Project loss insurance: Timely innovation in the face of economic uncertainty
The construction sector is amongst the riskiest sectors of the economy. Every project is unique, and these unique attributes make it very difficult for construction stakeholders to gain certainty around performance.
Design errors, bid errors, workmanship errors, unforeseen ground conditions, poor worker productivity and unpredictable weather conditions are just a few of the litany of risks faced by those in construction. Each of the industry’s risks can be managed using risk controls (engineered, contractual, operational, and technological) and a good portion can be transferred to risk finance capital like the insurance sector (property, liability, design, subcontractor/supplier failure, environmental, weather).
When it comes to risk finance or insurance, most reading this article have likely experienced an increase in your insurance costs as the insurance sector is experiencing what we in the biz call a “hard market.” Basically, the insurance sector has not been as profitable as they would like due increased losses and uncertain investment returns. As a result, they have to increase their premiums and restrict capacity. Thus, the ability to transfer risk to risk finance capital has become more difficult, leaving contractors with additional exposure to their balance sheet.
Thankfully some insurers have decided to work with the construction sector to design products that not only provide more coverage for the risks faced by the industry, but offer the construction sector access to improved risk controls (as required by the policies) to prevent and mitigate the risks covered under their policies.
One of those progressive insurers is Travelers and they are bringing to market an elegantly designed insurance solution called Project Loss Insurance, or PLI. It covers risks such as bad estimates, poor productivity, subcontractor failure/default, delay damages, price escalation, weather related delays and manufacturer/supplier failure (many of the top risks referenced above). This offering is a great compliment to the traditional suite of insurance used on a project (property damage, project delay costs due to property damage event, liability, design or professional errors, subcontractor failure, and environmental events). It is important to understand that PLI is intended to cover those losses that are not insured under other policies, so care needs to be taken to identify the cause of loss when making claims against your PLI and the other insurance coverage you have.
It is also worth noting that PLI does have significant retentions (deductibles and co-insurance), thus it is for catastrophic project losses. These retentions act as the contractor’s “skin in the game,” which ensures the alignment of the contractor (the insured) with the insurer (Travelers). This “skin in the game” ensures the contractor will adhere to those risk controls that prevent and mitigate the risks covered under the policy.
It truly is a more elegant insurance design, as it creates a partnership between the insured and the insurer whereby they are constantly seeking to find new ways to prevent and mitigate the risks covered under the policy as they will both benefit from not having these risks manifest on their projects. Further, by categorizing or classifying the risks by type, within the policy, PLI allows for more precise implementation of risk controls, thus improving the efficacy of the risk control prescriptions.
We have seen this design before with the Subcontractor Default Insurance (SDI) offering brought forward by Zurich Insurance and later adopted by several other insurers. SDI significantly improved the operational practices and tools that were put in place to prevent the risk of subcontractor/supplier failure and it was the very large retentions that drove the contractor to adopt these best practices.
Given this thoughtful combination of coverage and access to best-in-class risk controls, it would make sense for all eligible contractors to investigate this offering. You should catalogue your inventory of risk controls before applying to ensure you obtain optimal terms and conditions. A good risk advisor, in products of this nature, should be able to help you benchmark your operational practices and technology solutions to determine if you are ready for a solution like PLI. Such a pre-vetting of operational practices and tools would include looking at:
- Go or no-go protocols
- Escalation and sign-off protocols
- Scheduling best practices
- Internal/external peer review practices
- Design/subcontractor/supplier pre-qualification practices
- Bid levelling practices
- QA/QC practices
- Safety practices
- Project closeout practices
- Contractual practices
- Insurance program review
- Technology stack review
It is great to see an insurer taking the lead on developing an innovative solution that not only offers a great suite of coverage but helps to make the construction sector better at managing risk.
David Bowcott is Global Director — Growth, Innovation & Insight, Global Construction and Infrastructure Group at Aon Risk
This column first appeared in the October 2020 edition of On-Site. Click here to read through the whole issue.