Recent years have witnessed sustained construction of purpose-built student accommodation (PBSA), with a further increase in capacity of 4.7% expected in 2023. Placing the construction element of this risk within the London Insurance Market is, typically, relatively straightforward, but challenges often arise when considering insurance of the related revenue risk exposures during construction.
Delay in Start Up (DSU) or Advanced Loss of Profits (ALOP) insurance should be procured alongside the owner’s or developer’s project Contractors All Risks (CAR) policy. This is designed to cover different types of financial loss that would be suffered by the owner arising from delay, following damage to the building being insured under the CAR policy. DSU losses that can be insured include additional cost of debt finance or loss of expected revenue.
However, the key respect in which PBSA varies from other building risks, is that its completion is usually tied to a specific academic year. Thus, a small delay caused by damage under the CAR policy beyond the start of the academic year has the potential to trigger a far greater loss than would be experienced on a residential flat development, for example. This is due to the nature of the contractual relationship between the owner and the student tenants upon whom the owner relies for their future income stream. For instance, failure to deliver the agreed accommodation on time may require the owner to provide alternative accommodation for those students, and/or transport or food vouchers, all at significant additional cost. All these additional costs will require consideration and understanding when calculating the financial consequences of any delay.
How can the additional costs vary?
Various contractual arrangements may be agreed, but the following present two typical risk scenarios relating to the effects of construction delays on PBSA:
Due to unavailability of the building, the students are forced to find alternative accommodation for the forthcoming academic year. Alternative accommodation (houses/flats etc.) may only itself be available for a minimum 12-month rental period. Where students have no choice but to find alternative accommodation for the full year, this leaves the owner facing a shortfall in expected rental income for the whole 12-month period. This is a good example of how a relatively small delay can lead to a far greater loss over a longer period.
Instead, the owner may have contracted to find alternative accommodation for those students during the period of delay. This clearly has an additional benefit in that it limits the potential length of any loss and ensures the students will be able to move in when the building is eventually completed. However, this places additional burden on the owner as they will likely be searching for accommodation in the same market as the students, and short term accommodation, such as hotels, may be subject to far higher rental rates than would typically be paid by students for the original accommodation. The alternative accommodation may also create further costs for the students (travel, food etc.) which the owner may need to pay for to mitigate their financial position, rather than lose the rental for the full year.
Insurers considering these projects therefore need as much information as possible at quotation stage to properly understand the contractual position and the extent of any risks being faced.
Maximum Indemnity Period:
The DSU indemnity period is usually calculated based on the expected rebuild period, plus any further contingencies. There are no set rules around this and each owner must decide based on their individual risk appetite. In terms of alternate student accommodation costs, these are typically only considered for the first 12 months of delay, given that contingencies and alternative accommodation can be put in place should there be a greater delay.
Conclusion:
Understanding the alternative accommodation options and the basis upon which the Sum Insured has been calculated requires full transparency when approaching insurers at quotation stage. They will want to understand the mitigation strategies that are in place, including any ‘float’ in the construction period, together with the expected completion date. They will consider all these factors when calculating the premium rate.
Finally, it is important to ensure that the wording properly reflects the cover required for your project. Where a relatively small delay could trigger a loss for a longer period, this should be discussed and, agreed at the outset of the policy. Similarly, if a risk can be mitigated then this should be made clear to your insurers. Otherwise, they may assume, and charge, for the worst-case scenario.
For further information and details on our products and services, please visit our Lockton Global Real Estate and Construction Page (opens a new window).