Risk transfer through insurance is an important part
of any risk management strategy. This article summarizes techniques for
preserving insurance coverage.
A scenario can be used to illustrate
potential liability exposure: A fire protection engineer designs a dry
pipe sprinkler system with appropriate slope in the pipe runs to allow
for drainage of the system. The contractor installs the pipe level, with
the result that water does not fully drain. Water accumulates in the
piping and freezes, bursting the pipe. The owner is unhappy and demands
to know why the problem happened and who is going to fix it. The fire
protection engineer feels that he or she did not do anything wrong.
Should he or she report this to their insurance company?
The correct answer is "yes." The key
question is not whether or not the engineer did anything wrong. The
important question is whether or not the incident is likely to result in
a claim. All professional liability insurance policies are written on a
"claims made" basis. This means that they will only cover claims that
are made and reported during the current policy period.
Furthermore, all "claims made" policies
have a clause that says coverage only applies to claims when the insured
had no knowledge of circumstances likely to result in a claim at the
policy inception date. (A few insurers say one has coverage if they had
no knowledge of those circumstances at the first date of continuous
coverage with that company. This is called a "knowledge date" and is a
desirable feature in an insurance policy.)
DENIAL OF COVERAGE
The most common reason that professional
liability insurers deny coverage is failure by the insured to report
claims, or knowledge of potential claims, during the policy period in
which the insured became aware of the claim or potential claim. This
situation is preventable. The usual scenario involves a problem caused
by others. Maybe the owner made a value engineering change. Maybe the
contractor installed something out of conformance with the plans. The
design professional didn't do anything wrong and feels he or she should
not be implicated in any claim. He or she also is afraid to report the
matter to their professional liability insurance because he or she is
afraid the insurance rates will be increased. So, the matter is not
reported until later in a new policy period.
When the claim is made, the circumstances
are judged with the benefit of hindsight and it may appear that the
insured did have knowledge of circumstances likely to result in a claim
prior to the inception date of the current policy. It seems to the
insurer that the insured was trying to buy insurance on a burning
building, and the claim was denied.
Claims against engineers may occur, even
if the engineer did nothing wrong. This is because if there are large
losses, all potentially responsible parties may be sued with a goal of
letting the courts determine who is at fault. Design professionals get
named in lawsuits because they were at the scene of the crime.
The learning point is that while there is
some risk of increased rates due to reporting potential claims, this
risk pales in comparison to the impact of an uninsured claim. The choice
is even clearer if one considers that a significant rate increase is
not likely unless an actual claim develops and the insurance company
sets aside a substantial amount of money to pay anticipated defense
costs and losses.
OTHER COVERAGE PROBLEMS
Most other coverage problems for
engineers stem from assuming liability in a contract beyond that which
is imposed by law. Professional liability insurance provides broad
coverage for "legal liability," or the same liability that would be
imposed by a handshake deal. The legal obligation of any engineer is to
perform in accordance with the generally accepted professional standard
of care. One is liable to others for damages caused by failure to
perform to this standard of reasonable care. And, in states that follow
the "economic loss rule," the only party that can sue an engineer for
purely economic loss is the engineer's client.
When owners' attorneys draft a contract,
they frequently try to transfer as much risk as possible to the
engineering firm. They require that the engineering firm perform to the
highest standard of care, and indemnify third parties to the contract,
such as the owner's lenders, affiliated companies, agents, other
consultants and their attorneys. While they may think they are doing
their client a favor, what they are really doing is jeopardizing the
coverage that everyone is relying on to back the promises made in the
A typical owner-drafted indemnification might look like this:
consultant agrees to defend, indemnify and hold harmless the client,
the client's partners, members, affiliated companies, agents, attorneys,
contractors, volunteers, other retained consultants, and the
representatives, directors, officers and employees of all of them,
against all claims, liabilities, attorneys fees, fines and penalties
arising out of the work.
This defense and indemnification imposes
liability beyond what is required by law and exposes the consultant to
uninsured risk. One should delete the "defend" obligation because this
is the issue that is most likely to come into play in the event of a
Under the law, an engineer is not required to pay anything until he or
she has been found to be liable. If an engineer agrees to defend his or
her client, then the engineer will have to pay for the client's legal
defense regardless of whether or not the engineer did anything wrong.
