Commercial Real Estate

Insurance for construction and assembly risks (CAR) is a rather complicated and financially wideopen type of insurance. Under the current conditions of Russia’s booming market, it is still not widely preferred by those in the construction business, who generally do not insure or only partially insure possible risks at a construction site. However, Russians’ traditional faith in divine providence can backfire for the investor, construction company and the other participants in the construction process.

CAR insurance lets an investor be certain that his investment is protected at all stages of project completion. The contracting organization should be just as interested in an insurance policy, given that this party, according to Russian law, is responsible for accidental death risks or damage to the equipment, materials and facility under construction.

The chance of any type of accident occurring at the construction site is indeed quite high. Even though statistics show that insurance companies more frequently cover autorelated issues, possible losses during large construction projects are incomparably steeper. Could one, for example, really compare the financial losses of a construction crane falling into a ditch with the same losses suffered by an owner during a road accident?

Furthermore, insuring against CAR allows construction market participants to form reserve funds for unforeseen expenses. “These costs can reach 10% of the estimated construction cost, whereas insurance premiums on average do not exceed 0.8%,” says Yuri Belov, head of the engineering risks insurance department at Capital Insurance.

Voluntary Insurance for Guaranteed Risks

Despite specialists citing positive growth in CAR insurance policies, it is still too early to say that this type of insurance today is in demand always and everywhere. Moreover, the amount of construction activity could provide better insurance statistics.

“Construction is happening at a fast pace in Russia and new construction and contracting companies are appearing every day as part of specific large construction projects. Nevertheless, the CAR insurance market visavis other insurance markets, such as medical and auto, is not well developed,” believes Marina Ozhereleva, head of the engineering insurance department of the property and other risks insurance division at Rossia insurance company.

According to all experts’ evaluations, foreign companies most often insure themselves, given that this is the way they do business. Fairly often, contractors insure construction only because the developers and/or investors have insisted upon this.

Whereas nearly 100% of construction risks are insured internationally, this percentage in Russia is 7%10% and for the most part only in large cities. Alexander Barentsov, deputy general director at Mezhregiongarant insurance group, is certain that this type of insurance is operating at only 20% of its potential. Moreover, the lion’s share of all insurance policies for CAR is in Moscow and St. Petersburg, since CAR policies are taken out by companies building expensive facilities and these developers are concentrated in the two capitals.

According to Energoinvest, around 80% of the construction companies in the capital and only 10% of those in the regions carry insurance policies for CAR and civil liability. Ozhereleva notes, “Mostly because of large international companies and the growing influence of the authorities, around 80% of the facilities under construction in Moscow and St. Petersburg carry CAR policies.” Accordingly, Russia places thirteenth in the world in terms of the volume of CAR policies, according to data provided by the International Association of Engineering Insurers (IMIA).

Milan Dinets, deputy director of the property and liability insurance department at Ingosstrakh insurance company, values the CAR market at five billion rubles in premiums for 2006.

Specialists say that the reason for not taking out insurance policies is because of the underdeveloped insurance culture among contracting organizations, coupled with the local tradition of blindly trusting that nothing will happen. “The problem lies in the fact that construction companies often consider insurance expensive and unnecessary. Unfortunately, many contractors realize the advantages of insurance only once an insurance event has occurred,” argues Irina Terekhova, director of the property insurance department at Energogarant insurance company.

Incidentally, even large accidents at construction sites are not convincing arguments in favor of insurance. Barentsov says this is owing to the high yields in the construction business: “An accident at a construction site often is not catastrophic for either construction companies or investors. High profits allow developers to pay for losses from their own pockets, and the parties continue to work calmly without an insurance policy.”

According to Yulia Ionicheva, head of the engineering underwriting department at Russian Insurance Company, it is worth noting that Russian insurance companies have gained a significant amount of experience in issuing policies of this type and can fully underwrite the wishes of any client and policy irrespective of the liability.

