NEWS / Affiliate / Cladding: An ongoing concern for the Professional Indemnity Insurer


06 FEB 2019


Peter London from Willis Tower Watson on recent developments in cladding

Current Situation: On 29 November 2018 the UK Government announced details of its ban on the use of combustible materials on high rise buildings. The new legislation came into effect on 21st December 2018, and is being implemented through changes to Building Regulations.

It is beyond the scope of this article to outline the statutory changes, but headline details are as follows:

  • No combustible materials will be permitted on the external walls of any new buildings over 18 metres in height which contain any flats, including hospitals, residential care premises and boarding school dormitories / student accommodation. The same ban will apply to renovations of any existing buildings. Clarity has been provided as to what constitutes an ‘external wall’. Permissible materials will be limited to those with a European fire rating of Class A1 or A2 (wood products will not fall under this classification).
  • Further, in addition to funds granted previously for remedial works to publicly owned social blocks with unsafe Aluminium Composite Material (ACM ) cladding, the Government has now given powers to local councils to enforce the removal of unsafe ACM cladding from private sector blocks over 18 metres tall, potentially providing financial support if needed.
  • Dame Judith Hackitt’s review of Building Regulations and Fire Safety (which focussed on high-rise / complex buildings) stated that the then current regulatory system was unfit for purpose. Regulations and guidance were deemed confusing and open to interpretation, roles / responsibilities were unclear with a corresponding lack of accountability, and speed and cost typically prioritised to the detriment of safety. The review called for, inter alia, clearer responsibilities and accountability, clearer product classification and testing, better audit trails throughout whole building lifecycles, and less complex rules.
  • In spite of the legislative changes, PI Insurers are understandably nervous given legacy exposure. An uncertain landscape and unfit regulatory system will (in their and their advisers’ opinions) be conducive to potential PI claims, as evidenced by numerous ‘cladding’-related claim notifications to Insurers to date.
  • Whilst many have substance (and some significant payments have been made already) many appear to be ultra-precautionary, with third parties having highlighted ‘cladding’ problems, without necessarily having suffered any damage. Indeed, many of these matters might not ultimately trigger an indemnity from PI Insurers, instead proving to be commercial issues to resolve. Even so, protracted disputes may incur defence costs and require reserving.

Current Situation
On 29 November 2018 the UK Government announced details of its ban on the use of combustible materials on high rise buildings. The new legislation came into effect on 21 December 2018, and is being implemented through changes to Building Regulations.

UK PI Construction climate: To understand the impact of these developments on the UK PI market we must put first things into context. The UK construction PI market in our opinion, has deteriorated significantly over the last 12 months, and it continues to do so at pace. Construction PI has proved far from profitable, and many Insurers are suffering the effects of under-priced long-tail business they have written. Loss cost inflation is exacerbating their pain. Capacity is rapidly diminishing.

Lloyd’s have focussed on the many loss-making syndicates as part of their ‘Thematic Review’, with the worst performing syndicates being forcibly put into run-off, and others having their ‘stamp capacity restricted. In the last 12 months Brit, Novae, Aspen, Hamilton Syndicate 3334 and most recently Pioneer Syndicate have withdrawn from the UK PI market entirely, and several others have withdrawn from underwriting ‘design and construct’ / construction PI. Most insurers are quoting increased premium rates, challenging low levels of self-insured retention and are looking more closely at the policy coverage they are providing, so limiting their exposure.

This shift in landscape is not the sole result of the tragic events at Grenfell Tower, and it is too simplistic to attribute a more difficult PI market (and inflated premiums) to this alone. There has been heavy construction PI claims activity, particularly in relation to large infrastructure projects and renewable technologies (especially in the ‘Waste to Energy’ sector). Huge non-PI construction claims have impacted the same insurers too (the Colombian Ituango Dam loss looks set to be the largest ever construction claim, likely to cost in excess of USD1bn). Carillion’s demise has fuelled pre-existing concerns amongst Insurers about financial viability and supply chain resilience (especially in a climate where margins are so thin). Vicarious liability is a big concern, increasingly common given the prevalence of ‘Design and Build’ procurement and complex and lengthy supply chains. Insurers’ ability to make recoveries from the parties at fault seems ever more challenging.

PI Market Response to ‘Cladding’ issues
What constitutes ‘cladding’ is hugely significant, not least because PI Policy restrictions and exclusions need to attach to something specific. Further, Insurers need to understand the potential ‘cladding’ exposure facing their insureds, and the wider the focus, the more challenging and time-consuming it becomes for those firms required to provide that information.

