From Risk to Profit Benchmarking and Claims Studies

From Risk to Profit Benchmarking and Claims Studies

Victor has developed a unique range of professional liability coverages and risk management services to assist professional service firms of all sizes respond to the needs of their clients and provide services in a manner that meets their particular practice management goals.

From Risk to Profit: Benchmarking and Claims Studies is one of the many risk management tools available to design professionals insured in the professional liability program administered by Victor. For more information about the programs for design professionals from Victor, please contact your independent insurance broker, or call Victor at 301-961-9800, email us at info.us@victorinsuranceus.com, or visit our website at victorinsuranceus.com. This publication was created and is distributed by Victor for policyholders in the Victor and CNA programs. Policyholders are granted a nonexclusive license to reproduce this publication in whole or in part for any internal educational purpose and for the education of policyholder clients and their legal and insurance advisors. Except for the license granted to each policyholder, no other license or right shall be deemed granted to reproduce this publication, store any part of this publication in an electronic retrieval system, or transmit any part of this publication in any form or by any means without prior written permission of Victor. Statements concerning legal matters should be understood to be general observations based solely on our experience as risk consultants and may not be relied upon as legal advice, which we are not authorized to provide. All such matters should be reviewed with a qualified advisor.

From Risk to Profit: Benchmarking and Claims Studies

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TABLE OF CONTENTS

I ntroduction

4

Industry Trends

5

Evaluating Your Risk

12

The Client

13

The Project

16

Consultants

21

Contractor

24

Other Parties

27

Fee

30

Your Firm

33

Contracts

39

Tools to Help Identify Risks

42

Risk Management Matrix

43

Resources

55

From Risk to Profit: Benchmarking and Claims Studies

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Introduction In today’s complex design and construction environment, it is becoming increasingly difficult for design firms to remain profitable. To prosper, design professionals need to identify, understand, and manage their risks.

How to Use This Publication This publication is divided into three major components. The first, “Industry Trends,” will help you identify: • what project types are expected to see an increase in construction and which are not; • what project types may present greater risks; and • certain factors related to claims trends and issues that may influence the design and construction industry in the coming years. The second section, “Evaluating Your Risk,” looks at claims from eight different factors—client, project, consultants, contractor, other parties, fee, your firm, and contracts— and presents, where appropriate, a statistical picture, case scenarios, and risk management guidance. It is this section where firms will be able to benchmark themselves and establish future goals. The third section, “Tools to Help Identify, Assess, and Manage Project Risks,” includes a useful risk management matrix for any project and a listing of some of Victor’s risk management resources. Used in conjunction with the first two sections, this matrix and our resources can help firms manage current project risks and measure performance over time. Why This Publication Is Valuable to You The information in this publication has direct value in your firm’s management activities. It will help you identify progress as well as problems within the design and construction industry, enabling you to assess the potential for taking your firm into a successful future. Finally, in addition to the information in this publication, additional benchmarking and claims and case studies located at our School of Risk Management can be used by firms attempting to mark where they are today and where they want and need to be to remain profitable and successful.

For more than 60 years, Victor and CNA have been collecting information on claims against our policyholders and have analyzed the data to create risk management resources. From Risk to Profit: Benchmarking and Claims Studies looks at eight key factors Victor believes, based on claims studies, are crucial in assessing and developing appropriate responses to risk.

Why Benchmarking and Claims Studies Are Important

The design professional’s challenge in today’s competitive environment is to find ways to become more efficient and to reduce costs while improving and expanding services. The first step in meeting this challenge is to create benchmarks of your financial and competitive position and your preferred status in both the near and distant future. The information you need includes an analysis of your firm’s practice, a vision of how you want your firm to be organized and grow over the next few years, and the ability to benchmark your firm through comparison of your firm to similar firms. From Risk to Profit will allow you to examine industry trends and emerging issues, compare your firm to peer firms, and examine your firm’s experience with clients, project types, consultants, construction entities, other parties, fees, and contracts. This information will help you analyze your firm’s performance compared to peer firms and against your firm’s business goals. The claims data in this publication are based on roughly 4,000 claims per year presented in five and ten-year periods from 2009 through 2018. The figures represent claims dollars paid above our policyholder’s deductible obligations.

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Industry Trends One of the attributes of a professional education is the ability to apply lessons learned to new situations. Certainly, design firms are facing new situations that will have a major impact on their professional status and business operations. • In 2030, about half of the buildings in which Americans live, work, and shop will have been built after 2000.

