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Australia: Is latent defects insurance a 'game changer' for the construction industry?

A look into the policy and potential benefits for developers, builders and owners
05 Apr 2023    3 minute read

In brief

In light of NSW's efforts to reform the building industry, the introduction of latent defects insurance (LDI) (also termed decennial defects insurance), presents a possible solution to decreasing consumer confidence in builders.1 Recently introduced in Australia by Resilience Insurance and with other insurers soon likely to offer competing policies, LDI insures property owners against structural defects for 10 years post building completion. Whilst still a relatively new product in Australia, Resilience reports that large developers/builders have already begun to utilise the product, especially as a sales incentive to potential buyers. 

Contents

Key takeaways

LDI aims to offer consumer protection by providing consumers with the ability to claim the costs of defect rectification of structural defects on a first resort basis. The main points to note are:

  • Structural defects are defined under the policy to include defects attributable to design, planning, specification, workmanship or materials, including failures of waterproofing.
  • Whilst currently marketed towards residential buildings, LDI is appropriate for any building that falls within classes 2-9, inclusive, of the National Construction Code. This includes, inter alia, shops, carparks and hospitals.2
  • LDI must be taken out by either the developer or builder before construction starts, as the insurance effectively follows the whole project lifecycle and includes a complete examination of plans, specifications and other documentation, as well as periodic inspections through to certification of Practical Completion. This is intended to prevent the occurrence of structural defects in the first place. The costs of these inspections are additional to the premium paid for LDI.
  • The 10-year insurance period begins at practical completion when the Certificate of Practical Completion is issued under the building contract. The benefits under the policy transfer from the developer to the consumer when ownership of the building is transferred. This process happens automatically.
  • LDI is proposed as an alternative to "strata bonds" calculated at 2% of the construction cost that developers must currently lodge in NSW for two years post-completion. LDI is marketed as a benefit to the consumers in this respect, as the policy extends for eight more years than covered by the bond. The benefits are even greater for consumers outside NSW, where developers are not required to provide strata bonds at all, meaning consumers are left without any security for structural defects.
  • Costs associated with LDI generally range from 1.3-1.6% (inclusive of the costs of the inspections mentioned above) of the construction contract price. Notably, the premium cost of LDI is effectively less than that of strata bonds, which are required for 2% of the contract price.
  • LDI does not extinguish the consumer's rights to litigate, but largely puts the risk of litigation onto the insurer, which can choose to bring downstream claims to recoup its costs if commercially viable. This benefits consumers who are not in a position to/cannot commence litigation.3

Next steps

  • NSW was the first State to legislate with respect to LDI. This was done through the Building and Other Fair Trading Legislation Amendment Bill 2022 (NSW), which was passed on 8 November 2022. The legislation provides that developers of multi-storey apartment buildings (class 2 buildings) may obtain LDI in lieu of the current strata bond scheme to insure against serious defects in the building elements of the common property of 1 or more buildings in the scheme. As defined in the Strata Schemes Development Act 2015 No 51, common property means 'any part of a parcel that is not comprised in a lot' and for the purposes of LDI includes structure, waterproofing, fire safety systems, enclosures and building services. Whether other States will follow with similar legislation is yet to be confirmed.
  • As LDI becomes adopted more widely, it will be interesting to see whether developers and builders seek to use the existence of LDI coverage as a 'seal of approval' when selling buildings, intended to provide reassurance to purchasers.
  • Additionally, will the construction market see a gap open up between those developers and builders unable to obtain LDI policies due to claims history or insurer due diligence and those which can offer such cover to property owners?

The authors gratefully acknowledge the help of Olivia Bisset in preparing this client alert.

1 As shown in the McCrindle report commissioned by the NSW Government, only 3 out of 10 consumers are confident in purchasing medium to high-density properties, with 64% of respondents having concerns that properties may have defects.
2 QBCC, (2021): Building classes—Building Codes of Australia | Queensland Building and Construction Commission (qbcc.qld.gov.au)
 Note if the developer is dissolved, builders themselves are generally not liable to subsequent owners for defects as per Brookfield Multiplex Ltd v Owners Corporation Strata Plan 61288 [2014] HCA 36.

 

Contact Information
Alex Hartmann
Partner
Sydney
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alex.hartmann@bakermckenzie.com
Leigh Duthie
Partner
Brisbane
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leigh.duthie@bakermckenzie.com

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