The impact of modern methods of construction on insurers

This article was produced in collaboration with Insurance POST

Modern methods of construction may be a solution for the UK housing crisis but what risks do insurers face? We explore the risks across all stages of the construction process and look at what solutions insurers can adopt.

Some understand modern methods of construction (MMC) to be a means of making the construction sector more sustainable – in 2019 the World Green Building Council reported that 40% of all carbon emissions originated from the buildings we use or construct.

Others hail MMC as the solution to the housing crisis as it significantly reduces reliance on traditional building materials which can be both difficult and expensive to source; 40% of bricks used in domestic properties in 2019 were imported from the European Union.

However, MMC is simply a term to describe the use of technology, materials and ‘know-how’ in construction.

Impact of MMC on insurers

Insurers understand the risks associated with traditional building methods and materials. MMC arguably re-writes the rule book. It encompasses new skills, new materials, the use of old materials in new ways and new processes, all of which create new risks across all stages of the construction process as follows:

Design

The digitisation of design work allows for the production of quicker and cheaper designs in a controlled factory environment. In theory, designs can be perfected over time and the fabrication of off-site modules, pods, and panels – components – should help reduce the volume of claims arising from negligent design.

Off-site design and fabrication arguably results in a shift in risk to manufacturers. The risk presented by a defect emerging in a ‘product’ ought to be spread across both product and professional liability lines. The same ought to be true in the event of a claim arising from the specification of a new material advertised as a solution to a specific problem.

Transport

Components may be damaged in transit, while stored on site, or during installation. Traditionally, once on site, damage to materials or property would fall to a contractors all-risk policy or public liability policy. Those claims may now be significantly more expensive given the cost of replacing/repairing a completed module.

Installation

There is already a shortage of skills required to meet the demand for new buildings. This is likely to be exacerbated in circumstances where specialist knowledge and training is essential to install the various components correctly. 

Inspection 

Who is now responsible for inspecting the components, both once they arrive on-site and after installation? Inspection will be particularly critical where components interface with materials and services constructed on site and a broad set of skills and knowledge will be necessary. The syllabus required to provide training will also likely be developed through trial and error, leaving early adopters to bear the consequences. 

Risk

All of this remains uncertain and untested. To avoid uncertainty as to who is liable for what, and until a consensus is reached on how best to manage the risk, one expects to see an uptick in clients wanting to appoint consultants on terms that make them responsible for the design of specialist sub-contractors and for the specification of materials. Professional indemnity (PI) insurers therefore need to be aware of the basis on which insureds are agreeing to do business; it may be the difference between being on risk or not.

Professional indemnity insurers therefore need to be aware of the basis on which insureds are agreeing to do business; it may be the difference between being on risk or not.

In circumstances where a consultant assumes the risk of a third party design, or the risk of using a new material/product, it remains exposed to a claim with the option to either seek a contribution/indemnity or later pursue a recovery. In either scenario, the insurer is exposed to a greater level of costs, the risk of not making a recovery, the risk of the third party becoming insolvent, and the risk of being left with substantial irrecoverable costs even if it is successful. 

The potential cost of remediating a defect in a component is also likely to be significantly more than the cost of remediating a ‘one-off’ defect. We have already seen claims arising from defects replicated many times over in a single project. If the same defects are repeated across multiple projects then the losses quickly escalate. Aggregation clauses will need to be carefully drafted. 

New materials used in MMC are untested in real world conditions. Controlled test environments cannot account for each and every eventuality. There is real uncertainty, for example, regarding the control and spread of fire through modular buildings. This risk is often compensated for by the installation of state-of-the-art sprinkler systems. Nevertheless, building maintenance will be critical to the response of a buildings insurance policy and insurers need to consider appropriate exclusions for a failure to maintain. 

Given the changing face of construction, one queries whether a general statement of the work undertaken by an insured, at inception/renewal, and turnover details remain an appropriate way of providing a fair presentation of the risk.

Given the changing face of construction, one queries whether a general statement of the work undertaken by an insured, at inception/renewal, and turnover details remain an appropriate way of providing a fair presentation of the risk. 

Is there a solution?

Given the various stages of risk, standard form contracts will need an overhaul to provide for off-site fabrication. Until then, appointments involving MMC will likely need to be bespoke and that’s expensive. 

One solution insurers may adopt is the use of MMC specific policies. Such policies will need to embrace everything that MMC entails but may require insureds to appoint only accredited off-site manufacturers (the Buildoffsite Property Assurance Scheme is an example of an accreditation scheme) and to deploy only suitably trained personnel with cover extending only to trained personnel. Dual insurance clauses are also likely to play a prominent role.

An alternative solution is project insurance. However, project insurance often expressly excludes a right of subrogation. In any event, the Supreme Court has held that where an insurance policy exists to the benefit of all parties to a dispute, they cannot claim against each other in respect of the insured loss Ocean Victory [2017].

That makes commercial sense, although it is possible to provide for a right of recovery via express language in the contract. What appetite there might be for project insurance if subrogation becomes the ‘norm’, however, would be questionable. One also queries what the court’s view on such recoveries would be. It is unattractive to allow an insurer, who has been paid a premium by multiple insureds, to pay one and then seek to recover the same loss from another.

Given the court’s view on subrogated recoveries, it is likely that disputes would be resolved faster and therefore cheaper thus reducing an insurers’ outlay under a project insurance policy than had the same insurer provided a PI policy. That is particularly the case if the risk is shared.

The Ocean Victory was determined on the facts and policies will need to be clearly drafted to explain precisely who is insured, and for what, to avoid a dispute. To ensure consistency, there will need to be collaboration between parties when preparing the contract pack. 

Parties need only look to the Scottish decision in SSE v Hochtieff [2018] for the consequences of inconsistent language; Hochtieff was left without the benefit of either a contractors all risk policy or its PI policy to cover a £100 million loss. 

There are plenty of examples in the UK of buildings that have been successfully constructed using MMC. However, the scope for significant losses is very real and a careful, considered, and joined up approach will be required by all stakeholders to make MMC work.

This article was originally published on Insurance POST.

Related item: Modern methods of construction

Read others items in Professions and Financial Lines Brief - December 2020

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