From the industry movement toward integrated design and construction and building information models to marketplace demands for energy-efficient and sustainable designs, to security-conscious installations, to absolute contractual responsibility, the evolution of the design professions seems to be accelerating. This evolution, while providing the opportunity for enhanced services and innovative solutions, also may result in the dissolution of some professional service firms. While the past provides limited value in assessing the long-range future risks of providing professional services in a dramatically changing market, applying the benchmarks of claims and losses can assist a firm in positioning itself for near-term changes and opportunities. Need to Recreate the Built Environment There are many expert predictions for a strong and growing economy with an increasing demand for design services. The predictions, however, are not consistent as to what areas will be long-term growth centers. All predictions, however, indicate that the need for capital spending for new infrastructure and buildings and other productive resources in general is enormous. Most experts recognize that energy efficiency will be a driver of design. All recognize the changing demographics of the United States and the rapid development of many international markets. One long-range analysis published in 2004 by the Brookings Institution stated that while there is not a general sense of how demographic, household, market, and industry trends will require newly designed and constructed facilities to accommodate future growth, the need is apparent. The study, Toward a New Metropolis: The Opportunity to Rebuild America (Arthur C. Nelson, The Brookings Institution Metropolitan Policy Program, brookings.edu ), predicts the overall estimated demand for new housing, commercial, and industrial space over a 25-year period. Among the report’s findings are the following:

• Most of the space built between 2000 and 2030 will be residential, with the largest component being homes. • On a percentage basis, the commercial and industrial sectors will have the most new space, with over 60% of the space in 2030 being less than 30 years old. • Overall, most new growth will be in the South and West, with much of the West experiencing a doubling of space by 2030. • States with a strong industrial presence will see the largest amount of growth in industrial space. For instance, by 2030, 70% of the industrial space in the Midwest will be less than 30 years old. In 2030, about half of the buildings in which Americans live, work, and shop will have been built after 2000. - Toward a New Metropolis: The Opportunity to Rebuild America

Changes Caused by Economic and Demographic Pressures

The need for new facilities in the U.S. is well documented, and the international demand for projects is intensive. It is clear, however, that this massive expansion of the built environment will not take place along the same lines as in the past. The two major forces that will have the most significant impact on design firms are demographic changes and the rapid change in how projects are financed, designed, and constructed.

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Demographic Changes Result in Shifting Markets

manner. However, such firms may also see a level of vicarious liability that challenges their professionalism and profitability. They may find that in becoming a conduit of design services, rather than a provider of design expertise, they have created an uncontrollable competitor. The rapid change in technology and the cost pressures resulting from global competition may result in the dissolution of undercapitalized firms, and more consolidation of the industry may result. The increasing integration of design and construction, aided by information technologies, may be submerging the traditional design firm into an integrated project financing, delivery, and operation methodology run by financial and managerial consultants. Growing Reliance on Professional Expertise While the delivery system for professional services may be irrevocably altered in the next decade or less, the need for professional expertise would seem to intensify. Irrespective of how projects will be conceived and completed, there will be a significant increase in the world’s reliance on professional expertise as it is contained in U.S. design disciplines. To stay as independent entities, design firms will need to continue to create a new value proposition for their services. Firms will need to react to three significant factors that will affect their prosperity and stability. Sustainability The demand for creative design solutions incorporating innovative systems will increase. As energy costs continue their rise, the use of energy, both actively and as embedded in products, will increase the focus on green design. Concerns over climate changes will also emphasize efficiency and sustainability in design. The use of professional expertise in responding to the market demand, however, may result not only in an increase in professional liability claims from dissatisfied clients and facility users, but also in contractual, warranty, and statutory exposures that go beyond the scope of professional liability insurance coverage. Still, designing to an increased market acceptance or market demand for sustainable projects in a sustainable economy may represent the most profitable enhancement of professional services.

Demographic changes—the aging of the baby boomer generation born between 1946 and 1964, for example— will require a shifting of project types and create different patterns of facility use in the U.S. Each sector of the construction industry reacts to different demographic and accompanying economic changes. Surveys are published annually that look ahead to the relative strengths of building sectors based on demographic changes. In brief, while the decrease in both the percentage and the total number of adults in the 35-to-50 age category may result in some weakness in new construction markets, the huge growth in the 50-to-65 age category over the next five to ten years indicates that facilities for health care, assisted living, and even hospitality and hotel space will be needed. Expectations of shifting populations centers in the U.S. mean that demand for facilities in the South and West, especially housing, will outpace the rest of the nation. While the percentage increases between 2000 and 2030 in states such as Nevada and Arizona will be significant because of rapid growth on a relatively small base, California, Texas, and Florida will see the greatest demand in absolute numbers. According to U.S. Census projections for 2030, Nevada is expected to grow by 114% and Arizona by 109%, but together, California, Texas, and Florida will house over 30% of all U.S. citizens.

