A New Dawn in Civil Construction Underwriting
Pennsylvania school children know the tunnels on the Pennsylvania Turnpike by name — Blue Mountain, Kittatinny, Tuscarora, and Allegheny.
San Francisco owes much of its allure to the Golden Gate Bridge. The Delaware Memorial Bridge commemorates our fallen soldiers.
Our public sector infrastructure is much more than its function as a path for trucks and automobiles. It is part of our national and regional identity.
Yet it’s widely known that much of our infrastructure is inadequate. Given the number of structures designated as substandard, the task ahead is substantial.
The Civil Construction projects that can meet these challenges, however, carry a unique set of risks compared to other forms of construction.
“The bottom line is that there is always risk in a Civil Construction project. If the parties involved don’t understand what risk they carry, then the chances are there are going to be some problems, and the insurers would ideally like to understand the potential for these problems in advance.”
– Paul Hampshire, Vice President – Civil Construction, LIU
The good news is that recent developments in construction standards and risk management techniques provide a solid foundation for the type and risk allocation of Civil Construction projects they are underwriting. Carriers need to be able to adequately assess the client and design and construction teams that are involved.
For Builder’s Risk Programs, a successful approach prioritizes a focus on four key factors. These factors are looked at not only during the underwriting phase of the project but also in the all-important site construction phase, under the umbrella of a Risk Management Program, or RMP.
Four key factors
Four key factors that LIU focuses on in underwriting and providing risk management services on a Civil Construction project include:
1. Resource knowledge and experience: When creating a coverage plan, carriers work to understand who is delivering the project and how well suited key staff members are to addressing the project’s technical and management challenges. Research has shown that the knowledge and experience of those key players, combined with their ability to communicate effectively, is a big factor in the project’s success.
“We look to understand who is delivering a project, their expertise and experience in delivering projects of similar technical complexity in similar working conditions, even down to looking at the resumés of people in key positions,” said Paul Hampshire, Houston-based Vice President with Liberty International Underwriters.
2. Ground conditions and water: Soil and rock composition, the influence of ground and surface water, and foundation stability are key additional considerations in the construction of bridges, tunnels, and transit systems. If a suitable level of relevant ground (geotechnical) investigation and study has not been undertaken, or the results of such work not clearly interpreted, then it’s a red flag to underwriters, who would then question whether the project risk profile has been adequately evaluated and risks clearly and transparently allocated via suitable contract conditions.
“As we all know, ground is very rarely a homogenous element within Civil Construction projects,” LIU’s Hampshire said.
“It tends to vary from any proposed geotechnical baseline specification with the consequential potential for changes in behavior during construction. We need to understand who has assessed the condition of the ground, its behavior and design parameters when compared with a particular method of construction, and all importantly, who has been allocated the ground risk in a project and the upfront mechanisms for contractual ground risk sharing, if applicable,” he said.
Knowing how much water is associated with the in-situ ground conditions as well as the intensity, distribution and adequate accommodation (both in the temporary as well as in the permanent project configurations) of rainfall for a site location and topography are also key. Tunneling projects, for example, can be hampered by the presence of too much or unforeseen quantities of groundwater.
“In major tunneling infrastructure projects, the influence of in-situ groundwater pressures and /or water inflows is a major factor when considering the choice of excavation method and sequence as well as tunnel lining design requirements,” LIU’s Hampshire said.
According to a recent article in Risk & Insurance, tunneling under a body of water is one of the most challenging risk engineering feats. Adequate drainage layouts and their installation sequence for highway projects and, in particular, the protection of sub-grade works are also important. “But under all circumstances, we need to understand how the water conditions have been evaluated,” Hampshire said.
3. Technical Challenges: This risk factor encompasses the assessment of the technical novelty or prototypical nature of the project (or more often, specific elements of it) and how well the previously demonstrated experience of both the design and construction teams aligns with the project’s technical requirements and the form of contract determined for the project. The client can choose the team, but savvy underwriters will conduct their own assessment to see how well-suited the team is to technical demands of the project.
4. Evaluation of Time and Cost: With limited information generally provided, we need to be able to verify as best as possible the adequacy of both the time and cost elements of the project. Our belief is simply that projects that are insufficient in either one or both of these elements potentially pose an increased risk, as the construction consortium tries to compensate for these deficiencies during construction.
Small diameter Tunnel Boring Machine designed for mixed ground conditions and water pressures in excess of 2.5 bar.
In the 1990s and early years of this millennium, a series of high-profile tunnel failures across the globe resulted in major losses for Civil Construction underwriters and their insureds.
In the early 2000s, both the tunnel and insurance industries worked together to create new standards for high-risk tunneling projects.
A Code of Practice for the Risk Management of Tunnel Works (TCoP) is increasingly relied on by project managers and underwriters to define the best practices in tunnel construction projects. This process ideally starts at project inception (conceptual design stage or equivalent) and continues to the hand-over of the completed project.
