Building defects and insurance - what is the potential impact?

Building defects are a common challenge in the strata industry - particularly in new builds - and their severity can vary significantly, as can their impact on insurance coverage.

According to research by UNSW’s City Futures Research Centre ^1. , a substantial percentage of owners’ corporations have identified major defects in their buildings. The 2023 Strata Defects Survey reported that 53% of buildings in the survey have had serious defects in common property, increasing from 39% in 2021. 

Recognising the importance of addressing these issues, let's delve into how defects influence insurance coverage and availability, particularly in the realm of strata insurance.

What are common building defects?

Building defects encompass a range of issues, from minor cosmetic imperfections to major structural concerns. 

Some examples of major defects could include:

• Structural integrity issues 
• Compromised or insufficient fire protection
• Waterproofing
• Roof/rainwater disposal
• Safety hazards
• Electrical/mechanical/ventilation

Did you know that waterproofing and fire safety systems remain the most prevalent of defects, accounting for 42% and 24% of all defects respectively in 2023.

What does an insurer consider when assessing a building and whether any building defects will be covered by insurance?

Generally speaking, most insurance contracts have exclusions relating to defects, whether known or concealed. However, a proactive approach to rectifying defects is crucial for maximising the chances of obtaining insurance coverage and mitigating the risk of claim denials due to unaddressed defects and/or issues due to lack of maintenance.

Insurance coverage for buildings with defects varies between insurers. When it comes to CHU’s process of assessing a building with defects, it is contingent upon factors such as (but not limited to):

• Severity of the defects: to assess whether defects are minor cosmetic issues or pose major safety concerns, impacting coverage decisions
• Age of the building: Distinguishing between new builds and older structures is crucial, as it could indicate a lack of maintenance
• Legal actions: Ongoing legal disputes with builders and plans for future legal action may impact decisions regarding coverage
• Remedial works: Formal plans and the attitude and proactiveness by owners to rectify defects play a significant role in CHU’s review

Did you know that the proportion of serious defects that were reported to the regulator in 2023 has more than doubled since the 2021 survey. 34% of buildings with serious defects reported them to the regulator in 2023, compared to 15% in 2021.

Let’s go into a little more detail around two key areas that impact the underwriting assessment.

Severity of defects  

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

Minor 

Minor defects that remain unaddressed have the ability to turn into major defects therefore we still expect the insured to have an action plan in place. Minor defects may still impact the premium and/or a change in the excess.

Examples:

• Non-structural/hairline 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: Issues identified that can affect the structural integrity of the building such as basement cracking or others 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 and 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, failed or complete lack of balcony waterproofing, inadequate guttering/downpipes or leaking shower bases, etc.

Severe

This is when the defects create such a significant exposure that any premium loading or high excess structure would be 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.

What information is required to evaluate defects?

To evaluate defects effectively, insurers require comprehensive information, including:

• Professional dilapidation reports detailing the extent and severity of defects commissioned by the insured if not available or recent enough to meet the insurer’s criteria.
• Building contracts outlining remedial works and associated costs will need to be provided
• Minutes of Body Corporate meetings documenting decisions regarding defect rectification, contextual discussions around the issues, funding arrangements etc.
• Specific details about the defect/s, its impact, and proposed remedies from industry experts or repairers.

Please download the Defect and cladding supplementary information PDF here.

In conclusion, addressing building defects proactively is essential for maximising insurance coverage and availability and minimising financial risks. By providing thorough information and taking decisive action, owners can navigate the complexities of insuring buildings with defects effectively.

Does your building have defects and you’re not sure if it will be covered by insurance? Reach out to our expert team today to have a chat about your liability and risk.

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.