Improving Security of Payment Building and Construction Industry

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8. Insurance Page 99National Public Works Council IncImproving Security of Payment in the Building and Construction Industry• Subcontractor Indemnity InsuranceThis approach is where a Subcontractor takes out insurance as a protection againstnon-payment of monies due from a Head Contractor. It was reported that suchinsurance was considered relatively expensive at between three (3) to five (5) per centof the subcontract price, which, if extended across a project as a whole, would resultin a two and a half (2.5) to four (4) per cent project cost premium.It was concluded in the NPWC paper that:• Subcontractor indemnity insurance was not viable due to its high cost and difficulty inensuring universal compliance.• Contractor default insurance may prove to be viable, if the indicated premium levelscould be realised, as the NPWC could provide universal Subcontractor paymentsecurity through contractual provisions, or could be extended in the private sectorcompulsorily through legislation.• Cash security/retention insurance is only viable when the cost of premiums were lessthan the other options currently in use such as bank guarantees or trust arrangements.Further, the NPWC also found that it was possible for Head Contractors or Subcontractors toprotect themselves with credit indemnity insurance. However, it also found that, as suchinsurance was currently optional, it was relatively uncommon, resulting in an onerouspremium price of around three (3) per cent of the value of the contract.In accordance with the Brief this Consultancy has limited its examinations to Contractordefault insurance and cash security/retention insurance where the insurance is to be effectedunder universal insurance schemes and it is taken out by the Head Contractor.We contend that insurance under the above mechanisms should provide the Subcontractorwith reasonably effective financial redress against a defaulting Head Contractor, although thecost of insurance may be prohibitive.As with any service or product, insurance comes at a cost. When assessing a risk andaccordingly, the cost of insurance, an underwriter will consider whether it can generatesufficient premiums to cover the following:(i)(ii)(iii)Costs of claims;Cost of administration and other operating overheads; andMargin for profit.Underwriter's are conservative by nature and disinclined to "take a punt". Therefore,underwriter's are likely to not participate in the underwriting of a risk when they are unable toobtain adequate assurances about the quality and quantity of the potential risk.Clearly the success of an insurance scheme to cover Subcontractors will depend on thewillingness of the Insurers to provide the appropriate product to suit the market at a cost that
8. Insurance Page 100National Public Works Council IncImproving Security of Payment in the Building and Construction Industryis not prohibitive.8.3 Definition of "Insurance"Insurance can be defined as a contract between the Insurer and the Insured, which takes effecton the occurrence of a nominated uncertain event (insurable event), which may or may nothappen.An insurance policy is usually taken out by a party who wishes to minimise or eliminate hisrisk of loss should that uncertain event occur. To "insure" against such an event, the partymust pay a premium to an Insurer to compensate for a potential claim against the event.Insurance is premised on the principle of utmost good faith between the Insurer and theInsured. Accordingly, full disclosure must be made by the Insured to the Insurer in relationto all relevant facts and circumstances relating to the insured event. If full disclosure is notmade the Insurer is able to avoid the insurance contract in the event of a claim.In the current context, we describe an insurance policy as a contract between an insurancecompany and the Head Contractor (the Insured) the proceeds of which are payable to thegroup of Subcontractors upon default by the Head Contractor due to its insolvency.Only those Subcontractors who have privity of contract with the Head Contractor, through astandard form building contract, should be able to participate within such an insurancescheme.8.4 What to InsureThe cost of insurance premiums should be significantly reduced if the potential risk of theoccurrence of insolvency and the overall financial exposure of insolvency is minimised. Webelieve by acting on the recommendations contained within this Consultancy that the riskmay be reduced to a level where the potential risk and the financial exposure of insolvencywill be minimised and hence, the cost of the premium should not be prohibitive.The effective use of the proof of payment approaches previously mentioned combined withappropriate consensual dispute resolution mechanisms, should mean that Subcontractorsreceive progress payments on a timely basis throughout the duration of the building contract.Accordingly, a Subcontractor's exposure to non payment would be limited to two (2) aspectsof financial exposure:(i) amounts due for work performed since the last progress payment; or(ii) the final progress payment.Therefore, the risk of non payment by a Head Contractor would effectively be limited to onepayment within the contract. If the recommendation for Subcontractors to receive a prioritypursuant to an amendment to Section 556 of the Corporations Law is adopted, then we wouldcontend that the financial exposure would be limited to a reduced percentage of the totalsubcontract value. This represents a substantial reduction to the risk of covering the fullsubcontract value without increasing the financial exposure of the Subcontractors.
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