Cost blowouts & contract traps: Keeping construction projects insurable

Hello and welcome to Insurance Business TV for our fourth and final construction insurance panel of the year. We're going to take a look at how brokers can handle cost blowouts, delays, and contract traps. This panel is sponsored by Hutch Underwriting and we're joined by their chief underwriting officer, Dominique Varghese, who's in Sydney. Hi Dominique, welcome to the panel. Hi Danny, thanks for having me today. Yeah good to have you on. And we have our veterans of course, Peter Jeeves, Head of Construction at Lockton, he's in Brisbane, and Austin Rosier, Principal Risk Advisor for OmniShore, he's there in Sydney. Welcome to you guys and thanks for coming back on. So let's start with Austin, what are you seeing as the biggest gap between what head contracts assume is covered by insurance and what contract works and liability policies actually respond to when projects blow out in time or cost? Yeah I mean this is a question that obviously varies quite significantly depending upon the business you're looking at. If you're looking at I guess a smaller business or a smaller contract it might be something that's much more standardized compared to something that say Peter might be looking at for a large civil contract which would be highly negotiated and often quite bespoke to that specific contract or agreement. And so I think for us a lot of the times we find a misunderstanding from clients as to what insurance covers full stop. So liquidated damages are obviously a really common issue in the instance of delays and that's obviously something that insurance won't normally be able to respond to and that can be a significant issue for a small business that might not have the funds ready or available to actually respond to some of these things and we obviously suggest that clients have their legal teams review these to make sure they're signing contracts they can actually honor should the worst thing happen. But I think the big thing that we find is timing issues that's probably the issue we run into most frequently at our size of the market. Once you get over that sort of 18 months, two years and really towards three years there can often be an assumption that coverage can continue indefinitely and a lot of the time under standard binder agreements with underwriting agencies and insurers within the market once they take over those longer time periods their binders simply can't accommodate some of these longer time periods and longer insurance periods. So we find clients might get to three years assume that they'll pay the same amount as they paid for the prior six months and all of a sudden they find out not only can they not afford the premium if it were to be offered but oftentimes the premium isn't available because the cover isn't once they take over that period of time. That's a really big concern and a really big issue when projects blow out in time in particular. Peter coming to you on the bigger projects what are your concerns here about any gaps you're seeing? Look most of the large sophisticated head contractors are generally aware of the coverage available under insurance and what's not available under insurance so from that perspective it's relatively clear but there are nuances in the policy wording and covers particularly around things like betterment or improvements to the construction post a claim arising where particularly where there's been a design issue or a workmanship issue and they need to improve the original construction. So that's an area in which we find challenges and look the other area is around monitoring time and cost under projects and ensuring that the projects continue to be covered in full under their existing insurance arrangements be under an annual floater policy or a project specific policy because policies will have limitations around escalation and how much the value of the project is allowed to increase by as well as time particularly under annual policies which will have generally have maximum construction periods and maximum defects liability periods that the policy needs to remain within and it's ensuring that the brokers and contractors keep on top of that and ensure that the policies continue to respond and be updated to reflect the requirements of the project is going to be critical moving forward. Thanks Peter and Dominique welcome again to the panel good to have you. You bring an insurer perspective to this what are your observations? I think the guys have commented really well they're on that need to keep the contract up to date for the insurance contract making sure that any of those projects that are extending out are still going to be covered. Austin specifically mentioned there that some agencies and even some insurers under their treaties would have period limitations that they can't just continue to extend but I think it's also really important just to mention that the build up of values on a project and when the delay occurs can also impact the cost of any additional premium following a delay so you know if there's a delay early on maybe they're delaying breaking ground because of getting equipment in or getting the staff on site or labor shortages etc it's a very different risk profile having a delay at the start of a project to having a delay at the end of a project when you're 80 90 percent completed you've got your values all fully exposed maybe on an engineering project you're in your testing commissioning phase and further delays there could see the additional premium not being at that pro rata that the contractor might expect but it's something like 250 percent of pro rata so it's not just about the ability to get that extension but also what the cost of that extension looks like. Dominique let's stick with you for our next question if a broker only has half an hour say to scan a construction contract before going to market what sorts of clauses or assumptions should they look out for that are most likely to create some sort of risk or problem? Sure well I think everyone's very busy and there's a lot of time pressures and