Latent Defects Insurance

Latent defects insurance (LDI)policies are a key product for the protection of construction projects. This LDI mini-series article focuses on two different parts. Firstly, we consider the LDI policies in further detail and provide an explanation of the cover provided and how the product operates in practice. Secondly, we will focus on the benefits, coverage enhancements, and the pricing & capacity elements of the LDI policies.

Description of cover

A latent defect insurance (LDI) policy offers protection against defects in construction projects that are not identified during construction and manifest themselves after the project has been completed.

These defects can arise in the projects’ design, workmanship or materials.  Sometimes known as a structural warranty, LDI protects the insured against the cost of rectifying damage that has arisen because of defects within the building structure or waterproofing envelope.

A defect is normally defined as non-compliance with building regulations. It is important to note that LDI will only cover the cost of rectification work to a property that has been affected by major damage due to a structural defect, or a condition requiring immediate remedial action to prevent imminent danger.

The policy is bought by either the housebuilder, developer, or owner of a building project.  It protects the owner/occupier on completion, which might be the property owner or subsequent owner, the developer, a house buyer, or a building tenant who is responsible for damage under a full-repairing lease.

There are many different policy forms for LDI, all of which contain slightly different coverages and definitions, but in general terms the defect that causes damage must arise in the building structure or waterproofing envelope.  By this, we mean:

• foundations
• load-bearing floors and walls
• staircases
• walls and roofs
• floor decking and screeds
• wet applied plaster
• glazed panels
• external windows and doors
• external finished surfaces responsible for water-tightness

LDI incepts at the completion of construction works and largely falls into two separate sections.  For the first 12 or 24 months following completion, the developer or contractor signs a development indemnity agreement whereby they are obliged to return to correct any defects that are identified by the property owner or occupier. During this period, the policy will only meet the cost of defect rectification if the developer or contractor is unable to do so. Rights of recourse are retained against the contractor for losses arising in this period.

Once the defects rectification period has expired, the basis of cover changes. Insurers will provide first-party cover to the owner/occupier in circumstances where major damage has been caused (or where damage is imminent) because of a defect in construction.  This cover will continue until the expiry of the policy period and there are no rights of recourse against the contractor.

Commercial policies will normally have a one-year defects rectification period, whereas residential polices are normally two years.  It is possible to arrange residential projects with a one-year defects rectification period, but this requires a premium loading as they are effectively on cover one year earlier.

Period of insurance

LDI policies incept at completion of the construction works and run for a period of 10 years or 12 years if required. That said, it is crucial to identify this need and instruct the policy prior to starting the project due to technical auditing requirements.  Although cover starts at completion, the insurance provider will appoint surveyors to work with the developer/contractor and undertake inspections throughout the construction period; this cost is included within the total so there are no hidden fees.

The standard policy period is 10 years although some housing associations stipulate that the longer 12-year period is required. This is normally achievable with a 20% premium loading.

Underwriting process

The underwriters will consider the following key aspects of the project prior to offering cover. Policy inception will be subject to the successful completion of a technical audit during the construction period. This refers to the surveying process that the LDI provider undertakes during construction to mitigate the risk of defects and ensure the completed works comply with building control standards. An LDI provider will either outsource this or have in-house surveyors. This process happens alongside the building control inspections.

Project types

LDI insurance can be purchased on a wide variety of project types. It is most commonly used on private residential projects, where UK Finance requirements stipulate that LDI must be purchased on all new build projects to qualify for mortgage availability. This also applies to social housing projects.

Commercial buildings, student accommodation, social housing and the private rental sector are amongst the other development types where LDI is frequently obtained as it can protect the building’s owners against the risk of financial loss, such as loss of rent, due to a latent defect. LDI is also seen as a more stable protection than collateral warranties with either contractors or subcontractors as these are vulnerable to insolvency. For these reasons, it is often a requirement of the lender who is behind the project to protect their investment.

Conversions or extensive refurbishment are often overlooked when it comes to LDI in both the commercial and residential sectors as they are not “new build”. However, LDI is still required for residential conversions and frequently obtained for commercial development to satisfy lender requirements and protect against the potential of latent defects.

Mixed-use developments typically cause complications when it comes to obtaining LDI, as these require both residential and commercial policy cover. That said, LDI protection is available for mixed-use projects and will be stipulated as a requirement of the lender in relation to residential elements subject to open market sale. This can often apply to the commercial units too if finance is raised for the purchase. In the second part of this article series, we will be discussing the benefits, coverage enhancements and the pricing & capacity elements of the LDI policies.

_{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.}