Understanding key insurance covers
Martin Preston* explains each of the insurance covers that a contractor needs to be acquainted with to ensure the smooth completion of projects.
01 November 2007
A typical construction project involves numerous insurance policies which have a significant role to play through the development of the project.
This is why a better understanding of the types of the insurance that are available to contractors, as well as their scope and extent, is required.
Most of the aspects of insurance that are relevant to the construction sector are explained below along with a brief review of typical additional insurance requirements if the project is to be project-financed.
• Third-party liability: This type of insurance will often be a legal requirement, and so will have to be maintained by a construction contractor regardless of what is stipulated in the contract. However, since most construction contracts require the contractor to indemnify the employer in relation to any third-party personal injury or property damage claims, it is in the contractor’s interests to take out and maintain such insurance and most contractors will have a global policy covering their business as a whole. It will also usually be a contractual obligation for the contractor to have such insurance in place so that the employer is reassured that there will be funds to meet any claims he makes under such indemnities.
Employers (and lenders) will want third-party liability insurance to be written on an each-and-every-claim (rather than an aggregate) basis to avoid it being extinguished by a claim early in the construction period (or, if a global policy, by a claim on another project).
• Employer’s liability/workers’ compensation: Employees of the contractor will not be covered by third-party liability insurance; instead employers will need to take out and maintain employer’s liability/workers’ compensation insurance to cover this risk. Again, this will usually be both a legal and contractual requirement.
• Contractors all risks: The contractors (or erection) all risk (CAR or EAR) policy will cover damage to the works. Defects in the works are usually excluded, although this cover may be available on payment of an additional premium. Even if defects are excluded from the CAR cover, the employer would usually want it to cover the damage caused by the defect. This is particularly the case with power stations and process plants where a defect in a piece of moving equipment (such as a turbine) could cause damage to other parts of the works.
Other issues to consider in relation to CAR cover include who takes out the insurance and who bears the deductible risk? On project-financed construction projects, the lenders will usually want the employer (that is the project company) to take out the CAR insurance so that they have a greater degree of control than if it was taken out and maintained by the contractor. If the deductible risk is being taken by a party other than that which is taking out the insurance, it will need to ensure that the deductibles are set at an acceptable level.
• Delay in start up (DSU): This insurance covers consequential losses caused by damage to the works.
Usually, if the contractor completes the works late, liquidated damages for delay will be payable by the contractor to the employer. However, this will not be the case if the contractor has been granted an extension of time in accordance with the contract.
If DSU insurance is in place, this may cover the employer in relation to losses that are not covered by liquidated damages if the delay is caused by an insurable event in relation to which the contractor is entitled to an extension of time, such as force majeure provided that the event giving rise to the extension of time has caused physical damage to the works and is covered by the CAR policy.
• Professional indemnity (PI) insurance: It covers negligence on the part of the insured. In a construction context, its primary purpose is to protect the construction contractor (if employed under a design-and-build contract) and/or the professional team in the event that a claim is made against them for negligence.
However, employers are usually keen to see such insurance in place as it gives them comfort that funds will be available to meet any claim they bring within the ambit of the insurance policy. For this reason, they will often stipulate in the building contract and/or the professional team appointments that PI insurance be taken out and maintained by the contractor and/or the professional team.
Since PI insurance is renewable annually, and written on a claims-made basis (that is, the insurance has to be in place when the claim is made rather than when the negligent act or omission occurred), the employer will be keen to ensure that the contractor and/or the consultants maintain PI insurance for the duration of the limitation period under the relevant contract.
The contractor and/or the consultants, on the other hand, will be concerned that they may be required to maintain insurance when it is either not available or only available at exorbitant rates. The compromise usually reached is that the contractor and/or the consultants agree to maintain PI insurance for the duration of the limitation period provided that it remains available at commercially reasonable rates. In determining whether this insurance is available at such rates, any increases in the premium due to the contractor’s and/or the relevant consultant's claims record should be ignored.
Project finance issues
If the project is to be project-financed then the lenders will have a number of requirements in relation to the insurance arrangements. Essentially, the lenders will want to have control of the insurance proceeds so they will be a named insured on the CAR and DSU policies, and insurance proceeds will be required to be paid into an account controlled by the lenders.
The lenders will also require a “head for the hills” clause in relation to the CAR policy, so that if they decide it is uneconomic to reinstate after the occurrence of an insurable event, the insurance proceeds can be used to repay the debt rather than to pay for reinstatement of the works. In this scenario, the contractor should ensure that the construction contract contains a provision relieving it of the obligation to reinstate the works.
* Martin Preston is a senior associate at the legal firm Norton Rose (Middle East). Legal queries related to the construction sector can be addressed to Norton Rose through Gulf Construction Magazine at editor@gulfconstructionworldwide.com
