Building defects and insurance - what is the potential impact?

Defects are common in the building industry, particularly in new builds, but the severity can vary greatly and so can the impact on insurance cover. According to UNSW’s City Futures Research Centre, 75 per cent to 85 per cent of owners’ corporations have identified major defects in their buildings¹.

Nearly all insurance contracts have exclusions relating to defects, both known and hidden. So how do defects potentially affect the insurance of a particular building?

A proactive approach in rectifying any defects is beneficial for all parties involved. This will maximise insurance coverage and avoid the risk of a claim denial due to defects or defective parts.

It is important to be aware of the risks associated with defects as it may compromise the safety of the building. For an owner, it may have personal financial implications and potential exposure to legal action.The cost and type of insurance cover available for a building with defects will vary between insurers and their underwriting guidelines for defects. Generally, an insurer will consider a number of factors, including:

Severity of the defects 

• Are the defects cosmetic in nature or do they create a safety issue of potential injury or loss of life?
• Is the defect minor, major or virtually uninsurable?

Age of the building

• Is it a new build or existing/older building?

Legal action

• Is there a current legal dispute with the builder about rectification of defects?
• What is the potential or plan to take legal action in future?

Remedial works

• Are formal plans and timelines in place for rectification?
• Do owners have a proactive approach to fixing the defect or are they inactive?

So what information is required to evaluate defects? 

There are a number of sources of valuable information to determine the extent and severity of the defect and to decide the insurance cover available, such as:

Professional reports

These include:

• A builder’s scope of works to rectify the defects
• Engineer’s reports or similar 

Building contracts

If a building contract exists, it will provide details on the work required to rectify the defect and the value of remedial works. The contract value of works is also important as most insurance policies have exclusions for building works exceeding a certain value (often over $500,000)

Minutes of Body Corporate meetings

The minutes of a body corporate/strata meeting are useful to determine:

• if the owners have resolved to appoint a contractor to carry out remedial works
• the date for commencement of works and/or
• to confirm if Special Levies have been raised to fund the work.

Sometimes minutes of a meeting can provide evidence of inaction from the body corporate such as a resolution to appoint engineer and/or builder to inspect or rectify defects being defeated.

Delving deeper into some important factors that may affect insurance of the building… 

Severity of defects  

An underwriter needs to evaluate the severity of defects and decide on which course of action is appropriate:

Minor 

These defects would often be ‘noted’ on the policy record without any increase in premium or change in the excess. They are common or cosmetic in nature and don’t increase the chance of a property or liability claim.

Examples:

• Non-structural/hair line cracks
• Drummy/loose tiles that have not lifted and are not in common or high pedestrian traffic areas like walkways or stairwells.
• Minor & short-term efflorescence – the process where moisture moves through a masonry, leaving a white staining effect on the outer surface

Major 

These defects are more serious in nature and significantly increase the insurer’s exposure to property and/or liability claims. The body corporate’s attitude to remedial action and actions taken to repair/make safe is important in the decision to insure or not.Insurance may be offered but with an increased premium and a higher than standard excess applied. 

Some examples of major defects could include:

• Structural issues
• Items identified as requiring remedial action within the next couple of years such as concrete cancer in balconies or suspended footbridges, unstable retaining or boundary walls, sagging roofs, etc.
• Fire defects that exacerbate the spread of fire and compromise life safety, such as faulty fire dampers, unsealed penetrations horizontally and vertically between different living spaces, faulty fire suppression systems, such as sprinklers.
• Balcony or roof top balustrading – Balustrading may be unsafe due to gradual deterioration or poor workmanship. In older buildings, remedial works may have to include new balustrading installed to comply with current building codes.
• Water penetration – resulting from failed roof membranes or leaking shower bases, etc.

Very severe

This is when the defects create such a significant exposure and a premium loading or high excess structure are deemed insufficient to cover the risk.It is often described as a ‘hard to place risk’, where a standard strata insurance policy is not appropriate and special insurance terms are required as the potential exposure is too significant.

An example of a hard to place risk could be a building with a number of major defects, including structural elements that may lead to imminent collapse of building components, combined with a body corporate who are inactive in rectifying the defects.  

Age of the building  

There are valid reasons why there is differentiation between new builds and existing/older buildings and how this will influence the cover, premium and excess offered.

Some circumstances unique to new builds may include:

• A body corporate may be more inclined to rectify defects given the defect warranty period that applies under legislation and the legal avenues to get the builder/developer to pay (note warranty periods and times to lodge legal action vary between states and territories).
• Poor maintenance is rarely an issue as the building is new, so defects are more likely associated with poor workmanship rather than wear and tear.

Conversely, some circumstances more in keeping with existing builds may include:

• A body corporate may delay works as statutory warranty periods have long expired and, therefore, all costs associated with rectification are to be borne by all lot owners.
• A lack of general maintenance has led to gradual deterioration of the building, leading to rotting timbers and potential concrete spalling due to steel elements being exposed to long-term water ingress.
• Key building components reaching the end of their serviceable life, such as waterproofing membranes, roof structures, etc.

The important thing for a building with defects is to provide as much information as possible to achieve the best insurance outcome based on their specific circumstances.

CHU Underwriting Agencies

^1.  UNSW’s City Futures Research Centre, 2018, Defects in Strata: Research Overview

Important note:CHU Underwriting Agencies Pty Ltd (ABN 18 001 580 070, AFS Licence No: 243261) acts under a binding authority as agent of the insurer QBE Insurance (Australia) Limited (ABN 78 003 191 035, AFS Licence No: 239545). Any advice in this article is general advice only and has been prepared without taking into account your objectives, financial situation or needs.