In an industry beset with shrinking margins, rampant project delays and extortion, payment delays, serious price competition and increasing materials costs, South Africa’s construction industry faces a challenging risk landscape, where appropriately scoped insurance and risk management are fundamental to survival and ensuring a sustainable business.
A concerning trend at the moment is the undercutting of insurance coverage due to cost pressures. This is according to Sphamandla Stemela, a broker at Aon South Africa, who says that while the principal contractor takes full construction risk cover, sub-contractors only secure minimal contractors’ liability insurance instead of full cover.
“There seems to be a misinterpretation from many contractors on how liability is triggered, which can open a can of worms when the sub-contractor is operating on behalf of the principal contractor, not only during the construction period but also during the defects period,” says Sphamandla.
“Principal contractors require confirmation of insurance before appointing a sub-contractor. We find that sub-contractors confirm insurance coverage and request the policy wording or coupons to submit to the principal contractor as proof of coverage, but then fail to pay the premiums or cancel the coverage. On paper, everything looks above board, but these contractors are essentially entering a legal agreement with no cover in place that can have dire consequences down the line,” Sphamandla warns.
Tshepo Mofubetsoana, senior broker at Aon South Africa’s construction & engineering division, says the insurance industry has a great deal of ground to cover in stemming this trend and it starts with educating the parties involved on the risks they face, not just from a perils perspective but also from a legal point of view, where matters often end in a bitter and costly legal battle.
The insurance agreements put in place before the commencement of a project are often the only viable means of ensuring that a project stays on track. “The insurance aspect of a construction project is well documented during the risk management process and influences a means to guide risk during the design and feasibility of a project. Each participant in the project faces risks in the conduct of their business and it is imperative for each entity to carefully consider the risks that can be offset against insurance solutions and to implement an effective risk management programme that will protect assets, improve stability and long-term profitability, ultimately safeguarding future opportunities,” Tshepo explains.
During this process, the magnitude of risk can often be indeterminate, but we can determine the proportion of real versus perceived risks, the monetary quantification of risks and the real import and the impact of a type of risk.
Aon highlights seven of the key risks the industry needs to consider:
Adverse weather – According to Aon’s latest Client Trends Report, extreme weather and a changing climate are impacting many of the risks businesses face today. Organisations will need advanced climate and natural catastrophe models and expertise that can assess chronic and acute risks. The adoption of a robust Business Continuity Management (BCM) plan is key to addressing the issue and finding workarounds.
Cash flow or liquidity risk – Most construction work is done by sub-contractors who often lack the experience, resources and cash reserves of multinational contractors. When a principal contractor faces financial trouble due to a problematic contract or poor performance, it has a knock-on effect across suppliers, main contractors and especially subcontractors. It is also no secret that the construction industry has one of the longest payment cycles of all industries, creating risk at every level. Slow payments disrupt cash flow, increasing the risk of default, often leading to legal disputes from contractors and suppliers seeking unpaid amounts.
Common causes of payment disputes include:
- Work performance disputes
- Financing delays
- Change orders
- Back-charges
Contractual Obligations – Documentation errors or missed deadlines can lead to delayed payments and contractual disputes, especially when change orders are not properly vetted and approved, outlining the cost and schedule adjustment, before commencing with the work.
Contractual risk management provides a clear structured approach in addressing responsibilities to insure construction projects. Risk transfer using contractual liability is one of the most important risk management tools available to construction companies. Ideally, the parties, in their contract, will assign the risks and liabilities to the party best suited to manage and minimise the risks. It ultimately serves as a framework of the law between the parties involved and will establish which party has assumed or negated a particular risk in connection with the project.
Construction Mafia – The construction mafia refers to highly connected individuals or businesses within communities that extort a ‘protection fee’ or a percentage of the infrastructure cost from contractors or demand that associated members be recruited to work at the site. This trend is estimated to cost the South African economy R68b[1] by delaying and even preventing construction projects by creating safety concerns for staff members on the ground. Building a robust Business Continuity Management (BCM) programme around this is key while adding clauses into contracts from a liability perspective.
Defect in design – From an engineering perspective, defect in design is usually tied to costly legal liabilities and can severely damage the reputation of the engineer(s) and construction companies involved. An example is a bridge that is not adequately designed to span a river or is not sufficiently enforced to carry the weight. Many construction companies are paying closer attention to contractual wording related to engineering contracts and are including liability clauses for defects of design, which in turn highlights the need for Professional Indemnity cover for professionals in the field.
Specialised plant or machinery – It refers to ‘yellow metal equipment’ which is designed and built for specific tasks or functions such as excavators, bulldozers and cranes. These types of equipment are often costly to manufacture and purchase, and they require specialised knowledge and training to operate. Needless to say, cover for these items often needs to be very specific and bespoke taking into account the replacement value of the item; especially in instances where a piece of equipment was designed to fulfil a specific need and cannot be easily replaced.
Crime – Construction materials procured for a construction project are subject to the risk of theft or damage to property, with materials such as copper wire and other high-value items frequently targeted. Many insurance policies are specific on how items need to be stored in addition to having security personnel on-site.
“Construction insurance needs to be more than just a tick-box exercise and it is at this junction where a well-rounded insurance and risk management program is intrinsic to the success of a construction project and the livelihood of the contractors involved. Speak to an insurance broker who will be able to advise on everything from contractual obligations through to current risk trends in the market to ensure that your next construction project runs smoothly,” Tshepo concludes.
