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          Construction procurement and the role of insurance

          The impact of the construction industry is, of course, apparent to the public on a daily basis. Despite this, there are many specific aspects of the industry, about which little is commonly known. An interesting area is the procurement of medium to large scale construction works, i.e. the methods by which a client can engage a contractor to undertake large scale building and construction works.
           

          Date: 10/04/2018

          Construction practice

          It is first worth recognising that, contrary to practice perhaps 30 years ago, many of the largest builders and contractors, some of whom are household names, do not undertake any physical work themselves.  That is to say, they may employ only a minimal workforce and own only minimal plant resources.

          The majority of actual physical work is undertaken for the main contractors by specialist sub-contractors, who employ specialist operatives and own specialist machinery and equipment.  In large projects, the number of sub-contractors can be high.

          The role of a main contractor is therefore one of procurement of sub-contracts and their management, co-ordination and integration in accordance with contract programmes.

          However, there is a further aspect to this, and that is the overall financial management.  The capital invested by clients, whether private or public sector, can run into billions of pounds sterling in large projects.  The funds are invested by way of stage payments, for progress in the overall works, to the main contractor, who in turn makes stage payments to individual sub-contractors.

          This cash flow gives considerable power to main contractors, and delays in payment, which generate income for the main contractor, have been the source of much legal and contractual provision.

          In essence, a main contractor's profit margins do not arise solely as a percentage on turnover generated through sub-contracts, but also from cash flow management.

          Risk allocation

          A further issue that arises is the contractual allocation of risk, and the extent to which the party to whom the risk is allocated can recover payment for that risk.

          It is easy for the contractual risks to be passed down the contractual chain from client to main contractor, and in turn to sub-contractors, thereby affecting the latters' insurance requirements or levels of site management.

          There can, however, be financial disadvantages to a client where, for example, responsibility for damage by standard perils can often be bought more cheaply as a single purchase rather than for the client to ultimately pay through the contractual chain for insurance purchased by every sub-contractor, plus a main contractor's margin.

          An enlightened client, or a client whose activities themselves create specific risk, will often retain high levels of risk.  For example, a nuclear industry client will retain many of the risks of works undertaken on their sites and employ significant levels of control and management, as the potential liability for any problem arising out of working on such sites might otherwise deter contractors from registering any interest for such work.

          Forms of contract

          It is general practice to employ a main contractor, because it will carry overall responsibility, avoiding the risk to a client of two independent contractors working alongside each other being able to blame the other for all work and programme problems which might arise.

          Under design and build contracts, the main contractor also carries the overall design risk.  Post contract design might be undertaken by consultants or specialist sub-contractors engaged by the main contractor.  In addition, the main contract may provide for the main contractor to also adopt responsibility for pre-contract design, undertaken for the client as a means of identifying the scope of the works.  As a basis for tendering, such pre-contract design is often insufficient, requiring the main contractor to take financial risks, or to incur significant expense in additional pre-tender design, which might not necessarily lead to a successful tender.

          There are a large number of standard forms of contract, specific to the procurement options and intentions regarding risk allocation.

          Contractual insurance provisions

          The provisions within construction contracts for the purchase of insurance are intended to be commensurate with liability allocation.  Furthermore, the contractual responsibility for the provision of specific insurances can be held to be evidence, in itself, of intended risk allocation.  One consideration is whether such policies are intended to be to the benefit of more parties than solely the purchaser, and hence whether a cause of action for losses incurred by any one party arise against another.

          Such considerations can lead to the adoption of project policies, covering both contractors and consultants, which preclude subrogated recovery actions and encourage a blame free culture during a construction project.  Insurers on such policies will carry greater risks, but have less exposure to dispute resolution costs.

          Summary

          Many clients opt for minimal risk retention, at the potential risk of future contractor claims or difficulties, which can of course ultimately become a problem for the client.  It is common for such problems to be presented to insurers for consideration under a professional indemnity policy, given its response to financial loss, rather than the purely physical damage which falls for consideration under a contract works policy.

          Alternatives such as 'cost-plus', (whereby a contractor is paid an agreed percentage above project cost), an open book approach or the sharing of savings/losses are all available for consideration at the stage when the procurement of project works is being considered.

          The insurance broker, in conjunction with interested insurers, also has the opportunity to contribute to the deliberations on risk allocation, as the insurance costs are part of the overall project cost and, from the client's perspective, should be minimised.

          A further consideration is that, as an insurer carries an increased proportion of risk, there must be an increased entitlement to full project participation, thereby allowing the insurer an opportunity to influence loss mitigation.

          In summary, alternative methods of procurement in construction are becoming more prevalent and insurers have a large part to play in the risk allocation between parties arising from them.