Can insurance help make construction projects run profitably?
There are many ways that a construction project can go pear-shd. Unforeseen events can substantially affect the ability of the parties involved to complete it within time and budget. There are two broad categories of events that may affect a construction project:
Physical events, for example:
- ·Natural disaster
- ·Accidental damage (eg. vandalism, construction collapse)
- ·Machine breakdown
Negligence, for example:
- ·Financial failure (eg. poor initial pricing, insolvency of a contracting party)
- ·Poor project management
- ·Errors by professionals (eg. design, engineering)
- ·Defective workmanship (eg. by contractors installing components)
Most events can be put into one of these categories, and all of them may lead to either time delays or increased costs, and often both. Many unforeseen events can be insured, but not all.
What’s the solution?
Absent structural reforms to the market to re-balance the risks taken on by construction firms, how can construction companies and contractors manage their risk better? One way is to insure this risk. There are a few different ways to do so, but fundamentally a contractor cannot insure their own failure to make money from a contract or be profitable. If they enter into a contract without adequate provision for costs they cannot insure this contractual error. However, contractors can protect themselves from the failure of a principal or head contractor, and head contractors can protect themselves from the costs associated with the non-performance of subcontractors.
Trade credit insurance
This effectively insures the company’s accounts receivable asset (ie. the money owed to it by customers) against non-payment. So, if the customer becomes insolvent or doesn’t pay for a protracted period the contractor can claim the cost of that bad debt from their trade credit insurer.
Bonds increasing their appeal
As bank bonds become tougher to secure and more costly, insurance-backed bonds are increasing in their appeal. With this type of bond the contractor pays a non-refundable premium to the bond provider (called a surety), who guarantees to pay if the bond is called upon by the principal.
Performance & subcontractor bonds
A performance bond protects a principal from the non-performance of their contractor. Whilst less common, the same can apply between a head contractor and their subcontractors. If the subcontractor defaults the head contractor can call on the bond to cover any extra costs that may result. This enables the work to continue without the head contractor having to absorb those unforeseen costs.
Many head contractors demand retentions from their subcontractors. Recent legislation requires this money to be held on trust. This means it can no longer be used as a source of cashflow as it must be held on the balance sheet as a liquid asset and subcontractors have the right to demand visibility of their retentions at any time.
Rather than sit on the cash, main contractors can apply for a bond to cover the value of the retentions they hold, thus freeing up the money to use as cashflow once again (as long as they can return it to the subcontractor when it’s due).
Subcontractors can also provide a bond instead of having this cash withheld from their invoices in the first place, improving their own cashflow and reducing the risk of losing this money if their head contractor gets into trouble.
However, contractors must demonstrate that they are well managed and in a sound financial position before bond providers will consider them. This can put insurance-backed bonds out of reach of smaller operators.
Westpac finance initiative
A condition of the Westpac finance initiative is that an insurance-backed completion warranty must be obtained. Our partner Builtin Insurance offers this cover and there is currently no cost to apply for the accreditation required to access it. Download the accreditation application online here.
In a nutshell
The fundamental issue of poor margins and the transfer of risk from one party to another within a contract can’t be fixed with insurance. However, trade credit insurance is a good option for contractors on large projects if there’s a risk of default by their principal or head contractor. Alongside this, insurance-backed bonds are becoming an increasingly common means of managing risk by all parties in the construction industry.
Builtin Insurance are New Zealand’s trade insurance experts. For more information and an instant quote visit builtininsurance.co.nz or contact Ben Rickard at firstname.lastname@example.org or 0800 BUILTIN.