Know the Drill: 2022, Issue 1
Know The Drill: Issue 1, 2022
For the first issue of 2022, we explore three focus topics:
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Considering all the options - How contractors can free up capital in a cost-effective way.
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Contract works - With current cost escalations are the contract works policies keeping up?
- The supply chain conversation - An insurance perspective.
We hope you find the insights and perspectives useful. For more information on any of the topics, please contact one of our expert construction specialists today.
How contractors can free up capital in a cost-effective way.
Bonding is essentially a surety (a finance industry product). A surety is a promise to pay by one party to assume responsibility for the debt obligation of the other party. In New Zealand, the party that takes on the obligation (Surety) has historically been the banks. To protect their position, the bank typically have the bonds issued secured by capital (deposit in a bank account that cannot be accessed or similar). This can be up to 100% of the value of the bonds issued. Insurance companies can be the Surety and issue bonds. Insurance companies do not require the capital backing that the banks do. There are two avenues where insurers can assist contractors, as below:
Access to performance bonding: This is becoming a concern for a number of reasons in the industry. Banks are tightening requirements around bond facilities and not increasing facility limits, at a time where many contractors are looking to increase facilities. Insurer (surety) facilities:
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Are not required to backed by capital - thereby freeing up that capital.
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Are on-demand bonds and follow your construction contract requirements/ wordings.
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Can be bank fronted - thereby meeting the requirements of your Principals.
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Can complement your current banking arrangements – it is not a case of one or the other.
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Spread you risk of relying upon just one provider for your bonding arrangements.
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With many contractors having a couple of strong financial years in a row - now is the time to be considering alternative facilities.
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Overall costs of having bonds issued is often cheaper than bank facilities.
Retention instrument: This is a new product launched in 2021. It protects (guarantees) the subcontractor retentions that the head contractor withholds from a subcontractor. This means the head contractor can use that cash (subcontractor retentions) within their business. The Retention Instrument meets the requirements of the Construction Contracts Act (“CCA”) and will still be compliant with the proposed changes to the CCA. With the proposed changes directors (and staff) of head contractors will be liable for substantial fines for breaching the Act so it is important to ensure that head contractors comply with the legislation. In summary, a Retention Instrument:
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Complies with the CCA
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Does NOT require capital backing or guarantees from directors/ shareholders
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Cost is cheaper than an unsecured loan from the bank
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Frees up capital.
More information on the Retention Instrument is available on our website. Insurance companies should be considered as a viable solution for contractors as a means of freeing up capital – often at a cost cheaper than it can be acquired from your bank. Aon is the only insurance broker able to offer both Performance Bonding and Retention Instrument solutions to contractors. For more information, contact warren.tucker@aon.com.
With current cost escalations are the contract works policies keeping up?
Annual contract works policies (the following points also apply to project specific policies as well) are held by contractors to meet the ongoing requirement of insurance for projects. In the current construction environment these policies/ facilities need to be reviewed to ensure that they meet the needs of current projects and the projects in the pipe. Points to consider include:
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Is your maximum value of “any one project” adequate? The overall cost of projects is escalating
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If the policy is on a minimum deposit and adjustable basis, the adjustment at the end of the insurance period could be significant. Allow for it in budgets.
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Is the maximum period any one project adequate? Delays due to COVID, supply chain etc have meant that projects are taking longer to complete. On annual contract works policies the policies will cease automatically at the end of this maximum period – even if the project has not been completed.
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Principal provided materials. Have you been advised of the value of any materials supplied? Don’t assume the value. Check for any maximum values limits in the policy.
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Additional Sub-limits. Costs have been increasing significantly. Typical additional limits included are:
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Removal of Debris
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Increased Costs during construction (variations)
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Inflationary costs. Should apply to the built and un-built portion.
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- Consideration should be given to increasing these to reflect the current environment. One suggestion to us recently is the inflationary cost allowance should be 20%.
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Many projects are acquiring materials in advance to secure supply (See following article). Some policies have limits on the maximum value of materials stored at any one location. They can be as low as $25,000.
With the escalating prices across construction projects, it is important to ensure that the contract works policies are keeping up so that, should there be a claim, there isn’t a short fall in any claims proceeds. These limits can be increased in consultation with insurers. Talk to an Aon specialist to review your contract works policy.
The supply chain conversation - an insurance perspective.
Supply chain issues are well known, but you also need to consider – what are the insurance implications? You don’t want to be in a position where there is under insurance on a loss. Issues that need to be considered can include should there be a loss:
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Where are materials coming from? If coming from outside of NZ how will be you get them here to ensure the project is able to finish in a timely manner. Is there any airfreight allowance? And is it sufficient?
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What is the lead time to get materials that you may need? A plaster board supplier has recently said they are not talking any forward orders until July. Currently time to deliver is circa 6 months. Is the escalation provisions and additional costs (for example to allow for additional labour to reduce time of installation) within the policy adequate?
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Bespoke or specialist equipment. If a contract nominates a specific piece of equipment what happens if the manufacturer is no longer making that specific piece of equipment/ it is no longer available? Does the contract allow for the next version/ model to be utilised? What happens if it costs more? Do you need to get the manufacturer to make it specifically for you (and at what cost)?
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If ordering early:
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Is there sufficient cover for while it is being stored? What are the maximum limits for offsite materials in the contract works policy (these can be increased)?
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Where is it being stored? Is there adequate security, fire protection etc. We have had a couple of instances recently where hi ab trucks have been used to uplift materials over security fences.
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When trying to get ahead of the supply chain issues you need to consider the insurance implications as you don’t want all of your forward planning and logistics to be let down by not considering the insurances.