Assessing the construction sector’s protection against pandemics
So what does this pandemic mean for the construction insurance market? And how can you protect your business from an uncertain future? David Lyle answers some of the most pressing questions.
What effect has Covid-19 had on the construction insurance market?
A survey conducted by constructiononline in 2020 with over 4,000 main contractors showed that 87% of businesses had been affected by Covid-19 and that 62% had to suspend operations due to the pandemic. The most cited reason for the suspension of operations was that the main contractor closed the site, followed by the project having been put on hold and the duty of care to protect staff. Of all contractors participating in the survey, 38% believed that they would face significant financial difficulties as a result of Covid-19.
Will my existing insurance cover my losses from Covid-19?
Unfortunately, only a fraction of the losses incurred by the construction sector are likely to be covered. We will now run through the main classes of insurance where there is a potential exposure and what cover there may be.
Delay in Start-Up/Loss of Anticipated Revenue
This cover may have included an infectious disease extension to
provide cover for the employer’s loss of rent/revenue/debt
finance if practical or sectional completion is delayed due
to an infectious disease (such as Covid-19). It is also worth
looking at whether there is a ‘denial of access’ extension on
the policy though unfortunately, in England these claims are unlikely to be successful as the government never actually enforced a shut-down on construction projects.
Third Party (Public) Liability
This provides cover for sums that the contractor is legally liable to pay arising out of third party injury, which may (depending on policy drafting) have included diseases. There is a potential exposure if a third party (which could include sub-contractors) contracted Covid-19 at the project site and the contractor did not take adequate precautions to protect them.
This covers sums arising out of injury which the employer is legally liable to pay. These may include disease to employees (including labour only sub-contractors). It is unclear as to whether a contractor would have legal liability if an employee contracted Covid-19 during their employment, though claims under this class are more likely to be successful than those under the third party liability policy. Claims resulting from stress and mental health issues as well as injury from home-working are probably more of a pressing risk to employers.
Professional Indemnity (PI)
This does not strictly cover Covid-19, but the pandemic brings increased exposure to construction PI insurers due to changes in working habits. For example, a reduction in the quality of advice or service or a lack of collaboration or supervision due to remote working or financial difficulties of a firm.
Directors and officers (D&O)
EY data shows that more FTSE-listed construction companies issued profit warnings in the first half of 2020 than over the whole of the 2008 global financial crisis. In addition, according to The Insolvency Service, Construction also holds the unenviable title of the industry most affected by insolvencies with 2,778 contractor insolvencies during the 12 months to June 2020 in the UK. With any insolvency, there is always the risk of action by affected shareholders bringing claims against Directors of a company as happened with Carillion following its demise in 2018. Whether the claim is successful or not is largely irrelevant as the majority of D&O claims costs relate to the defence of a claim rather than any actual payment to the claimant.
Property (business interruption)
A contractor may have a property policy covering its head office and satellite sites that includes business interruption (or more likely alternative accommodation) cover. However, even if this did have an infectious disease extension, this is unlikely to be any real benefit to contractors as in the majority of cases, these offices will not be revenue-generating. This is because revenue is coming from the construction sites and, as such, there is no (or limited) loss to insure.
The outbreak of Covid-19 has resulted in an increase in both the likelihood and impact of cyber-attacks. At home, employees do not have their colleagues around to sense-check an email, and many employees are distracted with additional care duties. Criminals are capitalising on this. This was recently highlighted when one of the US largest insurers suffered a sophisticated cyber security attack which caused a network disruption and impacted their systems, including corporate emails, for over a month. Luckily, they did have cyber insurance in place.
These are an effective way of protecting an employer against risks such as contractor insolvency. However, over the last 12 months, due to the increased potential risks due to Covid-19, buyers of surety bonds have faced increased underwriting scrutiny and selectivity so that this cover is now harder to obtain.
Costs have fallen as having fewer drivers on the road has led to a reduction in motor claims.
What can I do now to protect my business?
Progress any delay in start-up/loss of anticipated revenue claim (if the cover was in place and there was an infectious disease extension).
Unfortunately, the insurance industry has been quite slow to respond to these (and other business interruption) claims due largely to the magnitude and complexity of the losses. However, following the UK Supreme Court judgment on 15 January 2021 in the FCA vs Arch Insurance and others, we have seen some positive movement.
This case was primarily SME and property related (rather than construction) but the judgement has influenced the views of insurers on other similar forms of cover (such as construction delay in start-up) and we have seen payments being made under this form of cover.
