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Principal arranged contract works insurance can help retain critical cover

Published 22 March 2022

The construction industry is under enormous pressure. Supply chain delays, shortages in experienced staff, coupled with rising inflation, are making it difficult for projects to remain on time and on budget. Insurance has an important role to play in enabling large project developers to balance their risks.

Recently the Australian construction industry has been rocked by news of major contractors in financial crisis. These circumstances have had a ripple effect downstream and on to others such as subcontractors and suppliers.

This raises a difficult question for construction project developers/principals, when a head contractor is selected how much control do they want to maintain over elements of the project? One of these elements is the insurance requirements. 

Developments can take years of preparation. Selection of the correct site, development of an acceptable development application in conjunction with the right financing for the project. One of the key decisions is the selection of the head contractor and the type contract under which they will execute the build. 

The insurance arrangements required under these contracts can vary, and different aspects of the insurance program can be arranged by either party, in particular the contract works insurance policy aspect of the construction project.
 

Construction principals relying on head contractor to arrange contract works insurance

In the past the contract works insurance market has been extremely competitive due to an excess of capacity, which has been reflected in competitive pricing of insurance premiums. But the capacity in the insurer market has since reduced, pricing has increased and insurers are no longer willing to provide the broad coverage it has in previous years. 

Historically principals have tended to allow the head contractor to arrange the contract works insurance policy. The contractor market was relatively stable and insurers were able to provide a competitive pricing outcome. 

Principals completed a thorough tender, narrowed down the list of prospective head contractors and checked their capabilities, reputation, financials, past experience and expertise before handing on responsibility.


Questions arising from contractor arranged contract works cover

When a major builder in Australia calls in administrators sites are locked up, subcontractors turned away and the principals are left to work with the banks to figure out what to do. 

One of the first questions asked is if there is a major storm, earthquake or other catastrophic event is ‒ is the project covered by insurance, in particular contract works insurance? 

Where the head contractor has arranged the contract works insurance policy for the project the principal is reliant on their insurance arrangements to provide coverage ‒ but this may not be possible. 

The policy may not provide coverage for cessation of works under these circumstances, or if it does it might be limited to only a 15 or 30 days’ extension to cover. What then? 

If the contractor has failed to pay the insurance premium will the insurers walk away? If the policy is paid will administrators cancel the insurance and seek a refund? What about current outs
tanding claims, will they be paid?  
 

Contract works insurance considerations for developers 

These are all difficult questions to deal with, especially if the head contractor is under administration and no longer able to continue on with the project. For the principal the project needs to be completed to meet financial commitments to the banks and other investors. 

The preferable option for the principal would be to appoint a new head contractor to take control of the project and of the insurance requirements of the site as soon as possible. 

The problem is that it’s not that simple. Insurers may not agree to the same cover as previously undertaken by the previous head contractor, pricing may change and the policy terms and conditions might not be as favourable. Unfortunately this is a reality in these circumstances.
 

Alternative solutions to contract works cover issues via principal arranged insurance (PAI)

Principals do have a choice in avoiding some of these issues. At the time of entering into the contract with the head contractor the principal can insist on executing elements of the insurance program for the project, in particular the contract works insurance. 

The principal can organise this principal arranged insurance (PAI) contract works insurance policy and design it in such way that it meets their own requirements and those of the contract. The PAI contract works insurance policy avoids the need for the head contractor to purchase a contract works insurance policy on behalf of the principal, which will provide savings for the contractor on their project costs which benefit the principal.

With the principal undertaking the PAI, if the head contractor is unable to continue with the project (if they go insolvent, for example) there are time provisions clauses written into the PAI contract works insurance policy that allow the insurance coverage to continue during the extended cessation of works period and allow an interval for the appointment of a new head contractor.

The PAI contract works policy undertaken by the developer maintains insurance coverage for the works already completed and future works yet to be completed. Current and future claims are honoured based on the pre-agreed policy terms and conditions that continue to apply during a period of interruption.
The arrangement of PAI by a principal may not be suitable for some projects where the contractor arranged method is preferable, but it is a choice available to the principal.

Our Gallagher construction insurance experts encourage project principals to explore the options that best fit their requirements or circumstances for each project from a risk management and financial perspective.      
 

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Gallagher provides insurance, risk management and benefits consulting services for clients in response to both known and unknown risk exposures. When providing analysis and recommendations regarding potential insurance coverage, potential claims and/or operational strategy in response to national emergencies (including health crises), we do so from an insurance and/or risk management perspective.
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