you know your clients will be coming to brokers at the last minute with a contract and a large project and a sudden need for insurance that clearly couldn't have been foreseen earlier but it does leave people in a tight spot so absolutely you know with such a short time frame it's very hard to go through a full contract and looking clause by clause and absorbing and understanding the implications of clause in a contract so I think that it's a very good question helping brokers to hone in on the important areas there are a few areas to focus on the insurance clause obviously a obvious place to start but going through and identifying those contractual promises that are coming through in the contract that insurers don't actually underwrite that's where you're going to have that uninsured exposure so the reinstatement clause for example that's designed to require the contractor to reinstate the loss of works under the under contract so regardless of fault but often we're seeing written into there the requirement for existing structures or third-party property to be covered as well and that's not the intention of the construction contract works and construction liability policies the contract works insurance clause will also sometimes include a requirement that the policy should cover the principal's loss of revenue for any delays but that's really not something that should sit with the contractor that's then more of a principal controlled insurance policy the public liability insurance clause will occasionally be requesting for the principal or the head contractor to also be covered as named insureds under the insurance policy and that's not something that's easy to achieve generally in the market the professional indemnity was another one where the insurance clause will often require there to be cover on an unlimited or in the aggregate basis and that can be an issue for the professional indemnity space there's also occasionally clauses in there for the way in which claims will be settled and I think that's an important one just to call out you know generally that would be unacceptable to insurers you know they would be looking to settle claims in their usual manner and the contractors can't sign away the rights of the insurers there there was also item there that looking for the excesses where you've got a maximum excess allowable under the contract that's something that's you know very complicated if you've got a a large project or a complex project the insurance market might require higher excesses and it's something that the contractors might struggle to comply with under the contract but as I said I think the the gents who are reading contracts on a daily basis will potentially have some extra things to uh to outline there for us yeah definitely true so Austin as one of the gents on the panel you've got half an hour to scan a contract what do you look out for yeah I mean look I think as I touched on before one would hope the lawyers have had a look at it before us and I think something we often have to tell clients is we are not lawyers we cannot give legal advice and we can really only advise on the things that are obviously insurance related and obviously as Dominique said before I think principles joint insurers waiver of liabilities they're things that are quite common in the construction space and obviously can be cause for concern and oftentimes insurers are unwilling or unable to honor it and not without good reason a complete waiver of liability can obviously place a smaller insured in a pretty precarious position if they're finding themselves responsible for things that they weren't 100% responsible for and perhaps should be joint liability but I think something that we find quite common is just trying to understand I guess the overarching requirements of the contract is it a DNC contract does it therefore require additional scope of coverage because of the nature of contract that you have signed and then and then even looking further if you're looking at perhaps a head contract so principal insured program that can be really well and good but we have one that we actually reviewed a few weeks ago for a client where they were providing some landscaping services to a very large new apartment development and it was all well and good to have principal insured insurance in place but there was a $750,000 excess under that policy the value of works that they were doing was just shy of a million so for us we looked at it and said you know what guys you're actually going to be better off taking out your own insurance even though the insurance technically already applies because if you're at fault you simply cannot stomach a $750,000 excess and this is a business that's turning over four or five million dollars so it's sort of a quarter of their annual revenue on an excess so that's something to be mindful of that even when you might have insurance in place as well from a head contractor does that insurance actually practically cover you if you're then responsible for meeting the terms of it. Austin that $750,000 that was a good catch but Peter moving to you you're under time pressure no doubt what do you look for if you're pressed? Look I think being under pressure is the thing that you try and try to avoid when doing contract reviews I understand that we all have time pressures but it's in order to provide you know relevant advice we need to ensure that we have context around what the insurances are there to cover so it's important to take a step back look at the project that we're ensuring the relationship of the contracting parties the scope of works the location the contract value any unique project risks as a starting point in order to ensure that the insurance clauses and the indemnity clauses that we're referring Dominic and Austin referred to are relevant and appropriate for the risks that the project is addressing we often see requirements for insurances that don't reflect the risks that are being covered under the contract and it's important that we spell them out to the client and ensure that they've got information that supports any