UK: Risk Assessment In The Construction And Insurance Industry

Last Updated: 29 January 1999
Which industry has a turnover of £58 billion per annum, representing 10% of GDP, employs 1.4 million people, but is described in a recent report as under achieving with low profitability and a lack of investment? Coming fast on the heels of the Latham Report, Sir John Egan has reported (Rethinking Construction) on the ills of the construction industry and has called for wide sweeping change in a sector that have generally been perceived to be dogged by inefficiency and failure. Construction risks represent a significant proportion of the business written by insurers and have contributed to some of the largest claims and losses in the past few years. The Jubilee Line extension and the Heathrow Airport Express collapse, are two cases in point. It is clear to see that any improvements to the construction industry will directly benefit insurers through a reduction in claims.

One of the principal purposes of construction contracts, whether they be for the employment of a contractor or the appointment of an architect, is to manage and allocate risk. Risk comes in many forms: liability for delay, cost over-runs and defects, to name just a few. During the negotiation stage of a contract, the developer will often attempt to pass as much risk as possible to the contractor and consultants and the contractor and consultants will attempt to resist such attempts. In practice, most of the risk is generally taken by the contractor and consultant, which is primarily due to their weaker bargaining position and competition for work. This is of great significance to the insurance market as much of that risk will in turn be passed to insurers in the form of professional indemnity, contractors' and erection all risks, employer's liability and public liability insurances. This is precisely where the construction and insurance industries share a common interest in examining the problems identified in the Egan Report and looking at proposed solutions.

So what is wrong with the construction industry? Egan identified a number of matters including poor productivity, low profit margins, high cost, delay and defective work and design. Fragmentation is a problem identified as being at the heart of the matter. The Report states that one of the most striking things about the industry in the UK, is the number of construction companies that exist, some 163,000. It is stated that this level of fragmentation has resulted in the "extensive use of sub-contracting which has brought contractual relations to the fore and prevented the continuity of teams that is essential to efficient working". It is easy to see that, where you have a large project with numerous sub-contractors dealing with work as varied as mechanical and electrical equipment, cladding systems, flooring, sprinklers, curtain walling, structural steel work and piling, each with varying degrees of design responsibilities, it is almost inevitable that disputes will occur. When, for example, part of the services located on the roof of an office development causes damage to the roof, who is responsible? Is it the roof sub-contractor who cast the concrete on which the roof beams rest, or the structural steel sub-contractor who designed the roof beams on which the services are located, or the mechanical and electrical sub-contractor responsible for the layout and load distribution of the services? Where the claim runs into several million pounds and covers several jurisdictions, it is not surprising that an atmosphere of hostility soon develops.

One of the main vehicles identified as a means of resolving the problem is the concept of partnering. This simply involves two or more organisations working to improve performance by agreeing mutual objectives and devising ways of resolving disputes. Rather than a developer tendering for a new contractor and consultants every time it is involved in a new project, it simply retains the same team to work in partnership. Partnering is by no means a new idea, and a number of companies have applied its principles successfully. Tesco, the supermarket chain, has used partnering to reduce its capital costs by 40% and The Whitbread Hotel Company has used it to reduce construction time for its hotels by the same amount.

In addition to partnering, the concept of "lean construction" is raised in the Report. This involves defining value in a specific product from the end customer's perspective and eliminating waste. Instead of managing the work load through successive firms in a sequential manner, processes are reorganised so that the product flows through all the value added steps without interruption. Activities across each firm are synchronised by pulling the product or design from upstream in time to meet the demand from the end customer.

This can work in project implementation, where all the key suppliers (e.g. contractor, sub-contractors, architect, engineer etc.) can work together to design the product, select key materials and pre-plan the construction. This of course pre-supposes that a team is already in place. It is therefore clear that both partnering and lean construction are ideally intended to work side by side.

Egan has looked at other sectors that once had a reputation for inefficiency and which have now been turned around, such as car manufacturing. It is said that the construction industry can also be turned around. In particular the following targets have been set:

  • reduction of construction costs by 10%
  • reduction of construction time by 10%
  • reduction of defects by 20%
  • reduction of accidents by 20%

In fact, the challenge set down by Egan has been picked up by the Major Contractors Group who have announced that they intend to set up a benchmarking club to allow 23 of the UK's biggest construction companies to compare their performances against the performance indicators set by Egan.

You do not have to be a genius to imagine the benefits to contractors' all risks and professional indemnity underwriters if these targets are met. Egan is not an esoteric issue limited to a single business sector, but of crucial importance to insurers too. If the risk that is passed on to them can be reduced by contractors and developers achieving these targets, then this will feed directly into the profit and loss account of insurers.

Leroy Levy is a solicitor in the Construction and Engineering Group of international law firm Norton Rose.

This note is intended to provide general information about some recent and anticipated developments which may be of interest. It is not intended to be comprehensive nor to provide any specific legal advice and should not be acted or relied upon as doing so. Professional advice appropriate to the specific situation should always be obtained.

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