PRINCIPAL ARRANGED INSURANCE PROGRAM Kieran Lynch LL.B, M.Proj.Mgt Abstract This article provides an update on the works and construction liability cover provided by Main Road s principal arranged insurance program first introduced in 2003. The insurance program covers Main Roads road construction projects. The program offers value for money in the premium cost savings and the breadth of cover offered by the policy. Professional indemnity insurance for alliance works is also discussed. Introduction The state-controlled road network is not generally insured for damages, unless the National Disaster Relief Fund is able to be accessed or specific insurance cover is arranged. Public liability cover is maintained post-construction under the Queensland Government Insurance Fund which also provides limited professional indemnity cover for the Queensland government and its employees. In the past, during the construction phase of projects, the contractor has been responsible for obtaining the required insurance policies to the amounts specified by Main Roads in the contract documents. Also, it is a requirement for designers of roadworks and bridge structures to have professional indemnity insurance to and for a specified value and period. RoadTek has a separate insurance program covering its own program of works called Main Roads Internal Insurance Scheme (MRIIS). On 15 March 2001, the HIH 1 Administrator received approval from the NSW Supreme Court to place HIH into provisional liquidation. The collapse of such a large insurance organisation subsequently caused serious repercussions for the insurance and construction industry insurance became scarce, value for money diminished, massive increases in premiums occurred and a contraction in the breadth of cover provided. 1 The demise of HIH (Health International Holdings) Insurance Group was the largest corporate failure in Australia s history. HIH liquidators estimated that the company collapsed with losses totalling up to $5.3 billion. 56
Since then there has been a refocus on corporate governance which is now regarded as one of the higher risks faced by both the public and private sector (1). Effective and efficient risk management is a critical component of good corporate governance (2). Two primary tools for risk transfer are through the contract and through insurance. The High Court s February decision 2 confirms that, as long as Main Roads appoints and supervises the work of an independent contractor with reasonable care, it can not be held liable for the negligence of that contractor. However, from a project perspective, the identification, mitigation and/or transfer of these risks are still an essential part of good project management. In 2002, the Department of Premier and Cabinet and the Treasury Liability Insurance Taskforce Report set a broad government direction on liability insurance, noting the benefits of bulk-purchasing. The contents of a contractor-controlled insurance policy for a project were best known to the insurer, with the construction contractor s knowledge limited and the Principal knowing even less. It was not practical or feasible for the Principal to examine or understand fully the details of every insurance policy. Additionally the currency of a contractor s insurance policy was generally only established at the commencement of a project. Main Roads believed that the introduction of a new Principal Arranged Insurance (PAI) program would provide better corporate governance. In 2003, to ensure stability in insurance costs and certainty of insurance cover for Main Roads works projects, the department established a PAI program for Main Roads open tender construction contracts. This program replaced the traditional contractor-controlled insurance where the contractor arranged insurance cover for the project. The establishment of a new PAI policy was not straight forward as Main Roads had no established insurance profile. The PAI covered material damage or works insurance and contract liability or construction public liability insurance. The PAI Program was renewed in 2004 with significant expansion in cover with only a notional increase in premium. This reflected the impeccable claims history established through negligible works or liability claims. With a longer claims history, more benefits and options could be incorporated into the policy to the benefit of the insurer, Main Roads and its contractors. In 2006 a successful marketing campaign was undertaken for the renewal of the PAI program both in Australia and United Kingdom. The aim was to secure further improvements over the previous PAI program. The new PAI program came into effect on projects awarded from 31 October 2006 and represents extremely good value for money. The 2006 PAI program represents savings of approximately 45% to the department when compared to the previous PAI rates. The insurance policies have been reviewed by lawyers specialising in insurance and they have acknowledged the significant improvements in cover. Significant cover improvements have created substantial reductions in residual risks held by both the Principal and contractor. It is believed that these insurance cover improvements should be reflected in lower tender box bids; however, this reduction will be difficult to quantify. Other Australian state road authorities have recognised Main Roads innovation in the area of PAI. Their keen participation in the 2006 marketing campaign was critical to establishing a unified brand name for road authorities within Australia. The South Australian Department of Transport Energy and Infrastructure has been successful in fast tracking the development of an insurance market profile to establish a PAI program. The Department of Transport Energy and Infrastructure is satisfied with the outcomes it has been able to achieve in such a short time frame thanks to the established relationships between Main Roads and the insurers. The very competitive rates of the 2006/07 PAI will also enable Main Roads Western Australia to move over to a similar PAI program in mid 2007, with potential for significant savings. 2 Leichhardt Municipal Council v Montgomery [2007] HCA 6 (27 February 2007) 57