pushback that they have in terms of those contract reviews I won't delve into the detail of all of the clauses that have already been addressed because I think they've probably been addressed in detail but one of the key aspects for me is particularly with the larger and more bespoke contracts insurances and indemnities and risk allocation can fit within different parts of a contract can be in definitions within the clauses part of schedules and or the contract particulars and so control f is often my best friend finding parts within the contract very quickly to identify where those provisions sit and finding elements very quickly without having to read the whole contract so that's my recommendation control f. I think I'll just add one thing on the end there is that it seems like there are no standard contracts anymore at any stage I think you know you start looking in every project everything you look at there is something different so I think you know Peter's spot on there the control f and finding where things have been randomly moved because otherwise you can misinterpret the contract if you are just doing that skim overview and because there's no such thing as a standard contract anymore I don't think. And I'll add to that as well of a recent note was one of the largest I guess principal contractors in the country recently redid their subcontractor agreements and at the time we actually submitted it to our client's insurer and they go oh hang on this is brand new this has changed and that actually had to go all the way up to effectively the CEO of the organization because they had to rewrite all their sub or all their principal contractor specific endorsements for this particular business and it drastically changed some of the previous considerations that was quite an ordeal to actually get coverage for what seemed like a relatively innocuous project because of the fact this underlying subcontractor agreement had changed. That's a very good example and we're going to get into some nitty-gritty in our next question. Peter starting with you are you able to share an example keep names out of it if you have to where cost escalations or delays really led to a pretty serious coverage dispute and what do you think could have been done to avoid that at the beginning if it's possible to explain that? Look we've had lots of disputes in the construction space there's a construction is particularly unique in that the party that's fixing the damage is also the party that's continuing to build the works that are that ongoing which is unique in the construction space to so to be able to work out what is repair works and what are normal works or what are works to that relate to something completely irrelevant to the to the to the reinstate that is is key but examples often include particularly in the civil space where we've had embankments collapse and fall in and in those circumstances that under a contract works policy there is often coverage under the policy but the reinstatement is to the original slope of the embankment and the type of materials used in the original embankment but quite often that's not appropriate because the embankment collapse so what generally happens is the embankment has to be cut back even further it often includes additional materials and drainage to ensure that there is no further collapses and that type of betterment or improvement is not generally covered under contract works insurances and that's where you often get disputes because the contractor's already done the works and then after the fact comes to you with a big bill and says can you pay it and insurers will say no we're not paying for most of that and then the dispute is okay well what is going to be covered and what's not going to be covered so that that's just a typical example that where we see disputes in this space. What about you Dominique from the insurer's perspective what what disputes are you seeing if you've got an example you can share? We've definitely seen that same example of the embankments I think a few of those have happened over the years and it comes up as a an example regularly I don't have a particular additional example to add but I would say that one of the other challenges that you see with this is where there are delays to a project which are you know non-insured delays things like you know labour shortages or you know delay to start works and you have a slippage of the program prior to a claim occurring then you have an incident an insurable event perhaps the you know storm damage or whatever it might be then you have the delay due to the damages and unpicking the difference between those two can be really complicated so if a project hasn't been well monitored or the program isn't being regularly updated then you end up arguing about the program rather than about the coverage and that's the you know unpleasant place for everybody to be it can be very hard to prove things one way or the other so one of the things you asked for there Danny was you know what could be done differently and I think that that continuous monitoring of a program having your particularly on your larger projects you know organizing for your risk surveys making sure that you know everybody at all all parties are aligned on where the program is up to and having those regular check-in points when there is an event then it's much easier to be able to differentiate between those non-insured delays and the insured delays. And Austin coming to you what juicy coverage disputes have you seen and and what could have been done differently? Yeah probably one of the most interesting ones was was actually under PI so construction adjacent but a DNCPI policy where there was a dispute between the principal or sorry the I guess the owner of the of the work salesman owner this is on a residential project where a house is being built and effectively the homeowner wasn't happy with the quality of work that was being delivered and in doing so stopped paying the construction company. Now obviously the construction company if they're not being paid for the works they've done the materials that they've