Construction

Portfolios for operational PFI are becoming increasingly popular, and the reasons aren't hard to work out - mostly, it's about cost but there are other advantages in terms of risk management and sustainability in the long term.

How do portfolios work?

Clearly, management of the cost of insurance over the period of a project is the key driver behind establishing a portfolio- thereby ensuring that the project remains viable and stakeholder value is maintained. More to the point, companies that bid for new projects and don't have an operational portfolio will be at a severe cost disadvantage when competing against other bidders that do.

The premium savings come from the power of bulk buying. On its own, a single project will be priced on what insurers refer to as a 'technical underwriting rate'. But with a portfolio, spread of risk presented allows underwriters to view their risk on a burning cost (premium volume versus claims) basis and thus justify significant discounts.

A portfolio can be created with 2 or more projects but the larger the portfolio the greater its ability to:
• deliver sizeable initial premium savings
• deliver stabilised pricing over the period of the project
• provide insulation against poor claims experience
• increase market competition including where there has historically been limited appetite e.g. schools, roads and prisons

Golden Rules

Control
• For a portfolio to work effectively there needs to be a dedicated person or executive body within the sponsor company to ensure stability and for the broker to discuss strategic issues such as the renewal of the insurances.
• Day to day issues can be dealt with either directly with the project or via a central point of contact at the sponsor company. In the former case it is important that the broker keeps the entity informed of issues affecting the portfolio. From the dozen or so portfolios we have been involved in it is not possible to apply one solution across the board.
• It is essential that the role and scope of work of the broker is fully communicated and understood. We expect further complexities of insuring operational projects to come to light exemplified by the current focus on premium sharing arrangements; and the broker world needs to ensure that its service delivery model is robust enough to deal with the demands.

Future proof
• Insurers' interests should be fully aligned with full visibility of and support for the types of projects the portfolio anticipates including
• Price is important but stakeholders should take into account long term stability and risk management

Tread carefully
Some Insurers would arguably not thank JLT for our central role in summoning the storm of intense competition that portfolios have generated; and the new landscape has created its own challenges for buyers of PFI insurance.

My advice generally, is to tread carefully. There are some schemes that look to act like a properly structured portfolio and although there is some merit behind these arrangements a project stakeholder needs to ensure that their own best interests are being protected. A stakeholder with 2 or more projects may be better served by establishing their own portfolio.

The Civil Engineering Contractors Association Accident Statistics Report for 2009, published recently, reveals a 66 per cent reduction in fatal injuries in the year 08/09. Fatal injuries fell from 4.4 per 100,000 workers in 2008 to 1.7 per 100,000 workers in 2009. Major injuries fell by 15 per cent from 220 per 100,000 workers to 188 per 100,000 workers over the same time period and the rate of 'over 3-day injuries' fell by 3 per cent.

Civil engineering is of course but one sector within the overall construction industry. Generally our clients buy their EL across the entire business so a reduction in one sector may well be countered by other activities in the business, which may, for example, include Facility Management which has of course its own EL challenges. Further, it is not unusual to have a particularly large claim which can easily skew an experience over and above a slight reduction in reported accidents.

Considering fatalities in particular, according to Health and Safety Executive statistics, there were 41 fatal injuries over the whole UK construction industry in 2009/10 (2 per 100,000). This represents a reduction of 37% when compared against the average 3.2 per 100,000 for the previous five years. Clearly the industry is making good headway in improving the historically poor construction related statistics using more and more initiatives to keep up the momentum.

Although a reducing accident rate is good for the overall experience the actual cost of claims is increasing. Increasing claims costs can in some cases counteract the effect of any reduction in the accident rate leaving base EL rates generally stable. Full and proper information gathering at the time of an accident can mitigate claims costs substantially. Main Contractors should also use best efforts to ensure their subcontractors, as well as having robust Health and Safety systems, are suitably insured to minimise the potential of the Main Contractor collecting claims under their own Public Liability (PL) policies.

With a Cyber Risk seminar taking place on 15 July at JLT, I found myself wondering "is cyber risk is really an issue for Building Contractors?"

I can see how it makes sense for banks and IT companies to insure against Cyber Risks as they have potential loss of revenue, profit, increased working costs and even potential liability losses to protect but do contractors face the same types of exposure? Is it worth them buying insurance to cover this type of risk?