This deprives the engineer of due process. And, since their legal fees
will be covered, there is no incentive for the client to shop for a
reasonably priced lawyer.
This makes the engineer the insurer of the client,
but the consulting fee probably does not include a premium to assume
this risk. The obligation to defend a client is not covered by
professional liability insurance because additional insureds cannot be
added to a professional liability policy.
One also should limit the duty of
indemnification to the "client, its officers, directors, members (if the
client is an LLC) and employees." The "partners, affiliated companies,
agents, attorneys, contractors, volunteers, other retained consultants,
and representatives" are not parties to the contract. In states that
follow the economic loss rule, they cannot sue for economic loss.
Therefore, an agreement to indemnify them against economic loss is a
purely contractual liability that will not be covered by professional
Finally, one should change "arising out of the work" to
"to the extent caused by the negligent performance of the work." The
words "arising out of" have been construed by the courts to mean that
one is responsible for the fault of other parties who were also involved
in the work. One should also delete "fines and penalties" because many
policies exclude coverage for fines and penalties. And, the words
"reasonable" should be inserted before "attorneys fees" because
claimants have a duty to mitigate their damages.
STANDARD OF CARE
Language contained in a contract between
an engineer and his or her client might require him or her to perform to
the highest standard of care. According to Black's Law Dictionary, the
highest standard of care is the highest standard ever attained by anyone
at any time. This is a very difficult standard to meet each and every
An engineer's standard of care can be increased in more subtle ways as
well. A contract might require that the consultant "comply with all
codes, laws and rules in effect at the federal, state and local levels."
When dealing with abstractions such as building codes, reasonable minds
can differ. An engineer should not be responsible for costs associated
with revisions to comply with the interpretation of a code official if
the engineer's interpretation was reasonable and customary. This
language amounts to a warranty of perfection. A suggested revision would
be to say that the engineer will "comply with the professional standard
of care relative to applicable laws."
Another provision that owners might try
to insert for their own protection is right to withhold payment of fees.
Professional liability policies say that withholding fees is not a
covered event, even if the basis of withholding is to protect the owner
against potential claims. The effect of such a provision is to make the
consultant the insurer of the project. Giving the owner the right to
withhold payment in anticipation of a possible claim deprives the
consultant of due process.
If the owner insists on a right to withhold
payment, it should only be for services that are not properly performed.
In that event, payment should be made for the portion of services
performed satisfactorily. However, the preferred position is that there
shall be no withholding of the consultant's compensation except for sums
for which the consultant has been adjudged to be liable.
The goal of negotiations is generally a
win-win solution. Frequently, the best argument to revise unfair
contract language is to appeal to the owner's self-interest, which is
served by preserving the insurance coverage available to the consultant.
Claims for purely contractual liability will not be covered by
professional liability insurance and will likely complicate the
adjustment of any claims that the owner may have. In order to assure a
smooth process, it is better to have a contract that reflects the legal
liability exposures of the consultant. The following language should be
acceptable to any insurer:
Standard of Care
performing services, the consultant shall endeavor to exercise that
degree of skill shown by similarly situated professionals practicing in
the community at the time services are offered.
consultant shall indemnify the owner, and the owner's directors,
officers and employees against damages to the extent caused by the
negligence of the consultant.
Fortunately, the vast majority of reported
professional liability claims are covered. The two most important
things an engineer can do to preserve his or her coverage are to report
claims or potential claims to his or her carrier immediately, and strive
to negotiate contracts that reflect legal liability standards in the
engineer's jurisdiction. It is wise to consult with legal and insurance
counsel who have appropriate experience in professional liability.
While construction experience is useful,
there are significant differences between the commercial general
liability policy, which is relied upon by contractors, from the
professional liability policy, which is relied upon by consultants. An
attorney can provide general risk management advice, while an insurance
broker should review select contract clauses for insurability issues.
Most brokers will not charge additional fees for this service.
Mark Blankenship is with Willis HRH.