Risk: Project-Specific Insurances
March 1, 2015 by DAVID BOWCOTT
How much is enough when it comes to choosing the limits of insurance and performance security for your project? I am asked this question almost on a daily basis – usually, as it pertains to a specific cover used on a project.
We are talking about possible events in the future and events that could have catastrophic consequences. How much is enough usually comes down to the risk appetites of the key project participants: the owner; the lenders; the contractor(s); and the design firms. Sometimes, stakeholders outside this core group – such as regulators or neighbours to the project – have an influence on the chosen project limits.
Besides the risk appetite of the participants, the nature and location of the project itself influences choices. For instance, is it a straightforward project with little rip-and-tear risk, or is it a complex project where the asset being built houses a process with output thresholds that must be met? Is the project sitting in the middle of a high-risk earthquake zone? The nature and location of the project have a significant impact on the choices of limit.
Both factors are driven strongly by information – that is to say, data regarding things that have gone wrong on previous projects. Primarily, it is experience, or the data provided from experience, that drive these factors. You must have accurate and fulsome data to ensure that you are making the right choices when setting project limits. With the right data, your perception of risk is in line with reality and you have done adequate due diligence to ensure the right choices.
Next, we can discuss the actual core project policies for which limits have to be set. We can also discuss some standard project benchmarks in the current marketplace.
Let’s use a hypothetical $300-million hospital project in Toronto to set our limits.
• Builder’s Risk Insurance (property insurance during construction): Limits for builder’s risk tend to be to the full value of the asset at completion of project. In some cases, due to the size or nature of the project, key stakeholders agree to take limits less than the full value of the asset. Usually, this is done in conjunction with a probable maximum-loss study that shows the key stakeholders that their maximum exposure is actually less than the full value of the asset. Think of a road that stretches for 50 km. and consider the chances that the entire road might be destroyed, and you get the idea how PML studies work.
• Wrap-up General Liability (liability insurance for third-party bodily injury or property damage during construction and in the completed operations phase): A key driver of the wrap-up limit is the location of the project. The greater the exposure to third parties (e.g. in downtown Toronto), the greater the chance there could be a significant liability event. The current market usually looks for limits between $50 million to $100 million for an asset of this type.
• Professional Liability (liability insurance for errors and omission by professionals on the project – namely, design): There are many techniques used to set professional limits for projects, Some make little sense, like setting limits based on level of design fees. Either way, limits for an asset of this nature tend to come in between $10 million to $25 million.
• Pollution Liability (liability insurance for environmental events on the project – unknown and exacerbation of existing conditions): Limits for an asset of this nature tend to fall in the range of $10 to $15 million and can be significantly influenced by the location.
• Prime Contractor Performance Security: The nature of the security on a project of this nature changes, depending on the delivery model being used and the stakeholders that have influence. We usually see the following instruments used to secure prime contractor performance: performance bond (usually 50 per cent of CV); the new liquid-performance bond and/or letter of credit (usually 10 per cent of CV); and a parental guarantee.
• Subcontractor Performance Security: Once again, this depends on delivery model being used and stakeholders involved. We tend to see: subcontractor default insurance (usually the per loss limit is set between 20 per cent to 50 per cent of the largest subcontractor and aggregate is 20 per cent to 50 per cent of CV); performance bond (again usually 50 per cent) or potential use of liquid performance bond; and/or parental guarantee.
These limits are by no means etched in stone. They vary, based on the stakeholders involved, the risk appetite for those stakeholders and, of course, the nature and location of the asset itself.
It is vital that you examine the underlying covers and endorsements for each of these insurance lines, to ensure that you are getting the coverage you expect as well as the latest technology available in the marketplace for those covers. There are some truly great coverage add-ons and/or coverage integration that could significantly improve your project’s risk profile. Further, there are some exotic covers making their way to the marketplace and these solutions are beginning to take on risks previously seen as being uninsurable.
Good luck and happy limit setting!
David Bowcott is senior vice-president, national director of Large/Strategic Accounts at AON Reed Stenhouse Inc.
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