LIU’s Hampshire said alongside TCoP, the project-specific Geotechnical Baseline Report and its interpretation and reference within the project contract conditions gives the underwriter greater clarity as to who recognizes and carries the ground risk and how it’s allocated.
“The bottom line is that there is always risk in a Civil Construction project,” Hampshire said. “Is the risk transparently allocated or is it buried? If the parties involved don’t understand what risk they carry, then the chances are there are going to be some problems, and the insurers would ideally like to understand the potential for these problems in advance,” Hampshire said.
Paul Hampshire can be reached at Paul.Hampshire@libertyiu.com.
To learn more about how Liberty International Underwriters can help you conduct a Civil Construction risk assessment before your next project, contact your broker.
This article was produced by the R&I Brand Studio, a unit of the advertising department of Risk & Insurance, in collaboration with Liberty International Underwriters. The editorial staff of Risk & Insurance had no role in its preparation.
In September 2008, the state of Indiana was ordered to reimburse the consortium that operates the Indiana Toll Road $447,000 for tolls waived for travelers evacuated during a severe flood.
The trigger was a compensation clause in the 2006 leasing agreement between the state and the private group that provided the state with an upfront payment of $3.8 billion in exchange for the consortium’s right to operate the 157-mile toll road for 75 years.
Such clauses guarantee that governmental entities compensate private operators when there’s an event affecting the leased asset’s revenue.
That 2008 cost to the state government of Indiana is just one of the risks that may crop up as public-private partnerships — or P3s — are used more by cash-strapped governments as a means to shore up or operate aging U.S. infrastructure.
More recently, the consortium that paid Indiana for the right to run the highway encountered liquidity problems, leading to even more uncertainty over the highway’s future management.
The consortium’s timing was bad. It paid billions to take over the toll road right before the onset of the Great Recession.
P3s are fairly common in Europe and Canada, especially as a way to design, construct, and fund social infrastructure such as courthouses and hospitals.
But here in the United States, P3s are still in their infancy, and some surety carriers look at them skeptically.
“I have not seen a single project recently where the surety industry has not been able to provide a 100 percent performance and 100 percent payment bond.”
— Drew Brach, a Marsh managing director and U.S. surety practice leader
The arrangements permit governments to contract with private financiers and lending institutions to build, finance, operate and maintain major infrastructure development, with private entities covering the upfront costs in exchange for the ability to run the facilities and to collect tolls or other payments for long periods of time.
The “operating and maintaining” phase of an infrastructure project often ranges from 25 to 40 years.
Carriers are particularly concerned that many states using P3s have yet to enact enabling legislation calling for the payment and performance guarantees that surety underwriters typically provide on infrastructure development.
Although a total of 34 states have laws enabling P3s, only 26 of those states require payment and performance bonds on P3 projects, said Mary Alice McNamara, second vice president and counsel with surety provider Travelers Bond & Financial Products.
Examples of some recent P3 projects that have surety bond requirements include California’s Presidio Parkway program, Ohio’s River Bridges East End Crossing program and the Indiana and Illinois Illiana toll-road project, McNamara said.
When surety bonds aren’t required to guarantee project completion and payment to subcontractors, suppliers, and laborers for work performed on P3 infrastructure projects, lenders may call for letters of credit (LOCs) instead, as performance security.
However LOCs “don’t offer any payment protection to subcontractors, suppliers and laborers who have worked on the job,” said McNamara, who also stressed that “LOC beneficiaries will be the ‘concessionaire’ ” or private investors providing the financing for the P3.
“A performance bond guarantees to the owner of the project that the project will be completed according to the underlying construction contract,” she said.
“A payment bond guarantees that subcontractors, suppliers, material, men, and laborers who have provided labor, services, or supplies to a project will be paid.”
Moreover, LOCs tend to be in an amount covering only a small portion of a project, often just 10 percent to 20 percent. Payment and performance bonds, on the other hand, “each provide up to the full amount of the construction contract,” McNamara said.
And yet P3s are a tempting concept at a time when national infrastructure needs and public sector budgetary challenges are so acute.
Deficient Roads and Bridges
Six years ago, the American Association of State Highway and Transportation Officials (AASHTO) warned that the country’s bridges would reach their average expected lifespan of 50 by 2015.
In 2013, the American Society of Civil Engineers’ (ASCE) “report card” grade for America’s infrastructure was a dismal D+.
“Deficient roads, bridges, and ports hurt our GDP, our ability to create jobs, our disposable income and our competitiveness with other nations,” ASCE President Randall Over said in April.
So little has been done to shore up the nation’s bridges and other infrastructure that ASCE estimated deficient and unreliable surface transportation will cost each American family $1,090 a year in disposable income by the year 2020.
