The paper takes a deep dive into construction contracts and their intersection with various insurance policies undertaken throughout the life cycle and after the completion of a project under various jurisdictions. Given the emphasis on insurance being used as a tool to manage risk under internationally recognized standard form construction contracts, all the types of insurance policies are analyzed in detail through this paper. The author further deliberates the consequences of the overlap of various insurance policies while deliberating the subrogation principle. Lastly, the paper emphasizes on the collective benefits insurance policies provide to projects under construction law both economically and commercially.
Insurance under Construction Contracts and Projects
Thenature of insurance in a construction contract or an infrastructure project protects the insurable interest of the assured in the event of a foreseeable liability or financial loss resulting from an event or the happening of an event. In construction insurance, the key underlying factor among insurance protection under construction contracts is uberrimae fidei or premised upon good faith, with a strict duty to disclose between the parties. The disclosure may be related to any material facts relating to the contract that has a significant potential to affect or impact the contract. Thenon-disclosure of any key material fact can render the insurance policy voidable.
Due to the various parties involved in each project such as the owners, developers, experts, contractors, and sub-contractors some of which may even be associated with the concerned project in phases various types of insurance are in place to protect each aspect of the project under construction contracts.
Construction projects are susceptible to hazards caused by nature, political or human elements. Due to the extensive investment, time and resources associated with each construction project, one of the primary risk management mechanisms is construction insurance.
Potential complications may range from climate conditions, unforeseeable site conditions, design faults, domestic permit issues, and variations to name a few. With effective risk management being built into increasing construction contracts insurance cover is an essential safeguard. No construction and infrastructure projects are devoid of risk and uncertainty. Given the increased scope of globalization, standard construction contracts are widely accepted norms in infrastructure and construction projects, therefore the option of construction insurance is a widely accepted and practiced standard of risk management across jurisdictions. Construction contracts often provide multiple insurance policies or are often absorbed under a collective policy to protect the interest of the parties over a lengthy period.
Types of Insurance under Construction Contracts and Projects
Risks in construction projects are multi-fold, therefore over time the worldwide accepted international standard form contracts such asFIDIC contracts incorporate wide standardized insurance requirements. There are varied types of insurance policies incorporated and negotiated for the purposes of projects under construction contracts.
Works or Property Insurance essentially provides insurance coverage with respect to the risk of occurrence of damage to the concerned project works while the duration of the construction contract, risks such as fire, flood, and unfixed materials on site are some of the risks insured against by the parties. This works and/or property insurance is in general widespread practice taken under the joint names of the contractor and the employer. It is pertinent to note, a joint policy necessitates a joint insurable interest. However, theextent of the contractors obligation for completing his obligations extends the liability on the contractor in the event of any damages to the works, independent of fault. Only in absence of contract or negligence will the works insurance be interpreted as the owners undertaking sole risk.
Contractor’s All Risk Insurance Policy is termed as inclusive insurance cover in construction contracts for the entirety of the life cycle of the project. This comprehensive insurance policy in general practice extends liability coverage for defects related to design, material, workmanship and consequential loss. The policy remains in force after the completion of the project too. Due to the all-inclusive structure of the policy, it has the ability to contribute to the reduction in overall expenses against unforeseen financial losses. The Australian case ofTrident General Insurance Co. Ltd. v. McNiece Bros. Ltd., clarified the position of the contractors on all risk insurance policies. It was held to extend to all its subsidiary or all related contractors, companies and suppliers, as per the facts of the case where despite the name of the sub-contractor not being attached to the policy, the court held the concerned sub-contractor was covered under the contractors all risk insurance policy.
Third-Party Liability Insurance covers claims raised by third parties with respect to personal injuries or damages to property to the concerned project. Unless caused by the owner’s acts, claims for personal injuries shall be allocated to the contractor. With respect to insurance claims for damage to the property of third parties, it shall be the responsibility of the contractor only in the instance of the contractor’s default or negligence. Unlike other forms of insurance policies, third-party liability insurance does not fall under the bracket of joint insurance as there is no subrogation against the owner in the event of fructification of the insured risk. The key factor of third-party liability insurance is that the understated requirement of the concerned sub-contractor shall be insured to the same extent.
Adjoining Property Insurance, as the name suggests is the policy that covers both fault and no-fault instances towards a third party or adjoining owner depending on the situation. The lengthy and high-risk nature of construction projects is the primary reason why adjoining property insurance is widely adopted to prepare for all forms of cover in the event of substantial risk occurrence and issue of indemnity between the parties to the owner of the adjoining property. Such insurance policy is to be undertaken jointly between the contractor and the employer to avoid dispute on the subrogation between them.
