Constructive Conversations: Professional Liability considerations when insuring modular construction
Modular and prefabricated construction continues to grow worldwide. In 2017, the global market value was USD 106 billion and it’s projected to reach USD 157 billion by 2023, at a CAGR of 6.9% during this forecast period. From healthcare to hospitality, many industries are embracing this ‘off-site’ construction model to potentially save time, reduce scheduling delays and improve overall quality. But what about the risks? Ray Allen, Underwriting Manager within AXA XL’s Construction Professional Liability team, looks at the possible professional liability risks and the need for the right insurance. He explains more here.
What do you see as the positive aspects associated with modular and prefabricated units in construction?
Allen: There are a lot for positives. First, modular and prefabricated construction can lead to increased speed of completion. The units or modules arrive complete with most, if not all, critical systems such as mechanical, electrical and plumbing already installed. The significant reduction or even elimination of scheduling multiple trades on site streamlines and expedites the construction process and also has the potential to minimize the impact of weather delays and extreme site conditions. Also, this streamlined, condensed schedule can lead to faster completion with fewer issues and fewer delays. Collectively, this should lead to fewer claims. Another plus about ‘off site construction’ is a dedicated in-house workforce that can contribute to a higher quality work product.
Are there any unique professional liability exposures specific to this delivery method?
One exposure that’s relatively unique in modular and prefabricated construction is the potential for an error in design or manufacturing to repeat itself in every module or component used on a single project, or multiple projects. This could drive claims costs up significantly depending upon the number of units manufactured and used in different projects. Construction materials procurement, sequencing, and scheduling are also traditional construction professional liability exposures that can be amplified when using modular and prefabricated components. If you have problems getting lumber, windows or other materials from one supplier, all you need to do is identify alternative sources out there. On a project utilizing very specialized modular or prefabricated components, there may not be an alternative source, which could potentially delay completion.
Does modular construction pose a higher or lower professional liability risk than traditional methods?
Yes and no. It depends on how well or poorly the project process is managed and controlled. Modular and prefab continues to grow across the medical, education and housing sectors. On one hand, exposures can increase due to repetitive defects, limited manufacturing capacity impacting supply chain, and transit related incidents. But on the other hand, modular and prefabricated products are subject to additional layers of QA/QC in the manufacturing process and are typically built indoors inside of a manufacturing facility in a more controlled environment by a specialized workforce highly trained to perform this work. This can lead to better quality components with tighter tolerances. Additionally, this can lead to a reduction in workforce on the jobsite, simplification in subcontractor sequencing, and even increased speed to completion over more traditional construction techniques. All of these can help eliminate some common causes of professional liability claims.
Are there special considerations for reviewing a professional liability submission for a company that uses a significant quantity of modular or prefabricated components?
Yes. For firms utilizing a lot of modular or prefabricated units from third parties, we look to understand their manufacturer’s selection process. Are they performing any of their own additional QA/QC on their supplied modules or prefabricated unit? Do they rely on their suppliers’ data? We also want to know if they require their manufacturers to maintain design E&O coverage as well as manufacturer’s E&O limits to cover potential design defects, product recall, or warranty issues.
What about any considerations for a company that actually manufactures and uses their own prefabricated components?
There are several. First, we review their internal QA/QC program and inquire if they also purchase manufacturers E&O coverage to cover product defect or warranty issues. In addition, geography becomes a consideration as well. Is the potential insured very focused in a specific geography where transport times are short and transit conditions easily monitored? This could be viewed as a positive. On the flip side, are they nationwide and susceptible to various localized and regional weather and transportation issues? This is where procurement, sequencing and scheduling could become adversely impacted causing delays in completion and the potential for general damage from transit also increases. My colleague, Bob Haskell, has written extensively on this.
" Traditional contractors’ professional liability policies have a products exclusion as the carriers do not intend to cover product sales, pure product recall, or product warranty."
From a coverage perspective, is the module or the prefabricated unit a product or not?
