‘Latent Defect’ Exclusion in Property All Risks Insurance

As property underwriters, we should know each and every exclusion items on property all risks insurance wording, one of which would be discussed in this article is what we call as “latent defect” (also known as “inherent defects” or “structural defects”) exclusion.

We can find this exclusion in the Special Exclusion on Material Damage Section point 2.5 of Munich-Re Property All Risks wording. It clearly mentioned and declared that “the insurers shall not be liable for loss, destruction of or damage to the property insured directly or indirectly caused by or arising out of or aggravated by all gradually operating causes, including but not limited to wear and tear, rust, corrosion, mildew, mould, fungus, wet or dry rot, gradual deterioration, latent defect, inherent vice, slowly developing deformation or distortion, insect larvae or vermin of any kind, microbes of any kind, unless sudden and unforeseen physical loss destruction or damage ensues, in which case Insurers’ liability shall be limited to such ensuing loss damage or destruction…”.

Nowadays, one of us, may still confused with the word of “latent defect”. What is the proper definition of “latent defect” which also called as “inherent defects” or “structural defects” ?. According to Wikipedia : in the law of the sale of property (both real estate and personal property or chattels), a latent defect is “a fault in the property that could not have been discovered by a reasonably thorough inspection before the sale”.

Under the general law of the sale of property, the seller should let the buyer beware to inspect the product would be purchased. But there was often not sufficient for a buyer to detect any damages or deficiencies of the product since need special inspection such as destructive testing or other means. In another hand, at common law, there is no automatic right for a buyer to sue the seller for any latent defects discovered when there is no an agreement in the buy and sell contract.

To prevent such buyer from suffering a loss due to latent defect, they can be protected by special insurance product named “latent defect insurance”. So, latent defects insurance can be defined as a type of insurance product covering buildings or other objects against loss or damage caused by defective design, bad workmanship, and poor materials used when the building or other objects are in the course of construction.

“The property coverage doesn’t insure against loss caused by, resulting from, contributed to, aggravated by inherent vice, latent defect, wear and tear, marring and scratching, gradual deterioration, …, unless loss by a peril not otherwise excluded ensues and then the company shall be liable only for such ensuing loss…”

Perils excluded section of the Acme's policy

An example of “latent defect” claim on property insurance can be found in Acme Galvanizing Co., Inc. v. Fireman’s Fund Insurance Co., (1990). Acme Galvanizing has a steel kettle which was insured under an All Risk Commercial Insurance Policy issued by Fireman’s Fund Insurance Co. One day, the steel kettle at Acme plant ruptured, resulting several tons of molten zinc to spill onto surrounding equipment. Acme then submitted an insurance claim to Fireman’s Fund Insurance Co. (as the insurer) but denied based on the ground that the loss was not caused by an external cause, but a latent defect or inherent vice that was excluded in the policy exclusions.

In the investigation report, the expert said that the kettle failure was principally due to poor welding techniques. So, it concluded that the inadequate weld seam was an internal characteristic of the kettle which wasn’t readily detectable upon reasonable inspection and could only be found after destructive testing was performed.

Latent Defect Insurance

Latent defect insurance (LDI) is a type of insurance that provides cover for the cost of remedying and rectifying damage arising out of latent or inherent defects in design, workmanship, or material, which undiscovered at the date of practical completion.

An indemnity is provided in respect of the costs incurred up to the total sum insured (commonly the full reinstatement value of the building) and the period of cover is usually available for 10 (ten) to 12 (twelve) years from the date of practical completion. Once a latent defect insurance policy has been issued, it can’t be cancelled.

Not like property all risks insurance which latent defect was excluded, in the latent defect insurance, when a claim occurred, the insurer need not prove there was a negligence on building architect or design engineer or the building contractor is in breach of contract. The source of damage can be faulted by defective design, bad workmanship, inadequate supervision or site preparation, or poor materials used in the building construction.

Coverage of latent defect insurance can also be extended to indemnify for loss of profit and loss of rent as a consequential loss caused by a latent defect, increased cost of working from alternative premises, damage to mechanical and electrical services, etc.

This insurance can be purchased by property owners, tenants, or contractors. So, this insurance will be useful for those parties who own or lease the building as a commercial business because they may be faced with serious financial problems upon discovering a defect in its building. Some insurers also now tend to offer latent defects insurance for projects retaining existing buildings and for existing buildings including some cover for non-structural components.

For the main consideration in the underwriting process, the insurers or underwriters must ensure that the final building is fit and appropriate with the specification and building design provided, also the materials used are of a good quality and the building was constructed by proper method. To meet these requirements, the insurers need to hire a specialized person (i.e civil engineer and architect) who know the technical aspects of building design and construction, able to check the quality of materials used, and regularly monitor the process of construction from the beginning to the end.

Latent defect

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