Project risks are often inadequately insured. The outcome is a disaster for those affected and a blow to the insurance industry's reputation. But this can be prevented.
Five tips on effectively insuring an infrastructure project
- Choose project-specific insurance.
- Combine the policies strategically to avoid overlaps and minimise gaps in cover.
- Insure against the common risk of design errors, for example with Specific Project Professional Indemnity insurance (SPPI).
- Insure your project against severe and catastrophic losses.
- Increase your deductible for small but frequent losses, but reduce their likelihood with effective risk management.
Infrastructure projects face a vast variety of risks
The spectrum of risks is broad. These can include political risks, construction, operations and maintenance, legal, contractual and financial risks, income projections and force majeure. How to manage this diversity? Individual risks should be borne by the party best placed to manage and mitigate them. To do this, all participants must first agree on how to allocate the various risks. N.B.: Risks should only be transferred to private investors where it is possible for them to control the risks or insure against them.
Once all parties have agreed on the risk distribution, a legal agreement or so-called Project Deed is drawn up. The disparity between minimum or benchmark insurance cover and an optimal solution that covers all risks under contract is often considerable.
The challenge for brokers is to transfer as much as possible of the risk assumed by the various project parties under the contract. In doing so, it is essential that brokers be aware of the breadth of insurance available for transfer of those risks. Price only plays a minor role, since the cost of the premium is generally trivial in proportion to the overall project costs.
And although the vast majority of risks are insurable, there can never be complete all-round protection. Nevertheless, insurance brokers can add value by minimising any gaps, by selecting appropriate project insurance and tailoring the coverage to fit the needs.
Project-specific insurance is the product of choice. When properly interpreted, it covers the risks that building owners, planners and contractors can incur during an infrastructure project. The participants basically buy a "set-and-forget" package, with the agreed cover known from the outset and a one-off premium paid before the project begins.
Adjust policies to causal relationships
If damage to the infrastructure or third parties occurs during construction, it is usually the result of a combination of many factors. The culprits are frequently defective design, materials or workmanship in any combination.
Available research, e.g.KPMG, Global Construction Survey 2003, shows that design errors account for over a third of all underperforming projects and over 40% of all losses in underground construction projects (study by the University of Hannover). Such risks should therefore be covered by every project insurance policy.
A Specific Project Professional Indemnity insurance (SPPI) policy would cover the loss to the extent that it arises from a failure in professional services causing the design defect, and the SPPI policy should include a ‘multiple causes’ trigger as a precondition. Otherwise, coverage could be contested.
The significance of an SPPI contract can also be seen when looking at the liability damage section of the Project Construction and Third Party Legal Liability policy (CAR/TPLL): this covers risk of loss and damage, as well as third-party injuries that are due to defective materials and poor workmanship – with the exception of gross negligence. This is because insurers expect building contractors to be competent, and to provide skilled resources with best industry practices that comply with all building code provisions. In addition, infrastructure projects also need to meet all specific contractually prescribed technical requirements.
Most CAR/TPLL policies therefore provide only limited cover against design errors, and apply exclusion clauses (Leg 2 or 3), so that the need for SPPI cover becomes all the more important. Even if some form of design cover is included in the CAR/TPLL, it may have a sub-limit. It is also unlikely to apply during the run-off period after defects maintenance, though most latent design defects manifest precisely during this phase.
Conclusion: In order to avoid redundancies and minimise gaps in cover, the various policies should complement each other. Ideally, the complete suite of insurance solutions for a project should be covered by the same insurer.
It pays to get more effective insurance cover
In some markets, Munich Re’s experts see project insurance coverage limits that bear little relation to the total project cost. Many decades of experience has led us to a guiding rule of thumb that a severe loss will cost a minimum of 10% of the total project value – with catastrophic losses costing significantly more.
Although severe or catastrophic insurance losses from major construction and infrastructure projects are infrequent, they have major consequences. The premium needs to reflect not only this exposure but also the lengthy cover period required (commonly up to ten years).
Saving on the premium does not pay if cover for severe or catastrophic losses is inadequate. On the other hand, large deductibles make more sense when dealing with frequency losses, though these smaller but more common losses should be mitigated through risk management.