Understanding sub-limits under construction policies – how to ensure adequate coverage is maintained
‘Sub-limits’ are amounts payable by insurers for certain types of losses. In this article we consider limitations to sub-limits of indemnity under contract works policies outlining the implications to projects if they are not considered properly.
What are the types of contract works (material damage) sub-limits?
Usual sub-limits under a material damage policy include:
- Professional fees: Covers costs associated with architects, engineers, or other professionals needed to assess damage or plan repairs after a covered loss.
- Removal of debris: Covers the cost of removing debris from the construction site after a covered loss.
- Expediting expenses: Covers additional costs incurred to expedite repairs and get the project back on track after a covered loss. This might include overtime pay for workers or expedited shipping of materials.
- Mitigation expenses: Covers reasonable costs incurred to prevent further damage after a covered loss. This could include boarding up windows or installing tarps on a damaged roof.
- Temporary protection: Covers the cost of setting up temporary structures like fences or enclosures to protect the site or materials after a covered loss.
- Government fees: Covers fees charged by government agencies for permits or inspections required to rebuild or repair damage caused by a covered loss.
- Restoration of records: Covers the cost of reconstructing or replacing lost or damaged business records (e.g., blueprints, contracts) after a covered loss.
- Idle or standby costs: Covers additional expenses incurred due to a covered loss that forces a temporary halt in construction (e.g., renting idle equipment, paying salaries to workers who can't work).
- Inflation protection: covers increased costs due to cost inflation from commencement of works until loss or damage.
- Additional cost of unbuilt works: Covers the increased expenses associated with rebuilding or repairing uncompleted sections of a project that are damaged by an insured event.
- Escalation cost: covers specifically rising material costs due to factors like supply chain disruptions, variations or non-inflation related cost increases.
- Claims preparation costs: Covers costs associated with preparing and submitting an insurance claim, such as hiring an adjuster or lawyer.
- Materials in transit: Materials being transported in relation to a project.
- Materials in storage: Material stored off-site awaiting installation.
How do sub-limits work?
Ordinarily, insurers will set a policy limit of indemnity for material damage based on project declared values. In the usual course, these are set based on the material subject of the works that are declared at inception of the policy period or project.
Sub-limits are those costs which are incurred following loss or damage which are payable in addition to the direct costs of remediating or rebuilding. For contractors, this may include overtime pay for workers or express transportation of materials to expedite the project and protect against further delays. These expedition costs are ordinarily expressed as additional sub-limits, and it is critical to ensure that these are appropriately set.
Why apply sub-limits?
We have evolved from a recent “hard” insurance market. Construction material damage insurers faced significant losses ranging from natural disasters, construction defects, changes in regulation, onerous contracting obligations, inflation, labour shortages and supply chain disruption.
To return to profitability, insurers have not only looked at premium uplifts. They have also had regard to increased excess structures, reduced limits of indemnity (lessened their capacity or exposure), and in instances excluded specific types of loss.
Current state of the market
In our January 2024 market update we state “there are signs of improvement in the [construction] material damage market. Renewal rates have stabilised, and some reductions have been achieved”. That said, we have not yet seen insurers resile from the strict approach taken on sub-limits imposed during the last hard market.
By way of example:
- Prior to the last hard market, insurers offered high sub-limits with limited underwriting information or regardless of risk exposure. In the hard market, these sub-limits are much lower or non-existent.
- Coverage extensions such as Professional fees and debris removal are now typically aligned with the minimum requirements under contractual requirements which are often set at 10% of the project value. However, sub-limits for coverage extensions such as idle standby, and additional cost of unbuilt Work are presently very low or non-existent.
- The market standard for escalation costs cover is 15% of the project value. Now however, contractors should pay particular attention to cost projections as this can become a significant concern in an inflationary environment like the current one. Projects could balloon to several times the initial estimates by the time work starts, and even more by completion. This is particularly problematic for fixed-price contracts, where miscalculated bids can be disastrous for budgets potentially leading to financial hardship.
What should policyholders do to ensure appropriate coverage?
It is always important to understand specific project risk and coverage for same. Working with an experienced risk advisor, can effectively help you manage these complexities and ensure adequate protection for your projects.
Your risk advisor can help you:
- Conduct risk assessments to identify potential exposures and determine appropriate sub-limits.
- Engage in proactive dialogue with insurers to negotiate favourable terms and work with all parties to understand which sub-limits are important. There is no utility to ask insurers to cover remote losses.
- Access specialised markets: specialised construction intermediaries will access the most appropriate insurer depending on the specific risk profile of the project. It is the role of the intermediary to obtain the most appropriate cover priced most competitively.
- Regular review and adjustment: Insurance needs evolve. Regular reviews of your insurance programme are prudent to ensure coverage remains adequate and aligned with your business objectives.
- Claims advocacy and support: In the event of a claim, your risk advisor ought to serve as your advocate, guiding you through the claim process. At all times they should assist with the flow of information, management of experts and claim costs.
Key takeaways for policyholders
To set appropriate coverage for construction projects we recommend as follows:
- Early engagement with risk advisor: Engage with your advisor prior to commencement of a project. This expertise can guide your own risk assessment and tailor appropriate risk transfer (including insurance requirements) for the specific project.
- Comprehensive disclosure: providing particulars such as construction plans, contracts, sub-contractors, budgets, timelines, and risk mitigation strategies for a project empowers your representative to advocate more effectively with insurers.
- Alternative risk transfer: Open communication regarding risk tolerance, desired coverage level, and potential project challenges is key. Collaborative development of negotiation strategies with your advisor might involve proposing alternative risk mitigation measures to offset the need for higher than standard sub-limits or exploring alternative coverage options to supplement specific risk exposures.
- Prioritise more immediate risk: Focusing on securing adequate coverage for the most critical project risks is crucial. Prioritising securing capacity for extensions that offer the greatest risk mitigation benefit for your project. Highlighting the implemented risk management strategies, including safety protocols, quality control measures, and contingency plans, can convince insurers to offer higher sub-limits.
By following these steps, construction insurance buyers can increase their chances of obtaining the right sub-limits for their project. Remember, open communication, collaboration with a risk advisor, and a strategic approach to negotiation are key to navigating the current market.
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