Generally, the focus has moved on from just tall residential buildings featuring ACM panels, to all combustible materials on a wider range of buildings. Of particular concern is the fact that for some PI Insurers the definition of ‘cladding’ informing their restrictions seems to be shifting to incorporate all elements of fire safety. Clearly this extends the ambit significantly. ‘Cladding’ coverage restrictions are increasingly applicable to any situations relating to fire safety, and in respect of buildings above and below 18 metres in height. Widespread adoption of fire safety restrictions would mean heavily restricted PI cover in such a crucial area (not exactly in the post-Grenfell spirit). But whilst insufficient risk transfer in the area of fire safety is far from ideal, is it reasonable to expect Insurers to take on potentially enormous exposures as a result of regulatory system failures rather than the negligence of their insureds?

In terms of the PI market response, some form of ‘cladding’ coverage restriction is increasingly standard for those with potential exposures (especially for professional services firms like architects, engineers, surveyors and contractors). In more extreme cases, ‘cladding’ cover is being excluded altogether. Unsurprisingly, some of the Insurers who were initially relaxed are tending to adopt the more restrictive conditions favoured by others. Subscription PI placements where multiple insurers participate on one layer will mean that the most restrictive of the conditions put forward by those participating Insurers will be need to be utilised).

As well as defining what they deem to constitute ‘cladding’, ‘cladding’ restrictions will typically limit the coverage available to a single aggregate amount in the policy period (such amount including all defence costs). They will usually set out a higher level of self-insured excess for ‘cladding’ claims (often dictating that such excess is triggered by defence costs, if that is not already the case). They will frequently limit the cover available to a ‘rectification only’ basis, so there would be no cover for any consequential losses beyond the rectification work (the costs of decamping and rehousing often being specifically excluded), and the insuring clause is often weakened to a negligence basis only. Full ‘cladding’ exclusions are being used in the market, but restrictions in cover seem more commonplace. Nonetheless, with restricted cover and higher levels of excess, firms’ balance sheets are increasingly exposed.

Risk Management Advice In terms of your PI renewal, early engagement with your broker is crucial, particularly when you have identified potential ‘cladding’ exposure. The renewal process is likely to take much longer given current market conditions, and the chances of obtaining a satisfactory result should be improved with early attention. You need, of course, to be engaging with your PI broker as and when necessary to determine whether or not there are any potential ‘cladding’ claims or claim circumstances that need to be notified to Insurers on a precautionary basis.

By now Insurers will expect their Insureds to have undertaken internal (and potentially external) audits to identify any potential ‘cladding’ exposure. Such audits should certainly have focussed, as a minimum, on projects where firms have had any responsibility for the design, specification, installation of ACM or equivalent combustible materials, or where they have supervised/inspected others doing so (especially in relation to buildings over 18 metres tall).

Firms should be thinking about current projects and their approach to future projects. They should have a suitable risk-focussed narrative ready to provide to their Insurers. For example, are they comfortable that they are undertaking all duties they reasonably feel that they should be, taking into account current focus on these matters and the tighter regulations to follow? Are they accurately recording such work? Do they feel that their internal procedures and protocols are sufficiently robust?

Firms need to manage and understand the exposures emanating from the supply chains in which they are involved. This is an area under the microscope at present, and is hugely pertinent to ‘cladding’ exposure. Are you comfortable with the performance and systems of any specialist sub-contractors that you are engaging for such work? Are you comfortable with the extent of the PI cover that they hold – specifically in relation to ‘cladding’? You do not want to be the only party involved in a project that benefits from any cladding cover – though this is likely to be an unavoidable situation for some. In such a situation, the use of net contribution clauses in contracts could prove invaluable, especially where other parties on a project might have limited or no cover in place for certain risks, despite those risks seemingly being their responsibility. In addition, consider whether you would be able to insist upon direct contractual links between fire / cladding specialists and the client?

Firms should consider carefully the contractual obligations into which they enter. Given Dame Hackitt’s proposals, which could lead to greater accountability and harsher penalties for non-compliance, you should be careful to clarify your specific roles and responsibilities in contract (confirming roles for which you are not responsible too). Consider the pitfalls of signing up to wide indemnity clauses in contract.

Many indemnity clauses mean that you will be indemnifying your client for all manner of losses / liabilities / damages / costs (many of which could be excluded by your PI Policy) even when you have not been negligent or at fault. Is the risk versus reward balance satisfactory for you?

You should also consider carefully the ‘deleterious materials’ clauses in contract. As a designer or a firm specifying materials, you should only agree to be potentially liable for the status of materials at the time of specification – not at the time such materials are incorporated or used in a project. There could be a long delay between the date on which you specify a material, and the date that the project comes to be built – in which time the status of that material could have changed.

This is by no means an exhaustive list of considerations, but should provide some food for thought.

Unfortunately, this situation is not going away and the rapidly deteriorating construction PI market is not helping. It might not be possible to obtain ‘cladding’ cover as wide as you would like, but early engagement and affording yourself as clean a bill of health as possible will improve chances of mitigating the extent of any restriction / exclusion. A ‘good risk’ will no doubt be seen as one whose house is in order, at least as best as is possible.