Financial Pressures Result in Project Delivery Changes

Change will not only be rapid, it is also expected to radically alter the way projects are financed, designed, and constructed. The transformation in the design and construction industry will require a shifting of roles. The financial pressure for timely and efficient project delivery— with significant negative consequences to those firms that cannot react productively to the pressure—will recast the industry. The stability of design firms will be increasingly challenged by the demand for new and remodeled facilities in the U.S. and the immense need for development around the world. Many firms may see a negative impact on their traditional operations, resulting from new global business process outsourcing initiatives and direct international competition. Some firms may see outsourcing as a viable method to cut costs and respond to client demands in a more timely

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Claims Trends Looking back at claims experience can be helpful to firms as they expand their markets and enhance the range of professional services they offer. Information on the frequency and severity of claims, however, has limited usefulness for less traditional professional services because claims can only record past problems. The past, however, is a good predictor of future disputes, claims, and losses for more traditional services on common project types. For many project types, the frequency of claims might be considered a “coincident indicator” of the professional liability exposure for that project type or specific client base. The raw claims count—not just those claims that are ultimately resolved—can herald future losses. The frequency of claims indicates that, in some way, the design firm has not met expectations or has been identified as a cause of an economic loss or bodily injury. Even if claims do not result in payment by the insurer, they represent costs to the firm, distractions from the firm’s practice, and damage to the firm’s reputation. Even if claims do not result in payment by the insurer, they represent costs to the firm, distractions from the firm’s practice, and damage to the firm’s reputation. Often, claims for a specific service that is less traditional, such as design subcontracting on a design-build project or reaching a target level of sustainability in design, take years to develop as a trend. Patterns are not usually readily apparent. Changes in procedures or roles or even consensus contract language may not be construed by the legal system for many years. Still, a look at when claims are brought, how many occur and end up with payments, and what those payments average can be helpful in benchmarking professional liability exposure.

Security The dramatic increase in governmental and private concerns over physical security early in this decade was only the initial wave. Security in all forms will shape not only the demand for design solutions, but also how those solutions are delivered. Mission critical solutions are just one aspect of the growing market. Increasingly, clients are requiring integrated security both in the design and in how design firms manage confidential information. Firms that can respond to what is an evolving standard of care for security-conscious design solutions may find their services to be both marketable and in high demand. Integrated Design and Construction Perhaps the rapid movement toward the use of building information models rather than plans and specifications will cause the greatest impact on design firms. This sharing of information fundamentally changes the interests of stakeholders in the design and construction process. By both unbundling design services and blending design with construction and operations, building information models create a shared risk in the design of a project. As their use becomes the primary vehicle for project communication, the process would seem to move more seamlessly to the design-build project delivery system. The roles of design and design firms have yet to be determined. Firms modifying their practice management systems to incorporate building information models, as well as their business practices to take charge of the information sharing process, may be able to reduce their professional liability exposure while creating and controlling project information in a highly valued and appropriately compensated way. The design industry is changing. Professionals and their service firms will be facing many unknowns. Often, there is little time to look back; the road ahead seems too perilous. Having a clear idea of the past is essential to planning for, or responding to, the future. And we at Victor and CNA know that firms with an understanding of historical claims and liability information are more likely to avoid claims in the future.

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Reported Claims Per 100 Firms

50

HOW FREQUENCY VARIES This graph shows that the average number of claims per 100 firms insured through the Victor program peaked in 1983 during a time of high inflation. The interaction of many factors seemed to lead to the increase. But one factor seems clear: when the construction economy was vigorous and client demands led to constraints on the time allocated for design, claims followed. Reported claims should be expected to track with construction volume.

