Contract works insurance: what brokers need to know

Vol 46: Issue 4 | December 2023

When Australian house builder Porter Davis went into liquidation in March 2023, it left more than 1,700 people with half-finished homes and made insurers even more selective in their appetite for construction risk.

Factors like fixed-price construction contracts, an inflationary squeeze on costs and the availability of materials and labour have added significant pressure on the industry. Porter Davis is among more than 2,500 construction companies that have folded in Australia since mid-2021, according to data from the Australian Securities and Investments Commission.

The industry in New Zealand is also feeling the strain, with data from Centrix showing 199 construction companies have filed for liquidation this year, a 35 per cent increase on 2022.

The ongoing hard insurance market is also contributing to the higher cost of cover like contract works insurance, which covers builders, tradies and subcontractors against accidental loss or damage to their projects during the construction period.

“The cost of claims contributes to the hardening of the market and, over the past few years, weather perils have impacted the construction industry in terms of high-level losses,” says Lesley Connolly, principal at Irecon Insurance Services, an authorised representative of Insurance Advisernet.

“The claims are more complex because the bigger the loss, the more work involved to get it resolved. The cost of reinsurance goes up, which flows on to the customer.”

Struggle for cover

Jennifer Steger, principal broker at Trade Risk, says there are two main components to contract works insurance. 

“The first is the material damage side, which covers risks like weather-related damage or malicious damage, and the second component relates to liability. If a policyholder causes any injury to a third party or damage to someone else’s property, they may be covered by contract works insurance.”

In places like Australia, Connolly says there is a shrinking pool of insurers willing to provide this kind of cover, especially for high-risk construction projects, such as wet civil risks and large refurbishment projects on high-value residential and commercial properties.

“If you’re doing a $600 million job where there’s a big fat premium, you get a bit of interest from the big insurers, but when you’ve got someone doing a high-risk project for $4 million, there’s a struggle,” she says. “Few insurers like to cover wet civil construction because it is high risk. We’ve got about three insurers in this country that will do it at that value.”

Natural disasters are also leading to a spike in premiums in New Zealand, says Caleb Dowman, senior broker — Construction at Gallagher (formerly Crombie Lockwood).

“Places like Wellington are prone to natural disasters, so the premiums tend to be astronomical, especially for big projects where you’re going to need a decent panel of insurers. Right now, you’re not going to be able to obtain that from the local market,” he notes.

Asking the right questions

Contract works insurance is complex and Connolly says customers often misunderstand exactly what they’re covered for.

“We have several different manuscript wordings, which have been written to cater to specific buyer groups. This makes the wordings more relevant and easier for clients to understand,” she says.

Connolly points out that every policy has exclusions, which can influence what damage will be covered if there is a loss.

“No two claims are the same and, as brokers, we can never guarantee claims outcomes based on the ‘what if’ scenarios.” Steger says some customers assume contract works insurance provides complete cover.

“Often the customer might believe that the equipment they’re using on site is automatically covered under the policy for something like theft, whereas it’s not an automatic cover, it’s an optional cover.”

Connolly says brokers must have a thorough understanding of their customer’s business and ask the right questions to provide the right cover.

“The number one question is, what’s your business activity as a builder? Are you building dams, rivers, bridges, houses? What’s your maximum construction time and what’s the contract value?

“Some of the biggest failings arise from administration issues, rather than the actual construction works themselves. Builders breach policy limits such as maximum construction period and maximum contract value, rendering themselves uninsured with no knowledge of even doing so. It’s our job, as the client’s representative, to make sure we educate clients well enough that they understand how the policy operates and set up ongoing reporting to mitigate any potential breaches.”

Finding the solutions

In a hard insurance market, Connolly says it’s challenging to find innovative solutions for contract works clients.

“There’s no trick to it, to be honest, and you really just have to understand the risk,” she says. “The best way to do this is to get everyone in a room and ask the right questions.”

Dowman says engaging independent consultants to review items in a construction contract can assist with cover exemptions.

“We’ve called in independent consultants to look at items in a contract that may be exempt from the Fire Service Levy, for example, because it can be quite expensive,” he says.

Connolly adds that brokers should review and clarify policy wording to ensure that the cover is understood.

“We checked a policy the other day with a $50,000 excess for water damage, but there was no definition of water damage in the policy. We went back and asked, ‘What do you classify as water damage? Leaking pipe? Flood? Tsunami?’.

“Clarifying the intention upfront is critical, because that’s where things could be won or lost when it comes time to claim.”

Contract works insurance outlook

Higher-hazard industries like construction continue to attract premium increases, with insurers being more selective about the risks they write. However, the latest Construction Market Update from broking and risk advisory firm WTW (formerly Willis Towers Watson) suggests pressure is beginning to ease. Renewals for contract works insurance range from flat to increases of 15 per cent for good risks.

However, WTW also notes that insurers remain concerned about materials and labour inflation, particularly in light of recent insolvencies across the construction industry.

“As a result, insurers are requesting greater detail around clients’ financial position, their contracting regime and how they are mitigating against inflationary pressures,” says WTW.

“Clarifying the intention upfront is critical, because that’s where things could be won or lost when it comes time to claim," says Connolly. 

“Fixed-price contracts are common across the Australian construction sector, leaving companies exposed to the rising costs of materials. This is outside the control of brokers, but the more they understand their customers’ business, the more they can help them to navigate the complexities of contract works insurance.”

Read this article and all the other articles from the latest issue of the Journal e-magazine.

Read issue 4 of the Journal