Indeed, have construction companies even had time to give this exposure their full attention? 

These days, Contractors rely less on paper and more on technology to run their business, and as IT improvements increase so do exposures that are often not insured under their traditional insurance programmes.

What would the cost implications be if...
- A virus deleted all of the site data? Including drawings and calculations? 
- Or if all of the Employee data was posted on a public forum

Protection: I have a Fire Wall! And you have Employees...
All big companies have Fire Walls in place; however Employees sit inside the firewall... and that's where the problem lies. 

Whether malicious or accidental people make mistakes. Professional Indemnity will cover errors or omissions in the performance of a professional duty.  But if an employee deliberately plants a virus on your system and the result is your site (or many sites) are shut down for days, this would not be covered by PI. 

But, would the delay it be covered by your Property/BI?
Maybe not...  Also, there is no theft, so there would be no cover under a Fidelity Policy.

Under the Cyber Insurance, this is an insurable risk.  So the question is, should contractors be buying this cover?  How would shareholders react if a multi-million pound loss was insurable, but not insured and worse still... the cover was not even investigated?  Are construction companies not concerned about this type of exposure, or are they just not aware it exists?

Some key issues will be investigated at the JLT Cyber Seminar on 15 July.  It will also look at risk management methods for cyber exposure as well as the insurance solutions. 

I would be really interested to hear what your view on this exposure is for the Construction Industry.  Share them by posting a response to this blog or if you'd rather remain anonymous email me and in a few weeks I will post up the responses along with some of the interesting detail that came out of our Cyber Seminar.

The race is on in the UK for councils to implement 'waste to energy' schemes. This year is the first deadline for EU Landfill Directive targets aimed at reducing biodegradable municipal waste and the UK is way behind.

When bidding for projects the costs of insurance remain a risk in themselves.

Fixing a price for insurance 2-3 years before construction commences brings risks, as you don't want the cost of insurance eating away at your margin once the project is operational.

The 6 key ways to manage your risk on insurance cost for your Waste to Energy Project Finance Initiatives (PFI) are:

- Ensure you have a robust premium sharing agreement that reflects market changes within the market that you will be using.

- Review and identify all factors that could affect the costs.

- Nail down your risk management and address key areas of concern to Insurers.

- Have an open dialogue on insurance with the Authority and agree at what point insurance costs should be fixed.

- Consider whether savings can be made an operational premiums by including it in a PFI portfolio with a range of other PFI projects.

- Factor in the insurance market cycle by having a good understanding of its current stage and knowledge of the potential variance.

The more information provided to the broker and the more experience the broker has within the sector, the better they will be able to understand the project and get it priced effectively.

This is just one of the issues explored in this month's PFI Bulletin: Waste to Energy, PFI in 2010. Here, I review the main risk management and insurance challenges facing those involved in PFI Waste to Energy projects. Please click here to read more.

The sense of dread hanging over the UK Construction Market before this week's emergency budget seems to have receded somewhat.  Projects worth several billions of pounds have made it over this first hurdle and the 1% increase in Insurance Premium Tax could have been considerably worse. 

Over £7 billion of spending on construction projects was approved last week following the review of projects award between January 2010 and the May General Election including:

- 7 Building Schools for the Future projects
- 3 major hospital projects
- £5.67bn of transport spending including the recently closed Birmingham Highways
- Projects and the proposed Tyne and Wear Metro Project.

Although Contractors are now looking for clarity on which projects are going to be pushed through first, they are also keeping a wary eye on the Autumn spending review which may crystallise some of the current uncertainty.

The rise in IPT in the June 22nd Budget has been long foreseen by insurance brokers, but has been an awful long time coming - the last increase we saw was as far back as 1999! However, our new rate of 6%, effective next January, is still far less than our European counterparts, where rates are often equivalent to VAT levels.

Although the increase comes into effect in January 2011, the impact on instalments and extensions on existing project policies will fall within the anti-forestalling measures under the Finance Act 1994. However, more importantly, the answers to the impact will depend on how the insurer's accounts for the premiums.

Insurers may use either:

1. the cash receipt method of accounting - in which case the new rates will take effect for premiums received on or after 4 January 2011; or
2. the special accounting scheme - in which case the new rate will apply to premiums written in their (i.e. the insurers) books on or after 4 January 2011.

