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Risk Managers' Forum Financial guarantee insurance Project owners can purchase specialized coverages to handle risks that normally are “uninsurable” By Richard G. Rudolph, Ph.D., CPCU, ARM
A specialized form of insurance coverage generally referred to as financial guarantee insurance can close the gaps that are produced by exclusions in traditional package policies available for project owners. There are four broad types of financial guarantee insurance, each designed to address a specific issue. One type is Force Majeure coverage. This policy protects a project owner and its lender by guaranteeing payment of the debt service if the project is not completed or turned over to the project owner by the contracted delivery date. For example, if a project owner borrowed $1 billion to build a high-rise office building, but a long strike by steelworkers delayed its completion date nine months, there will be a corresponding delay or a reduction in the expected flow of rents. The shortfall in expected rents may force the project into bankruptcy or liquidation. The Force Majeure perils include delay in commissioning (turning the project over) or completion; permanent abandonment resulting from labor strikes affecting suppliers; change in governmental ordinance, code, or law; order of a court changing a law; or any other cause beyond the control of the owner, contractor, or other project participant. System Performance coverage protects both project owner and lender if the system, such as a power plant or manufacturing process, does not perform at the specified level (or at all) and the predicted revenues are not generated. For example, two decades ago, a public entity built a series of hydroelectric power plants in Washington. In order to obtain a more favorable interest rate, the public entity purchased debt repayment insurance from a specialized municipal bond insurer. When the project failed to generate the projected levels of power and the revenues needed to repay the debt, the insurance company had to pay and the public entity partially abandoned the project. The System Performance peril is underperformance (including non-performance) that results solely from deficiencies in the system’s design, materials, or construction that becomes known after completion and commissioning of the project. Efficacy coverage is the contractor’s version of System Performance. It protects the contractor from the risk of liquidated damages caused by the contractual assumption of liability for underperformance. The Efficacy coverage perils are delays in commission-ing or completion, permanent abandonment, or under-performance (including non-performance) resulting solely from deficiencies in the project design, materials, or construction. Inherent Defects coverage provides protection for the owner for damage to the property caused by inherent defects in design or construction. This is the owner’s first-party coverage for what would normally be covered by an architect or engineer’s errors and omissions policy, but it would require an owner to file a suit against the negligent professional and face more delay and uncertainty in recovery. Inherent Defects perils are similar to some traditional physical damage perils. They include collapse or threat of collapse and physical damage arising out of the inherent defects, but not ordinary perils like weight of snow. In addition, there are exclusions similar to those found in a difference-in-conditions policy. These include inherent defect in non-structural work, improper or inadequate maintenance, abnormal or excessive use, alterations or modifications that adversely affect the stability of the structure, and acts or omissions of the insured (the project owner), as well as some common “natural” perils. The market for these coverages is limited, with only a few insurance companies offering the coverage. The premiums charged are usually sizable and the insurance budgets of smaller companies normally cannot handle the cost. However, there is another reason most insureds do not buy these types of coverage—they don’t know about them because their agent or broker did not identify the exposures. And that means, if there is an uncovered loss, the agent or broker could be facing an E&O claim. If a buyer says “no, thanks” to an offer to provide a quotation for these specialized coverages, the agent or broker should get a signed declination. * The author |
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