Professional Indemnity and/or Insurance Cover is considered a specialist insurance policy that is discretionary in nature. In general practice professionals on board the construction projects such as engineers, designers, and/ or architects seek such protection under the policy. The professional cover protects, professionals with respect to exposure to legal liability in the event of any negligence committed while carrying out their roles in the project. The policy operates on a claim- made basis which is continued in an annual manner covering the concerned claims during the concerned year, unless the policy is retrospective and maintained into the future years. Cases of negligence which are generally discovered at a later date are covered only in the same policy subject to the policy being continuous. The professional’s insurance policy may, subject to the terms with each project, continue to subsist after the project’s completion. In the case ofWimpey Construction (UK) v. Poole, the court highlighted insurers were only liable as per the wording of the policy in this case negligence on the design was not under contention rather the construction department had not carried out their repairs correctly for no fault of the design.
Latent Defect Insurance Policy stipulates insurance cover against design defects, material defects, or construction defects which are not identified and/or discovered until after the completion of the project. This policy is incorporated right from the inception until the completion stage of the project. The positive effect of this policy is multi-fold for the parties as it allows for the speedy rectification of defects, and reduces the risk burden with financial cushioning reducing the difficulty in resolving such latent defects. Under certain negotiated contracts, the insurance policy may be made conditional on conditions such as information symmetry being maintained between the parties, procedure, and incorporating consultants’ professional inputs with respect to design and material as well.
Plant and Machinery Policy deals with the risk coverage and liability protecting the plant and machinery on lease by the contractor and subcontractor on the project site.
Floater Policies are maintained on an annual basis intending to provide broad cover to the entirety of the project. Due to the extended nature of the insurance coverage, the owners need to declare their annual turnovers at renewal.
Design and Construct Insurance are insurances wherein the contractors under the design and build contracts are responsible for all aspects related to design and risks associated with the design. Such a policy ensures damages as a result of the design are covered, however, any and all defects or damages caused due to the incorrect execution of such design are not protected under the coverage.
Builders Risk Insurance is the insurance on direct losses or defects to the project including access facilities to the project and materials that are a necessary part of the undergoing works.
Business Interruption Insurance concerns coverage for loss in profits and expenses due to the occurrence of a stipulated insured loss leading to push-back on the daily business under the insurable event, an example such as rental payments are stagnant due to the occurrence of an insured event such as the breaking out of a fire.
Transit Insurance is undertaken to ensure successful transit while entering and exiting the location of the project, limited in general practice strictly to be transited by land in domestic projects. It is pertinent to note, transit insurance is not exclusively available for the purposes of construction projects. Whereas for international projects such insurance coverage would extend to cargo by air or sea as required. The valuation under the coverage of the insurance policy is determined as per the cargo valuation.
Contractor License Bonds essentially necessitate the contractor’s compliance with regulations and the concerned contract license bond protects the general public and all those who carry out business with the contractor. The bonds are issued and valued on the creditability of the concerned contractor.
Other kinds of insurance such as terrorism insurance, theft insurance, unemployment insurance, warranty insurance, cybersecurity insurance and property insurance are some of the alternative insurances policies available under construction and infrastructure projects while negotiating and consolidating construction contracts for the purposes of various projects.
A consistent problem faced during the life cycle of construction projects is the multiplicity of insurance policies which leads to an undesirable overlap of such policies. The overlapping policies are more often incongruent, leading to higher rates of contract and project cost with premiums being met. This in turn leads to chances of the multiplicity of claims being raised and an overall procedural failure.
Despite the various options of insurance policies offered with respect to construction contracts, the most widely adopted insurance policy remains the contractor all risk insurance policy. Especially under the FIDIC and ICTAD as well as other standard form contracts the contractors all risk insurance policy is in-built and considered mandatory and commercially stipulated as a condition to contract.
Consideration must be deliberated upon. For instance, a policy should not be limited to the contractor but must extend to the concerned sub-contractors as well, in the event the project has any existing structures or properties this must be included in the insurance cover, it may also consider covering reasonable costs due to the order of concerned civil/ domestic authorities among a few additional parameters to be gauged with.
Factors that should be considered while selecting the insurer are the structure of the policy, premium, service quality, re-insurance rate, goodwill and reputation.
