Contractor's All Risks Policies: An Additional Source of Revenue on Construction Projects
June 27, 2005
(The following outline was used in a presentation to the Overseas Construction Association of Japan, Inc. (OCAJI) on July 29, 2004.)
Construction is a high risk industry. Accidents, including personal injuries and property damage, happen all the time, and these accidents cost the contractor money.
Many times these property damage claims are or could be covered under the Contractor's All Risk (CAR) policy.
With proper management, which includes identifying covered or potentially covered claims and properly documenting the claims, CAR policies can provide an additional source of income for the sophisticated contractor.
What Is CAR Insurance?
CAR policies insure against physical loss or damage to works, plant, equipment and materials during the course of construction. They sometimes are called Course of Construction or Builder's Risk policies.
The key characteristic is that, unlike other types of insurance, the CAR insurance clause is not limited by reference to specified perils - in other words, everything is covered unless it is excluded (expressly or by implication).
CAR insurance usually is combined with (but must be distinguished from) Public Liability Policies or Third Party Liability Policies.
Six Rules for CAR Insurance When Negotiating Prime Contracts
Insurance is something to which most contractors pay scant attention when contracting. Typically, the only thing the contractor will do is send the insurance section of the contract documents to its insurance broker to get a price for the insurance required to be provided by the contractor so the contractor can include this price in its estimate.
If CAR policies are to be a source of revenue down the line, the first step in the process is to ensure that a CAR policy is in place that contains the proper terms and conditions.
If problems with the CAR policy are identified before the contract between the contractor and the employer is signed, the parties can negotiate the risks, including reducing the CAR excess or removing some exclusions in exchange for payment of a slight additional premium.
The terms of the CAR policy are, like the terms of a prime contract, subject to negotiation. To prepare to negotiate, make sure that:
||A CAR policy will be place in for the project.
||The contractor inspects a copy or specimen of the policy.
||The policy names the contractor and the employer as insureds.
||The excesses/deductibles are reasonable.
||There are no unusual exclusions from coverage (broker/attorney review).
||There are no unusual limitations on the measure of damages (broker/attorney review).
Typical Policy Wording
Policies bearing the title "Contractor's All Risks Insurance" vary considerably in their terms. Nevertheless, such policies have a number of common features.
The central provision is the indemnity clause. A typical example from a CAR policy is as follows:
The Insurers will indemnify the Insured in respect of physical loss or damage to the Insured Property described in the Schedule arising FROM ANY CAUSE except as hereinafter provided.
All the features of CAR insurance can be found in this example. It is an indemnity policy against physical loss or damage to identified property from all causes except those identified.
Elements of the Insuring Clause
This usually includes the employer, contractor, subcontractors/suppliers and, more unusually, consultants.
Under all internationally accepted forms of construction contracts, the contractor will have care of the works until completion and will own the equipment and materials.
In other words, it is the contractor that will be contractually responsible for any accidental damage to the works, the very risk that CAR policies are issued to cover.
As a result, as between the employer and the contractor, it is the contractor that should be more keenly aware of the terms and conditions of the CAR policy. Therefore, it is incumbent on the contractor to ensure that a proper CAR policy is in place.
Typically, the CAR policy will stipulate that there is a limit of liability for each "occurrence." Generally, an "occurrence" is physical loss or damage to the works. Generally, there is an excess or deductible for each occurrence. This can lead to disputes over what constituted the "occurrence."
Occurrence Case Study: Philippine Bridge Typhoon Case
Severe damage was caused to a public works bridge project in the Philippines by Typhoons Iliang and Loleng, which struck the Philippines on October 14-15 and 22-24, 1998, respectively. The damage was caused by flooding from waters from two separate releases from the Magat Dam Reservoir.
Two bridges and approach structures were damaged during the typhoons. A substantial portion of the damage was to temporary works and structures, including temporary construction bridges.
The deductible for Acts of God under the CAR policy was quite high, about $400,000 per occurrence.
An endorsement to the CAR policy essentially provided that "any loss or damage to insured property arising during any one period of 72 consecutive hours, caused by storm, tempest, flood or earthquake, shall be deemed as a single event and therefore to constitute one occurrence with regard to the Excesses provided for herein."
While this clause did not say that if the period exceeded 72 hours it was deemed to be two occurrences, there is a strong inference that this is what was intended.
As a result, the case was settled based on two deductibles, which reduced the recovery by an additional $400,000. Certainly the high deductible and the 72-hour endorsement are matters that the contractor could have attempted to negotiate before issuance of the policy and execution of the prime contract.
The meaning varies according to the context, but generally "consequential loss" refers to loss beyond the normal measure and includes such things as loss of profits and expenses caused indirectly by the event. Generally, such losses are not covered by the policy in the absence of express words.