Over the next two years, based on existing premium rates, savings of up to $10M are anticipated on projects up to $250M. It is expected these premium savings will be magnified further on major projects greater than $250M. The PAI program for Main Roads ensures a reasonable balance between local and global insurers. An international component optimises Main Roads position in the negotiation for projects valued in excess of $250M. Advantages of PAI The perceived lack of control of the contractorcontrolled insurance cover for Main Roads risks caused considerable concern. Therefore, one of the main aims of the department s risk management strategy was to achieve a much higher level of control. The PAI model offers strong control of the cover provided, together with several other important features: Use of the whole of the department s buying power to secure optimum insurance cover Establishment of clear accountability for the insurance cover delivered Better control of policy documentation Creation of a robust, historical claims profile The opportunity to manage risk through better control techniques Encouragement of better relationships with projectoriented insurance as opposed to each party having to provide separate cover controlled by separate insurers with conflicting interests Enhanced potential for a less adversarial contract relationship Facilitation of improved performance resulting from more comprehensive pre-qualification of contractors Promotion of risk management at all phases of a construction project Enhancement of the construction industry s private/ public sector relationship through a fairer method of risk transfer Administration of claims management externally ensuring Main Roads project managers continue to focus on core business Simplification of construction insurance internal conformance as a result of the amalgamation of over 300 insurance policies into a single centralised PAI policy, negotiated annually. Entities Covered The entities insured under the current PAI for both works and liability cover should be verified at the commencement of a project, however, they are generally as follows: The Crown in right of the State of Queensland, including Main Roads, Queensland Transport and Queensland Motorways Limited, subsidiaries as well as controlled and joint venture companies Project managers Professional consultants, including architects, engineers and construction managers Joint venture partners Alliance participants Suppliers while on the project site Lessor, financier, mortgagee or trustee Superintendents Contractors Sub-contractors All other interested parties Insurance Cover The PAI Program provides cover for loss or damage occurring to contract works during the period of insurance and legal liability to third parties for personal injury or property damage caused by an occurrence in connection with the insured works. As part of the 2006 renewal, liability insurance is now extended to $250M 58
for any single claim or the aggregated total of a number of claims for a particular project. The works policy automatically covers projects with contract values up to $100M or bridgework up to $20M. Project-specific approval is required for projects above these limits. Under the works policy, loss settlement will be made on the basis of cost of reinstatement at the time of reinstatement provided that the work is carried out within a reasonable timeframe. The insurer will not be liable for any payment beyond the amount which would have been payable if the works had occurred in a timely manner. No payment is made until the full cost of reinstatement has been incurred. Limits of insurance cover Insurance needs should be analysed early in the project to allow sufficient time for successful negotiations with the insurer. A risk analysis must be undertaken in the preconstruction phases to identify areas of risk not covered in the insurance policy, or where the offered level of cover would be inadequate. Leaving these activities to the last minute may jeopardise the project s timely or efficient delivery. A number of potential losses are not covered and therefore require other risk treatments. If necessary, the broker can obtain project-specific cover for these risks. A brief summary of the things to consider and limitations of the standard PAI policy follows: Timing of construction there are different deductibles for wet season claims Movement of public utility plant this activity is not automatically covered by PAI and may require an extension of insurance cover High-risk activities such as pile driving, working close to public utility plant Open tender roadworks (which may include some bridgework) should be less than $100M (incl. GST). However, provision exists for projects of up to $250M to be included with the prior agreement of the insurers RoadTek works are covered where awarded in open competition, but not on a sole invitee basis. These are covered under the MRIIS The amount of insurance cover provided through the PAI policy must suit project requirements A project must not be a maintenance project. However, where there is significant liability exposure to Main Roads, large maintenance projects may be included with the prior agreement of the insurers If the works include a bridge(s), the value of each bridge must not exceed $20M (incl. GST). A bridge in excess of $20M may be included with the prior agreement of the insurers The Contract must be completed in less than 24 months from contract award date 3 Maintenance/defect period 4 must be less than 24 months The construction of underground passageways, subways and/or roads by digging under or through the earth is permitted provided the cost does not exceed $2.5M. PAI and the contract process Main Roads tender documents must describe the type of insurance cover required for the project. It is necessary to ensure that all parties to the offer, evaluation processes and subsequent contract have a shared understanding of the terms and conditions of the PAI cover together with instructions for the 3 Extended from previous 18 months. Liability automatic cover for 36 months 4 Extended from previous 12 months 59