Similar to the way General Liability policies respond, the answer is, “it depends.” Traditional contractors’ professional liability policies have a products exclusion as the carriers do not intend to cover product sales, pure product recall, or product warranty. Some carriers will modify the exclusion to afford coverage for a specific product designed for a specific client on a single project, or multiple projects for the same client, but not for products intended for sale or distribution to the general public. When a construction company selects modules or prefabricated units from an independent supplier, there should not be an issue as the suppliers E&O insurance should cover any issues or defects with the module or prefabricated unit. Where it gets tricky is when you have a company that both manufactures modules or prefabricated units and performs installation and construction services using their own units. In this instance, the line could be blurred between a design or installation error or a manufacturing or product failure error. Any uncertainty in this area will lead to additional challenges in the event of a claim and could also lead to an increase in legal or claims expense.
Further complicating the matter is the question of jurisdiction/location of the manufacturing work, and the consideration of a particular State’s application of the Uniform Commercial Code (UCC). Traditional construction professional liability case law deals with the provision of “professional services’ rendered before, during, and after the construction project, whereas the UCC governs the “provision of goods” on a construction project. Since case law involving modular or prefabricated construction is limited, it is fair to say that cases involving defects or issues with modular or prefabricated construction may fall on either side depending upon the nuances of the matter. In cases where the application of the UCC prevails, it may prove difficult to trigger professional liability coverage as there may be no negligent act, error, or omission in the providing of “professional services”. Each state varies with it application of the UCC and it will take some time for case law to be established so for the time being there could be a wide variation in the applicability of the UCC.
What about claims? Are there special challenges?
I think the most prominent challenge is the conflict modular and prefabricated construction causes with the Products Exclusion found in all professional liability policies. There are numerous factors to consider when determining if a module or prefabricated unit is an actual product or just part of the construction work. Size, complexity, availability to the public for sale, distribution platform, and level of customization could all play a part in that determination. As this is a recently emerging trend, most likely, there’s not enough case law to draw a definitive line between product and work. This will have to sort itself out over time, especially as this becomes a more widely accepted form of construction and carriers take various positions on the matter. It will likely be tested in the courts.
How would Contractor’s Protective Indemnity Coverage respond to a claim pertaining to an error or defects arising from a module or prefabricated unit?
Part of the traditional Contractor’s Professional Liability Policy, this coverage is designed to provide the contractor excess indemnity protection for losses arising from a subcontracted Design Professional’s negligent act, error, or omission in professional services which exceed available limits of the Design Professional’s E&O insurance. With that in mind, there are circumstances where this coverage may have the potential to apply, and where it may not. If the firm providing the modules or prefabricated units has a designated design group that carries traditional architects and engineers E&O insurance and the cause of the loss is a design error there is a possibility that the Contractor’s Protective Indemnity coverage may indemnify the insured for the loss in excess of the suppliers E&O policy. If the cause of loss arises from a manufacturing error or defect, the loss most likely would not be covered and would fall under the supplier’s manufacturer’s E&O policy if they have one.
Again, this is another place where the applicability of the UCC could have an impact as well. Should the UCC apply and the matter is considered a “provision of goods,” there may be no negligent act, error, or omission required to trigger the policy. In addition this could be further complicated by how the underlying Design Professional E&O insurance handles products. If the module or prefabricated unit is considered a product by the Design Professional’s E&O carrier the underlying insurance may exclude coverage.
Looking ahead, how do you see Professional Liability coverage evolving as the industry increasingly embraces modular construction technology?
As modular and prefabricated construction continues to gain a foothold in the current construction industry, it’s creating a host of new exposures for the insurance industry to consider. Some, like off-site design and engineering of modules or prefabricated units, may already be covered under some contractor’s professional liability policies. Others like manufacturer’s E&O may require the current contractor’s professional liability market to better understand and underwrite to the exposure in order to possibly modify their existing products to cover. There are other exposure considerations like logistics and supply chain management that may also lead us to innovate and develop new products to cover the contractor’s ever changing insurance needs. It’s all about keeping up with our customers’ new exposures and finding new ways to address them.
Modular and prefabricated construction can raise lot of questions about insurance. With nearly 20 years insuring the construction industry, Ray Allen is ready to help answer them. Reach him at firstname.lastname@example.org.