At a time when there is serious pressure on public entities to stretch their infrastructure project capacity, many state and municipal officials are looking to P3s for assistance, said Dorothy Gjerdrum, senior managing director of Arthur J. Gallagher & Co.’s public sector practice.
However risk specialists and decision-makers need to know the potential pitfalls of these arrangements and consider the broad range of uncertainties, she said.
Risks and Responsibilities
Gjerdrum, who spent more than a decade as a risk manager for a pool of county governments in New Mexico, said that there are a myriad of risks and legal issues involved when implementing a P3, including the review of the contractual agreement and which parties will be responsible if there is a major loss.
“There needs to be a significant review as to who is in the best position to bear the consequences if something happens,” Gjerdrum said.
“Sometimes public entities will take on too much responsibility for the things that can go wrong,” she said. Alternatively, “they may be too trusting that the large private organizations with whom they have partnered with will bear responsibility.”
“In a P3 situation,” said Travelers’ McNamara, “risks that would have traditionally been kept or retained by the public entity project owner are being pushed entirely down to the concessionaire level.”
Design builders who once negotiated with public entities are now dealing with a private concessionaire entity instead, she said.
Beyond that, different coverage issues will arise once a building or renovation project moves from the “design-build” phase into the “maintain and operate” phase. These issues call for the involvement of multiple insurance experts and good risk management oversight, said Gjerdrum.
“One example is whether (and how) sovereign immunity will apply if a facility is owned by a public entity but operated by a private business,” she said.
Sovereign immunity in many circumstances means that the sovereign or government involved in a project is immune from lawsuits or other legal actions.
“What happens if the private business fails? What if revenue projections fall short? What if the environment changes and the service or facility is no longer viable?” Gjerdrum asked.
“P3 solutions can help public agencies solve a myriad of infrastructure problems, but managing the associated risks requires thorough review, long-term thinking and good oversight,” she said.
There are clear advantages to P3s too, of course.
Virginia pioneered the P3 concept more than 20 years ago with a prison that was privately designed and built, according to Governing the States and Localities magazine.
“The prison, which ended up costing $42 million to construct, had to be built to state specifications, but the private company had its own design ideas that arguably were more efficient and less expensive,” according to the magazine.
“The point they made was they could build it cheaper,” Michael Maul, associate director of the Virginia Department of Planning and Budget, said to the magazine.
“It was built more quickly and for less cost.”
Virginia officials estimated that using a P3 to build and operate the prison would generate savings of between 15 percent and 20 percent.
But some in the insurance industry are weighing in with their own concerns. Among the critics is the industry group, the Surety and Fidelity Association of America (SFAA).
In its 2012-2013 SFAA Annual Report, the organization stated its position that P3s are “just another method of project delivery” and that “the construction portion of the project needs to be bonded under the Little Miller Act.”
The Little Miller Act — which is based on the federal Miller Act — requires state contractors to post performance bonds.
“By issuing a bond, the surety provides the public entity and the taxpayers and subcontractors with assurance from an independent third party, backed by the surety’s own funds, that the contractor is capable of performing the construction contract. The other primary benefit of the bond is that the surety responds if the contractor defaults,” the SFAA stated.
Insurers are working with P3s, however. Stephen Rea, general counsel for Liberty Mutual Surety in Boston, said that Liberty “has written bonds for P3 projects in states where enabling legislation requires public work to be bonded under Miller or Little Miller Act legislation.”
Drew Brach, a Marsh managing director and U.S. surety practice leader, said that he has done work with several P3s, adding that surety bonds were obtained for each and every one of the deals.
Strain on Capacity
Surety industry capacity may also become more of an issue as P3s gain momentum.
Given that P3 projects are often valued at $500 million and up, project size could be a strain on a smaller surety provider’s ability to underwrite projects, said Roland Richter, vice president, marketing and analytics for Liberty Mutual Surety.
“Only a handful of sureties have sufficient capacity to bond P3 projects,” he said.
“Thus, as some of these P3s move forward, smaller surety companies may find an erosion in their premium base as their customer base may not be large enough to bid P3 projects,” Richter said.
On the other hand, Rick Ciullo, chief operating officer at Chubb Surety, said that surety underwriting capacity has been on the rise since 2007.
“Contractors became better risks during the construction boom of 2002 to 2006, though they may have had trouble getting surety capacity because the surety industry was losing money during this construction boom.”
Ciullo said he has seen many more projects within the industry valued at over $500 million bound by surety insurers since 2008.
Marsh’s Brach has also seen surety industry capacity grow over time. Five years ago, Brach said, if you asked an underwriter to issue a $3 billion bond, the answer was generally “no,” said the brokerage executive.
But that’s changed, he said — even for larger projects.
“Some sureties say we’re going to analyze case by case what bonding is required [for a P3 program] and decide what the risk is.