40

30

20

10

0

HOW CLAIMS RELATE TO BILLINGS

Claims Frequency per $10 Million Gross Billings

Larger firms have more claims than smaller firms. That is obvious simply because of the scale of operations and the number and size of projects. But when the frequency of claims was adjusted to a fixed-dollar basis of billings, small firms were far more likely, per dollar of revenue, to have a claim. Part of this difference was likely caused by a difference in deductible obligations. Some larger firms may not have reported disputes as claims if they sensed that the dispute could be resolved without insurer involvement. WHAT CLAIMS COST All disputes cost firms in lost productivity, internal costs, and professional reputation. When claims result in payment on behalf of a policyholder, the dollar costs are significant. Even for smaller firms, the average paid claim, including legal defense costs and the amount to correct harm caused by the firm’s negligence, was over $167,000 from 2015 through 2019. The average larger firm claim cost almost $494,000 over that same span.

$5 million and below annual billings Above $5 million annual billings

2.5 3.0

2.0

1.5

1.0

.5

0

2015

2016

2017

2018 2019

Average Defense Costs and Indemnity Payments

$5 million and below annual billings Above $5 million annual billings

$0 $100,000 $200,000 $300,000 $400,000 $500,000 $600,000 $700,000

2015

2016

2017

2018

2019

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Claims Closed with Indemnity Payment

HOW MANY CLAIMS ARE PAID Many claims are closed without payment above the firm’s deductible obligation. Nationally, from 2010 - 2019, 16.6% of all claims reported ended up with the insurer paying for property damage, economic loss, or bodily injury because of the policyholder’s negligence. This varied by firm size. Firms with higher deductibles absorbed much of the cost of correction or harm. For larger firms, insurance indemnity payments occurred, on average, 10.3% of the time. Smaller firms, however, required payments 22.7% of the time. Even if no payment is made to correct harm, defense costs can be significant. Defense costs occurred, on average, in another third of all claims. But this graph only represents the percentage of claims where insurance funds were used beyond the deductible obligation of the policyholder. Because the Victor and CNA program allows for incident reporting where CNA funds are used—without the commitment of the deductible—to prevent incidents from becoming claims, those insurance costs are not documented as claims- related expenses.

$5 million and below annual billings Above $5 million annual billings

25%

20%

15%

10%

5%

0%

2015

2016

2017

2018

2019

Claims Closed with Defense Payment Only

$5 million and below annual billings Above $5 million annual billings

10% 15% 20% 25% 30% 35% 40%

0% 5%

2015

2016

2017

2018

2019

Firms could argue that if payment by an insurer on behalf of policyholders for their responsibility for causing property damage or personal injury through negligence in performing or furnishing professional services happens only in about 17% of the claims filed, the other 83% must not have a level of merit against the insured firms that signifies culpability. Thus, 83% of all claims against insured firms insured could be considered “meritless” using a tort liability measurement. Almost 34% of these “meritless” claims, however, require defense expenditures above the firm’s deductible obligation and all could be assumed to require expenditures of time and money by the firm. This unproductive use of time and the commitment of defense funds by a firm increase costs. Clearly, claims that result in no payment to correct damage or harm drain the design professions and the economy of productive time and force an increase in the cost of providing services to the public.

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Comparing Severity with Frequency The severity of claims as an indication of the economic risk of providing services should be recognized as a long-term rather than instant measurement of loss. Usually, claims are not resolved until long after services are provided. Paid claims are a “lagging indicator” of risk and, therefore, have little predictive value for firms entering into emerging professional service sectors. Statistics on the cost of paid claims, however, are extremely valuable for those firms providing services in a mature market segment. The following graphs show five industry sectors and compare frequency and severity. To aid understanding, the frequency of claims is indicated as a percentage of all claims in that year for the five-year period. There is no

comparison between the amount of reported fees for the type of project or the number of projects in that category and the frequency of claims. The comparison of the percentage of severity—the percent of all the defense and indemnity costs paid when an indemnity payment was made on behalf of a policyholder— to the indicated percentage of frequency can be helpful. The severity percentages shown for a specific year indicate the percentage of the five-year total of all costs for claims closed in that year. Therefore, they may actually relate to claims from an earlier year. Still, the comparison between the percentages of frequency and severity can indicate that claims cost more on some projects.

Residential Project Claims

Residential projects, including condos, apartments, and single-

family and townhouse structures, not only represented a high severity to frequency ratio, but when compared to reported billings for professional services, these projects were at the top of the risk-to-reward ratio. Although most claims for this project type were brought against architects as the prime design professionals, direct and interprofessional claims against mechanical and structural engineers accounted for a high level of paid losses. Unlike most other project types, highway-related claims of negligence included a significant proportion of user injury claims. Often, peaks in severity, such as in 2018 and 2019, were the result of significant bodily injury claims. The frequency often lags a few years behind funding, and for non-bodily injury claims, seems to be highly dependent on client procedures and the pressure of the political system for cost recovery as a problem develops.