In a typical CAR claim, there will be three damage components: The direct loss (the costs to repair); the prolongation costs to the employer; and the prolongation or extended general conditions costs to the contractor and subcontractors.
CAR policies are not consistent in their treatment of prolongation costs, which may be considered consequential losses.
Because prolongation costs arising out of a loss covered by a CAR policy are so significant, it is a good practice to review the CAR policy to determine whether such costs are covered and even to pay a higher policy premium to ensure that prolongation costs arising out of a covered claim are covered.
Consequential Loss Case Study: Philippine Bridge Typhoon Case
The policy contained an exclusion stating that the insurers shall not be liable for "consequential loss of any kind or description whatsoever including penalties, losses due to delay, lack of performance, loss of contract."
In essence, this clause meant that the CAR policy did not provide coverage for delays to the work resulting from the "occurrence" and resulting damage. In the case of the flood claim, no delay damages were paid to the contractor even though the flood and resulting repair work caused considerable delay to the project.
This will be defined in the policy. It will include primarily the works but also is likely to include temporary works, equipment and material provided that it is on site or in transit intended for incorporation into the works.
For larger projects where materials may be produced off site, a wider geographical limit may be used.
Property will be expressly defined or impliedly limited to that which is owned by the insured or for which the insured is responsible.
Insured Property/Temporary Works Case Study: Philippine Bridge Flood Case
The Philippine bridge flood case also involved exclusions regarding temporary works and materials.
The Depreciation Structure Endorsement effectively allowed the insurer to depreciate the value of any temporary facilities or structures in determining the amount of payment.
The Formworks, Scaffolds Endorsement allowed the insurer to depreciate the value of any formworks, scaffolds and supporting structures in determining the amount of payment. Special rules applied to steel/metal scaffolds and forms, which were treated as construction equipment.
As a result of these provisions, the contractor faced substantial discounts on the temporary works (temporary bridges and scaffolding) that were effectively washed away as the result of the flood/typhoon.
Fortunately, the contract between the contractor and the Philippine government provided that the government was responsible for damage to the permanent works resulting from acts of force majeure to the extent not covered by the CAR policy.
The contractor appealed to both the insurer and the employer for reimbursement for the temporary bridges, which formed a great part of the claim, on grounds that the temporary bridges were not "temporary works" or, alternatively, that they were in the nature of permanent works.
This is a good example of the interplay between the CAR policy and the terms of the prime contract.
Implied and Express Exclusions
Exclusions in General
The simplicity of CAR policies -- they cover physical loss or damage unless excluded -- is eliminated because a typical CAR policy has many exclusions to coverage that can make analysis of whether coverage exists in a given case very complicated. There not only are exclusions but exceptions to exclusions and even exclusions to exceptions to exclusions.
Below, examples of how exclusions operated to cause CAR claims to be covered or uncovered are discussed.
As with building contracts, there are certain requirements that always are implied into the policy and that limit the cover. One of these, already considered, frequently is consequential loss.
The other important implied exclusion is that the loss must be fortuitous. Loss will not be fortuitous when it was inevitable from the commencement of the cover or it was caused by the willful misconduct of the insured. In these cases, the loss is excluded by implication.
These may be implied exclusions given express form. Wear and tear, obsolescence and deterioration, rust and mildew are not risks because they are inevitably occurring events, but it nevertheless is usual to find express exclusions confirming that. An example is:
Any repairs or replacements necessitated solely by wasting wearing away or wearing out caused by or naturally resulting from ordinary use of works, rusting, corrosion or gradual deterioration of any part of an item of Insured Property, but this exclusion shall not apply to damage resulting from such causes to other Insured Property by this policy.
Defective Design and Workmanship Exclusion
One of the most important exclusions is for defective design and workmanship.
An example of the wording of such an exclusion would be to exclude liability for:
. loss or damage due to fault, defect, error or omission in design, plan or specification, failure of design, defective materials or workmanship.
The impact is that if the damage was caused by defective construction, the loss is excluded from coverage. One method used to avoid the impact of this exclusion is to characterize contractor error as defective "means and methods" rather than defective "workmanship."
Defective Construction Exclusion Case Study: Poured-in-Place Concrete Collapse at Singapore Plant Building Case
This CAR claim arose out of a temporary formwork collapse at a chemical plant building project in Singapore.
In essence, the concrete second floor of a building, 14 meters in the air, collapsed while the concrete was being poured. This necessitated rebuilding the collapsed portion of the building at substantial additional cost.
The policy contained relatively favorable language, stating that it covered: "All accidental and unforeseen loss of or damage to the Property.." Of special importance, the "Exceptions" section of the policy provided in part:
No liability shall attach hereunder for
1) loss or damage due to fault, defect, error or omission in design, plan or specification..