Insurance Objects

CAR is considered to be a rather complicated form of insurance service. However, the complete product insures varying interests. A contractor can insure his construction equipment and machinery, temporary buildings and structures used for constructing a project. Moreover, damages caused to the clientdeveloper’s existing property at the site and nearby area can be insured. Losses for these risks are compensated according to the agreedupon limits in the policy and when the insured party adheres to all the conditions, agreements and exclusions of the policy.

A fullscale CAR policy includes thirdparty liability coverage in case of damage connected with construction. Also, postlaunch liability insurance for the insured party’s property in connection with the (guaranteed) operation of the building, materials, machinery and equipment must be noted. There are several approaches taken when insuring CAR. One is insurance on specific risks (named risks). This is considered the optimal means for the construction of small facilities or to insure reconstruction, interior finishing or deconstruction. Another means is full insurance coverage from all risks which could occur at the construction site.

When insuring CAR, damages and losses are compensated as a result of the following incidents:

•  explosions, fire, spontaneous combustion resulting from drilling, gas and electric or other work;
• flooding (damage) of a ditch, well, equipment, construction, water machinery, water leaks (accidents), connection networks (water lines, sewage, heating lines);
• sagging, collapse, cavein, soil creep of the ground, ditches and wells;
• natural disasters (earthquakes, floods, downpours, hail, tornados, hurricanes, tsunami, collapses, landslides, mudflows, snow avalanches, extremely low temperatures and other unusual natural occurrences);
• unintentional actions (namely, unintended results from gross negligence), damage to construction equipment and other machinery used for construction or other work;
• wrongful acts by third parties, including theft and larceny;
• short circuits, power surges, explosions resulting from centrifugal effect;
• assembly errors;
• falling/collapsing assembly objects.

In terms of insuring thirdparty civil liability, insurance protection is extended with respect to the property and/or physical damage caused by a worker of the insured party during work (official), namely the responsibilities connected with construction and assembly work. In this case, property damage is understood as causing harm to a third party who reports damage or destruction his/her property or other property loss, and physical damage, death or harm caused to health.
Moreover, a number of specific exclusions can be stipulated in the rules of a CAR insurance policy, such as:

• damage or destruction caused to property during a period of full or partial stoppage in work;
• the insured party not adhering to the instructions for storage, operation and service of an insured object, as well as using this object for other purposes for which the object was not intended;
• the insured party not adhering to equipment safety rules and conducting construction and assembly work and other work on insured objects;
• errors caused during the design of the constructed object;
• errors in construction, defects in materials or errors during preparation or when conducting construction and assembly work;
• experimental or research work;
• damages directly caused by continuous operation (wear, corrosion, oxidation, rotting, spontaneous combustion)
• the insured party being informed of paying fines and penalties on an insurance claim as a result of poorquality or untimely completion of construction and assembly work (rendered service), cancellation or nonfulfillment of agreements;
• bodily injury, illness or death to workers of the insured party or other organizations involved in the construction and assembly work;
• destruction, loss, damage to plans, drawings, photographs, models, mockups, securities, money, accounting and other documents
• damage occurring at the time of signing the insurance contract or were known to the insured party or his representatives;
• incomes (lost profits) occurring as a result of an insurance event.

The most common risks are fire, tipping of construction and assembly equipment, collapse of foundation areas, theft or larceny. The least common risks are natural disasters, although these types of risk can cause the most damage and loss.

Additional Options

In addition to the basic coverage, there are supplementary options to extend coverage. For example, the standard insurance policy for thirdparty liability does not extend to the period of additional technical service (guaranteed period). When including special clauses in a policy, insurance coverage for thirdparty liability may be extended for a previously indicated period. Risks of strikes, disorder and political risks (for foreign investors) may also be insured.

Moreover, financial losses suffered by the insured party in relation to extended construction may also be included in the coverage. This extension must occur as a result of an insurance event as per the material loss clause.

