Defects in commercial building construction can be dangerous, costly and damaging to reputations. Inherent Defects Insurance (IDI), also known as Building Defects Insurance, can provide a cost-effective solution.
Despite the recent progress made in the construction industry, building defects remain a regular occurrence. The construction of buildings and structures has become increasingly complex. New developments, innovative materials and designs as well as cost and time pressures create potential hazards for the effective delivery of a defect-free project.
Inherent defects in high profile or iconic buildings can attract adverse media coverage, as happened after the collapse of the Royal Plaza Hotel in Thailand (1993) and a section of Paris' Charles de Gaulle Airport (2004). Even if the problem is less spectacular, the consequences can be very serious. "In the worst case, responsibility for the fault can never be clearly established, and the owner ends up having to pay for the repairs himself," explains Paul Smith, IDI underwriting manager at AGCS in the UK.
For structural defects discovered a few years after completion, contractors usually carry a legal responsibility towards the owner to rectify the problem. However, this requires proof of liability which can be a lengthy process. Due to the number of different parties involved, often sharing responsibilities, it can be very difficult to prove negligence. While the legal process proceeds slowly, restoration work is typically on hold.
Inherent Defects Insurance explained
Inherent Defects Insurance, also known as Latent Defects or Building Defects Insurance, reduces the risk for building owners. IDI covers the physical damage to the property caused by defective design, materials or workmanship which was undiscovered at completion. The best part is that the policyholder does not have to prove the negligence of a third party to make a claim.
In practice, when an inherent defect is discovered, the insured can simply file an IDI claim, thus avoiding contentious discussions with the contractors in clarifying liability for the loss. Repairs and restoration work can start without delay.
"IDI provides comfort to the owner or developer that they will be covered for large expenses incurred after completion of the building," explains Smith. "This is particularly important in the current economic climate where contractor insolvency means the usual measures of redress such as collateral warranties are proving ineffective."
IDI is typically a 10- or 12-year contract hence the financial strength of the provider is a key consideration. Allianz has over 20 years' experience providing IDI and has demonstrated resilience by emerging positively from the recent economic turbulence.
"Any additional premium is a major consideration for clients," adds Smith "but the premium and technical audit fee combined are typically less than 1 % of the construction cost – good value relative to the negative impact on project cost and delivery experienced from major defects." "However there is still a disjoint between the residential and commercial sectors. In the UK the Council of Mortgage Lenders requires a 10-year defects "warranty" before lending on residential properties, but for major commercial developments of perhaps hundreds of millions, lenders do not universally insist upon the same. Maybe this is because of a false perception of the benefits of collateral warranties but signs are that the benefits of IDI are becoming clearer to clients."
In an industry feeling the strain of the recession, lack of investment, and contractor insolvencies, clients are demanding greater protection for their assets. Developers also increasingly feel the need to attract tenants with more innovative incentives. Inherent Defects Insurance delivers on both counts.