got they then couldn't meet their debts when they failed you. Really interestingly there was an insolvency clause quite a broad insolvency clause under this PI policy and effectively said if there is any actual or alleged failure of your debts to or ability to pay your debts then there'll be no cover available the policy will be null and void and this is a scenario where the client wasn't actually insolvent they just hadn't been paid for the works because there was a dispute with the property owner and they'd obviously had to communicate that to their trades and so in this PI claim we had to demonstrate to the insurer that the client wasn't actually insolvent they were perfectly able to meet their debts when they fell due it was only by virtue of having payment withheld on this specific project they obviously couldn't pass forward funds so that was a more a more unique scenario and quite an interesting dispute to work through with the claims team and understanding how the wording was intended to apply and off the back of that there's been learning for us where we're saying only an actual failure not an alleged failure or a more gray scenario like this we've I guess asked for redrafting of those insolvency exclusions under the PI policies but I think a far more standard one is sort of Dominique alluded to is really that failure to keep us updated and I think the two that we've most frequently run into are either sums insured exceeding like a binder capacity or the time period exceeding a binder capacity and I think that far and away is the thing we most frequently have issues with and you have clients that really can have quite significant issues and we did have a scenario where there was a claim that occurred after the three-year time period and we said to the client look we followed you up we asked you for the information we didn't receive it and the insurer wasn't able to maintain coverage after the fact and that was a bit of an interesting one where the client was put in a bit of a tough spot and had to unfortunately do some work out of pocket to rectify the situation. Well thank you for those examples and Austin let's stick with you for our last question I mean given ongoing rises in construction costs what levers as a broker do you think are the best ones to help keep projects bankable and insurable? Yeah look I think track record is incredibly important obviously that is partly claimed but increasingly so the ability to maintain a project on time and on budget and that's something that insurers really look at particularly on more complex projects they want to know that you've done something before that you've seen it before and then I think on any submission particularly those that are complex like for vanilla risks they're still relatively straightforward to get coverage for but anything complex we've really got to have really clear risk mitigation really clear and detailed information and then really clear and open communication with both the insurer and the client around expectations any foreseen changes or delays that might occur. I think communication is always going to win out when making sure that it's bankable and insurable then obviously the very typical levers you can pull like excesses and coverage limits and all that but I think communication still is going to get you the best outcome on all of those. Peter what about you what are your favourite levers? Well certainly yeah I think the fundamentals around insurance are key having a compelling underwriting submission with all the relevant information is going to get you the right insurance results at the end of the day but in terms of the bankability I just wanted to touch on the fact that you do see the insurance lens that lenders apply to different projects varies dramatically from not really having just requiring standard insurances through to having very bespoke and broad range of insurance solutions for larger projects and even to the point where they require insurance due diligence and reliance letters to be issued for very large projects and under those circumstances it's ensuring that you've got evidence that the insurances that are being procured are going to cover the insurable risks of the project and for that it's having all the evidence that you've gone through, analysed the insurable risks, analysed the maximum foreseeable losses under the projects and the limits are appropriate and reasonable given the market conditions at the time that's going to be critical to ensure that the banks and the lenders are comfortable with the insurance solutions that are supporting those projects moving forward. And Dominique coming to you as an underwriter what broker levers do you like to see being used? I think Peter and Austin both you know describe some very important things there that early communication providing the full details of the project to allow underwriters to do their underwriting that's really what underwriters want as well to understand the risk and build by the appropriate insurance as something that Austin mentioned specifically was track record so understanding what a client has been doing previously and their ability to meet their project deadlines and not be constantly coming back and blowing out on their periods all their maximum contract values that is really helpful because what we do see occasionally particularly at the smaller end is a rose-coloured glass as kind of a view where contractors will be declaring the lowest possible costs and the lowest possible periods often with the cost saving in mind but it actually then just increases the admin and increases the risk for them down the line of not maintaining appropriate insurance because then of course you need to be declaring those escalations in cost and period as well so I think that having that clear communication up front between the client the broker and insurer that's the way to get the best outcomes down the line. Thank you Dominique and thanks to Austin and Peter and especially for all your work on these construction panels this year and thank you for watching the Insurance Business TV. Bye for now.