Project insurance: Spread the risk (News analysis)

Current construction project insurance is divisive and costly. Carol Millett looks at a radical new project-wide insurance scheme that aims to promote collaborative working and cut premiums.

There is a saying that every industry gets the insurance it deserves. If so, construction insurance schemes, which are largely based on establishing blame, are a damning reflection of the industry.

Traditionally most project risks are pushed down the supply chain with suppliers expected to insure those risks by way of individual liability or indemnity insurance policies. The result is myriad insurances spawning a blame culture in which liability is usually established through hugely expensive litigation, arbitration or adjudication.

Brokers Griffiths & Armour calculate insurance premiums are costing the construction industry £1bn a year and that 80% of the cost of construction claims are in legal and forensic costs.

The need for a new form of insurance which better reflects the construction industry's transition to a more collaborative way of working has been recognised for some time.

A key recommendation of the Strategic Forum's seminal document 'Accelerating Change', launched by Sir John Egan, in 2002, was the creation of a project-wide insurance scheme that underwrites the whole team in order to "facilitate integrated working".

This recommendation was reiterated in The National Audit Office's report "Improving Public Services Through Better Construction" in March last year.

The MoD and BAA have risen to the challenge, introducing forms of project-wide insurance on the North Andover project, the Heathrow Express and later the Heathrow T5 scheme, which operates a Professional Indemnity and All Risks insurance.

Proving liability

However, although these are project-wide insurances, they still operate to some extent on proving liability.

More recently the baton has been taken up by Martin Davis, the head of the Strategic Forum's integration team, and David Adamson's Smarter Construction team.

Davis explains: "We wanted to get away from liability completely by identifying costs for the project at the very beginning and getting insurers committed to that figure. Then, if there is any overspend above that figure, it is taken from the combined profit of the integrated team, capped at a certain level, with insurers paying anything beyond that. So this is a policy based on financial loss. It is completely new and a very clean and simple policy."

In June this year, the scheme, known as Single Point Project (Financial Loss) Insurance (SPPI), reached a significant milestone when Davis presented a paper to the influential Public Sector Construction Clients Forum, chaired by Sir Christopher Kelly.

The Forum gave SPPI its full backing, sending out the order for key government spending departments to identify at least one project each, worth £10m-£20m, by the end of the year. These will include projects from the Department of Health's ProCure 21 initiative, the DfES Building Schools for the Future programme, and schemes from the Highways Agency, Defence Estates and Cambridge University Estates.

SPPI works by covering the whole of the construction delivery team, from the client, consultant and contractors to the subcontractors, for financial loss incurred on the project. It is based on a scheme operating in Belgium, where integrated teams are monitored by SECO, an independent 'technical assurance' bureau. The scheme has resulted in the cost of premiums plummeting by 30%.

The beauty of the system, says Rudi Klein, chief executive of the Specialist Engineering Contractors' Group, is that it encourages much greater integration. "If the team fall out with each other, they have to sort it out because instead of the insurance being based on finding fault, it is based on finding a solution, since everybody's profits are on the line," he explains.

Panel system

Under the SPPI pilot scheme the client will appoint a panel of five insurers at the very outset. Insurers that have applied to take part in the pilots include Norwich Union, Royal & SunAlliance and Zurich. The client and insurer panel then appoint two independent experts.

For the purposes of the trial this will be SECO for technical assurance and Davis Langdon for cost assurance. These experts then advise on the strategic plan, help select an integrated team, assess the design solution and the cost plan. They also monitor risks affecting safety, performance and cost, allowing prompt remedial action and cost-effective latent defects insurance.

The integrated team's collective profits are geared to strict performance criteria with their individual share of the profits agreed upfront. Team members also pledge not to sue each other for anything but fraud.

The panel of insurers in turn agrees to cover any financial loss over and above the cost plan, subject to the first level of loss being shared by the integrated team on a pre-determined formula and with minimal exclusions such as war.

Blame culture

The hope is that SPPI will not just do away with the blame culture and the costly litigation that comes with it, but also drive down the cost of premiums. "By bringing in the insurer and the cost and technical advisers early on the risks are much better understood by the insurer.

"That in turn should result in lower premiums as well as greater innovation and much more prompt payment if cost overruns do occur," explains Klein.

But why should insurers change their policies? Stephen Bamforth, senior partner at Griffiths & Armour, which along with Tysers will be brokers for the trial, says the insurance market must move with the times. "As the construction industry continues to move towards working in integrated teams, traditional insurance will no longer work. For example, where a client has a team of three design consultants working on a design and something goes wrong, you can't prove who was at fault, so their personal indemnity insurances can't be triggered.

"It's a mess. I am convinced the insurance industry must adapt and those insurers that get involved in the pilots will get a competitive edge."

Some insurers are yet to be convinced. Aon director Mark Courtneidge said: "In theory it appears fine, but whether in practice it proves to be value for money is another matter because some of the covers aren't usually put in place on a project wide basis, so that is one area of uncertainty."

Disappointment

Not all clients are championing this method. There is widespread disappointment that the Olympic Delivery Authority, in its draft procurement policy, plumped for a project-wide insurance based on Contractors All Risks and Third Party Liabilities. "This doesn't even go as far as what is being used on T5," laments Klein, but there is still hope that the ODA can be encouraged by the OGC to offer one of its projects for the SPPI trial.

Lawyers and funders are also cautious. Graham DeRoy, Tysers director of new business, said: "The biggest challenge will to convince the legal profession and the funders that this is the way to go. The banks are advised by lawyers and for some lawyers to back this is akin to turkeys voting for Christmas."

[Contract Journal, 23 august 2006, pp 6-7]