Blog Question Benefits and Disadvantages of using Principal Arranged Insurance over Contractor Arranged Insurance

Crane and construction siteHi Allan

Just wondering if LMI has put together any articles/ blogs in regards to the pros and cons of having an annual contract works insurance policy, versus relying on the Principal/ house owner/house purchaser to arrange separate insurance.

Thanks and Regards

Felicity [surname and email provided]

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Hi Felicity, I have based my reply on a comprehensive article filed in the Knowledge Centre of LMI PolicyComparison, along with some additional commentary that came to mind after re-reading the article.

Construction Insurance: The Benefits and Disadvantages of using Principal Arranged Insurance over Contractor Arranged Insurance

Some types of insurance applicable to the construction industry can only be held by the contractor, such as worker’s compensation insurance and professional indemnity. Other types of insurance, such as insurance of the works and insurance against public liability, can be arranged by either the Principal or the Contractor.

Contract Works insurance is designed to cover losses during the construction of a building. Usually Contract Works Insurance extends through the Construction, Maintenance and Testing Periods of a project (but third party liability under the policy extends through the Construction and Maintenance periods).

The Maintenance period begins at the end of the Construction period and extends for a specified period. The Testing period is the time allowed for test running or commissioning of the project’s mechanical or electrical components. This is a nominated period within the Construction period.

A contract works policy usually includes combined property damage cover (damage to insured property) and public liability cover (damage to third party persons or property). It is also a safeguard should other construction workers become injured on site.

Contract Works Insurance may be issued in the names of:

  • the Principal
  • the Project Managers
  • the Contractor
  • the Sub-Contractor
  • the lending authorities

Such policies are usually taken out by the developer or the principal contractor to cover works carried out pursuant to a particular contract, and defects arising during the maintenance liability period. Alternatively, there can be an annual policy which responds to specific notified contracts.

Under some Contract conditions, each Contractor may be required to take out their own insurance. In others, the Principal takes out insurance while still holding the Contractor to indemnify the Principal:

  • against damage to the Principal’s property
  • for any claims against the Principal for injury arising out of the performance of the Works.

This type of policy can provide cover for:

Insurance of the works

During the construction period as materials are incorporated into the structure, the works progressively become the property of the Principal. However the works will not be covered by the Principal’s usual property insurance until they are completed, handed over, and notified to the Principal’s property insurer.

Insurance of the works covers the works against damage or destruction, while under construction, and provides for reinstatement or reconstruction of works that are damaged or destroyed. The amount of insurance of the works should be sufficient to fund the reinstatement of the works in the event of destruction or damage. Cover can include:

  • The contract price materials, materials supplied by others and an escalation allowance
  • Contractual requirements to insure loss or damage to the works including items on site to be included in the works and pre-existing structures
  • Temporary buildings, plant and equipment
  • Automatic tools cover to a specified sublimit whilst on site including hired in plant and mobile equipment where this is the insured’s responsibility to insure and employees effects
  • Cover for maintenance periods up to a specified length of time after handover
  • Professional fees, demolition/removal of debris, expediting expenses in addition to the contract price
  • Cover for contract variations or cost escalations up to a specified percentage of contract price
  • Cover for storage of materials off site and in transit up to a specified sub-limit
  • Plans, documents and data

Public liability insurance

Public liability insurance covers liability for personal injury, death, property damage, or other loss sustained by persons other than the Principal and the contractor, arising out of the project or contract. Public liability insurance should also cover costs of responding to and defending claims for any such liability. It should be noted that this type of policy is required in addition to the usual range of liability required by a business rather than as a substitute for the same, since liability coverage under the Contract Works is only for liability arising out of the specific contract/contracts and not, for example, general premises liability at, say, a head office.

The Benefits and Disadvantages of using Principal Arranged Insurance over Contractor Arranged Insurance

Allan Reynolds of Steadfast, kindly identified the following advantages of a Principal Controlled Program include:

  1. The choice of Insurers, and determination of their security, is in the hands of the Principal.
  2. The Principal is able to dictate the extent and level of the cover to be arranged.
  3. The direct supervision of Insurance costs, budgeting and identification are simplified.  There are considerable savings in the costs of administration.
  4. The possibility of an uninsured loss arising, either due to misunderstanding or absence of insurance cover, is greatly reduced.
  5. There is no need for the Principal to check a multitude of different policies, provided by different contractors and subcontractors, to ensure that adequate cover is given upon each contract.  The “Principal Controlled” method will relieve the Insurance Officer or Risk Manager of the onerous responsibility of assessing acceptable policy conditions under the terms of the policies affected by each contractor.
  6. In many cases, construction commences and the only evidence of insurance presented is a “cover note”, which does not show the full extent of cover nor the restrictions of the insurance contract utilised.  Sometimes, through oversight, contractors may begin work before they have arranged insurance.
  7. The Principal can impose excesses upon small contractors that they are capable of bearing without offending their financial efficiency.
  8. A single Insurer or panel of Insurers deal with all losses appertaining to the risk and subsequent prompt settlement of claims is achieved.
  9. Cover can be extended to continue after completion of separate parts of the works.  It is important to continue “Contract Risks” cover whilst work is still continuing rather than immediately place the assets concerned upon an Annual Material Damage Insurance Policy.
  10. Some overall premium saving should be achieved since premium rates will not be loaded by all of the contractors’ and subcontractors’ profit elements, on-site costs and insurance costings. Also, it is worth remembering that many contractors have blanket policy premium rates which take into account heavy civil activities, thus loading normal construction and machinery installation rates.
  11. In a difficult economic climate, the risks associated with liquidation following major loss are largely removed.  The Principal can ensure that all claims are payable directly to themselves for distribution In accordance with the terms of the contract. Thus, any large claim payment will not be available to the creditors of a contractor in liquidation.

While there are advantages there are also some disadvantages that need to be understood as well. For example, if Principal arranged insurance is used, there is a risk that tenderers may not correctly allow for the costs and risks of insurance in respect of conditions, exclusions and deductibles, unless tenderers are provided with details of the insurance policy.

Other issues in my experience are:

Principal Arranged Insurance

The Contractor must consider:

  1. The level of excess under the Principal’s Policy. It is important that the Contractor’s policy has an “excess” cover Condition provision in respect of any insurance arranged by the Principal and that the Contractor understands the effect and extent of the excess under the Principal’s policy if relying upon it.
  2. Unknown warranties and endorsements because the Client probably does not get a copy of the Principal’s Policy.
  3. Whether the Principal’s Policy is for Material Damage and Public Liability and whether it includes Completed Works cover (Products Liability).For Government Contracts it is usual for such cover to remain in favour of the Contractor for as long as the Principal has an annual policy and keeps it in force. Other Principal’s Policies may not be that generous and if it is one arranged by one of the major Builder’s they are as hard as nails in accepting the liabilities of Sub-contractors going forward

Contractor Arranged Insurance

In my experience it is dangerous for the Principal to exclude contracts where the Contractor is responsible for arranging insurance altogether from his own cover. Such attempts may be negated by Section 45(1) of the Insurance Contracts Act 1984 (Cth).

It is, in my opinion, better to proceed on the basis that the Contractor’s Annual Policy is an Excess policy in case there are any cover gaps.

  1. If the Contractor’s annual Policy is not endorsed, the Principal’s policy will likely to be called into contribution. The Principal should therefore sight a copy of the Contractor’s policy and confirm the currency and endorsement of the policy to note the interests of the Principal
  2. If the Principal’s Policy is for a specific contract then obviously there won’t be any continuing Product cover once the project is completed. The Broker therefore needs to ensure that his Client has that cover.

Alan Fong, head of LMI RiskCoach and himself an experienced Contract Works underwriter added.

  • Annual policies (provided they renew) will have continuity of cover for incomplete projects
  • Premium is based on adjustment, that is, what is completed and incomplete at the end of the period
  • Single risk policies run the risk of obtaining continuation of cover if the building is incomplete at the end of the specified construction period – most insurers will allow one extension, after that they become very selective, especially for Owner Builders. The premium could be higher and/or a higher excess could be applied (it is nearly like taking out a new policy because the original contract is based on a specified construction period). The construction should be for the period the builder genuinely thinks it will take to build – it is dangerous just to say 12 months and then extend the cover, it may not always be accepted).
  • An annual policy could give the Insured more flexibility with the policy, excesses, cover for existing structures etc. as it is a renewable policy
  • All parties should have their own insurances, especially Liability, for example if the builder only has the policy and the principal does  not then if the annual policy or the single risk is not renewed or extended then the principal could be left without protection. Otherwise the principal will have to be diligent to make sure they obtain a Certificate of Currency on every renewal or extension period.

I think that just about covers it and I trust this gives you plenty of food for thought.

As always, if anyone has any additional thoughts I am more than happy to receive them.

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