Depending on the form of contract and drafting of this, contractors may have had contractual remedies/relief from liquidated damages (and possibly costs) associated with Covid-19 (e.g. under the JCT Force Majeure clause or FIDIC shortage of supply or prevention clause). This should be investigated.
Monitor interested parties and take protective measures
As mentioned earlier, it is more important than ever to monitor the interested parties in a contract, be that the contractor, supply chain or employer, so early warning can be flagged and protective measures can be taken. Considering the $25bn insured losses from Covid-19, it is also important to monitor the financial strength of your insurers; your broker should be doing this as a matter of course and flagging any potential issues.
Analyse your insurance cover
Breadth of cover will vary significantly depending on your policy, so detailed analysis of your specific terms and conditions is key. Below are some potential pitfalls to be aware of:
Extensions - With the majority of projects suffering from some sort of delay as a direct or indirect result of Covid-19, the extension provisions on project policies are key. Ideally, the policy will be written so extensions are automatic and the insurers are obliged to extend, however, it is not uncommon (especially on non-UK or Insurer worded [vs broker worded] policies) for extensions to be at the insurers gift. In these circumstances, insurers have been known to refuse to extend or impose restrictions on the cover which can cause major issues.
Mothballed/shut-down site – There may be a strict or implied requirement in a policy to notify if a site is shut-down for any length of time. Failure to follow this requirement may result in a loss not being covered.
Communicable disease exclusions – Most liability or revenue policies placed in the last 15 months are likely to have some sort of communicable disease exclusion. These exclusions vary. For example, in their rush to bring out an exclusion shortly after the first lockdown in the UK, one large industry body brought out an exclusion which, on its strict interpretation, could have excluded losses not arising from an infectious disease (e.g. a fire on a construction site caused by a lightning strike during a pandemic). A revised versions was subsequently brought out which is a lot better but as with everything in an insurance policy, care should be taken before a restriction is imposed.
Changes in working practice - The Covid-19 crisis has changed the way construction is undertaken, as firms adopt new working methods. Examples of this are the increased use of drones for surveys or increased use of off-site production and it is key to ensure that the insurance cover adequately deals with these exposures as many standard insurance policies will not.
What can I do to protect my business against future pandemics?
The question that has undoubtedly come up in every boardroom over the last twelve months is: “What can I be doing to protect my business against a future pandemic”? With communicable disease exclusions now common on most insurance policies (especially any covering revenue/rent), unfortunately, there is very little that can be done to cover the disease effects of another pandemic. However, from the insurance perspective, there are certain things that can be done to protect against the indirect effects of another pandemic such as:
Latent defects insurance
These policies provide cover for rectification of defects in new build works that manifest during the ten or twelve year period after completion of these works. Traditionally, you may have been able to claim against the contractor or architects insurance in the event of a defect that manifests post-completion. However, proving they are at fault five years after works have been completed can be challenging and if they have become insolvent in the intervening period, claiming against them will not be an option. As such, latent defects insurance is becoming a common way of protecting an asset and making it more bankable.
Purchase epidemic insurance
There is one insurer that provides epidemic insurance (though note that Covid-19 variants are excluded but future epidemics could be covered). Capacity is limited and, as such, they will only really look at large portfolios or mega projects. However, depending on your exposure and risk appetite this may be worth considering.
Unsurprisingly, this is an area of increased focus as different parties involved in a contract look to try and push the risk on to the other party. The key question is: “what is equitable?”, and this largely comes down to whether it is fair and reasonable to push this risk onto the contractor on a development where their profit margin may only be 2%.
Knowledgeable insurance broker
Insurance policies generally fall into two generic categories: (1) insurer-drafted wordings, and (2), broker-drafted wordings. As you would expect, a broker-drafted wording provides wider cover than insurer wording as it is not in the insurer’s interest to provide the widest cover possible. Having a knowledgeable and specialist construction insurance broker can be crucial particularly in the current hardening market.
Adequacy of sum insured
Prices for construction materials, in particular steel, timber and aggregate, have dramatically increased over the last fifteen months. Most contract works insurance policies will have an escalation provision included in the sum insured, which is the maximum amount the insurers will pay. This is typically between 15% and 25% of the original contract value. In the event of a major loss (e.g. fire) just before practical completion, the sum insured on the policy could be inadequate. That said, total losses are rare but the adequacy of the sum insured should be closely monitored.
For further information, please contact your usual Lockton contact or:
David Lyle | Senior Vice President, Lockton Global Construction Practice
T: +44 (0) 20 7933 2066
Daryl Harris, Vice President, Lockton Global Construction Practice
T: +44(0)20 7933 2588
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