Ensuring financial certainty in the construction sector
What is Delay in Start-up Insurance?
Delay in Start-up Insurance (DSU) covers the loss of anticipated income and/or additional costs in the event that a construction project suffers physical loss or damage during the construction phase, meaning a delay to completion. The insurance policy can only be taken out by an entity with an insurable interest in the asset’s ongoing revenue stream, e.g. the employer or funder. Purchasing this insurance coverage provides the relevant party a degree of comfort that if an insurable loss were to occur, during construction, then the income they had forecast to receive will remain protected up to the chosen sum insured and indemnity period. This would also provide cover for debt servicing obligations throughout the course of the delay.
What would happen if not purchased?
In short, a large uninsured risk and a significant exposure to future potential revenues. For example, if a commercial building that was due to achieve practical completion next month, with a tenant already lined up to move in, suffered a major fire or escape of water incident. The owner of the building would suffer a loss of rental income, missing out on the earnings they would have received had the project handed over on time. The owner of the property may have been relying on this income for other investments, which in turn could delay other ventures. In this scenario, it is likely the owner would be unable to claim liquidated ascertained damages (LADs) against the contractor because the standard position within the Joint Contracts Tribunal (JCT) forms would afford the contractor the benefit of an extension of time.
How to calculate your exposure
Calculating the appropriate level of DSU sum insured can be difficult. As a simple guide, we would recommend using the following steps:
Indemnity Period: The Indemnity period should allow for the complete reinstatement of the buildings in the event of a total loss, including time for debris removal and potentially another planning approval.
Anticipated rent/revenue/income: Calculate the income you estimate to receive per annum. Consideration needs be given to any ongoing debt service costs plus additional sales/marketing following the reinstatement of works.
A live example of a DSU claim would be as follows:
Type of project: Build to Rent scheme, 10 storey building with 300 beds and a projected income of £1,500 per month per room.
Annual rental income: £5,400,000
Loss: major fire
Reinstatement period: 2 year rebuild
The fire caused a delay to the construction project meaning that the residents were not able to move in until two years later than they would have but for the damage. As a result, the owner would have lost two years’ worth of earnings if they had not purchased DSU cover.
Many of our real estate sector clients and their tenants will be following Government advice and have arranged for their employees to conduct business from home, rather than at their usual place of work. This is likely to become more widespread as time goes by, with a large number of premises becoming unoccupied or occupied intermittently.
The integration of technology in buildings and the data-gathering this enables is helping real estate operators and investors to raise the profitability of properties but it is also changing the nature of risk exposure in the sector.
While the current COVID-19 pandemic has emptied city centres, life will eventually get back to normal.
Rates for professional indemnity (PI) in construction are likely to continue rising throughout the year as insurers reduce their exposure to this line following large claims in the space and a profitability review at Lloyd’s of London.