Potential Misuse of the Subrogation Principle
It is widely advised to undertake the concerned construction insurance policy in joint name of the owner and the contractor of the project so that in the event of the claim arising there does not arise a conflicting right of subrogation. In the event there occurs a conflicting right of subrogation, the insurer is put in a rather difficult position. If the policy is not in joint names of the contractor and the owner, the subrogation principle can be practiced by the owner’s insurer to shift the burden of claim onto the contractor. Whereas, if the policy is undertaken in joint names there is no possibility of shifting the burden between the parties and they fall under one umbrella. Preventing the misuse of the principle of subrogation.
There can occur an instance where the right of subrogation being exercised ends up being itself affected. Such as an instance of a sub-contractor claiming insurance due to an identified defect, may not be able to fructify such claim as upon exercising the right of subrogation the insurer for the sub-contractor and the contractor is the same. To ensure the insurer is not put in this precarious position, while estimating and undertaking the contract for insurance it is necessary to account for a higher valuation of premium to ensure coverage of all the potential instances of risk associated.
Benefits of Insurance under Construction Contracts and Projects
As previously stipulated, insurance is considered as a standard form of risk management under construction contracts, beyond the necessity to cure and efficient management of project risks the benefits associated are vast.
Reduced risk works as an appetite for businesses as insurance policy provide a mitigating mechanism for risk’s that may occur during the lifecycle of the project. Managing the risk outcomes reduces the financial pressure and potential loss impact on a business engaged in such a high-stakes industry.
Awareness is increased across the spectrum with all the concerned participants in the project facing a higher threshold of responsibility such as the design and construction insurance enhances the scrutiny and precision the contractor must employ while developing such design and carrying out the construction. This increased threshold of awareness in turn reduces potential negligence automatically providing an additional layer of comfort to the employer.
Economic benefits such as the collection of premium is the primary benefit. Other than that, in the event the project is being undertaken in a developing nation, this creates opportunities for the local insurers to extend insurance to the domestic contractor or sub-contractors which has a positive impact over the duration of the project.
Security cover is provided to the extent of certain insurable events, the capital-intensive nature of the construction industry is heavily regulated in all aspects, the insurance policies act as additional security cover. The security cover warrants and provides financial comfort in the instance of unforeseeable circumstances or instances that are not a result of fault or negligence of either of the contracting parties.
Ensuring continuity as a risk management mechanism, certain construction and infrastructure projects mainly PPP projects tend to be of national importance. To ensure the continuity of works and meeting the set project milestones insurance policies are instrumental coupled with indemnities undertaken by the parties as insurance essentially targets to make up the cost resulting from the occurrence of the risk event. The extension of insurance policies ensures the project is not brought to a standstill on the sole issue of the occurrence of the risk event.
Limiting risk exposure as the financial burden with respect to the insurable event is dispersed and reduced expanding the risk appetite of the project.
Tax benefit depend on each jurisdiction, often policy holders are subjected to various tax benefits increasing the capital retention ability of the parties with respect to the project.
The paper has analysed types of insurance available under construction contracts while outlining the benefits and incorporating the widely used risk management mechanism of insurance policies. Both from the perspective of the owner and/or employer as well as the contractor the importance of having strongly negotiated and highly valued substantial coverage is imperative for the smooth functioning of the project. The contractors all risk insurance policy taken in joint standing with the employer is the widely practised mechanism under international contracts in construction law. The overlap of insurance policies is still an ongoing contention faced under various projects, however, the key takeaway remains the cohesive selection of insurance policies to further ensure limited financial resources towards the payment for such premiums. Taxation and financial security benefits remain as another key attractive factors for various parties while contemplating the scale and volume of protection under insurance policies. As there are specialised and general insurance policies to ensure a streamlined project cycle and completion of construction projects which afford additional comfort and availability of finances for insured events to see these projects completed.
The views expressed in this blog are the original views of the author, and the journal does not have any contributions to it.
About the Author
Ms. Aashana Chandak is a Masters of Law student at National University of Singapore specialising in Corporates and Financial Services Law. She has previously worked as a transactional lawyer in Mumbai. Interest areas are Corporate Law and Project Laws.
Managing Editor: Naman Anand
Editors-in-Chief: Jhalak Srivastav and Muskaan Singh
Senior Editor: Naman Jain
Associate Editor: Tisa Padhy
Junior Editor: Sathvik Reddy
Preferred Method of Citation
Aashana Chandak, “Analysis of the Types of Insurance to manage Risk under Construction Projects” (IJPIEL, 1 February 2023)