Know the Drill - May 2021

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Know The Drill - May 2021

Welcome to the May issue of Aon Construction’s Know the Drill. In this issue we:

  • Discuss the policy additional item limits required in Contract Works Insurance and explain what they are for and why they are needed;

  • Take a closer look at Performance Bonds and why they are viable alternative to bank facilities;

  • Provide an update on travel insurance now that offshore travel is all go (to Australia and the Cook Islands).

Contract Works Insurance | Policy additional item limits

Most construction contracts stipulate separate limits for various items that the Contract Works Insurance policy must have. These are in addition to the Contract Works Value. Each item needs to have its own separate maximum limit. After a loss, each item is capped at the maximum limit stipulated.

It is important to understand what these separate limits are and why they are needed as, if the limits are insufficient and there is a loss, it could impact on the re-instatement of the works.
 
Below we provide some examples of what separate item limits look like and what they are for:

1. Allowance for the costs of demolition, disposal and preparation for replacement works

What is it for: Provides an allowance to cover the cost of demolition, disposal and preparation for replacement works. If there has been a loss on the project, it will cover the costs incurred to remove the damaged property and clear the site so that the project can re-start.
 
Examples of things to consider:

  • Labour costs - number of hours required;

  • Equipment to be used in clearing the site of the debris;

  • Disposal costs;

    • Clean fill, managed fill or land fill for the disposal site (with differing disposal rates);

    • Weight (wood is lighter than concrete);

    • Distance to disposal site.
       

2. Allowance for Professional Fees

What is it for: Allowance for Professional Fees provides an allowance to cover the cost of the specialists needed following a loss. For example, engineers will be needed to re-survey the project and the works. Once surveyed, the project team will need to develop a plan to move the project forward to the point that it was at the time of the loss.

Examples of things to consider:

  • What needs to be removed in terms of debris and damaged parts of the project;

  • How to protect the site from further damage while a solution is worked on;

  • How the project will be re-instated.
     

3. Principal Supplied Materials (PSM) 

What is it for: PSM needs to be included as a separate limit to ensure that Principal supplied materials are added to the Contract Value. This gives the true cost of the project and ensures the correct value to be insured. If the Principal provides materials to be included in the project, and their value is not disclosed, they will not be insured.  This could leave the project under-insured if there is a loss.
 

4. Allowance for increases in the Contract Price due to variations

What is it for: This provides an allowance for the Contract Value to increase to ensure that the project is not under-insured.
 
Having this allowance means that the party that arranged the insurance doesn’t have to regularly advise the insurers of changes in the overall Contract Value. Instead, they need to advise the insurer of the increased Contract Value once the total amount of variations processed gets close to the allowance allowed.
 
If the increased Contract Value surpasses the value of the variation allowed on the insurance, the project will be under-insured
 
Things to consider:

  • Is the scope of works or plans a bit “light” on detail

  • Indecisive Principal that keeps changing the scope
     

5. Allowance for increased construction costs due to inflation.

What is it for: This provides an allowance to cover the increased inflation cost of materials and labour, which would need to be re-purchased so the project works can be re-instated following a loss. This cover is important because it is unlikely the cost of materials and labour will be the same as when you tendered/first purchased them.
 
Note that this item limit only deals with inflationary costs to materials on the built portion of the project that is damaged. It does not allow for inflationary costs to materials on the unbuilt portion of the works. In some policies, it is possible to include inflation costs on the unbuilt portion however, this needs to be discussed with your insurer and is on a case by case basis.
 
To provide an example, if concrete was initially priced in the tender at $500 per m3, and a loss occurs 12 months after the start of the project, the cost of replacement concrete has probably increased due to inflation. This item limit will cover the inflation cost because this material is in the built portion of the works.
 
Using the same example, concrete was needed at the very end of the project, 18 months after starting. But, because of the loss on the project, the project losses 3 months in its program, meaning these materials will be purchased 3 months later than initially anticipated in the tender. This means that prices are likely to have gone up. This item limit will not cover the inflation cost because this material is in the unbuilt portion of the works (unless the cover is included in the policy).
 
Currently, with supply constraints on some materials and labour demands, we are seeing costs go up substantially - at a greater rate than annual inflation.
 
Examples of what can impact of the costs:

  • Seasonal demand or weather;

  • General supply and demand;

  • Lead times on key components (especially if sourced outside of NZ).

 

Which limit? | Specific Limits or a % of the Contract Value

The construction contract allows either of the above. Generally, we see a % of the Contract Value for all items except items to be incorporated into the works (PSM).

A % is generally preferred because, as the Contract Value goes up, the sub-limits also increase in proportion, allowing a higher sub-limit in the case of a loss. We generally see anywhere between 5% – 15% but this is dependent on the nature of the project (and is to be considered a loose guide).
 
We recognise this increases the cost of your insurance (as the total value insured is increased), however, the cost is negligible as it reduces the risk of under-insurance.
 

Performance Bonds

Insurance companies are able to offer Performance Bonds as a viable alternative to bank facilities.
 
Currently, banks are focussing very closely on lending in general to the construction sector and we know of at least one bank reviewing all Bonding facilities to reduce their exposure in this area.
 
Consequently, Aon has seen an increase in enquires on Performance Bonds (and have arranged a number of bonding facilities).

 
What is a Performance Bond?
A Performance Bond is an unconditional, on demand guarantee issued by a Standard & Poors rated financial institution in lieu of bank guarantees. It works to secure a client’s obligations under a contract.
 
The benefits of using an insurance Performance Bond facility are:

1. Unlike a bank, an insurer doesn’t require a charge over assets or other collateral. This allows the contractor to free up banking facilities to support working capital requirements or to invest elsewhere in the business.

2. Bonds are also a cheaper alternative to a bank with:

  1. lower issuance fees;

  2. no line fees so capacity can remain on standby until required with premiums only paid when the bonds are issued;

  3. cost of bonds are comparable to the rates offered by the Banks.

 
Performance Bonds are widely accepted as a form of security but where bank paper is specifically required by a beneficiary Aon can arrange for these bonds to be fronted by a bank to meet a client’s specific requirement.
 
For further information contact the Aon Construction team.
 

Travel Insurance Update

It is now possible to travel quarantine free to and from Australia and the Cook Islands. With these announcements, travel insurance queries have increased.

It’s no surprise that to date, our clients’ major concerns are centred around Covid-19 disruption to their travel.

It is important to note that disruption and cancellation costs caused by government, state or local mandated restrictions (lockdowns) or alert level changes are not claimable through your travel insurance at this stage – this is market wide, not just policies purchased via Aon.

Some insurers are offering “Covid-19” cover. This cover protects the traveller or their travelling companion for the costs incurred should they contract (or are suspected to have contracted) Covid-19 and are therefore refused travel by the travel provider or are placed into mandatory quarantine by an authority.

All responses and policies from insurers are different and sometimes it can be hard to determine what you are and aren’t covered for. Our advice is that if you are thinking about travelling to either Australia or the Cook Islands (for work or for pleasure) speak to an Aon broker for clarification on the extent of coverage available under your policy - before you book!

 

For more information on any of the issues discussed above, contact an Aon Construction specialist today.

 

 

This website contains general information only and does not take into account your individual needs or financial situation. It is important to note that limits, excesses, terms and conditions and exclusions apply to the products and services outlined on this website. Please refer to the relevant policy documents for details of cover, the provision of which is subject to the insurer’s underwriting criteria that apply at the time. Please contact us if you have any questions.