has appropriate insurance to cover liability claims by third parties. CGL insurance coverage, however, frequently becomes enmeshed in contractual disputes regarding the performance or the quality of work performed by the contractor. These disputes may be exacerbated by the existence of indemnity provisions in the contract. These overlapping contractual and insurance provisions can make it difficult to discern the scope of insurance coverage under a CGL policy.
Generally, the CGL policy is designed to provide broad liability coverage for liability claims by third parties against the insured. Thus, the insuring clauses of the CGL speak broadly in terms of the obligation of the insurer to pay “those sums” which the insured is “legally obligated to pay” as damages because of “bodily injury” or “property damage” to which the insurance applies. The broad insuring provisions, however, are subject to a long list of explicit exceptions. It is these exceptions which many find incomprehensible. The purpose of many of these exceptions, however, can be found in the fundamental purpose and function of CGL coverage. CGL coverage is third party coverage. Its principal function is to protect the insured against claims by third parties. CGL coverage is not property or casualty insurance for the property of the insured. Nor is CGL coverage a substitute for payment bonds or performance bonds. The third-party character of CGL coverage is reflected in several of the explicit exclusions to coverage, including:
- The Property Owned Exclusion
- The Care, Custody and Control Exclusion
- The Failure to Perform Exclusion
- The Product Exclusion
- The Faulty Work Exclusion
- The Contractual Liability Exclusion
These exclusions principally operate to prevent the CGL policy from becoming a form of casualty policy. Thus, the “property owned” exclusion excludes coverage for property damage claims for property owned, rented, or occupied by the insured. Similarly, the “care, custody, and control” exclusion precludes coverage for personal property in the care, custody, or control of the insured. These exclusions also operate to avoid the transformation of the CGL into a performance bond. Thus, the “failure to perform,” “product exclusion,” and “faulty workmanship” exclusions preclude coverage for property damage arising from faulty workmanship or failure to perform the terms of a contract entered into by the insured. This type of exclusion arises principally in cases where a purchaser or owner has received the product or work of the insured and subsequently claims that the insured's work was faulty or inadequate. In such cases, the owner or purchaser seeks compensation from the insured for breach of contract or breach of warranty. This arises frequently in the context of building contracts or contracts for the manufacture of commercial/industrial products. The “failure to perform,” “product exclusion,” and “faulty workmanship” exclusions seek to avoid coverage in such instances.
The contractual liability exclusion is in some senses a misnomer. It does not operate to exclude coverage for all liabilities arising under a contract entered into by the insured. Rather, the exclusion seeks to preclude coverage where the insured assumes liability by contract or agreement, as in the case of an indemnity agreement. Thus, this exclusion operates as a limit upon the insured's ability to unilaterally determine the scope and effect of coverage by entering into contracts which include indemnity provisions. Under most formulations of this exclusion, however, the exclusion does not operate if the insured is liable for damages independent of the contractual agreement. Thus, the exclusion has little application where the insured is jointly responsible for the injury by virtue of its conduct rather than a contractual duty of indemnity.
The force and effect of these exclusions can be mitigated or eliminated by appropriate endorsements which enlarge insurance coverage. For example, the “failure to perform,” “faulty workmanship,” and product exclusions can be mitigated by a “products-completed operations” coverage endorsement. Likewise, the “contractual liability” exclusion can be eliminated for particular contracts by a contractual coverage endorsement. Nevertheless, the exclusions in the CGL, both individually and collectively, reflect the nature of the coverage. Fundamentally, the policy operates to insure against property damage or bodily injury to third parties rather than business risks.
BUILDER'S RISK INSURANCE
Builder's risk insurance is a specialized type of commercial insurance used in the building and construction industry. It is a type of casualty insurance which covers the loss of property rather than the defense of claims. In this sense, builder's risk insurance is a specialized type of property insurance. Specifically, it is a type of property insurance which insures against the loss or damage to structures under construction. After completion, builder's risk insurance is replaced by permanent property and casualty insurance. In addition to the coverage for structures under construction, builder's risk policies may also insure materials stored by a contractor for use in construction.
Builder's risk insurance is typically procured on an “all risk” basis or “named peril” basis. Most construction contracts require the contractor to procure builder's risk insurance on an “all risk” basis. The difference between the two types of policies is significant. The “all risk” policy is defined principally upon the exclusions. Thus, under the “all risk” policies courts have imposed upon the insurer the duty to prove the applicability of an exclusion once the insured has demonstrated the fact of loss to the insured property. On the other hand, in the case of “named peril” policies, courts have imposed the burden upon the insured to demonstrate not only the fact of loss but also that the loss was occasioned by a “named peril.”
Fundamentally, builder's risk policies are structured to insure against “fortuitous” loss occasioned by external forces. Consequently, builder's risk policies contain exclusions similar to the CGL policy. These include exclusions for faulty workmanship and defective design. The underlying premise of these exclusions is similar to the use of such exclusions in the CGL. Since the builder's risk policy is principally a vehicle for insuring against loss by external losses, the policy attempts to exclude losses which are caused by those who are parties or participants in the construction work. The complexity of construction, however, can create complicated causation problems. For example, a fire loss may result from the combination of both faulty workmanship as well as the actions of third parties. In such instances, the question arises whether the faulty workmanship operates to exclude coverage even if it is not the initial or dominant cause of the damage. Some courts have employed “an efficient cause” analysis, focusing upon which of the current causes is the predominant cause of the loss. Other courts have rejected such a test and have permitted coverage unless the excluded cause of the loss is the sole cause.
