The Australian infrastructure insurance market has hardened significantly over the past 18 months, alarmed by a run of major claims, natural disasters and the Covid-19 pandemic.
As a result, Australian contractors are facing one of the most difficult insurance markets in recent memory – particularly, but not only, in relation to professional indemnity insurance.
It is therefore time for participants in the infrastructure sector to consider their position and take steps to minimise their potentially increased project risk exposures.
Symptoms of the hardening insurance market are already widely felt. Owners and contractors attempting to renew or enter into policies of insurance are being offered terms proposing policy limits at less than full reinstatement value, seemingly regardless of geographic spread, lower sub-caps, more exclusions, higher deductibles or excesses, and higher premiums. In many cases the market is unwilling to provide coverage at desired levels or sufficient to meet contractual obligations, or securing such coverage is proving impossible at an economic premium.
Risks such as infectious disease, natural disaster – particularly flooding, bushfire and cyclone – and cyberattack are being subjected to broad exclusions and sub-limits are being set well below the reinstatement value of affected assets.
Professional indemnity insurance is also affected, with excess layers of coverage becoming more difficult to obtain, and sometimes on less favourable terms to the primary layer, and premiums are increasing significantly. It has also become difficult to secure cover for breach of a contractual warranty of fitness for purpose – this being a standard non-negotiable obligation imposed upon contractors by principals.
This hardened market is seeing an increasing number of risks which contractors are neither able to manage nor adequately insure against. Clients, including governments, are proving reluctant to assume the full burden of these risks and equally reluctant to pay for hefty premium increases. These uninsurable risks have significant implications for infrastructure projects in both the public and private spheres.
As federal, state and territory governments continue to pull the infrastructure lever to kick-start Australia's economic recovery efforts, they will have to grapple with the reality of this difficult insurance market. 'Standard' infrastructure contracts, which governments have long used, may no longer be fit for purpose given the realities of the current insurance market but, given the risk allocation regimes which have long underpinned such contracts, securing substantial contractual changes favourable to contractors will not be easy to achieve.
Many private infrastructure contracts provide no relief for the contractor where a risk becomes uninsurable. Generally speaking, if insurance cannot be procured in the terms required by the contract, the contractor will be in breach of contract. Contractors faced with a hardening insurance market may be forced to take out insurance at an uneconomic premium or even be forced into a position of default.
Practical mitigation steps
Contractors can take a number of practical steps in order to account for the current difficult insurance market.
Infrastructure contracts generally set out, in the insurance clauses or schedule, the insurance policies a contractor is required to take out and the minimum terms of such policies.
Tenderers should give careful consideration to the proposed insurance clauses and schedules to ensure that the requisite policies are able to be procured at economic premiums. Insurance advisers should be engaged early, and prior to proposing initial departures or tender pricing.
Tenderers on private projects will also need to consider how any uninsurable risks are to be managed under the contract documents. For example, tenderers may seek to carve out any uninsurable risks from their reinstatement obligations or seek to apply liability sub-caps for certain risks outside of their control.
Tenderers on private projects could also potentially seek to include public-private partnership (PPP)-style uninsurability provisions in the contract documents. However, this is not the market standard position and – unlike government clients on PPP projects – private owners will not likely have the financial wherewithal to take on uninsurable risk.
In connection with major project tenders, contractors should also consider seeking specialist 'front end' insurance legal advice as to whether the coverage terms of proposed policies of insurance will be sufficiently extensive and robust to effectively cover (under other heads of cover) risks such as fitness for purpose warranties. This is notwithstanding that cover for such warranties is explicitly excluded or not provided by the policy.
Higher insurance premiums should also be reflected in tender pricing and, where a tender process may take several months, contractors should take into account likely further shifts in the insurance market.
If, during performance of a contract, a contractor discovers an uninsurable risk, it should take immediate steps to protect its position. For PPP projects, the project documents will usually provide a process to follow upon discovery of an uninsurable risk.
Generally speaking, this involves the contractor providing the state with notice of the uninsurable risk within a defined period after it is discovered. If the state agrees that the risk is uninsurable, the state and the contractor will meet to discuss how it can be managed. If no agreement is forthcoming, the state will typically indemnify the contractor against the occurrence of the risk.
The parties may also have scope to consider other options for managing the uninsurable risk, rather than the state simply indemnifying the contractor. These may include self-insurance by either party, paying the higher premium and passing the cost through to the state, or coming to some other bespoke risk management strategy.
Private infrastructure contractors are in a more difficult position. Australian private infrastructure contracts typically involve full risk transfer from owner to contractor and will rarely include uninsurability provisions. This means that, unless an amendment can be negotiated, the contractor takes the uninsurability risk.
The possibility of split placements, with different insurers covering different risks, could be explored. Even in a difficult insurance market, different insurers may have varying risk appetites – for example, in terms of infectious diseases, some insurers may decline coverage altogether while others may not.
Finally, contractors need to be proactive and engaged in managing their insurers and their insurances. Insurer response times are becoming extremely drawn-out and last minute changes to policy wording are becoming more common. Renewal processes should be commenced early.
Where claims under polices are being contemplated or pursued, the framing and proving of those claims is required to be addressed by the insured with care and with attention to detail so as to limit the scope for insurers to delay or to refuse coverage. At both the front and back ends, meaningful engagement with the broker, who is almost always the insured's agent, is desirable as the brokers have influence with the insurers.
Ultimately, the insurance market tends to be cyclical and is likely to soften again over time, once profits increase and the market re-capitalises. This will put downward pressure on premiums and enable more acceptable policy terms and conditions to be secured. However, the current market difficulties are likely to remain in the near to medium term.
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.