Dealing with risk in the construction industry is not solely about dealing with one problem. With construction projects growing in size and complexity as well as in the number of stakeholders, it is no longer as easy as one risk, one insurance policy. Mr Andre Martin of Swiss Re Corporate Solutions gives an insight into how a more strategic approach to insurance and risk management can help the construction industry take advantage of its positive growth path.
The risks faced by project owners and contractors today are complex. They overlap at different points and create a matrix of issues, problems and headaches that seem impossible to untangle to the uninitiated.
With an increasing number of projects being delivered via Public Private Partnerships (PPP) or Build Operator Transfer (BOT) contracts, this complexity will only grow, and with it the challenge to protect the physical assets, revenue streams and ultimately, the financial viability of a project in an efficient manner.
In a soft market, the promise of a quick insurance fix is seductive, but in today’s economic climate, where developers are competing to attract a limited pool of investment capital, a solid risk transfer proposal can make a difference. It is all about de-risking a project and providing peace of mind to investors and lenders that they will see the return on their investment.
Piecemeal stand-alone insurance policies not the way to go anymore
Historically, and still relevant today, the construction industry has been served by piecemeal stand-alone insurance policies, purchased by different stakeholders, often with conflicting interests, at different stages of the project life cycle.
The basket of policies for one project can range from the purchase of surety bonds, through cargo, construction, liability, professional indemnity, to operational covers and long term defect protection after completion. This exposes the project as a whole to possible cover gaps and overlaps, resulting in inefficiencies and the potential to endanger the viability of a project altogether.
Ultimately, the aim for developers is to secure future cash flows. An incorrect level of insurance, or the wrong mix of products, however will have a knock-on effect on the attractiveness of a project to potential lenders and investors, limiting access to capital and increasing the cost of loans. Without the right support, some projects cannot even break ground in the first place.
Spotting the opportunity
Providing protection for this growing level of complexity requires in-depth knowledge of the construction industry, as well as an innovative and creative approach to tailoring risk management solutions to fit each individual client and project. It also means having the capacity and expertise to deal with risks that were traditionally uninsurable.
The global construction industry is now gaining some growth momentum, with the Asian Pacific region being the main driver. The forecasts vary, but the APAC construction sector is expected to grow between 8% and 10% per annum until 2020. Despite recent worries over the slower than anticipated growth in China, the signs are still positive across Asia.
With such a promising outlook, there are massive gains to be won by reducing overall risk and helping those projects to get off the ground. If the insurance market can support the construction industry to improve a project’s risk profile, it becomes more “bankable”. It becomes more attractive to potential investors and lenders. Insurance should be considered as a contingent capital provider, ultimately supporting the economic growth in the region.
Understanding the customer
So what has changed and what can be done? With new project delivery forms becoming increasingly the norm in Asia, the number of stakeholders, with their differing interests, will only grow. On the other hand, innovation and new technologies are playing an ever more important role on construction sites. As a result, not only the complexity in the risk portfolio increases, but whole new risks will emerge that the traditional set of project insurances might not cater for.
The traditional fragmented approach to insurance purchasing, where individual stakeholders protect only their own interests, will not lead to the most efficient solution, let alone be able to deal with new exposures and risks.
Avoiding gaps in project insurance
The insurance industry has a whole range of tried and tested insurance products geared towards individual exposures during a project life cycle, be it to protect physical assets, financial losses, credit exposures or legal liabilities.
These covers are mostly considered in isolation. Quite often they overlap; at times there are gaps. For example, in a mining project, determining exactly when to transfer from construction to operational insurance; or how to allocate project delay responsibility to transit and construction works. These are very real issues in project insurance that can be avoided by taking an integrated approach.
However, providing a holistic and efficient risk transfer solution that adds value should be more than pasting individual insurance policies together. It is about understanding the very specific risk profile of each project and stakeholder. Insurance should be more than a tick-box exercise to fulfil contractual obligations. It should be used on a strategic level and be aligned with the individual risk appetite of the purchaser.
Real value comes from the capability to combine these existing insurance covers more effectively, tweaking the scope, evaluating potential new features and tailoring the solution to the specific risk profile and requirements of a project.
As such, a holistic insurance solution will have to be bespoke, flexible and modular.
Non-traditional solutions that stretch the limits
With the share of private funded projects in the Asian region increasing, one growing concern is the impact of project delays, which is the most significant driver pushing up costs and disrupting cash flows. Under the current practice, such delays caused by extreme, force majeure, events are easily insured via Delay In Start-Up or Business Interruption policies.
However, project delays caused by day-to-day inclement weather are invariably passed on to the contractors. Project owners feel the burden of responsibility lifted, but such inclement weather risk is mostly left uninsured, often leaving contractors’ balance sheets critically exposed.
From a project perspective though, a delay is a delay and the financial impact on the project is the same, whether the developer, owner or contractor is contractually liable. Additionally, often ignored in such cases, are the implications on top of the financial impact, such as lengthy claims disputes, due to a growing number of stakeholders, or the impact on the financial health of contractors and subcontractors.
Again, a holistic approach to project insurance and risk management would lead the way to investigating new and non-traditional insurance solutions, geared towards the financial loss rather than physical damage.
Weather hedges for construction projects
Parametric weather insurance is now a standard hedging instrument in the energy sector, and has become increasingly popular in other industries as well. The construction sector is still slow to adopt such new solutions, but there are strong arguments that weather hedges are also a very efficient tool for construction projects, in order to transfer pure financial risk, or non-material damage risk, to the insurance sector.
Transferring the financial impact of all weather related risks, rather than just force majeure risks, can be a very effective risk management strategy, but will only be considered if project risk is analysed on an integrated basis.
Bespoke multi-faceted risk financing solutions
Ultimately, the aim is to de-risk a project by providing a holistic assessment of its unique set of circumstances, and create bespoke multi-faceted risk financing solutions. Blending different types of insurance covers, which normally operate in isolation, simplifies the process and eliminates gaps and overlaps, helping to improve a project’s attractiveness to lenders, investors and partners. This approach should ensure efficient and cost effective insurance coverage as well as the ability to deal with less traditional and more challenging risk areas.
By moving away from the traditional fragmented approach to insurance buying, projects as a whole will benefit from a flexible modular approach, combining traditional and potentially non-standard solutions designed to address very specific risk profiles. In turn, this will help the construction industry to gain momentum as the economy improves. It will enable project owners to focus on building their businesses, rather than rebuilding them.
Mr Andre Martin is Head Engineering & Construction APAC at Swiss Re Corporate Solutions.