December 11, 2020 FEATURE

Solving the Quandary of Designer Quantity Risk in Alternative Project Delivery With Insurance

Kent W. Collier

The Quandary

Alternative project delivery (“APD”) – namely design-build and public-private partnership methods of contracting – are popular and growing in the United States, particularly among construction projects for civil and transportation infrastructure, manufacturing facilities, healthcare, and educational buildings. The prospects of a post-COVID-19 construction recession hint at even more opportunity and incentive for public owners to offload design and financing responsibilities to design-builders and concessionaires via APD. 

As these projects multiply and continue, however, owners and contractors must face a stark reality: inequitable risk allocation to designers on APD projects must be remedied before reeking catastrophic results on design firms.  Without a notable shift in approach and results, highly qualified and experienced design firms and their professional liability carriers may simply refuse to accept the risks and instead exit the APD market entirely.

Under traditional design-bid-build project delivery, the owner provides design documents to bidding contractors from which quantities can be estimated in order to formulate a contract price.  After construction contract execution, the owner remains responsible for completing or refining the design – typically through a design team contracted for separately from the contractor – and can be held liable to the contractor for the consequences of defects in the design under the well-known Spearin doctrine. 

By contrast, an owner on an APD project delegates much of its design responsibility to the design-build contractor after providing only partially completed conceptual design information and/or performance requirements.  This shift reflects the fundamental APD value proposition: placing most design decisions and tasks in the hands of contractors and designers on a coordinated team with incentives and efficiencies that produce faster completion and innovation.  In some APD models, financing and long-term operations and maintenance are also transferred – providing public owners with limited funds more latitude to spend and build.  Public infrastructure “mega” projects are, in particular, increasingly taking the form of APD and in exchange for proceeding on an APD basis, public owners have been rewarded with shiny new assets of the highest profiles and accolades.

A Dark Underbelly

The popularity and success of APD on large public infrastructure projects hides a dark underbelly of trouble for architects and engineers designing the projects.  With restricted opportunities for recoveries from public owners, design-build contractors are targeting designers and their professional liability insurance programs with claims for cost overruns and delays.  These claims are increasing in frequency and severity – with a common root cause wherein the design-builder has aggressively bid the project and a resulting fixed-price contract with insufficient contingency and little meaningful recourse to the owner and thus turns to its subconsultant design team seeking damages for quantity growth over early estimates based on preliminary and understandably incomplete design schemes and studies.

Few reported cases analyze APD and designer liability for quantity growth as many projects use alternative dispute resolution and claims are often settled without generating public verdicts or decisions, but two recent orders highlight the precarious position of designers with respect to APD quantity growth in relation to the fees these designers command for preliminary design work.  In Middlesex Corporation, Inc. v. Fay, Spofford & Thorndike, Inc.,  the design-build contractor for a bridge replacement project in Massachusetts sued its designer for approximately $2.2 Million in additional costs related to structural steel procurement, in comparison to a design fee of approximately $300,000 for the designer’s work during the preliminary design phase In Walsh/Granite JV v. HDR Engineering, Inc., the court summarizes circumstances where the design-builder of a P3 project to replace hundreds of bridges in Pennsylvania withheld over $18 Million in owed fees in response to an alleged $40 Million cost overrun based on quantity growth after an initial design phase where the designer was paid approximately $1.4 Million. The quantity growth exposure compared with designer fees and ordinary limits of professional liability insurance are incongruous and unsustainable.

In addition to responsibility for changed quantities, designers also repeatedly face exposure on APD projects from, among other things, prime contract flow-down of improper contract terms, ambiguous or inadequate scope of services, compensation pressure, uninsurable warranties including fitness for purpose and “free from defect” language, overly broad indemnification and duty to defend, fee withholding and backcharges, standard of care, schedule related clauses such as liquidated damages for delay, responsibility for cost estimating, and requirements to design within budget or re-design due to value engineering or performance criteria and optimization.

For designers to avoid crippling claims and exposure on APD projects, the participants must recognize the inherent limitations of preliminary design work particularly with respect to quantity and cost estimating, and then provide a fair allocation of risk regarding such quantities and costs – most commonly through establishing proper contingency,  protecting firms with unqualified limitations of liability, and procuring insurance. 