Notwithstanding this, the anti-forestalling measures (which were included in FA 1994) to cover increases in rates may apply such that certain premiums received between the date of the announcement (22 June) and the date of change may be subject to an increased rate.
 
The key factor, on the tax treatment will be dependent on how the insurer accounts for the premium, so it is important that clients obtain their own independent tax advice in this regard if they are concerned with the proposal from insurers.

In relation to PPP projects, the increase in IPT has a couple of obvious implications:

- Current bids will need to take into account the higher rate - projects already at preferred or   selected bidder phase may need to swallow the increase as the insurance costs are normally set before this stage unless the project company can demonstrate that there is significant project change or project delay.

- Existing Projects will need to pay more in terms of overall premium

It is this point where our clients need to consider the effect of any insurance premium risk sharing schedule (IPRSS) in their contracts. The later versions of the IPRSS, for example in the SOPC4 drafting exclude the effect of IPT entirely, leaving this increase as a pure Project Company risk, but earlier versions put in place post 2001 in many cases incorporated the total cost of premiums inclusive of IPT. In even earlier projects, there was complete pass through of premiums in certain cases. 

Clearly on projects closed under the current SOPC4 guidelines, increased IPT will result in an additional cost to the project Company that is not recoverable under contract, and it is for this and other unforeseen matters that an adequate insurance contingency should be considered for any project.

In conclusion whilst more recent projects will get no relief for the IPT increases due in the future, we recommend reviewing the IPRSS in all contracts to understand whether any premiums can be reclaimed and for any project contingency to consider the effects of future IPT increases.

So the fear factor built into many of the construction related pre-budget announcements seem to more about expectation management than reality, however contractors will be still waiting for the projects to be awarded and closed before breathing a full sign of relief.

A new development in the UK/Europe

The economic recession has placed many contractors in a precarious position with their subcontractors. This issue has been highlighted in the UK which has seen a steady increase in awareness of Subguard over the last 18 months. Subguard protects Main Contractors against subcontractor default, and it is important to understand that the default is not just restricted to insolvency.  Performance, quality and programme issues are also covered.

Many contractors view Subguard as an alternative to subcontract bonds. A bond will typically provide protection up to 10% of the subcontract value.  This is low level protection and will be of little comfort when faced with a substantial default. There are substantial retentions, such as £1M per loss, but the indemnity available in excess of this figure can be as much as £25M.

The difference is clear.  For a comparable cost the Main Contractor is purchasing a substantial level of protection for a catastrophic loss, which is not available utilising bonds. In fact the bond amount could be viewed as protecting the manageable or attritional default cost.

Subguard also comes with other benefits, such as transferability to the Building Contract Employers, who will benefit from the policy in the event of a Main Contractor insolvency.  It is for this reason, tied to the six year period of cover post completion, that it has sparked interest with property developers in the UK.  The policy could effectively provide a form of latent defects insurance in the event that the Main Contractor and its supply chain were to become insolvent.

In order to qualify for the Subguard programme the Main Contractor must conduct a stringent due diligence of subcontract procurement processes and this also provides some independent validation of risk management standards in its supply chain management.
The benefits of Subguard are clear as it provides:

• Greater cover than bonds and at a similar price.
• A long period of cover.
• Transferability

However it is only available from Zurich and the product will need to meet strict due diligence criteria.

Awareness amongst employers means that Subguard is gaining traction in the UK market.  It seems that Subguard is here to stay so Main Contractors would do well to explore it!

For more details on Subguard or to see if you can purchase this cover please contact David Cahill.

Liquidated Damages (LDs) also referred to as Liquidated and Ascertained Damages (LADs) are utilised to provide a pre-determined indemnity to principals for delays in project completion.

LDs are legally required to be a genuine pre-estimate of loss and legally cannot be punitive in nature.

Typically LDs are requested by lenders and generally reflect the debt service associated with a project. Equally, contractors often use LDs as a contractual way of capping their liabilities for consequential financial loss.

Delays for force majeure provide contractual extensions of time for Contractors and are deemed to be delay risk assumed by the employer. Some force majeure risks are obviously insurable under an advanced loss of profits policy, however it should be noted that force majeure risks of a non-damage nature are typically uninsurable in the insurance market.

Is LD insurance available and is it worth buying? Moreover, can it be acquired for non-damage delay or failure to meet performance criteria?

