Chris Davies, director of Prescott Jones Property and Construction Risks, part of the Prescott Jones Insurance Group explains how to satisfying lenders’ insurance requirements
One of the less reported effects of the global financial crisis is the rising influence banks have on the construction sector as they press for extra layers of financial protection.
Traditionally, the only extra insurance policy needed by contractors would have been the old JCT 21.2.1, more recently known as the 6.5.1 policy that provides protection against loss, claims or proceedings due to non-negligent damage to property.
Below I have examined a selection of typical insurance requirements, but it is important to recognise that each contract and each lender’s terms will require a tailored solution. Put simply, specialist advice on the right protection has never been so important as without it, the consequences can be costly.
Professional Indemnity (PI) insurance is now commonly required for anyone acting as a main contractor, even where all design work is being sub contracted to an architect. Lenders rarely accept the argument that design work is being sub contracted. They require the main contractor, all consultants and key bona fide subcontractors to have their own Professional Indemnity insurance. This means, if any company goes bankrupt, they have options against the others should subsequent problems in the building arise.
As one-off project PI is not generally available, a contractor will have to budget for six years (UK Limitation period) or twelve years (where collateral warranty is required), although there is benefit in the legal cover it provides when a claim needs to be defended. In addition, some insurers provide a free collateral warranty checking service.
Contaminated land policies cover unexpected and fortuitous losses arising from historical contamination. This means land has to be analysed and remediated if necessary. Policies typically cover injury and property damage, cleaning costs and fees. Lenders are usually also looking for loss of rental income and policies are typically issued for single periods of insurance up to ten years.
A standard public liability policy covers pollution that can be identified as a sudden specific event, for example, a tank bursting. However, where pollution occurs gradually over a period of time, for instance, a slow drip from a supply pipe connecting to the tank, it is specifically excluded. Consequently, there are a number of policies available that cover gradual pollution which are more focused on contractors’ environmental exposures.
Contractors All Risks
Normally the principal contractor covers the new build structure throughout the lifetime of the contract until practical completion and handover to the employer.
It was common under the JCT Contract Form for cover to be required in joint names of the contractor and employer. However, lenders now typically want their interest to be noted by way of a Joint Insured, Co-Insured or Composite Insured endorsement. They also often require to be made “First Loss Payee”.
Whilst there may be no cost implications, there is a significant amount of compromising between lenders, solicitors and insurance companies until an agreement can be reached.
Delay In Start Up
In the event of major damage to the Contract Works, prior to Practical Completion, the repair/re-build will inevitably delay handover. The income that the building was going to generate, by rent for example, may be delayed by a month or even up to two years.
It would be typical to cover lost rent or additional finance costs and have an indemnity period reflecting the rebuild time in a worst-case scenario.
It is very difficult for developers to source cover separately from the Contract Works as quickly restoring damage reduces unnecessary delays therefore, typically, the same insurer has to be involved i.e. the Contractors Insurer.
There is currently a huge demand for performance bonds, which have been around for a long time.
Bonds are typically valued at 10% of the contract and given in favour of the employer, providing a financial buffer to complete a project where the original contractor defaults.
They are typically available from banks and insurance companies, however insurance market bonds are favoured where use of a bank bond would severly deplete the contractor’s working capital. However, there are certain classes of bonds e.g. “On Demand” bonds that insurers will not underwrite.
The cost and availability of insurance sector bonds is dependent upon the financial strength of the contractor. Premiums also depend upon the duration for which the bond remains in force. This is normally tied to the contract period with release of the bond on practical completion of the contract.
Unexpected Archaeological Insurance
Still in its infancy, employers and funders increasingly demand this.
The UK has a huge, undiscovered archaeological heritage that is protected by several pieces of legislation aimed at protecting and preserving it.
Contractors and developers can and have been badly caught out when archaeological finds have been made on the contract site. For instance, the discovery of archaeological finds at a major road scheme in Northern Ireland in 2007 resulted in costly delays and financial expenditure for parties involved.
The key to the cover is contained in the word “unexpected”. A policy would be available following evaluation of the site by means of a desk study and possibly field investigations.
A typical policy would cover cancellation or delay, extra archaeological costs; redesign costs and loss of profit or value.