A policy may also include a clause to cover design errors, costs for necessary extra work, and work during nighttime hours, etc, as well as risk for performing technical service. It is also possible to insure against strikes and political risks (for foreign investors). Insurance for natural occurrences, such as floods, earthquakes, tornados, hurricanes, etc, are usually agreed upon separately. If an insurance event requires the immediate delivery of equipment or material via air transportation, the CAR insurance may cover such expenses.

Insurance companies can also underwrite the transport of materials. In this case, the insured party is not required to sign a policy each time for cargo and freight, he/she simply indicates in the CAR policy the transport route of the construction materials and equipment from the storage area to the construction site.

Another extension is called mutual liability insurance. When several contractors are working on one facility, this extension allows one policy to cover all parties, thus a separate policy does not need to be concluded for each legal entity. The construction companies taking part in the construction are indicated in the insurance application in the section listed as “additionally insured parties,” thus the insurance policy will extend to the indicated parties as though they had separate CAR insurance policies. If there is housing and storage and temporary buildings and offices for construction management, which are not construction facilities, on the construction site, this property may also be additionally insured via a special clause in the insurance policy.

There is another risk worth attention: in the event of an accident or other damage, a contractor may require additional funds to clear and clean a territory. When including this risk in the insurance contract, the underwriter assumes the costs of cleanup.

Who Will Foot the Bill?

Any organization with an interest in insuring its property may take out a CAR policy. However, general contractors most often take out such policies, as they assume the risk for destruction or damage to a facility under construction. At the same time, a policy holder may be the owner of the future facility and is therefore more interested than others that all the construction work is completed qualitatively and in a timely manner.

Many large industrial companies and the owners of shopping and entertainment, business and warehouse complexes today prefer to independently insure facilities under construction, which most times requires a contractor to take out a thirdparty liability policy. Also, a construction company, as a clause in the contract, could be required to insure personnel from accidents, as well as cargo and freight.

If a client does not hire a general contractor to complete construction and assembly work, but rather hires separate contractors for different stages of construction, the insured parties are usually the contractors, who are insured according to the stage and work they are completing. The same happens with subcontractors and design companies. For example, if there is a subcontractor completing equipment assembly in a building, the construction company will be liable only for the section of work being completed by the insured subcontractor, namely, for the assembly work.

Moreover, in addition to the insured party for the CAR policy, the interests of many parties participating in the project under construction are insured. This includes the client, contractors, subcontractors, equipment supplier, designers, technical inspection authorities, etc.

So, What’s the Cost?

The central factors influencing the cost of an insurance policy include the type of facility under construction (the number of floors, underground floors); the location (including geophysical factors); the level of difficulty (typical or nontypical project); the scope of insurance coverage; experience of the contractor; fire safety measures; security measures and how close the facility is to other buildings.

It is necessary to thoroughly review the contract for construction and assembly work with an appendix to its technical documentation when determining the level of risk and establishing adequate policy rates. Particular attention must be paid to the rights and responsibilities of the contractor and client, the terms and conditions of the postlaunch guarantee and thirdparty liability limits. Moreover, the following factors must be considered when establishing the risk level: the type of facility under construction, the type of the main and ancillary material used for constructing and assembling, the construction and assembly equipment, the structure of the ground at that site and the susceptibility of flooding, earthquakes, hurricanes and other natural disasters in the construction area, as well as the qualifications of the engineering and technical personnel and the contractors, etc.

The process of determining insurance risks is as follows: a prospective policy holder completes an application in which he/she indicates all areas and points to be insured. Based on this information, an underwriter determines the level of risk. In separate instances, underwriters may go to the site itself to review it, such as when the insurance application does not contain enough information.

In addition, the deductible applied to a CAR policy (the amount or a percentage of the policy holder’s own interest in the risk) affects the amount of the insurance premium. The higher it is, the lower the insurance rate is. The deductible encourages a policy holder to be careful with the insured property, decreasing the risk of an insurance event occurring as a result of negligence on the part of the policy holder and his/her personnel rather than the standard unexpected insurance event.

