Latent Defects Insurance (LDI) is also known as Decennial Strata Insurance. It is common in several
overseas countries, such as France and Sweden, where the residential construction and development
sector is dominated by large corporates akin to our Lend Lease and Stocklands.

LDI is now being promoted in Australia as an alternative to the NSW Strata Building Bond and
(Defects) Inspection Scheme, commonly known as the SBBIS. To help funnel developers into the
new scheme, the Building Commissioner has recently increased the SBBIS bond from 2% to 3% of
development costs.

To learn more about the SBBIS, please see: In JP’s Kitchen — LINK Commercial Mortgages (linkcm.com.au) and
download the detailed discussion paper to learn more about how it works.

LDI is being touted by a small, closed group of property industry pundits as a lower cost and game
changing alternative to the SBBIS. The LDI push has not so far demonstrated transparency and this
raises several concerns, some of which are outlined below.

LDI is promoted as a product that provides purchasers of residential strata units with a ten year
(hence, “decennial”) warranty against defects in their apartment and the building or structure of which
their apartment is a component.

In simple terms, the developer purchases an LDI policy prior to the commencement of the construction
of a Class-2 building with the view that the building and the future owners of apartments within the
building are protected against defects.

The fact is that LDI addresses major defects, of which there are four categories:
a. Water ingress
b. Wet area water proofing
c. Fire risk
d. Structural defects (within the superstructure)

Reading between the lines, these first two points of concern come to mind:

1. Any other category of defect is not covered, for example, should cracks appear in an internal
wall of an apartment, the rectification of these will not be covered by LDI
2. In the case of a qualifying defect, one may anticipate push-back from the LDI provider, which
is an insurance company – insurance companies are the most profitable businesses in the
world, they are experts in the assessment and pricing of risk as well as in the avoiding or
minimising exposure to risk and the payment of insurance claims.

The SBBIS on the other hand does cover minor defects as well as major defects. Industry research
shows that the majority of defects in a residential strata building are minor defects, ie; the occurrence
of minor defects is significantly more common than is the occurrence of major defects, refer to the
research by Deakin University: Examining-Building-Defects-Research-Report.pdf (griffith.edu.au) para 2.3.2.

Proponents of the new LDI scheme purport that the costs of LDI cover are significantly less than the
cost of the SBBIS bond, and, that projects with LDI cover experience a ~5% increase in sales prices;
the developer advertises the units as being covered by the 10 year LDI to add appeal and increases
sales prices to try to recover some of the costs outlaid for LDI cover? Caveat Emptor !! …are the
purported benefits of LDI actually applicable to individual purchasers of units in a project?

The facts of the matter include that the:
▪ SBBIS bond is not a cost; rather, it is a bond that is fully refundable once the project has
been cleared of defects by the Department of Fair Trading’s Building Commissioner.

Also, the SBBIS bond is to be lodged with the Department of Fair Trading well after project
commencement, in fact within six (6) months of anticipated application for Occupation
Certificate, ie; at the tail end of the project.

As such, the SBBIS bond is usually covered in a project financier’s project funding allocation
so the developer is not out-of-pocket prior to project commencement.

▪ LDI scheme includes a doubling up of substantial professional fees and consultant costs at
the Construction Certificate stage, ie; prior to project funding being released, usually when
the developer is short of financial resources. Also, the cost of purchasing the LDI policy must
be met prior to commencement. These costs are not refundable.

Further consideration is required: prior to being eligible to purchase an LDI policy, the developer
must engage a closed, set group of consultants who duplicate the documentation process undertaken
by the developer’s own consultants as part of preparing for application for a Construction
Certificate…and the developer must pay full-freight consultants’ fees for both his and the insurer’s
consultants.

Payment of these costs, and paying for LDI cover, is at a time before project finance is made available
and may be bleeding developers at a cash flow critical stage of preparing for a project.

From the perspective of the writer, there is a limited benefit to individual unit purchasers and the
discussion is hence thrown open – should the reader have any comments or queries, please contact
the writer:

jpalouan@linkcm.com.au

Contact LINK today to find out more about our tier-1 institutional commercial / industrial property
investment finance and specialised project finance for any property transaction that you may be
considering.

Disclaimer

The information in this article is of a general nature and is not intended to address the circumstances of any particular individual or  entity. Although we endeavour to provide accurate and timely information, we do not guarantee that the information in this article is  accurate at the date it is received or that it will continue to be accurate in the future.