claim s system. Directions for seeking further PAI details online should be given. It is the tenderer s responsibility to assess the adequacy of the established cover and arrange further insurance, if required. If PAI is not applicable to a project, it must be clearly stated in the project tender documents, so that the offerer can calculate the cost of insuring the works to the level required by the Principal and include that amount in their offer. The contractor s contractual indemnity arrangements with the Principal are not impacted by insurance and remain unchanged. Main Roads has a limited role in the administration of the PAI policy issues. Main Roads advises the contractor of the type of insurance cover under which the contract will proceed. The Contractor undertakes to meet the conditions of the policies. Main Roads does not provide advice to contractors on the cover provided. This advice is provided by Aon Risk Services. Main Roads should have no part to play in the claims process unless it is itself claiming against the policy. Funding All PAI program costs (including brokerage) are being recovered from projects, with districts accommodating a deemed percentage below the line for all contract values approved as PAI contracts through the Roads Implementation Program Application (RIPA) Financial Approval Process (FAP). If PAI is applicable on projects, an amount calculated to cover the cost of the premium must be added to the project estimate so that the application for financial approval shows the full, anticipated cost, including the insurance. Insurance for major projects, falling outside the automatic cover under PAI, needs to be negotiated separately and is charged specifically to the projects, along with brokerage fees. The cost of brokerage for projects outside of the PAI bulk arrangements is charged below the (contract) line. The premium is included above the line, as this reflects the risk appetite of the insured and directly impacts the contingency costs. Under alliance projects, premiums are included in the Target Cost Estimate. However, brokerage for such projects is a Main Roads project cost charged below the line, as it covers work before, during and after the contract delivery stage. The brokerage is pre-determined at a corporate level, based on contract value (rather than premium) reflecting services provided to Main Roads before, during and well after an Alliance. Spin Offs from PAI Program Alliance Professional Indemnity Cover The Queensland government, as a matter of policy, has traditionally required professional indemnity (PI) cover for professional consultancy work, especially high-risk professional work such as architects, engineers, lawyers, accountants and project managers. The traditional PI product or policy is triggered by an insured actually being sued. Because of the way Alliances are usually structured, an Alliance designers PI policy did not respond to losses incurred either within the Alliance or from outside the Alliance, particularly where this was claimed against other members of the Alliance. Some Alliance agreements had to be restructured to allow Alliance participants to sue each other to effect or trigger the PI policies. Some Alliances, which are not comfortable with such a behavioural compromise, remained uninsured for such risks. On small projects the risks are manageable however on major projects such as the Tugun Bypass, an alternative cover to the traditional PI arrangements became critical. 60
In the event of professional negligence and subsequent loss, what was required was a PI policy that was triggered by the loss, rather than through a litigation process. Through the well established relationship between Main Roads, the insurance market and the department s insurance brokers, Aon Risk Services, a special PI policy was developed. This Alliance PI policy has now been extended across all Main Roads Alliance projects and brings projects back within the traditional risk transfer arrangements as for construction work. Alliance PI has been affected on projects ranging from a $6M bikeway through to major road tunnel and bridge works in excess of $500M. The product is focussed on the transfer of the risk of catastrophic losses both during and after the Alliance, with some policies extended over ten years from the completion of construction. Since the development of this policy, interest from other PI insurers has rapidly increased as they gain an understanding of Alliance contracting and the net reduction in traditional PI risks for alliance projects. Alliance PI policies do differ between insurers. However, the model essentially has the alliance team advising the Insurers of a loss flowing from professional negligence, an assessment of the claim being made and both the Insurer and Insured being able to have determination by an agreed third party if required. It needs to be noted that Alliance PI cover is part of a matrix of project insurance. The optimum cover is found as a mix of works, liability and PI cover that reflects Alliance Risk Appetite. The new policies, frequently asked questions and claims manual are available for perusal on the Aon Risk Services web site: www.mdms.aon.com.au/obs/ mainroadspai. Project managers and pre-qualified contractors are advised of their user name and password and can access the web site. For further information contact John Ward, Manager (Risk Mitigation Services). The Governance and Risk Management section of the Major Projects Office (ph 07 3337 8356) can assist in the development of a project-specific PAI program where a project is not automatically covered. Conclusion Certainty of insurance cover has become a critical issue of good corporate governance. The PAI Program and joint marketing initiative has affected a good financial outcome providing value for money and has yielded significant improvements in the scope of cover. With the recent significant increases in road and transport infrastructure construction in Queensland, the insurance industry has shown extensive interest in the insurance initiatives of the department. References 1. Aon Insurance Annual Risk Publication. 2006 2. Main Roads Risk Management Framework and Queensland Audit Office (Audit Report No. 7) Corporate Governance Beyond Compliance. Further Information Guidance on calculating insurance costs is provided in the department s Insurance Manual and in the user guide for General Conditions of Contract for a Road Construction Contract 5. 5 http://www.mainroads.qld.gov.au > Inside Main Roads > Publications > Road Related > Road Construction Contract > User guides for the General Conditions of Contract 61