Latent defects insurance (LDI) can cover the cost of repairing or reinstating newly-built properties, or new works to existing buildings, where there is physical loss or damage as a result of an inherent defect in design, workmanship or materials.
Damage from a latent defect is typically excluded from coverage under ‘all risks’ property insurance policies, so may not be covered from the point where the project hands over to the property insurances. However, tenants are more frequently requesting that a latent defects policy is in place before they will sign up to a lease, as they are reluctant to assume risks associated with building defects.
Latent defects insurance is designed to protect against the financial implications of a hidden defect becoming apparent later down the line. It can provide a cost-effective, high-performance alternative to collateral warranties across a diverse range of residential, mixed and commercial new builds.
What does a latent defects policy include?
The policy covers the scheme reinstatement cost, including professional fees, in the event of damage due to inherent defects, the threat of imminent collapse, ingress of water (excluded for first 12 months) and subsidence, landslip or heave (only if due to inherent defects). It also includes debris removal, dismantling, demolishing, shoring up of the property, temporary removal of contents, and resultant damage to non-structural elements.
Additional covers, such as loss of rent, waiver of subrogation, and damage to mechanical and electrical services are also available.
Key benefits of cover
- First party policy—cover designed to rectify damage without requiring proof of negligence. The contractor’s professional indemnity insurance is typically dependent on negligence, which can be difficult to prove, and policies may not cover poor workmanship or materials. Collateral warranties provided by the contractor may also require proof of negligence.
- Freely assignable policy—the policy can be assigned to future funders, owners and tenants. It can also be assigned to purchasers to help with the process of securing a lease or sale.
- Prompt resolution in the event of major damage—claims response is dependent on proof of damage alone, enabling proactive reinstatement and minimised loss of enjoyment and business interruption.
- Contractor insolvency—beneficiaries of the policy can take comfort that it is unaffected by contractor insolvency.
- Cover remains in place for 10 or 12 years, without the need to renew annually.
Latent defects insurance can be taken out for commercial new builds (including conversions and significant extensions), and mixed-used developments where cover is required for both commercial and residential aspects; in this instance, a latent defects insurance policy is provided, along with a UK finance mortgage lender compliant warranty.
When to arrange cover
Latent defects policies should be procured prior to the start of construction so that insurers can carry out their full technical audit throughout the construction period. Cover is possible to arrange after construction starts, but exclusions may be applied, and the cost of cover may increase in relation to how far the works have progressed.
Technical audit fees and premium
The technical audit fee along with a small deposit premium (normally 5-10%) is taken following acceptance of formal terms, with the balance of the premium being taken at practical completion. The premium rate pre-agreed at the start of construction will be applied to the reinstatement value of the property at practical completion, to generate the final premium payable. The proposer is able to opt for a larger policy deductible, in exchange for a reduction in premium.
Technical audit inspections are carried out so that insurers can monitor the build to ensure it is of an appropriate standard and in compliance with building regulations. If, at practical completion, the technical auditor is satisfied that any outstanding issues incurred throughout construction have been resolved and the build is to specification, they will issue a certificate of approval to confirm to the insurers that cover can be provided.
An expanding market for latent defects insurance
In our experience, collateral warranties, supported by professional indemnity insurance, have long been the favoured route to resolve property damage caused by structural defects, however, the commercial latent defects market has expanded in recent years due to growing demand.
Latent defects insurance transfers risk to help protect the owner’s balance sheet, improve saleability, and help to secure the property asset value for 10 or 12 years. Commercial developers, owners, financiers and tenants are now turning to this cover as a more robust, responsive, solution in light of increased contractor insolvency coupled with the challenges of a hardening professional indemnity insurance market.
Our specialist team is here to answer any questions you may have around latent defects insurance, and arrange cover for your construction projects accordingly.