Similarly, causation problems arise in the context of “earth movement” exclusions contained in builder's risk policies. The policies typically provide coverage for the settling, cracking, or bulging of structures. These policies, however, typically exclude from coverage property damage which results from sudden earth movements such as earthquakes and landslides. Thus, complicated causation questions arise when weather combined with soil conditions causes property damage. In trying to divine the applicability of the policy in such circumstances, many courts try to differentiate between cataclysmic events and gradual, non-cataclysmic earth movements. These courts interpret the purpose of the policy as covering loss for non-cataclysmic earth movements but excluding coverage for cataclysmic events.
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This set of videos and the accompanying study book is a product of the Mile-Hi PMI Chapter. It is based on actual presentations by the instructors for our 1993 Project Management Professional (PMP) Certification Preparation Workshops. Seven of the nine presenters of these workshops were certified PMPs at the time of their presentation. Mile-Hi PMI Chapter has successfully trained over 75 PMPs and has achieved a 73 percent first-try pass rate of those who have taken the PMP Certification Examination after having attended the Mile-Hi PMI Chapter Certification Preparation Workshops over the past four years. This pass rate exceeds the overall pass rate (60.1 percent) of all who have taken the exam during the past four years.
It should be noted that each time the Certification Examination is offered, each section of the exam is unique. Each section is composed of 40 questions randomly selected from a total of 300 questions on that section. Thus, preparation for the Examination must be based on understanding each knowledge area as opposed to being able to answer the example exam questions included in the PMI Study Guide or derived from a particular PMP's specific experience in taking one version of the Examination.
The concepts and discussions included in these videos and the study book are based on the PMBOK as approved by PMI on March 28, 1987. PMI does not represent or warrant that the material contained in these videos or the study book are technically accurate nor that the study of these videos and study book will, by themselves, result in adequate preparation for taking and passing the PMP Certification Examination.
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A/E LIABILITY INSURANCE
Architects and engineers typically maintain errors and omissions insurance which is generally referred to as “architect/engineer liability insurance” policies. These are liability policies pursuant to which the insurer agrees to pay and or defend the insured against claims by third parties arising from the performance of professional services. Thus, the insurance is a form of professional liability policy analogous to that maintained by doctors and lawyers. Unlike most CGL policies, A/E liability policies are generally issued on a “claims made” basis rather than an “occurrence” basis. A “claims made” policy provides coverage for any claim asserted against the insured during the policy period, even if the claim arises from events which occurred prior to the policy. An “occurrence” based policy provides coverage for events or “occurrences” during the policy period which result in a claim. Thus, under an occurrence based policy, coverage is provided for “occurrences” during the policy period even if the claim is asserted after the policy period.
Errors and omissions coverage for architects and engineers is provided for the performance of “professional services.” Such services include not only the preparation of design drawings but also review of shop drawings and product submittals; supervision and inspection of the work; and preparation of remedial plans or drawings. One of the most common disputes in connection with A/E liability insurance is whether the particular activity giving rise to the claim is a “professional undertaking.” Generally, courts look to the technical and intellectual nature of the tasks being performed. Some courts refer to professional licensure statutes to determine the scope of coverage under the policy. In some instances, the provisions of a CGL policy will cover the claim if it is excluded under the provisions of the professional liability policy.
Like all liability policies, the A/E liability policies include exclusions. These exclusions are principally designed to limit coverage to certain types of claims of professional negligence arising from work performed by the named insured. Consequently, the policies typically exclude coverage for extraordinary engineering services which are not usually or customarily performed by the profession; preparation of cost and quantity estimates; and the provision of advice regarding payment or performance bonds. Some policies may also exclude certain types of professional services such as soils testing or surveying. Like the CGL, the A/E liability policy limits the ability of the insured to expand coverage by entering into contractual agreements. Thus, an A/E errors and omissions policy generally excludes from coverage joint ventures or business enterprises other than the named insured.
Traditional methods of insuring construction projects require the owner, the general contractor, and each of the subcontractors to obtain its own insurance. With wrap-up insurance, one party, usually the owner, procures insurance policies protecting the owner and the various contractors. Generally, a wrap-up program will cover commercial general liability insurance, builder's risk insurance, and worker's compensation insurance. Wrap-up insurance has the benefit of reduced costs from establishment of uniform coverage, the elimination of redundant coverage, and improved management of losses. Some of these economies, however, can only be achieved in large, labor intensive projects. Wrap-up programs also have distinct disadvantages. The use of wrap-up coverage increases the administrative burden of the project and may complicate the bidding process.
The structure and syntax of insurance policies make them difficult to read and understand. Nevertheless, some of the fundamental concepts outlined above can help to understand both the language and the purpose of the policy. At the very least, these concepts will make the process less of a crap shoot.
Owen J. Shean, Esquire, is a partner in the lawfirm of WickWire Gavin, P.C. He graduated magna cum laude from the University of Virginia, and is a graduate of the University of Virginia School of Law. Mr. Shean's practice focuses principally upon construction, commercial, and insurance litigation. He is currently wntmg a book for The Michie Company about insurance coverage under GCL, A/E Liability, and Builder's Risk insurance policies.
In the Project Snapshot in the September PMNetwork, page 10, “Powering Up With Project Management Software,” we incorrectly stated that…the goal at PG&EO plants is to maximize power outage.” What we meant to say, of course, was that “…the goal at PG&E plants is to maximize power output.”
We apologize for any confusion this typographical error may have caused.