Frequency = reported claims Severity = CNA dollars spent

25%

20%

15%

10%

5%

0%

2015

2016

2017

2018

2019

Highway Project Claims

Frequency = reported claims Severity = CNA dollars spent

60%

50%

40%

30%

20%

10%

0%

2015

2016

2017

2018

2019

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Schools/Colleges Project Claims

Both the claims frequency and severity for school projects seemed to be driven by problems with “delays and extras” and HVAC problems. Although mold-related claims were a component of the overall frequency, such claims were not significant components of either the number of claims brought or the resolution costs for those claims. The severity in certain years may have resulted from a building boom and less skilled constructors.

10% 15% 20% 25% 30% 35%

Frequency = reported claims Severity = CNA dollars spent

0% 5%

2015

2016

2017

2018

2019

Healthcare Facility Project Claims

The severity statistics for this project type were often driven by the coincidence of extremely large claims. This appears to be the situation in 2016 where large projects resulted in expensive claims. As with other institutional projects, mechanical systems were the biggest source of claims and a costly component of the severity of those claims. In frequency alone, roughly 30% of all claims during this period alleged negligence in HVAC design.

Frequency = reported claims Severity = CNA dollars spent

40%

30%

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15%

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0%

2015

2016

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Commercial and Retail Project Claims

Commercial and retail projects, ranging from banks to stores to office buildings, often are seen as having a good risk-to-reward ratio—the risk of loss is not disproportionate to the fees. But claims were quite common, and even though some did not result in indemnity payments, they did consume time and defense costs. Economic loss claims, often from delayed openings, added to the severity problem. Losses were often related to interior construction, HVAC problems, and building superstructure.

10% 15% 20% 25% 30% 35%

Frequency = reported claims Severity = CNA dollars spent

0% 5%

2015

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Evaluating Your Risk

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The Client

Perhaps the most important step in assessing potential risks for any project is to evaluate your client. Clients often spend great effort in evaluating potential design professionals. They do this because the selection of the right design professional is a crucial first step in maximizing the potential success of any project. The same is true for design firms. Frequency of Claims by Claimant Id (2010 - 2019)

Since nearly two-thirds of claims against design professionals in the Victor program originated from the project owner, design professionals should take the same level of care in the selection of their clients. It is not surprising that the project owner is the largest source of claims against design professionals since in most situations it is the project owner that has retained the design professional. Therefore, it is with the project owner that design professionals have a direct obligation. Design firms need to be thorough in their evaluation before deciding to work with a particular client, whether the client is the project owner or a general contractor that has retained the design professional for a design-build project. Design firms should select clients that understand, appreciate, and value the services of design professionals. This can help avoid claims alleging professional negligence, disputes involving fees, and other potential disputes that may arise during the design or construction of a project.

Project Owner/ Client Third Party Property Damage General Contractor

6.4%

4.2%

2.7%

7.6%

8.4%

Bodily Injury (Worker) Bodily Injury (non-worker)

61.9%

8.8%

Specialty Contractor

All Others

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CLIENT: CASE SCENARIOS

LITIGIOUS CLIENT An interior designer agreed to work for a client that was frequently involved in litigation. The client did not approve of the antique French floor that was moved to his Palm Beach estate from a chateau in France. He filed suit and refused to budge from his initial demands. It was estimated that the cost for taking the case through trial could exceed $400,000. The interior designer and client finally agreed to a settlement of $235,000 and a waiver of the interior designer’s $70,000 in fees. In addition to the $235,000 settlement, the insurer also paid more than $250,000 in legal and expert fees. JOINT AND SEVERAL LIABILITY A municipality hired a civil engineer to design a pedestrian walkway across a 12-lane highway. One night, a vehicle struck two minors as they crossed the highway. Although the engineer’s design included crosswalk warnings, it was alleged that the warnings were not large enough. The injuries were very serious, resulting in an estimated jury verdict of $20 million. The department of transportation and the city each had statutory caps of $250,000 per child. Because of the joint and several liability laws in the state, the engineer could have been responsible for the entire settlement, even if the engineer was found to be only 1% negligent. The case settled for $3.5 million. COLLECTING FEES AND COUNTERCLAIMS A small town retained a civil engineer to design a new sewer system. The town wanted additional components and eventually ran out of money. The town sued the engineer for cost overruns of $1.2 million. The engineer was still owed fees of $350,000. Although there was no liability on the part of the engineer, the town could not release their claim as long as they still owed fees to the engineer. The engineer was finally forced to compromise his fee claim, accept partial payment from the town’s insurer, and collect the remainder of fees over a period of years. POOR CLIENT SELECTION An architect agreed to design a condo project for a developer that was new to town and had no ties to the community. The developer’s emphasis was on cheap, fast construction with little concern for quality. He paid low fees and refused to allow the architect to provide construction contract administration services. Several years after the units were sold, the homeowners association filed suit, alleging numerous design and construction defects. The developer had left town and did not have insurance. Despite minimal liability, the design team contributed over $2 million to settle the claim.

