A version of this article was published in The Lawyer.
Over the past decade construction spending has gradually shifted away from Europe to Latin America, Asia, the Middle East and Africa where expansion in the construction industry has been fuelled by economic growth and urbanisation. Construction companies have taken advantage of a truly international construction market, exploiting opportunities to take on construction projects in countries that lack their own expert construction contractors, suppliers and consultants.
However, the growing international demand for new buildings and infrastructure has been mirrored by a growing trend in increasingly severe and frequent claims faced by global construction companies and their insurers. The main loss trends that have emerged over the past five years are more frequent, and severe losses arising from natural perils, increased severity damage caused by fire and a rise in faulty defective design or workmanship claims. The cause of the disproportionate rise in losses coming from the developing markets is that international contractors and consultants often fail to grasp the risks of operating in a new, challenging environment.
One of the key contributing factors that has led to an increase in claims is the lack of knowledge of local ground conditions that exist in developing countries; flood losses in particular are driving a rise in natural catastrophe perils. One of the key challenges faced by construction companies is minimising the risk of flooding by developing and distributing better flood mapping tools and by increasing awareness of how to protect from flash flooding and the impact of building in high-risk areas.
Another explanation for the trend is that global construction companies often remain dependent upon local sub-contractors in order to deliver large scale projects. Although there has been a similar tendency over the past decade for large construction companies to depend upon sub-contractors for goods and services in a domestic context, which brings with it its own risks regarding contractual default and non-performance, many of the developing markets do not have major experienced domestic construction contractors, subcontractors or suppliers with the requisite expertise. It is therefore often the case that international companies without regional experience are left with no other choice but to trial sub-contractors with an unknown track record, with the additional risk of local contractors bringing in unskilled labour with little construction experience or training.
As well as depending upon local subcontractors, international construction companies are also increasingly relying upon local joint venture partners in order to enter international construction markets. Joint ventures generally offer a number of benefits such as reducing a company’s exposure and allowing it to compete in a diversified international market. However, at the same time problems can arise due to the association of two or more companies from different countries, with differing political, cultural and legal frameworks. The obvious risk for an international company relying upon its joint venture partner is when the technical and managerial capabilities of that partner, fall short of what is necessary to execute the project.
Developing countries also have different standards in building materials leading to a rise in claims relating to defects. Indeed, materials procured from the emerging markets are not subject to the same testing and assurance and quality control processes as supplies and materials sourced from developed, industrial markets. The problems encountered by international contractors are also exacerbated by the fact that there are less rigid building rules and regulations in developing countries, and there is also a significant difference in attitudes to corporate responsibility and health and safety issues. Health and safety issues on site also create potential risks for the reputation of international companies, particularly if an accident occurs on site.
These problems are capable of being mitigated against so long as effective risk management procedures are put in place. Construction companies operating in the international construction market must also be astute to the different laws applicable in different jurisdictions, which can present a number of complications for ensuring that there is adequate and compliant insurance coverage for the project. Policies that do not comply with local regulations may not provide the company with coverage that is adequate in the local jurisdiction or may lead to unexpected problems with taxes and fines.
The lesson to be learnt from the increase in claims in the emerging markets is that the focus on ‘international’ must not obscure the importance of ‘local’. If international construction companies wish to continue to take advantage of global opportunities, there will need to be an increased focus on improving risk management, taking into account the risks associated with the jurisdiction.
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