Project Specific Coverage Helps, With Limitations

Project specific professional liability (“PSPL”) insurance provides a critical method of protecting designers from claims by design-builders on these projects.  Many large design firms desire, if not mandate, PSPL in order to accept the imbalanced risk allocation frequently imposed by prime APD contractors.  PSPL offers the following benefits to designers:

  •  Transferring risk of a claim by the prime APD contractor (i.e., design-builder or concessionaire) alleging negligent professional services of the design team – particularly with respect to quantity risk and cost escalation attendant to design development and revision;
  • Insulating design team practice insurance programs from claims outlined in the foregoing bullet;
  •  Facilitating the agreement of appropriate limitations of liability in design subcontracts on APD projects commensurate with limits of PSPL insurance obtained;
  • Standardizing the coverage terms, limits of insurance, and risk management approach of all design team members from prime or joint venture level to subconsultants of all sizes and disciplines (and thus promoting participation of smaller and disadvantaged enterprises); and
  • Encouraging innovation by providing a financial safety net to reasoned risk taking in design.

These worthy benefits, however, do not come without a cost.  Primary PSPL is an expensive proposition that many owners and contractors refuse to entertain solely for financial reasons.  Even when utilized, PSPL has notable pitfalls that must be avoided through careful placement, structure, and contracting:

Relationship to Contractor and Other Insurance.

In some instances, owners require, or contractors suggest, that a proper PSPL structure is to have the prime APD contractor place PSPL that insures both its professional exposures as a design-build contractor and the professional services of its subconsultant designersThis structure is attractive to owners and contractors because the coverage may be less expensive when procured as a contractors’ professional policy or in lieu of two separate insurance programs for contractor and designer.  This approach is extremely problematic for design firms because the naming of both contractor and designer as insureds typically leads to an exclusion that prevents coverage for a claim by the contractor against the designer.  In addition, PSPL can be primary or excess, and careful coordination must occur with placement.  When placed as protective excess, the coverage provides little to no benefit to the designers and actually leads to an incentive to exhaust underlying primary insurance in order to access the PSPL as excess.

Responsibility for Self-Insured Retention. 

Primary PSPL often involves a self-insured retention of several hundred thousand to over one million dollars.  Smaller members of the design team may be accustomed to much smaller deductibles or retentions and may be unable to satisfy such a major expense in the event of a claim determined to implicate their services.  There are several approaches to equitable allocation or responsibility for the PSPL retention, including deductible gap in-fill policies for smaller subconsultants, but these mechanisms must be explored and clearly set forth in design team contracts.

Additional Premium for Material Variance.

PSPL policies typically allow insurers to charge additional premium when the project materially changes during execution – most notably if the construction schedule is extended or the construction values or professional fees constituting the underwriting baseline increase by a specified threshold.  How these common charges are addressed is an issue that must be agreed early on to avoid disputes and possible policy cancellation later in the project.

Even after navigating these potential issues, two major concerns remain. 

Insurance for Professional Negligence, Not a Performance Bond.

Other parties must view PSPL as insurance for actual negligence (a designer’s failure to comply with the applicable standard of professional care), rather than as a surety bond for schedule and cost impacts related to design and quantities derived from the developed design.  Having paid a substantial premium, too many owners and contractors view the PSPL limits as a bucket of money to draw on in the event of probable schedule delay or increased costs.  Insurance does not function in that way, and utilization of PSPL in this manner jeopardizes the long-term viability of the product.  Without the availability of PSPL, many designers who currently pursue APD (so long as they obtain appropriate contract terms with insurance protection) will likely withdraw from the APD market.  This issue emphasizes the need for design contracts to be properly drafted with respect to liability arising from negligence and the insurability of warranties, guarantees, standards of performance, and delay provisions.

No Substitute for a Contingency.

PSPL is not a replacement for a proper contingency.  Instead, contingency, at significant levels, is critically required on APD projects, with PSPL structured in support.  PSPL and contingency are mutually beneficial, work in tandem, and are equally necessary for proper risk allocation on an APD project.  The global professional liability marketplace is hardening as of late 2020 (partially in reaction to COVID-19 but more so in reaction to claims trends).  Repetitive poor performance on PSPL placements will significantly impact the pricing, limits capacity, and coverage terms for future PSPL policies.

Closing Thoughts

APD contractors should fully understand the untenable position of their designers because they, too, feel the pain of estimating based on preliminary information that will assuredly change while then contracting for fixed prices without proper recourse for those inevitable changes.  Without such opportunity for recovery, they are turning downstream too often, with staggering impact.  Owners must be made aware of these massive claims simmering in the background of otherwise successful APD projects and support the industry with agreements on contingency, equitable adjustments, limitations of liability, and PSPL.

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Kent W. Collier

Greyling Insurance Brokerage, Alpharetta, GA, Division 7 (Insurance, Surety & Liens) and Division 3 (Design)