Across my 15 years in the insurance industry, ten of which involved underwriting financial lines insurance, one common misconception I often encounter is that insureds believe that if they appoint a contractor to undertake work on their behalf, their exposure for that work will be transferred in full to the contractor should there be a claim. In practice, this is not the case.
In this article, I will delve into proportionate liability within professional indemnity insurance claims, focusing in particular on the impact of sub-contractors with respect to an insured’s exposure.
Professional indemnity insurance
Professional indemnity insurance (PI) stands as a safeguard against potential claims arising from errors, omissions or negligence during the course of the insured professional business.
PI defends the insured against claims for loss or damage made by their clients or third parties resulting from allegations that their services were rendered negligently.
Unless explicitly noted, professional indemnity policies will typically provide the insured with a level of vicarious indemnity for works undertaken by sub-contractors on the insured's behalf during the course of the insured business.
The activities performed by sub-contractors must be declared on the insured's policy and fall within the insured’s business description/scope of professional services outlined on the policy schedule.
What if a sub-contractor has their own cover?
Some insureds believe that if their appointed sub-contractor is covered by insurance, they can be worry-free concerning claims related to that sub-contractors’ work.
However, it's a common pitfall to expect a contractor's insurance to handle issues that arise directly from a contract.
Equally, when a third-party engages an insured to perform services and compensates the insured directly, the ultimate responsibility for the task's completion remains with the insured, regardless of how much of that contract is outsourced to other contractors.
Breaking down proportionate liability
Proportionate liability is a principle that divides liability among multiple parties, such as architects, engineers or consultants involved in a single project, based on each one’s degree of fault or contribution to the loss or damage. Its application varies by jurisdiction, often determined by local legislation or case law.
In complex projects like construction, the involvement of sub-contractors introduces a new layer of complexity when considering proportionate liability.
A sub-contractor is an independent entity contracted by the insured to perform specific tasks within the project. If an issue arises from work where a sub-contractor was utilised, determining the extent of their contribution to the problem and distributing liability fairly becomes imperative.
In the context of proportionate liability, the insured’s decision to include sub-contractors in their business brings forth a range of considerations, such as
- Accurately identifying the role and responsibility of each sub-contractor. This is paramount, requiring thorough documentation and, in some cases, expert analysis when multiple sub-contractors are involved.
- Ensuring open communication between the insured and sub-contractors, which is vital for clarity and transparency. This can help mitigate potential misunderstandings that could lead to disputes and shared liabilities.
- Determining the legal relationship between various parties and understanding the extent to which sub-contractors should be held accountable. This can vary based the contract terms.
- Determining the extent of the sub-contractor's accountability, which may also be influenced by specific contractual clauses such as "hold harmless", "indemnification", or "waiver of subrogation". These clauses can also play a pivotal role in delineating responsibilities and potential liabilities.
The inclusion of sub-contractors in professional indemnity insurance claims also brings a range of implications. For example:
- Claims involving sub-contractors often result in shared responsibility among the various parties. Insurers need to assess each party's contribution to determine the appropriate allocation of liability.
- If a sub-contractor does have their own insurance, there may still be defence costs the insured will have to pay themselves.
- Insurers must ensure that policies accurately reflect the involvement of sub-contractors and avoid coverage gaps.
- Premiums need to be calculated and charged according to the risk associated with projects involving multiple parties, each contributing to the overall liability.
The introduction of proportionate liability, especially in cases involving sub-contractors, balances accountability and fairness in insurance claims. This approach acknowledges that issues can often stem from a combination of factors and participants, preventing one party from bearing an unjust financial burden.
Let’s say the insured is a construction company appointed to design and construct a building.
The insured has an in-house architectural team, however they hire a sub-contractor to handle the structural aspects of the project. Following completion, it becomes evident that the building has some structural flaws that might compromise its safety. An investigation reveals that both the insured and the sub-contractor contributed to these flaws.
In applying proportionate liability, the insured might be found 40 per cent responsible for inadequate oversight, while the sub-contractor is found to be 60 per cent responsible for incorrect calculations. As a result, any claims arising from the structural flaws will be distributed proportionally based on these assigned percentages.
It is important to note however, that during an investigation to determine proportional liabilities, both parties are incurring and accumulating legal expenses. Even if the sub-contractor bears a higher level of responsibility and has their own insurance, the insured will still incur defence costs to reach that determination.
In summary, proportionate liability plays an essential role in claims settlement by ensuring fairness and shared accountability for work undertaken on projects. Insureds must ensure that they are appropriately covered for any work that a sub-contractor undertakes on their behalf.
While it is good practice to ask sub-contractors to have their own insurance in place, this does not exempt an insured from getting involved in a potential claim or from incurring defence costs along the way.