INDECS – INSIGHT 15

Whether for onshore or offshore construction, if insurance coverage is being arranged by the Owner, as opposed to the Contractor, the “norm” is to purchase an additional 12 or, to the extent it is available, 24 months maintenance period cover. The premium paid for such an additional maintenance extension can often be quite significant.

This Insight explores the reasons why this cover is bought, for which party’s benefit, and whether it might actually be unnecessary.

Using the offshore construction insurance WELCAR form as an example:

“The cover provided hereunder shall be no wider than that contained elsewhere in the Policy.  Coverage under Section I only shall continue during the maintenance period(s) specified in individual contracts but not exceeding a further 12 months from expiry date of the Project Period as set out in Item 3 of the Declarations.  During such maintenance period(s), coverage is limited to physical loss or physical damage resulting from or attributable to:

a. faulty or defective workmanship, construction, material or design arising from a cause occurring prior to the commencement of the maintenance period; and

b. operations carried out by Other Assureds [Contractors] during the maintenance period(s) for the purpose of complying with their obligations in respect of maintenance or the making good of defects as may be referred to in the conditions of contract, or by any other visits to the site necessarily incurred to comply with qualifications to the acceptance certificate”.

On completion of the construction period, concurrent with any maintenance period purchased, the owner will insure its assets under an Operational All Risks insurance. This will cover:

• Loss of or damage to the asset which has occurred after completion.
• Loss of or damage to the asset caused by a Contractor visiting to meet maintenance obligations.

Although Operational All Risks insurance excludes the cost of repairing that portion of property that is defective in design, workmanship or material, it does not exclude resultant physical loss or damage to the remaining property or to other property.

Can we conclude, therefore that as long as there is no discovery limitation contained in the construction all risks insurance, there is no difference in protection to the Owner?

But what about deliberate damage caused in order to access an excluded defective part? This is sometimes referred to as the “In and out costs”. It would be a challenge to contend that this expenditure fell under the category of “resultant” damage.

Are you any worse off under the Operational Policy than the Maintenance coverage that was purchased under the Construction Insurance? Much will depend on which design exclusion clause you have (onshore) and whether the Defective Part Exclusion Buy-Back has been purchased (offshore).

Onshore

The London Engineering Group’s design exclusion clauses are to be the subject of a future INSIGHT, but in summary:

LEG 1/96 contains a broad defect exclusion under which the Insurer shall not be liable for any loss or damage due to defects of material, workmanship, design, plan or specification. The effect of the LEG 2/96 clause is to exclude such cost of replacement or rectification which would have been incurred in any case if replacement or rectification of the defect had been undertaken prior to the loss. It can be concluded that what is being provided is the incremental costs caused by the damage.

LEG 3/96 is a further improvement covering the full consequences of damage due to defects, excluding only any improvement on the original design.  The more recent LEG 3/06 clarifies the damage definition to “include any patent detrimental change in the physical condition of the Insured Property”. Essentially, it would appear that only if you have the LEG 3/96 are you, as an Owner, going to be worse off relying on your Operational All Risks Insurance.

Offshore

The standard form WELCAR contains an absolute exclusion for Defective Part, which is defined as:   “For the purposes of this clause a “Defective Part” shall mean any part of the subject matter insured which is or becomes defective and/or unfit or unsuitable for its actual or intended purpose, whether by reason of faulty design, faulty materials, faulty workmanship, a combination of one or more thereof or any other reason whatsoever.  The term “Defective Part” shall also include such ancillary components, which are not themselves faulty, but which would normally be removed and replaced by new components when the component that is faulty is rectified.”

It is clear from this that there is no cover for in and out costs to replace a part which is defective.

The Defective Part Exclusion Buy-Back, if purchased, will however provide some protection for in and out costs, but subject to a fairly low per-part limit.

In conclusion, can we say that if an Owner relies on Leg 2/96 or below for onshore construction, or does not buy the Defective Part Exclusion Buy-Back for offshore construction, that there is no value in purchasing an additional maintenance clause?

One insured party that might be concerned about this move, who, arguably, would stand to benefit much more from the Maintenance coverage than the Owner does, is the Contractor, although their concerns might simply be allayed if the Operational Policy insurers could provide a waiver of subrogation in favour of contractors.