UK: Insurance: a brief update

Last Updated: 31 March 2003

The global insurance market is currently in a state of flux following 9/11 and a series of high profile corporate failures (Enron, Worldcom. etc.). 9/11 itself is estimated to have cost the insurance industry £30-£40 billion.

The market has also become even tighter following the collapse of a number of insurers, most notably Independent Insurance whilst other insurers have "pulled out" of the higher risk areas of the market. Successful claims against insurers are on the increase. Exclusions are becoming wider and premiums are rocketing. Where does this leave the construction industry; an industry heavily dependent on managing risk through insurance?

Indicative of the way in which the construction industry is having to adapt to changes in the insurance market are its approach to terrorism cover and the changing professional indemnity and employer’s liability insurance markets.

Insurance against terrorism

Most JCT forms of building contract require an all risks insurance policy to cover the works (whilst being carried out) which will be taken out either by the contractor (Clause 22A) or the employer (Clause 22B or Clause 22C). Included in the definition of all risks is terrorism.

The problem is that since the IRA bombings in the 1990s most insurers have issued a standard exclusion limiting cover for damage by fire or explosion due to terrorism to £100,000 per event.

Full terrorism cover is obtainable but the contractor or employer now has to buy back the exclusion on payment of an additional premium which is credited to Pool Re.

Pool Re (Pool Reinsurance Company Limited) was established by the Government in the wake of the IRA bombings to act as an "insurer of last resort". The theory is that because the insurance market can lay off risk (via reinsurance) it can always offer increased cover for risks caused by terrorism so long as the employer or contractor pays the additional premium.

However, there are a number of problems with this system.

Firstly, the reinsurance facilities offered by Pool Re only cover a period of 12 months.

Consequently, when a building contract exceeds that period, there is a possibility that renewal might not be possible.

To prevent the employer or the contractor, through no fault of their own, being in breach of insurance obligations to provide full cover against fire and explosion, Amendment 3 to the JCT forms of contract was introduced.

Amendment 3 deals with the withdrawal of terrorism cover, giving the employer the option of determining the employment of the contractor or of requiring the contractor to complete the works on the terms set out if terrorism cover ceases while the works are in progress (viz. up to the date of practical completion).

Whilst this approach protects the contractor from being rendered in breach of contract through no fault of its own, it potentially exposes employers (and third parties e.g. those providing development finance) to greater risk. Most employers will have little choice but to continue with the works or face a significant financial loss should terrorism cover (if obtained) cease. This cessation could also place the employer in breach of any development finance or other third party agreements (agreement for leases etc.) unless these have all been harmonised to accord with the building contract insurance provisions.

Secondly, Pool Re originally only covered damage caused by fire or explosion.

Post 9/11 and in response to claims that "full terrorism cover" under the old system was somewhat of a misnomer Pool Re has now agreed to cover damage caused by biological and chemical contamination (e.g. anthrax), the use of aircrafts in attacks, impact damage, flood damage and as of January 2003, damage caused by nuclear contamination.

However, this is likely to prompt a rise in premiums that are charged to cover the extension of terrorism risk that insurers and ultimately Pool Re are expected to cover.

Thirdly, the definition of terrorism under the Reinsurance (Acts of Terrorism) Act 1993 which established Pool Re is much narrower than the definition under the Terrorism Act 2000. Of particular significance given 9/11, is that it does not cover terrorist activity for religious or ideological purposes. This issue remains to be dealt with.

Therefore, that which is excluded from cover is now defined more widely.

The risk balance matrix as between employer and contractor on terrorism cover has thus now shifted and it will be a matter of negotiation as between employer and contractor as to who bears the "uninsurable" risk. As indicated above, third parties will also have an interest in the outcome of that negotiation.

Professional indemnity insurance

Critical to developers and third party occupiers in the risk assessment of a project to be designed, built and occupied is that regarding liability for latent defects, i.e. those defects (usually design-related) which are not apparent at practical completion. Professional indemnity insurance provides a level of protection against this risk, which is currently acceptable in the market in place of that (to an extent sometimes) of the employer/developer.

There has been a gradual restriction of such cover (most recently as regards pollution and contamination and date recognition claims).

Also, with rises in professional indemnity insurance premiums (some reportedly up to 350%), availability of cover is becoming scarcer (and more expensive).

The standard obligation imposed upon contractors and consultants is to take out and maintain insurance with a "reputable" insurer and to notify the employer (and others) if such insurance is no longer obtainable at "commercially reasonable rates". This obligation is likely to become increasingly negotiated and the "goal posts" may have to shift in relation to what constitutes "reputable" or "commercially reasonable".

Employer’s liability insurance

Premiums for this cover (dealing with public liability against death or injury to persons or damage/destruction to property not forming part of the works) are also significantly increasing and some insurers have effectively even blacklisted particular sectors of the industry. Scaffolding, demolition, roofing and asbestos removal companies have found insurance cover particularly hard to obtain with many having to pay a substantial excess in the event of a claim.

Others are reducing the amount of cover they take out so as to avoid the rocketing premiums. David Bishop, parliamentary officer for the Federation of Small Businesses cited the example of a thermal insulation business on the South Coast which had reduced its employer’s liability insurance from £10 million to £1 million. Yet, their premium rose to £8,000 in 2002 compared with £1,200 in 2001.

Conclusion

As with terrorism cover, the non-availability or restrictive nature of professional indemnity insurance and employer’s liability insurance means that there is a greater likelihood that the extent of "uninsurable" risk on construction-related operations will become greater over time thus increasing the business risk of those involved in the construction industry.

It remains to be seen how employers/ developers, contractors and interested third parties, e.g. development financiers, and occupiers deal with this uncertainty. For those developers with a significant covenant (e.g. institutional investors) it may be that they have to fill the uninsurable "black hole" and assume the risk.

It may become more difficult for those seeking development finance where, as is often the case, margins are tight and there is no significant cash or capital reserve to rely upon. Ultimately however it is more likely that the construction industry will adapt to the changing market conditions and perhaps in line with Latham-esque principles the risk will be borne by the party most capable of managing it.

© Herbert Smith 2003

The content of this article does not constitute legal advice and should not be relied on as such. Specific advice should be sought about your specific circumstances.

For more information on this or other Herbert Smith publications, please email us.

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