Construction

The recent natural catastrophes in Japan, Australia, New Zealand and elsewhere make 2011 the second most expensive year on record for insured losses - about US$70bn so far, not including losses form the current floods in Thailand.

In addition, the "Arab Spring" unrest has caused political and commercial uncertainties in a number of countries in the Middle East, although fortunately for all our economies, the main oil and gas producing countries (Saudi Arabia, Qatar, UAE & Kuwait), continue "as is".

Against this background, one would be forgiven for assuming that insurance rates must be rising - but this is not the case.  Why is this?  When trying to understand complex business issues, I sometimes try to revert to fundamental and simple principals - in this case economics 101, where many of us will recall the concept of supply and demand curves.  There is still plenty of capacity with financially acceptable insurers, and in the case of construction, less demand for capacity due to the economic downturn, so supply remains high, demand low, so prices remain stable (and indeed are under pressure not to fall further!).  The main reason, IMHO that supply remains high is that interest rates remain low so the "wall of money" that theoretically travels the globe looking for the best returns available is not deserting insurance because right now there are few better options.  This does however suggest to me that this model is brittle, and could harden rather fast if interest rates increase, but that's another story!  At the recent Monte Carlo Reinsurance conference in September, major reinsurance players admitted that it's "business as usual" - capacity remains plentiful and may even be at record levels by the end of the year!!

Whilst we have seen a slowing down of conventional construction orders from the UK & USA, some countries continue to award new projects - JLT Specialty's London construction team has won and placed over US$60bn of new projects from Arabian Gulf states, Brazil and Colombia so far in 2011. 

Finally, I cannot comment of the state of the construction market without touching on P3's in the USA - I am always surprised how few P3 projects have commenced in the USA to date (I think less than 20?  Compare this to some 800 closed PFI projects in the UK to date) On paper, I always think that P3 projects should be taking off all over the USA, but there are so many political and legal issues to address and overcome.  I do wonder if P3's will, for the foreseeable future at least, always remain the "next big thing" for construction brokers and insurers?

IRMI CONFERENCE - San Diego 14 - 17 November, 2011

I will be attending this conference, along with my colleagues John Thompson and Jerry Osborne.  If you would like to meet for a coffee, please email me at Tony_Rastall@jltgroup.com.

To keep you up to date on the London construction market, here are a few key recent underwriter moves:

At the end of April, JLT's Nordic construction team featured in Post Magazine with a piece (insert link) revealing their experiences of helping the region's largest construction projects.

Since the mid 1990s, the Nordic region has become known for its ambitious and ground-breaking construction works. Iconic developments such as the Oresund Link built between Denmark and Sweden in 1996 have put the market on the map and now as it emerges from recession, the future for construction in Norway, Denmark, Sweden and Finland is looking bright.

With their economies recovering well and governments that are burdened less than other European nations by spending deficits, evidence of private sector confidence is returning. Firms such as NCC have posted consistent profits on the back of a healthy order book and key services are viewing opportunities with enthusiasm.

Having played a role on numerous infrastructure projects including Malmo's City Tunnel, the Copenhagen Metro and the Stockholm City Line there's a recognition that projects like this, as well as those in energy and utilities will continue to grow. Meanwhile, housing and commercial property markets are stabilising off the back of restored rental income levels, meaning that not only infrastructure projects are on the cards.

In anticipation of this JLT has invested in the future of the region, with the addition of experienced local practitioners Asa Berglund and Anders Lindberg at JLT Stockholm and the team has worked on an innovative package created for the new SEK15bn Karolinska Solna hospital, the very first public private partnership project in Sweden.

PPP projects act as a good barometer of trends in Nordic construction. With combined local and international expertise, interested parties are looking for help navigating through all of the contractual hurdles of this unique method of financing a build. For example, the needs of equity providers, public bodies and legal representatives have to be married up with local and international underwriting requirements across linguistic and cultural boundaries.

As it evolves and becomes more sophisticated from a construction and an insurance point of view, the Nordic region will continue to be fabled for its competitiveness. However, although highly self-sufficient markets with domestic finance a strong feature, the construction industry will always seek out long term partnerships and a commitment to innovate. Brokers that can provide such a promise will succeed and thrive.

Related Items:

Post Magazine - Post Europe: Nordic Construction

I came across the below online article recently and found it particularly interesting because most of us at one time or another have been involved in reinsuring captives - some of you will also be Owners or Managers of Captives. The article talks about the variety of issues that the reinsurance of captive insurers may present that are not usually present in the reinsurance of non-captive entities. I think this article raises more issues than it addresses, especially since (in the USA, at least) there appears to be a lack of Case Law to guide us.

I would be really interested to hear your views on this. Please do feel free to comment below or contact me directly.

Issues Arising from Reinsurance of Captives

The IRMI Conference is coming up again in November so I thought I'd reflect on the past 12 months and look forward to what lies ahead in the Construction industry.

It was one of the hot topics at our inaugural three day construction insurance "Boot Camp" in Chicago a couple of weeks ago.  This was the first time we'd taken our "Boot Camp" out of London and we were delighted with the response we've had to our week long training.  We're thankful to the speakers from Munich Re and Zachry Holdings who supported JLT experts in delivering such a quality programme.

I found that among the delegates the general consensus was that it's been an "interesting" year.  So far 2010 has been slower than 2009 business-wise, and who knows where the US economy is heading?  This is relevant to us all, because the USA economy is a global driving force.  Will there be a "double dip" or will there be green shoots showing by the beginning of 2011? 

In the UK, major project new starts are slow, and a number of new P3's (known as PFI's in the UK) have been cancelled or postponed.  There has been far less USA regeneration type projects coming to London for insurance than we had originally and perhaps naively hoped for.

The predicted boom in renewable power plant projects has yet to fully occur, but in the last three months we have bid on three monster nuclear projects around the world, the biggest coming in at a contract value of over USD 20bn! On the positive side, global construction insurance capacity remains plentiful and markets remain soft and receptive"

Where do you think the construction insurance market and/or the economy is heading?  I would be really interested in hearing your opinion, so either respond to this blog below, e-mail me or catch up with me and my colleagues at IRMI.  We are staying at the Peabody so look forward to the "Duck Show" but guess it will get old pretty soon! In any event, we look forward to seeing you in Orlando.

For further information on the IRMI event, please click below:
The JLT Team at IRMI

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.