Can insurance make construction projects run profitably?

There are many ways a construction project can go pear shaped. Unforeseen events can substantially affect the ability of the parties involved to complete it within time and budget. There are two broad categories of risk that may affect a construction project:

Physical events, for example:

• Natural disaster
• Accidental damage (eg. fire, vandalism, construction collapse)
• Machine breakdown
• Theft

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.

Recent events

With the recent collapse of some high profile firms (and this is an ongoing trend) there has been increased focus on the profitability of construction companies and projects.

Large construction company collapses

2004 – Hartner Construction (4th largest construction company)

2013 – Mainzeal (3rd largest)

2016 – Stonewood Homes (3rd largest residential house builder)

2018 – EBERT Construction (4th largest)

Not to mention the recent struggles at Fletchers and Hawkins (and the receivership of Orange H Group). This is the tip of a large iceberg, with small construction businesses going under on a regular basis but often staying below the media radar.

Can insurance help?

Many unforeseen risks can be insured, but not all. Fundamentally a business cannot insure their own failure to make money from a contract or be profitable. If they enter into a contract without adequate provision for contingencies or their own profit margin they cannot insure this contractual error.

However, contractors can protect themselves from the failure of a principal or head contractor. Additionally, head contractors can protect themselves from the costs associated with the non-performance of subcontractors or suppliers of components.

In addition, industry professionals should have professional indemnity insurance in case their errors lead to losses that they are held responsible for.

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.  Contact Builtin to enquire about trade credit insurance.

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.

However, contractors or component suppliers 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.

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 or component supplier. If the subcontractor or component supplier 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.

Retention bonds

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. Instead, it must be held on the balance sheet as a liquid asset. 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. This frees 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. This improves their own cashflow and reduces the risk of losing this money if their head contractor gets into trouble.

Professional indemnity insurance

While it is common for architects, designers, surveyors, engineers and lawyers to have professional indemnity insurance, project managers and building contractors should also seriously consider this cover. In the event they make a mistake in the execution/construction/management of the project the principal (or any other party) could seek to recover any loss they suffer from the project manager or builder. And if the project goes sour because of mistakes made by another professional engaged in the project (like the engineer) it’s common for many other parties to be added to the case, with the builder/project manager being near the top of that list.

In a nutshell

While specific unforeseen events as well as negligence by professionals can be insured, the fundamental issue of contractors not making money from the projects they undertake cannot. 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.