When signing an insurance contract, one must remember that the insured party must inform the underwriter of all known conditions pertinent for determining the risk of an insurance event and the amount of possible losses in this event.

Consequences of an Accident

What should one do should an accident occur at a construction site? First of all, the policy holder must inform the insurance company of the event and then immediately approach the authorities responsible for conducting an investigation of the event. Following this, within three calendar days from the moment of the accident, the policy holder must file a claim with the insurance company, describing the accident in written detail. Next, the underwriter’s claims adjuster reviews the insurance claim, and all claims are compensated in the same currency in which the insurance premium has been remitted.

The amount of the insurance claim for damage to property is limited by the value to replace said object or the actual value at the moment of the insurance event (depending on which amount is lower). If expenditures for repair or replacement of the damaged property exceeds its actual amount, the property is considered destroyed or totaled. Only those elements included when determining the amount insured are compensated when paying an insurance claim and determining the value of the property. Moreover, when repairing damaged property, expenses are only compensated for the property on the condition that it was directly prior to the insurance event. A number of companies also compensate for expenses accrued with the goal of lowering losses, if this loss applies to an insurance claim as per the terms and conditions of the insurance policy.

In some instances, insurance companies have the right to deny an insurance claim and losses. For example, this could occur if a policy holder reported incorrect information for evaluating risks and did not inform the underwriter about substantial changes in risks, did not report damage and/or loss in the agreedupon timeframe from the moment of the insurance event or obstructed the participation of the insurance company’s adjuster in determining the conditions, nature and amount of losses, or did not present documents necessary to determine losses.

Once an insurance claim is paid, an insurance company receives the right of recourse. All disagreements arising as per the insurance contract are permitted in accordance with the laws of the Russian Federation.

Cancelled Licensing

Although not all construction players demand CAR policies, market growth today leaves hope that this type of insurance will develop.

Indeed, today CAR insurance policies are already quite in demand, and they should develop in conjunction with the growth in construction, and this concerns not only commercial real estate, but also all sectors of the economy where construction projects are being completed. In the near future, CAR policies will develop at the same pace as growth in property insurance, and this is not only related to the country’s overall growth in the insurance industry, but also to the favorable condition of the Russian economy, the inflow of investments and the large number of completed and planned construction projects. The CAR insurance market is presumably more than five billion rubles in premiums per annum.

As is known, Russian legislators have rendered a decision on repealing licensing of construction activity. Indeed, the new law was to have come into force on January 1, 2007, but the deadline was postponed for some time. How will such legislation affect the insurance industry?

Insurance could become the most important form of nongovernmental regulation of construction activity when licensing has been cancelled. When signing an insurance contract, an underwriter inspects a construction company and analyzes the risks of insurance events by visiting a facility and delivering recommendations for preventing possible losses. Accordingly, when insuring a construction company, the underwriter is fulfilling an important function by evaluating a company’s level of professionalism.

At the same time, the cancellation licensing for construction activity could result in an even lower number of construction companies taking out CAR policies. Licensing at least adheres to some sort of requirements. Insurance is a sort of sign of loyalty on the part of a contractor to the construction market itself and the client and enduser in particular. Contractors are concerned with quality construction work, means for protecting against financial risks for the period of construction and many other factors.

Furthermore, there is a possibility of another law replacing the licensing of construction activity in the event it is repealed, such as a law for obligatory civil liability insurance for construction companies. A corresponding bill is being drafted; however, nobody can predict the fate of this initiative, given the duration of passing other insurance draft bills in the State Duma. Additionally, if this legislative initiative is passed, all the issues with CAR insurance policies will still not be resolved. First of all, only insurance for civil liability will become obligatory, while other risks at a construction site will be insured on a voluntary basis. Secondly, this requirement could lead to many contractors insuring themselves only formally at an understated limit.