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RISK MANAGEMENT GUIDANCE

There are a number of different factors to consider when assessing potential risks that a particular client may present for a given project. There are certain crucial factors that should be considered for all clients.

They include the client’s:

• financial strength;

• clear project objectives;

• experience with this project type;

• experience with your firm;

• claims history;

• decisive decision maker; and

• attitude toward the project and design professional.

These factors are covered in more detail in the client evaluation portion of the Risk Management Matrix on page 45 . Addressing these factors and others that you experience can help you evaluate your clients and the potential risks they present.

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The Project

Architects: Claims by Project Type (2010 - 2019)

No two projects are alike. Even if your practice is concentrated on one particular project type, such as schools, no two sites are alike, so the projects themselves will be different. After evaluating your client, it is important to evaluate the project. Some projects are riskier than others in terms of the frequency (reported claims) and severity (costs paid by CNA) of claims. For example, according to these charts, condos projects were a relatively high risk for architectural services, but these projects were a lower risk for mechanical, electrical, and plumbing engineers. Another factor to consider is the region in which a particular project is located. For example, in the East, West, and Midwest, schools/colleges projects represented the highest frequency of claims for larger firm architects, but in the South, condos had the highest frequency of claims within the same group. For more information on frequency and severity of claims for various projects in each region, refer to our benchmarking information and claims and case studies .

30%

25%

20%

15%

10%

5%

0%

Apartments Retail/

Healthcare Facilities

Houses/ Townhouses

Condos Schools/ Colleges

Office Bldgs/ Banks

Restaurants

Frequency = reported claims

Severity = CNA dollars spent

Engineers: Claims by Project Type (2010 - 2019)

12%

10%

8%

6%

4%

2%

0%

Apartments

Condos Schools/ Colleges

Highways

Office Bldgs/ Banks

Houses/ Townhouses

Land/Site Development

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PROJECT: CASE SCENARIOS

ARCHITECT’S NEGLIGENCE An architect provided design services for an upscale, high-rise condominium project. The firm’s contract was for design and shop drawing review, but no construction site visits. Soon after the building was occupied, water intrusion (one of the most common claims on condo projects) was discovered, primarily through windows and balcony doors. Experts were hired by the homeowners association, and the estimated cost to repair the numerous construction and design defects was $30 - $45 million. Allegations against the architect involved approval of EIFS, balcony slope issues, and negligent approval of shop drawings. The architect’s exposure was significant in view of the size of the claim and the low policy limits of several co-defendants. The architect settled for $1.7 million in addition to paying $450,000 in expenses. ENGINEER’S UNDER-DESIGN A structural engineer retained by a design-build contractor rushed to complete the preliminary design on a state-owned bridge project. The contract was awarded, but it was noted that the engineer had under-designed the steel by 75%. Unfortunately, the bid and award were based on the preliminary design. The contractor was unable to pass onto the state the cost of the additional steel and labor. Although the contractor recognized that the error was the result of the rush—from the start of preliminary design to notice to proceed was less than three months—this was a clear case of engineer liability with damages exceeding the engineer’s $2 million policy. BETTERMENT School projects generate a high number of claims in terms of frequency (reported claims) and severity (dollars spent). Mold and mildew developed in a North Carolina school. The allegation against the engineer was that the HVAC system was insufficient to handle local humidity levels. The engineer designed a fix that would have cost $300,000, but the school’s “emergency fix” cost $1.5 million. Despite arguments of betterment and failure to mitigate damages, the arbitrator’s award against the engineer was $750,000. DOCUMENTATION ERROR Hospital and healthcare projects also generate a large number of claims. The biggest problem areas often relate to the design of the HVAC system. In a 186-unit senior living center in the Southwest, there was inadequate power to the HVAC units in patient rooms. During design, the design professional provided incorrect data for the HVAC power requirements, which was the basis for the electrical design of the HVAC system. The design professional paid $450,000 to settle this claim.