“I have not seen a single project recently where the surety industry has not been able to provide a 100 percent performance and 100 percent payment bond,” said Brach.
A Dreaming Team
Chris Thorn is known as one of the most creative risk managers in the business. After all, his risk management program hit the cover of Risk & Insurance® in March, 2012.
Now the senior manager, payments and risk, for Southwest Airlines is working with Riskonnect, a technology partner that he thinks can take his program to new heights.
“For us, it’s a platform that gives you so many different tools that if you can dream it, you can build it,” said Thorn.
Thorn ditched his legacy risk management information system in 2012 and started working with Riskonnect, initially using the platform solely for liability claims management.
But the system’s “do-it-yourself” accessibility almost immediately caught the eye of Thorn’s colleagues managing safety risk and workers’ compensation.
“They were seeking a software solution at the time and said, ‘Hey, we want to join the party,” Thorn recalls of his friends in safety and workers’ compensation.
“For us, it’s a platform that gives you so many different tools that if you can dream it, you can build it.”
–Chris Thorn, senior manager, payments and risk, Southwest Airlines
What was making Thorn’s colleagues so jealous was the system’s “smart question” process which allows any supervisor in the company to enter a claim, while at the same time freeing those supervisors from being claims adjusters.
The Riskonnect platform asks questions that direct the claim to the appropriate category without the supervisor having to take on the burden of performing that triage.
“They love it because all of the redundant questions are gone,” Thorn said.
The added beauty of the system, Thorn said, is that allows carriers and TPAs to work right alongside the Southwest team in claims files while maintaining rock-solid cyber security.
“This has sped up the process,” Thorn said.
“Any time you can speed up the process, the more success you’re going to have when you make offers to settle claims,” he said.
Since that initial splash in claims management, the Riskonnect platform has gone on to become a rock star at Southwest in a number of other areas. And as Thorn suggests, the possibilities of the system are limited only by the user’s imagination.
With a little creativity and help from Riskonnect as needed, a risk manager can add on system capabilities without having to go on bended knee to his own information technology department.
In the area of insurance policy management, for example, the Riskonnect platform as built by Thorn now holds data on all property values and exposures that can in turn be downloaded for use by underwriters.
Every time Southwest buys a new airplane, the enterprise platform sends out a notice to the airlines insurance broker, who in turn notifies the 16 or 17 carriers that are on the hull program.
Again, in that “anything’s possible” vein, the system has the capability of notifying the carriers, directly, a tool Thorn said he’s flirting with.
“It is capable of doing that,” he said.
“We’re testing out this functionality before we turn on it loose directly to the insurance companies.”
In alignment with the platform’s muscle in documenting, storing and reporting liability and property exposures, the system monitors and reports on insurance carrier financial strength.
If a rating agency downgrades a Southwest program carrier’s financial strength, for example, the system “pings” Thorn and his colleagues.
“Not only will we know about it, but we will also know all programs, present and past that they participated on, what the open reserves are for those policy years and policies,” Thorn said.
“That gives us even more comfort that we have good, solid financial backing of the insurance policies that are protecting us,” Thorn said.
Like many of us, Chris Thorn didn’t set out to work in risk management and insurance. Thorn is a Certified Public Accountant, and it’s that background that allows him to take creative advantage of the Riskonnect platform’s malleability in yet another way.
With the help of the Riskonnect customer service team, Thorn added a function to the platform that allows him to calculate the cost of insurance policies on a monthly basis, enter them into a general ledger and send them over to his colleagues in accounting.
“It’s very robust on handling financial information, date information, or anything with that much granularity,” Thorn said.
The sky is the limit
Thorn and Southwest are only two years into their relationship with Riskonnect and there are a number of places Thorn thinks the platform can take him that have yet to be explored, but certainly will be.
“It’s basically a repository of anything that’s risk-related, it continues to grow,” Thorn said.
“This has sped up the process. Any time you can speed up the process, the more success you’re going to have when you make offers to settle claims.”
–Chris Thorn, senior manager, payments and risk, Southwest Airlines
Not only have Southwest’s safety and workers’ compensation managers joined Thorn in his work with Riskonnect, business continuity has come knocking as well.
Thorn met in July with members of Southwest Airline’s business continuity team, which has a whole host of concerns, ranging from pandemics to cyber-attacks that it needs help in documenting the exposures and resiliency options for.
That Enterprise Risk Management approach will in the future also involve the system’s capability to provide risk alerts, telling Thorn and his team for example, that a hurricane or fast moving wildfire is threatening one of the company’s facilities.
Supply chain resiliency and managing certificates of insurance for foreign vendors are other areas where Thorn and his team plan to put the Riskonnect platform to good use.
“That’s all stuff that’s being worked on by us,” Thorn said.
“They’ve given us the tools, but we’re trying to develop how we’re going to use it,” he said.