Construction Risk Instruments
- Construction contracts
Construction contracts allocate completion risks from the project company or the Special Purpose Vehicle to the construction company, which further transfer risks to their sub-contractors. Construction contracts are typically in the form of an EPC (engineering, procurement and construction) or turnkey contract. The construction company / contractor typically guarantees the completion of the construction on a fixed date, for a fixed budget (LSTK) and with defined performance standards. Thus, the contractor bears the completion risk which might include: obtaining permits and insurance, procuring required materials and labour, constructs and performance testing of the facility. Contractors are commonly requested to provide insurance and guarantees for these risks and to cover potential cost overruns.
Construction risk insurance is a major risk mitigation instrument in infrastructure projects. The project contract frequently requires construction companies to obtain insurance to cover construction risks. The main risks, like time delay, cost overrun and performance risk, can be mitigated to appropriate commercial risk insurance. For example, private insurers provide Construction All Risk (CAR) and erection all-risk (“CEAR”) insurance covering potential property damages to operations and assets on the site during the construction. Delay in start-up (DSU) insurance covers additional interest costs, revenue losses and fixed costs linked to the time delay in the project completion. The insurance mainly covers loses caused by property damage. Third Party Liability insurance covers any claim by third parties in connection with construction risks. Marine cargo insurance mitigates damage of equipment during transport. The primary insurer is likely to reinsure the risks to mitigate the impact of a major claim. To ensure a reliable insurance cover, lenders might insist on a “maximum retained percentage” for a local insurer and specify credit ratings for reinsurance.