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RISK MANAGEMENT GUIDANCE

There are several factors to consider when evaluating a project. These factors should help you identify which projects may pose a greater risk and give you clues on how to properly respond, whether it is through specific contract language or a change in fees for professional services.

Factors to consider when evaluating your project include:

• project type;

• project delivery method;

• geographic and regional considerations;

• environmental concerns;

• potential users and occupants; and

• political and community sensitivity.

The Risk Management Matrix includes more detailed questions to consider when evaluating your project on pages 46 and 47 . Understanding potential risks that your project may present is a crucial first step in taking appropriate actions to respond to those risks.

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The previous discussion on project evaluation noted that project type was an important factor to consider when evaluating potential risks. The next step in evaluating your project is to examine the problem areas that are typically associated with any particular project type. This is an important step as the problem areas associated with a given project will help you determine how you may want to respond to a specific risk.

superstructure had the three highest claims frequency rates. If you are the prime professional on a healthcare project and you are considering retaining the services of a mechanical/electrical/plumbing (MEP) engineer, the chart below indicates that you should consider MEP engineers that have successfully provided professional services for healthcare facilities in the past. Retaining an MEP engineer that understands the HVAC, interior construction, and building superstructure needs for a healthcare facility may help minimize the likelihood of claims in those areas.

For example, the chart below indicates that for healthcare projects, HVAC, interior construction, and building

Healthcare Facilities: Claims by Problem Area (2010 - 2019)

The biggest problem area surrounding healthcare facilities was HVAC systems. From 2010 through 2019, they represented 30.3% of all healthcare facility claims and 19.8% of all insurance company dollars spent. Interior construction was also another problem area, with 20.8% of the frequency and 15.1% of the severity.

30%

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Building Exterior Closure

Building Superstructure

Site Improvements

Electrical

Plumbing/ HVAC/Fire Protection

Interior Construction

Frequency = reported claims

Severity = CNA dollars spent

Commercial/Retail Projects: Claims by Problem Area (2010 - 2019)

25%

For commercial and retail projects, interior construction was a big problem area, with 21.2% of the claims frequency and 18.7% of the dollars spent. HVAC systems were also a big problem area, accounting for 16.6% of the claims frequency and 18.0% of the claims severity.

20%

15%

10%

5%

0%

Foundations/ Substructure

Building Superstructure

Site Preparation

Site Improvements

Interior Construction

Plumbing/ HVAC/Fire Protection

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Frequency = reported claims Severity = CNA dollars spent Residential Projects: Claims by Problem Area (2010 - 2019)

The worst problem areas for residential project types were interior construction, which was first in claims count (20.8%) and second in dollars spent percentages (19.7%), with building superstructure second in claims count (17.0%) and first in dollars spent percentages (24.2%).

25%

20%

15%

10%

5%

0%

Foundations/ Substructure

Building Superstructure

Building Exterior Closure

Site Preparation

Interior Construction

Plumbing/ HVAC/Fire Protection

Site improvements and site preparation for highway projects were big problem areas, with site improvements accounting for 44.1% of the claims count and 22.1% of the dollars spent and site preparation issues accounting for 29.6% of the claims count and 66.8% of the dollars spent.

Highway Projects: Claims by Problem Area (2010 - 2019)

70%

60%

0% 10% 20% 30% 40% 50%

Foundations/ Substructure

Site Preparation Construction Stakeout

Site Improvements

Site Utilities

HVAC systems represented the highest claims count (24.9%) and dollars spent percentages for schools/colleges projects (27.6%). Problems with high humidity levels due to faulty design and the potential for mold/mildew issues may have been a contributing factor to the high frequency and severity of HVAC claims on school projects.

Schools/Colleges Projects: Claims by Problem Area (2010 - 2019)

30%

25%

20%

15%

10%

5%

0%

Electrical

Building Superstructure

Site Improvements

Building Exterior Closure

Interior Construction

Plumbing/ HVAC/Fire Protection

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Consultants Selection of consultants is another important factor to consider when assessing potential risks. A particular project may require other design professionals to provide professional services for a portion of the project. As was discussed in the previous section on evaluating your project, consulting design professionals may be providing design services for portions of the project that have represented significant problem areas for that project type. Should a claim arise out of the services provided by consultants, and any of those consultants are uninsured or underinsured, the prime design professional will be vicariously liable for damages. Since prime design professionals are vicariously liable for the professional services provided by the consultants they select, it is important that design professionals give careful consideration to the selection of their consultants. Should a claim arise out of the services provided by consultants, and any of those consultants are uninsured or underinsured, the prime design professional will be vicariously liable for damages. Unfortunately, it is difficult to track the frequency and severity of claims against the prime design professional due solely to vicarious liability exposure. But exposure does exist and consultant selection is an important consideration for proper risk management.

