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Scarcity of project-specific professional liability cover adds to construction challenges

Construction projects continue to face challenges as insurance market conditions force contractors and design professionals to explore risk-financing alternatives.

By Vanessa Sheppard ,

Head of Construction Professional Lines, Marsh Pacific

25/08/2022 · 6 minute read

Construction projects continue to face challenges as insurance market conditions force contractors and design professionals to explore risk-financing alternatives. Project-specific professional indemnity (PSPI) insurance, a typical contractual insurance requirement for large, multi-billion-dollar infrastructure projects, has become more difficult to obtain due to shifts in contractual risk and large design and engineering losses over the past few years.

In recent years, several of the largest insurers — representing significant market capacity — exited the PSPI line of business. To help address the need for additional capacity, Marsh collaborated with carriers and clients to develop an innovative solution that uses captive insurers to provide risk-financing options for large projects.

The need for PSPI

Traditionally, an owner’s or developer’s contractual requirements included purchasing annual insurance policies, typically procured by a contractor or a designer.

For large projects that require significant insurance limits, considerations with this approach include:

Erosion of limits: When a single set of annual insurance limits applies to multiple projects, claims on one project can erode the overall coverage available for other projects. If several claims arise, or if it takes longer for a claim to develop, coverage limits may be exhausted or significantly eroded.
Standardization of coverage: When contractors and/or consultants form joint ventures to pool resources and expertise on large projects, the parties may have differing levels of professional indemnity (PI) coverage, excesses, and limits. If joint venture members rely solely on their separate annual policies, each member would have to seek indemnity from its insurers in the event of a claim.
Contract default risk: A contractor or design professional could default on their contractual obligation to maintain insurance coverage if they breach a policy term or condition, or if their insurer becomes insolvent during the term of the policy.
Uncertainty for long-tail liability claims: PI policies operate on a claims-made basis, meaning that the policy that responds is the one that was in force when the claim was first made. Designers that rely on annual policies have little control over insurance market conditions that could prevent them from renewing coverage in the years after they complete the project, a period when long-tail liability claims, including those under PI insurance, can emerge.

To solve these problems, insurers began offering PSPI insurance, which provides standalone coverage to a project and is not impacted by annual policy nuances. PSPI policies provide dedicated coverage for claims arising from a specified construction project during the design and build phases and extending beyond delivery — up to 10 years in some regions. A PSPI policy provides consistent levels of coverage for all project participants with responsibility for professional services rendered in connection with the construction process.

By purchasing a PSPI policy, a project owner, design professional, or contractor can achieve coverage certainty for the entire lifecycle of the construction project and for years afterward, depending on policy specifics. The cost of coverage also is clear from the inception of the project through completion and beyond.

What is design-bid-build?

Design-bid-build is a traditional form of project delivery in which project owners issue separate contracts for the design and construction of a project.

What is design-build?

Design-build is an alternative form of project delivery in which a project owner assigns both the design and construction to a proponent under one contract.

Current state of the PSPI market

There has been a shift in the delivery of large, multibillion-dollar projects from a more traditional design-bid-build structure to design-build, or other alternatives. Although potential advantages to design-build include greater collaboration between designers and contractors and shorter project delivery timelines, they have challenges due to certain unknowns.

The contractor typically bids these jobs as guaranteed maximum price, meaning they are unable to recoup errors in estimates. They are also usually bidding when the design work is not yet complete — often only about 30% finished — which can increase costs when final design is done. These unknowns have played a part in higher claims frequency and severity, making PSPI insurance unprofitable for some insurers and prompting some to cease offering it.

Finding sufficient PSPI capacity has become increasingly difficult in some regions, despite the entrance of new insurers. For example, maximum capacity in the US market historically has been about $100 million, depending on project specifics. Today, it can be a challenge to secure $50 million capacity in the US market. As a result, global insurance markets and alternative risk financing solutions may need to be considered for large infrastructure projects.

Alternative risk transfer options

Large contractors and project owners have long used captive insurers as a mechanism to fund self-insured retentions and make insurance costs more predictable.

As commercial insurance capacity tightened and rates increased, more construction companies turned to captives as a risk financing solution. For some, self-funding liability risks through captives presents an opportunity to achieve savings and certainty, despite the capital required to meet regulatory requirements.

In response to a lack of commercial market capacity, captives are often created by large groups of companies, or industry or trade groups as a mutual. They can assist large contractors and project owners in several ways, including:

Fronted insurance programs: Using a fronting insurer with a captive that reinsures all or part of the liability risk can help businesses meet contractual insurance requirements.
Cell captives: Known in various jurisdictions as protected cell companies (PCCs), segregated portfolio companies (SPCs), or “rent-a-captives,” cell captives are among the fastest-growing structures in risk financing. Individual cells come with licenses and infrastructure in place — needing only funding from the cell’s user — and they are insulated from losses to other cells. Cell captives can be a cost-effective option for construction joint ventures, which are common among design firms and contractors for large-scale projects.
Capital raising: Alternative risk transfer solutions such as captives can enable contractors to raise capital, through debt or equity, by showing evidence of insurability.

CASE STUDY: A Marsh PCC solution

Marsh successfully introduced and placed a PSPI hybrid solution using the concept of PCCs for a large infrastructure project in the Pacific region.

Four tier 1 contractors formed an unincorporated joint venture to deliver one of the region’s largest infrastructure tunnelling projects.

The lack of PSPI capacity meant it was not possible to secure the required limit of coverage through traditional insurance, a situation that was compounded by the lag between the tender phase for the project and the start of the work. As a result, a decision was made to pursue a captive insurance solution.

Following legal, accounting, and insurance advice, it was determined that a degree of risk transfer was required. The final structure included a combination of capacity from both the PCC and insurers to provide a PSPI limit that satisfied both contractual and regulatory requirements.

For more information about how a captive solution could cover your construction project’s professional indemnity risks, contact your Marsh representative.

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