Delays, Financing Risks More Common for Today’s Construction Projects

By John A. Tutera | June 27, 2011

While brokers on construction projects have historically focused primarily on owners and contractors, economic uncertainty has created a new focus area — financing entities. In addition to the usual construction risks, financing has emerged as a major concern, with more projects being delayed by lending issues.

Of course, brokers have always had to consider the needs of lenders. But, borrowing is now more difficult due to new conditions imposed by government agencies and private lenders. Some projects are struggling to get the financing they need to break ground; others have stalled after construction begins.

Brokers need to utilize a mix of risk management and insurance strategies to protect their clients from the risks of delay.

One solution is to add delay in completion and soft costs coverage, typically as an endorsement to the builders’ risk policy, protecting clients if a disruption in the project’s “critical path” delays the commercial turnover date.

Although coverage is critical, risk management is just as important.

This review begins at the earliest stages, with an accurate assessment of the unique needs and potential pitfalls of a project and continues throughout, with an ongoing dialogue among brokers, owners, contractors and, in some cases, lenders.

Comprehensive Information, Smart Underwriting

At the core of the process is the broker’s deep understanding of the scope of the project and its unique features. In order to get the best deal for their clients, brokers should present the project risks simultaneously to as many suitable carriers as possible. This gives the market the ability to compete in a meaningful way and provides the broadest range of options for brokers and their clients.

Providing underwriters with comprehensive information and data can help them make informed decisions. Such information might include the contract value line-item breakout as well as the owner-supplied materials, financial pro formas, construction and procurement schedules, project site location including offsite storage or fabrication, catastrophe exposures and protective measures to be employed, geotechnical summary report, site photos and plot plans, and insurance requirements from the lenders.

Skilled, knowledgeable underwriting can also help if financing issues do arise. Minimizing the number and severity of unexpected non-financial exposures can make it easier to stay on track even if finance-related delays occur.

Importance of Claims Paying

While many owners and contractors focus on price, quick claims payment is equally important, particularly when the owner or contractor encounters time-sensitive issues or needs to make up for lost time. Properly managed claims mitigate losses; brokers who have an in-depth knowledge of the claims field as well as the construction industry are a huge asset for clients.

Having a strong network of claims professionals, brokers know and trust, including underwriters, risk managers and engineers, is also beneficial in this environment. Don’t wait until a claim arises to assign a claim adjuster, particularly if there are multiple insurance carriers on the builders’ risk policy. Gain insight from the adjuster on any issues they can offer in policy review as well.

While many project delays involve financing, it’s by no means the only cause. There can also be public opposition to projects or other setbacks, including permit issues. Regardless of the cause, protecting future revenue streams is critical.

Unlike an operating risk, there are no offsets for a disrupted revenue stream so it’s important for brokers and their clients to consider the following questions at the project’s start:

  • Is the client comfortable with the amount of exposure?
  • Does the claim adjuster understand the coverage?
  • Have change orders and schedule changes been coordinated among contractors, owners and the insurance carrier?
  • Is there a structure in place to ensure an ongoing dialogue as conditions change?
  • Have we considered Murphy’s Law?

Guarding Against Soft Costs

While coverage for delays in completion and soft costs is sometimes overlooked, it’s critical in this environment. This is another area where brokers have to be extremely knowledgeable about the specific and unique features of individual projects.

It can be difficult to assess soft costs but, there is a distinction in builders’ risk coverage between hard costs (bricks and mortar) and soft cost endorsements. Since soft costs exposure values are somewhat of a moving target in terms of the insurable values, it’s important to project them accurately and, in many circumstances, involve the financial planning members of the project development team. This ensures that everyone has the same understanding and information. Typical elements of hard costs include cost of labor, construction materials, contractor’s overhead and profit, scaffolding, furniture and fixtures, among others.

Non-time-dependent soft costs, also known as additional expenses, are part of the project development expenses and include some or all of the following elements: architect’s and engineer’s fees, advertising and marketing fees, insurance premiums (particularly workers’ comp.), developer fees, legal fees and property taxes. These costs may need to be more accurately reflected as the developer’s or owner’s indirect expenses recoverable under the hard costs or physical damage element of a builders’ risk policy. Not securing coverage for soft costs can pose serious financial consequences, particularly if such soft costs are reoccurring expenses.

Time-dependent soft costs and loss of rental income and/or loss of gross revenues are even more critical as this is what the lenders are looking to accurately insure, particularly on non-recourse financed projects.

With the still-uncertain economy and the traditional lag in the real estate and construction markets, projects run a very real risk of encountering delays. In this environment, where financing arrangements and other critical elements can change quickly and dramatically, brokers must be vigilant about protecting their clients if their projects are derailed from their “critical paths.”

Tutera is senior vice president, Construction, for Hiscox USA. E-mail: john.tutera@hiscox.com.

About John A. Tutera

Tutera is senior vice president, Construction, for Hiscox USA. E-mail: john.tutera@hiscox.com.

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