Construction projects frequently make use of contractual allowances for variations during construction. These changes sometimes require adjustments to insurance policies, which often lack the same flexibility.
The main point that needs highlighting is that, under English Law (opens a new window), insured parties owe a duty to make a fair presentation of the risk, which will require you to disclose material information, both at inception and if there are any material changes to the risk. Material information is not a prescriptive list, but an ethos of information that would impact an insurer's decision to accept a risk, or the terms they would apply.
The following could be seen as a material change in risk:
Project scope:
Project scope changes significantly from the original plans (e.g. extra floors being added to a building, bridge being lengthened, tunnel size increasing, etc).
Project value:
Change in value beyond a reasonable level (not including change in project scope) - or signs of under-pricing in original estimates.
Period extensions:
Addressed in contracts through lost time frameworks and a frequently used option.
Potential interaction with construction policies
Principally, a material change in risk gives insurers the right to amend terms, conditions, premium, deductibles, and/or their level of participation.
Certain provisions are made in policies, typically to allow for marginal cost increases (up to around 15%) and time overruns (limited to 1-3 months at pre-determined terms and conditions). Frequently, these are utilised, and insurers accept that committing to insurance prior to construction commencing comes with the need to have this kind of flexibility.
However, if these are exceeded, then amendments are currently being applied with significant variation to the original policy terms. The impact of this will be negative to insured parties, and some changes may be seen as disproportionate – the London Engineering Group (opens a new window) has provided some good explanations around the premium aspects of this in particular.
Change in Project Scope is something that needs active discussion with the insurance team on. It is a process that needs management and can only be effectively handled if the insurance angle is brought into the discussion around impacts to insurance policies prior to variation orders being issued; so the implications can be included.
What about in the event of a loss?
In the event of a loss and material information has not been disclosed, insurers have options to address such issues that may include reducing claims payments, charging additional premium, or avoiding a claim all together. There may be further implications that allow insurers to cease offering cover going forward.
Overall Recommendation
Open and frank dialogue with insurers will ensure variations are managed in a timely and understanding manner. If insurers are aware of forthcoming changes, then they will be more open to them as it allows them to manage their exposures proactively rather than having to react. Surveys and progress reports are very useful tools to manage this commitment.
Visit the Global Real Estate & Construction page on our website global.lockton.com (opens a new window)