Latent Defects Insurance – Part two

In the first article of this series, we explored Latent Defect Insurance (LDI) policies in more detail and provided an explanation of how they operate in practice. This article will explore the benefits, coverage enhancements, pricing, and market capacity associated with LDI.   

Benefits

The benefits of LDI are largely similar for both residential and commercial developments, however there are certain benefits for each project type that are worth exploring in more detail. For example, a residential development with LDI in place will facilitate mortgage lender requirements, and a commercial LDI policy can increase the saleability and/or lease ability of a project.

Residential

NHBC has traditionally led the LDI market in the UK for residential projects and historically has been a leading player in the market. That said, similar providers that write this class of insurance, with equivalent market recognition, have a different underwriting approach. NHBC’s technical audit process adheres to their building manual which needs to be complied with to obtain cover. Other providers do not follow this approach; they mitigate latent defect risks by reviewing the design specification and use their technical auditing process to ensure that construction is carried out in accordance to building control. This should mean there is less scope for specification conflict between surveyors and could avoid coverage issues at a later date.

Traditional markets may also ask the developer to deposit an amount of money into an escrow which they will pay back in the event they are satisfied with the works upon completion. Other providers do not ask the developer to deposit funds into an escrow, which is highly beneficial to the project cash flow. Instead, they are happy to rely on the technical auditing process during construction as well as the strength of the professional team.

Commercial

Considering the current turbulent financial health of many companies in the construction industry, developers in the commercial space are increasing their focus on risk mitigation and insolvency protection products.  The insolvency of a main contractor can leave multiple gaps in protection for the developer and the building occupier. Though underwriters will review the strength of the professional team associated with a project, LDI can serve as an added layer of protection should the contractor not be able to fulfil its contractual obligation to remediate defects.

LDI mitigates the risk of a structural defect and provides far more comfort than just relying on collateral warranties with the original construction supply chain. An LDI policy does not require the client to prove a contractor’s negligence and will pay in the event of a valid claim, regardless of the responsible contractor’s solvency. LDI can therefore increase the commercial viability of a scheme and make it far more attractive to potential owners. This, on top of the requirement to satisfy lenders behind the purchase, makes LDI a very attractive product within the commercial space.

An additional benefit of LDI, both commercial and residential, is its assignability. Upon sale or resale within the insurance period, an LDI policy has no limit on the number of times it can be reassigned. This is largely a benefit to new owners of the property as they obtain first-party cover.

Coverage enhancements

There are a range of additional protection coverages that can be added to the standard LDI policy to offer additional protection throughout the insurance period:

• Mechanical & electrical (M&E) elements – the option to add new M&E equipment under the insurance period. This can also be obtained as a standalone product.
• Business interruption cover – coverage for a consequential loss arising from insured damage.
• Loss of rent – the option to add loss of rent receivable or payable that is caused by a latent defect.

Pricing & capacity

It is hard to offer an exact estimation of the cost of LDI, as each project is underwritten and assessed on a case-by-case basis. That said, for new build developments a guide price would be 1%-1.2% of the contract value. Conversions and refurbishments are often rated slightly higher; a guide price would be 1.5% of the contract value depending on the scope of work. These guideline rates are an indication of the total combined cost of both premium and site audit fees.

In addition to the project specification, underwriters will pay special attention to the experience of the delivery team and the financial strength of the contractor/developer which will influence the premium rating.

Any project that is part completed or completed will fall outside of these guidelines and incur a much higher premium rate. These projects will have missed some or all of the technical audit visits and therefore represent an increased risk to the insurer. If LDI is required, it’s best to arrange this prior to your project start date.

We estimate that there is in excess of £500,000,000 in capacity for UK LDI risks. Some of this capacity is unable to be deployed on residential projects as it does not have UK Finance recognition. In these circumstances, the capacity can only operate in conjunction with a scheme administrator that is authorised and accepted by UK lenders.

Why choose Price Forbes Construction as your LDI broker partner?

• Specialist market knowledge. Lloyd’s broker, with access to all markets.
• We can offer clients expert advice when arranging terms.
• Whole market comparison against your usual provider.
• Match the project specification to the most appropriate insurer terms.
• Competitive premiums against the likes of NHBC.
• A-rated underwriter capacity.
• Full lender acceptance, compliant with mortgage lenders.

_{The information contained herein is based on sources we believe reliable and should be understood to be general risk management and insurance information only. The information is not intended to be taken as advice with respect to any individual situation and cannot be relied upon as such.}