2) the cost of rectifying defects of material or workmanship but this exclusion shall not apply to the cost of making good accidental damage to the Contract Works which occurs during the Period of Insurance. as a result of such defects.
The critical issue was whether the collapse was the result of ["due to"] fault/defect/error in "design [or] failure of design." If this was the predominant or proximate cause, then liability was excluded under the policy.
This collapse was taken very seriously by the employer and the Singapore government, which demanded that a formal report on the cause of the collapse be compiled. The project manager hired an engineer to prepare the report, which predictably assigned fault to inadequate design by the shoring engineer retained to design the shoring (some beams were underdesigned by more than 20 percent) and to inspect the shoring to ensure that it was properly erected. The project manager was reluctant to assign blame to his construction team.
The CAR insurer denied the claim based on the defective design exclusion. At this point, the contractor retained counsel to assist with prosecuting the claim.
Counsel noted that the policy did cover defective construction. Recall that the exclusion quoted above excluded defective construction, but went on to state that the exclusion did not apply to the cost of making good damage to the works that occurred as a result of such defects. The bulk of the damage in this case was damage to the works due to the collapse.
Thus, the policy covered all damage to the works but excluded damage caused by defective construction but then provided an exception to the exclusion for defective construction.
Another report was prepared concluding that the collapse was caused by defective construction.
A lawsuit was filed, and the case settled on the day before trial for 60 percent of the claimed amount, which essentially allowed the contractor to break even on the costs of the claim.
And, the CAR policy in this case did cover prolongation costs.
Period of Cover
CAR policies are claims-occurring policies. The applicable policy is that in force when the event occurs that causes the "occurrence."
Generally the time will be expressly identified and should coincide with the period when the contractor is on site. It will end either when the employer takes possession of the works or when the contractor leaves site.
Some limited coverage also usually will extend to the period when the contractor is remedying defective works, in particular during the defects liability period.
Strategy for Claims Against CAR Policies
– Claims Against the Employer
On construction projects, especially those projects on which the contractor is losing money, the contractor will assert claims against the employer seeking additional compensation. This is the natural response on a losing project.
These claims will take a variety of forms: strong, weak and mediocre claims.
The contractor asserts this variety of claims because, at the end of the day, it wants to negotiate a settlement in which it will receive most of the money on the strong claims, some money on the mediocre claims and little money on the weak claims.
Sometimes the contractor will hesitate to pursue many claims against the employer because the contractor wants to maintain a good relationship with the employer, does not want to be seen as a "claims" contractor or because of cultural reasons, as is frequently the case with Japanese contractors, which are reluctant to pursue claims against employers because such claims are not pursued on construction projects in Japan.
– Claims Against the CAR Carrier
The strategy of pursuing strong, mediocre and weak claims also should be pursued in claims against the CAR policy. Frequently contractors do not assert small, weak or mediocre claims against the CAR policy, instead only pursuing major claims that obviously are covered.
This is bad policy. The contractor must be creative in attempting to identify claims that are potentially covered under the CAR policy and in pursuing these claims.
Note that asserting claims against the CAR carrier will not cause the employer to take a negative attitude toward the contractor, so asserting claims against the CAR carrier actually is a better practice than asserting claims against the employer.
– Managing the Claims
Before submitting a claim on the CAR policy, particularly a major claim, legal advice should be obtained.
Despite all of the problems on the Philippine bridge flood CAR claim - two deductibles, a high deductible, no cover for prolongation costs and reductions for depreciation -- the case ultimately settled, and the contractor fared well on the claim because the claim was put together by a professional who had identified the problems and took them into account before the claim was filed and because the negotiations were well-managed.
Even in the case of the Singapore plant formwork collapse, where the contractor had commissioned a report that placed the cause of the claim squarely within an exclusion, counsel was able to identify an exception to an exclusion and to make arguments in favor of coverage that eventually led to a satisfactory settlement.
– Documenting Damages
CAR Insurers, like any project employer, naturally will be inclined to attempt to reduce the amount of damages arising out of a claim against the CAR policy. They will attack prolongation costs. They will assert the maximum excesses allowed under the policy. They will attack mark-up for overhead and profit. And, CAR carriers will not pay on claims unless and until proper documentation is provided. Assistance from experienced counsel or consultants at the damages preparation stage is critical.
Japanese contractors need to change their perceptions about claims against CAR policies. CAR policies are a source of additional revenue. This source of additional revenue can be maximized by:
||Identifying and pursuing all covered and potentially covered claims.
Making sure to work the logic of the claim through before asserting the claim to avoid going down a path that ultimately will lead to no coverage.
||Being aggressive and creative in documenting the damages for the claim.
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