Construction Insurance:
Bridging Theory & Practice in Project Risks
Managing project insurance requires analysis of the
risks associated with a project and understanding of various insurance
protections available to mitigate such risks. Large projects which
involve civil, electrical or mechanical works always entail special
handling of risks and while onsite safety and health issues are the
prerogative of a vertical domain expert, other risk management
exercise including transfer of risk through insurance fall under the
purview of the risk manager. Contractors’ All Risks Insurance,
Erection All Risks, Contractors’ Plant & Machinery, Delay in Start up,
Decennial Liability, Professional Indemnity and Project Cargo
Insurance are some of the many protection available which must to be
used in combination with one another to manage such risks. The risk
manager is always faced with difficult choices; which insurance
policies, what coverage, what limits, what deductibles and the dilemma
continue.
Construction projects like any other risks require a
balance of risk control and risk financing as part of ongoing risk
management exercise. Feasible options under risk control technique are
loss prevention, loss reduction and risk transfer. Loss prevention
requires adequate safety measures to be kept in place so that losses
can be prevented from happening in the first place. Losses however do
occur despite best loss prevention measures in place and therefore
loss reduction techniques are applied in order to mitigate the losses
after it happens,. Another way to control the risk is to contractually
transfer the risk to a third party, e.g. a subcontractor or other
parties to the contract.
Risk
Management Techniques in Construction Risks
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Risk financing on the other hand deals with
situations when losses need to be absorbed or appropriated between the
parties contractually responsible for the risk. The owner or principal
of a project may decide to retain the risk and finance the losses
through either on-balance sheet or off-balance sheet provisions.
Alternatively, he may transfer the risk to an insurance company.
Normally, a prudent risk financing programme requires a mix of risk
transfer to an insurer coupled with certain amount of retention.
Identifying Risks
There are four main parties to a construction
project; (a) Project Owner (b) Main Contractor & subcontractors (c)
Architects, Engineers & Designers and (d) Banks and Lenders. All the
stakeholders have different interests in the projects and accordingly
the risk profile varies.
Parties
to a Construction Project
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Project owners run the potential risk of losing
investment if a major peril strikes. They are also faced with the
risks of consequential losses due to the delay in start up and
inherent defects in the structure which may cause losses to the
owners. They may however transfer the risk to the main contractor. The
main contractor and its subcontractors are then not only susceptible
to the losses arising out of risk transfer from the owners but also
have to live with the risks of material damage to works, principal’s
existing property and surrounding third party property. They are
further exposed to the loss of their own manpower due to death or
bodily injury to workmen and liability exposures from the third
parties.
Architects, engineers and designers form the third
block in the risk distribution matrix for a construction project. They
may be held liable for defective design, professional negligence and
errors and omissions in the conduct of their duty. Some of the risks
mainly arising out of professional negligence that architects,
designers and engineers face may not be the subject matter of
contractors’ all risks insurance but can be covered under a separate
professional indemnity insurance. Banks as lenders are faced with the
asset risks with the current magnitude of construction projects posing
serious problems in the event of a misjudgement in lending. Though,
expertise of the main contractor, his financial standing and track
record are taken into account while financing a mega construction
project, there could still be exposures such as market risks and
industry risks.
Components of Project Insurance
Project insurance for large construction risks
requires risk treatment on an end-to-end basis. This starts with
identification of risks followed by evaluation of various insurance
alternatives available and culminates in taking out the suitable
insurance covers with relevant and appropriate conditions and
extensions.
Components of Project Insurance
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A typical Contractors’ All Risks insurance or
Erection All Risks Insurance covers material damage to the works or
the machinery being erected and includes coverage for third party
liability for bodily injury or property damage to the surrounding
property. The policy can be extended to include consequential losses
or losses due to delay in start up following loss or damage under
material damage section. This cover is also called advanced loss of
profit. Contractors’ Plant and Equipment insurance pays for the loss
or damage to the equipments at site which are owned by the contractors
and are used as a tool for the construction work.
Professional Indemnity insurance covers errors and
omissions and professional negligence on the part of architects,
designers and engineers who may be held liable for losses due to bad
design or incorrect professional advice. Inherent Defects insurance or
Decennial Liability insurance generally protects the owners against
losses due to the threat of imminent collapse of the structure and
includes debris removal, costs related to remedial measures and legal
expenses.
Project Cargo insurance is another area which
requires expertise and skilled attention as such cargoes are generally
bulky, extremely expensive and crucial to the works being undertaken.
Any loss or damage to such cargo may result in the delay in project
completion and further consequential losses. Workmen’s compensation
insurance pays for the death or bodily injury to the personnel
employed at site. Motor fleet for the construction work should not
only have comprehensive insurance but should also pick up losses on
road as well as off road.
Key Issues in Project Insurance
There are several issues which need to be
considered while negotiating insurance for large projects and are as
follows:
1.
Sum Insured should be adequately
calculated and must include at least the contract value, contractors’
plant and machinery, principal’s existing property, projected cost of
debris removal, temporary facilities, value added tax and a provision
for inflation. To make sure that on site as well as offsite storage
facilities are included in the policy. Free issue materials should
also be included in case the principal transfers the risk to the
contractor under the contract.
2.
Limit for third party liability should
be adequate and should clearly reflect the risks. This should be
determined keeping in mind the value of the surrounding property and
distance from the nearest third party property. In case of underground
works, losses to the public utility infrastructure must be kept in
mind.
3.
In case the contractor has an annual
CPM policy (contractors’ plant & equipment); the TPL at site extension
must be endorsed to the policy. Further, the CPM policy must be
insured at values equivalent to the replacement cost.
4.
Whether incidental inland transit
between offsite storage and project site has been insured.
5.
The project plan must consider weather
conditions and open trench works must be avoided during rainy or
monsoon seasons. Sometimes, insurers put warranties to this effect.
6.
Professional Indemnity insurance must
address retroactive date clause and should reflect the risks and
requirements of the architects, designers and engineers. In addition
to the claims made or claims occurrence clauses, extended reporting
clause must be thoroughly discussed with the insurer. Project specific
PI cover is generally not preferred by the insurers and tends to be
expensive; therefore annual cover should be sought.
7.
Project Cargo should be insured on a
warehouse to warehouse basis while negotiating the deal with the
exporter. In the event, the main cargo policy expires at the port, the
transit from the port to the warehouse is considered as tail-end risk
and is not considered to be a preferred risk from the insurers point
of view.
Finally
Fortuitous losses can’t be eliminated but can be
managed by the combination of risk control and risk financing
techniques and therefore a sound insurance programme for large
construction projects are integral to any project planning exercise.
Large projects require meticulous planning and so do project
insurance. Good project insurance not only finances the risk but also
helps to implement safety rules at work place. Overall, it is a
win-win situation for all: project owners, contractors &
sub-contractors, architects and lenders; it’s good for the economy
too.
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