For more information on the risks of various design disciplines, please visit our School of Risk Management .

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CONSULTANTS: CASE SCENARIOS

LIMITATION OF LIABILITY A contractor made a claim against a city for $1 million in extra costs. The city settled with the contractor and looked to the engineer for contribution. The engineer contributed $500,000, but believed any exposure it had was related to services performed by the engineer’s geotechnical consultant. The engineer attempted to subrogate against the geotechnical consultant, but ran into problems because the contract between the engineer and geotechnical consultant contained a $25,000 limitation of liability clause. The engineer was only able to recover $25,000. VICARIOUS LIABILITY A large university retained an engineer to design a co-generation plant. The engineer’s only exposure was the vicarious exposure created by a structural engineering consultant that failed to adequately determine the structural loads for the design-build client. The consultant paid the entire $250,000 policy, leaving the engineer to pay the remainder of the $2.5 million claim. POOR DOCUMENTATION AND INSUFFICIENT CONSULTANT INSURANCE A client retained an architect to design a manufacturing plant, warehousing space, and administrative offices. Several years after the project was completed, the client filed an arbitration demand against the architect and contractor for construction defects. Although many of the allegations against the architect involved the structural components of the design, the structural engineer could not be forced into arbitration. In addition, although the structural engineer had been insured when retained by the architect, the engineer had since dropped professional liability insurance. The structural engineer could not afford to help the architect defend the structural allegations. Of the $2 million in alleged damages, $1.6 million related to a cracked concrete floor. The client had insisted on a maintenance-free, crack-proof floor. There was no documentation in the architect’s file informing the client that this was not feasible. The cost of the arbitration was prohibitive. The arbitrators would meet for two weeks and then recess for four months. After three sessions, although less than 50% complete, the architect had already spent $163,000 in expenses and estimated paying an additional $70,000 before the end of the hearings. Because the arbitrators seemed to have difficulty understanding the differences between the duty of care owed by a design professional as compared to the liability of a contractor, a decision was made to settle the claim for $350,000. The architect then had to negotiate with the uninsured structural engineer. After filing a lawsuit and spending another $44,000 in expenses, the architect finally reached a settlement with the engineer more than two years later. The engineer agreed to pay $25,000 plus ten annual payments of $10,000 for a total contribution of $125,000.

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RISK MANAGEMENT GUIDANCE

Consultant selection, and the professional services consultants provide, are important considerations in managing the risks of any project. Consultants play a vital role in the success or failure of a project, and prime design professionals need to be aware of their vicarious liability exposure.

When selecting consultants, consideration should be given to:

• availability of qualified consultants;

• past experience with a consultant;

• consultant’s reputation;

• adequate insurance;

• ability to meet project constraints;

• compatible systems between the consultant and prime design professional; and

• client-selected and client-controlled consultants.

More information on factors to consider when evaluating consultants can be found on page 48 .

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As the graph below indicates, when looking at a group of construction contractors and other construction- related entities as claimants, the general contractor was responsible for 68.1% of claims against design professionals and specialty contractors accounted for 22.3% of the claims against design professionals. ... the general contractor was responsible for 68.1% of claims against design professionals and specialty contractors ... Although the design professional has no direct say in the selection of the contractor in a design-bid-build situation, the design professional can provide information about contractors to the client. The information the design professional provides can help the client make an informed decision and select the most qualified contractor for the project. A qualified contractor performing construction can be a significant risk management factor. For design-build projects where the design professional has been retained by a design-build contractor, design professionals should look at the factors related to contractors, but also at the factors related to client evaluation since the design-build contractor is the design professional’s client. Victor has additional resources available related to design-build risks . Contractor According to Victor program statistics, the general contractor was responsible for bringing 8.4% of all claims directly against design professionals from 2010 through 2019. However, there were other design entities that made a claim against the design professional, including subcontractors, speciality contractors, and design-build contractors.

Contractor as Claimant: Claims by Frequency (2010 - 2019)

9.0%

General Contractor Specialty Contractor Design-build Contractor

0.7%

22.3%

Agency CM

68.1%

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