It is an extremely small insurance market, with Zurich being one of the recognised leaders. Typically, LD insurers like projects which have at least 30 days float for every 12 months of project period. Excesses of between 30-60 days are normally required.

Policies can be purchased either on a single project basis or as an annual facility covering all projects. Premium rates are between 5%-8% of the sum insured and the policy form will be bespoke and tailored to mirror the contractual LD provisions.

Insurance contracts are written subject to due diligence, which is performed on the adequacy of the construction programme. The due diligence costs are sometimes paid up-front by the insured and this can be up to USD50,000.

So yes you can insure your LAD exposure but:
1. You need good detailed information on your company's exposure.
2. It's not going to be cheap
3. It's not going to be a quick policy to place

If you want to know more, or want to investigate if you can insure your LAD exposures please contact me.

Give me a call to discuss further.

Andrew Harrison-Sleap

It looks as though European style Public Private Partnerships are slowly on their way to the US. Like many countries the US is facing the classic problem of the urgent need for infrastructure renewal combined with gaps in public funding.

The latest Infra-Americas P3 Conference in the US reported that Government entities are increasingly facing budget shortfalls with limited options to close the gap. In fact, 48 States are facing projected budget shortfalls in 2011 and 2012, with a USD180bn deficit projected for 2011.

With limited options, P3s and asset monetisations are now gaining political acceptance, with stakeholder buy-in and investor confidence. It's been slow going, but the concept is finally starting to gain traction: 24 States have P3 legislation, and 17 transactions have closed, with a further 18 transactions in process.

One big change is that while infrastructure as an asset class is still deemed an attractive investment class, more attention is now being paid to asset characteristic - in other words things like essential service, stable cash flows etc., as opposed to the type of asset (airport, parking, utility etc).

It's pretty clear that funding for P3s and asset monetisations is more readily available today than it was 18 months ago, but syndication is now a requirement with dedicated investment funds. It is worth noting that the larger, more sophisticated, pension funds are also now becoming important players.

It seems to me that virtually all kinds of infrastructure projects are potential P3s - at the moment, it seems as though large toll roads and parking asset monetisations are the most popular, with airport terminal upgrades/replacements now also gaining momentum.

If you want to know best ways to deal with the different risks on P3 projects click here.

I've just returned from the Arabian Power & Water Summit (held in Abu Dhabi 29 - 31 March, 2010) and wanted to share with you my thoughts coming out of this event.  The conference was well attended with over 200 delegates, really good numbers for an event of this type in the Middle East when you consider the current economic climate.  It was interesting that the Alternative Energy Forum Day that kicked off the summit was attended by just over 50, and a number of these were journalists - is this some indication that the main focus in the Gulf is still on conventional power generation?  After the event my colleagues and I sat down and we've come up with what we consider to be the five main issues that stood out at the conference:

1. A continuing and rising demand for power and water in the GCC region for the foreseeable future.
2. Concern regarding availability of gas supplies as feedstock, and the consideration of alternative, readily available fuel supplies. 
3. The opportunities and challenges of a GCC wide power distribution grid.
4. The current method of contracting, and whether that model was sound and if it should remain.  Interestingly there was a "split jury" amongst the panel discussing this (comprising Developers, Contractors and OEMs) where some felt that the current EPC model (one head to pat, one backside to kick, high risk/reward for the main contractor) had served the region and many Independent Water and Power Projects (I(W)PP) well, whereas others were more in favour of more risk staying with the Developer or State.
5. A concern that Lenders were still staying on the sidelines, or in some cases had disappeared altogether (up to recently, RBS had been a leading lender in the region for I(W)PP but are now totally out of this area).  Without project finance, I(W)PP don't get built.

Do you agree that these are the five big risk issues for Middle East Power and Water Projects or would you have others on your list? I'd be really interested in hearing your thoughts and any comments you might like to make.

In the USA, Green Building is taking off.

What's Driving Green Building?

- Unprecedented level of government initiatives
- Heightened residential demand for green construction
- Improvements in sustainable materials

In comparison to the average commercial building:

- Green buildings consume 26% less energy
- Green buildings have 13% lower maintenance costs
- Green buildings have 27% higher occupant satisfaction
- Green buildings have 33% less greenhouse gas emissions

The value of green building construction in the USA (both non-residential and residential) will be circa $60 billion in 2010 and is likely to increase up to $140 billion by 2013.
(stats provided by US Green Building Council)