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The shifting sands of risk management in construction projects

20th October 2017

The shifting sands of risk management in construction projects

Construction and engineering projects, whether land-based or marine, are inherently risky. For this reason, parties to construction and engineering contracts manage risk by seeking to allocate responsibility for each different type of risk to a particular party.

Allocation of risk

A contractor is obliged to complete a project in accordance with the project specification and will in most cases bear the risk of delay in completing the works. The party required to design the works will usually bear the risk of the design being defective.

However frequently risks are allocated by aversion. For example, some employers are prone to taking every opportunity to shift risk to a main contractor, who in turn shifts that risk onto its sub-contractors. This often results in risks being allocated to a party who has little or no control over the situation, is not adequately compensated for taking on that risk or has little motivation to assume the risk.

As a result, an employer who is seeking to avoid risk may then be faced with tender prices inflated to reflect the contractor’s evaluation of the increased risks upon himself. Alternatively, a less experienced contractor may win a contract because they are more likely to accept grossly inequitable risk allocation.  If the risk eventuates, the contractor may cease to trade or be incapable of resolving the issue, with the problem passing back to the employer.

Managing Risks by Insurance

Whilst some parties will “self-insure”, in construction projects many risks are managed by direct insurance rather than by allocating liability to a party.  For example, damage caused by events such as fire and flood are often covered only by insurance.

There are at present, two main categories of construction insurance: property and liability.

  • Property insurance covers the construction and engineering contract works and materials.
  • Liability insurance provides cover for claims by third parties in respect of personal injury including to employees, damage caused to property and the liability of architects, engineers and surveyors. Contractors also often now have professional liability insurance to cover those of their activities that are of a professional nature.  There is a range of other types of insurance available, including for delay in completion of the works.

Slow Pace Of Reform

Unfortunately different insurance markets specialise in providing each different type of insurance and, as a result, the insurance cover provided is often not integrated. It is not surprising that, against this background, insurance has recently been the subject of widespread reforms.

  • The Insurance Act 2015 effected substantial reforms to the pre-contractual duties of disclosure and misrepresentation with the aim of improving the insurance placement process and protecting policyholders from insurers “underwriting at the claims stage”. The draconian remedy of avoidance for any breach of the duty of utmost good faith has been abolished, and instead insurers will, largely, be confined to proportionate remedies for breach of pre-contractual duties. The Act also introduced new provisions targeting policy terms in order to modify the effect of a breach of warranty and a new statutory remedy for fraudulent claims made by the insured that governs the effect of a fraudulent claim on previous or future genuine claims made under the policy.
  • In 2016 The Enterprise Act also came into force. It introduced new provisions to allow an insured to claim damages for the late payment of insurance claims.

Notwithstanding recent legislation, the construction industry continues to present challenges to the insurance industry with ever more complicated projects being undertaken both on land and at sea. The changing face of construction and the technological advances (for example, in the renewables industry) mean new methods of risk management have been required.

Integrated Project Insurance

In 2011 the UK Government published its construction strategy endorsing Integrated Project Insurance (“IPI”).

  • The main aim of IPI is to facilitate construction professionals working together in a more collaborative way than has previously been the case. This was followed in 2014 by the publication of explanatory guidance.
  • At the start of a project an integrated project team (including the contractors and other specialists) is selected. This team then collectively decides where 15 – 20% of project cost savings can be made. The members of the project group then form a “virtual company” (or enter into an “Alliance Contract”) comprising a board, a project manager and a project team amongst others to implement the project. At the start of the project, members are also required to agree to a “no blame/ no claim” undertaking, which prevents members from initiating proceedings against one another if things go wrong during the project.

IPI is now being trialled through a number of pilot projects with the first public sector pilot completed earlier this year.  As part of the IPI model, an IPI policy insures the client and all other “Alliance” members including consultants, construction managers and their supply chains (including providing cover for latent defects for up to 12 years). The IPI policy is taken out once the design and cost plan agreed by the team for the project has passed independent technical and financial risk assurances.

The IPI policy therefore covers all overspend on the project up to the liability limit, with the members’ liability extending only to the limit of a “pain-share” threshold which is effectively the excess under the financial loss section of the policy.

Beyond the excess the insurers (subject to a maximum indemnity and exclusions) will deal with any overspend, whilst also waiving any rights of subrogation against all of the insured, at every tier.

If financial exposures exceed the insurer’s cap then the employer bears responsibility for it.

Conclusion

The construction industry remains one of the most challenging markets in which to anticipate and cover risk.  Although traditional ways of operating are entrenched, there are clear indications that, irrespective of how some of those involved in the industry wish to operate, there is increasingly the will to create a more co-operative and less adversarial environment.

This content is provided free of charge for information purposes only. It does not constitute legal advice and should not be relied on as such. No responsibility for the accuracy and/or correctness of the information and commentary set out in the article, or for any consequences of relying on it, is assumed or accepted by any member of Chambers or by Chambers as a whole.

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Sally Wollaston
Sally Wollaston
Business Development and Marketing Director
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