Delay in start-up (DSU) insurance claims, and the complexities that often arise in their management, are generally not well understood. This article explains the basic principles of DSU and discusses some of the main difficulties in identifying and measuring indemnified delays.
What is DSU insurance and who needs it?
DSU insurance protects principals, owners, financiers (and others with an interest in the revenue generated by a newly constructed asset) from the financial consequences of delays in completion.
Notwithstanding its relative youth, the demand for DSU insurance has increased significantly in the last decade due to the rise in private sector involvement in infrastructure projects through public private partnerships (PPP) and build own operate (BOO) contracts.
Inevitably, the banks and financiers behind these projects have insisted on DSU insurance to protect their interests.
- DSU cover is triggered by a delay in completion of a project due to an indemnifiable loss under material damage insurance, such as Contract Works or Contractor's All Risk.
- There can only be a single claim under a DSU policy during the original project period. However, the delay may comprise a number of indemnified events occurring during the construction period.
- A DSU loss can only occur once the project has been delayed beyond the original scheduled operation date.
What does a valid DSU claim look like?
A payable DSU claim must include three key elements:
- an event causing material damage, which is covered or would be covered but for the applicable excess under the relevant material damage policy
- a resulting delay in completion of the project that exceeds the applicable time deductible in the DSU policy, and
- a resultant loss to the insured, such as loss of gross profit, loss of revenue, fixed costs or debt servicing costs, or increased costs of working.
Why are DSU claims difficult to adjust and manage?
The criteria for a valid DSU claim looks simple, so you could be forgiven for asking what all the fuss is about. But consider applying those criteria in circumstances involving BOO contracts, where the principal and contractor are related entities, or where there are claims for liquidated damages in the event of delays, or where both insured and uninsured delays arise over the construction phase.
These factors put stress on the traditional DSU model, making underwriting DSU risks more difficult and managing DSU claims more complicated and expensive.
DSU claim analysis
When a claim is made or a potential DSU event occurs, insurers have no option but to respond.
Because there can only ever be one claim under a DSU policy and the potential for delay usually only crystallises as a project approaches completion, insurers usually have to adopt a post-loss approach. This requires adjusters, lawyers and experts to conduct the time consuming and usually expensive task of retrospectively analysing the claimed delay.
Retrospective claim analysis – some cautionary points
Because most DSU claims will involve at least some retrospective analysis, there are a number of factors that should be considered when assessing a DSU claim.
The availability of liquidated damages (LDs) to a principal in the event a project is delayed by the contractor's default, can cause serious problems in DSU claims.
Some DSU wordings deal effectively with LDs, but many don't, giving rise to the question of "who pays first"?
Insurers argue that the DSU policy is one of indemnity and that it only responds to actual losses. On this basis, insurers say they're entitled to offset the claim by the amount of LDs the principal may recover from the contractor. However, it's not that simple. Generally, when a project is two years late the last thing the contractor does is admit liability to pay LDs. Accordingly there's almost always a highly contentious question about the contractor's entitlement to extensions of time, versus the principal's entitlement to LDs. These disputes are often fiercely litigated or arbitrated and can run years after completion of the project.
Commercial decisions on material damage
Coverage decisions made at one point in time can have knock-on effects down the track. Consequently, where there's doubt about whether a claim under a material damage policy should be covered and the same insurers underwrite the DSU policy for the project, the terms on which that claim is resolved should be carefully considered.
In the case of delay, the remedy of acceleration may not necessarily be applied to the task causing the delay. Insurers are then faced with a claim for acceleration measures on an unrelated part of the project, at a point well after the loss, but still potentially 12 months out from completion.
In such circumstances, how can insurers be certain that the measure will mitigate the delay? Insurers may rightly question whether the acceleration measure proposed is actually masking another uninsured delay.
Is there an insured material damage event?
Is the material damage loss covered so the resulting delay might be insured under the DSU policy? For example, under the LEG 2 or the consequential losses design exclusion, the costs associated with the rectification of a defective component are excluded, but the material damage arising as a consequence of that defect is not. An expert will therefore need to distinguish between the delay arising from the covered consequential damage, and the delay arising from uninsured repair of the defective component.
The difference can be significant. In these circumstances, early issue identification and transparency are crucial.
DSU claims management is rarely simple. However early identification of potential issues and pitfalls, will give you the best chance of avoiding issues entirely, or at least minimising any adverse effects.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.