Usage based project insurance

One of the major problems of any insurance contract is its inflexibility. It can be difficult to vary the terms and conditions of the contract after it is? concluded. One may drive a hard bargain with the insurer and extract the maximum discount or better terms at the time of taking the policy. But once bought, the insured can be at the whim of the insurance company who may or may not choose to endorse the policy to reflect the change requested by the insured. This is not to suggest that change requests are unreasonably denied the insurers, but that the insured lacks agency over the policy, with contract control largely with the insurer.?

This problem is exacerbated if the insurance is long term in nature like Erection All Risks (EAR) and Contractor’s All Risks (CAR) insurances. You are stuck with the policy and the insurer for years together with very little option for change.?

In the Indian context, there are always delays in project execution due to political or other reasons that have nothing to do with the contractor. This is more pronounced in case of infrastructure projects that are executed on the public private partnership (PPP) model. Private greenfield projects and brownfield expansion projects may be subject to lesser execution delays comparatively, but delays are not uncommon. Timeliness is the exception and delay is the rule.?

In infrastructure development projects, the construction contract may require the policy to be taken from the date of award of the contract which becomes the appointed date. But actual start of work or arrival of material at site may happen only after several months. The project site may not be ready or made free of encumbrances or easements by the principal, which is the government. Since the policy is already taken and the insurer may not agree to rescheduling of the policy period, the insured ends up paying the premium for such period, where no risk is practically run by the insurer. Similarly, there can be work suspensions where exposure may be limited to storage risk only, but premium may be charged on full basis.?

Many contracts are aggressively tendered by governments for short and often unrealistic timelines for political grandstanding. Governments have five year terms, so they want project completion dates before the next election, which one can never be sure of winning.?

An example is the international airport project at Navi Mumbai. The project started in 2017 with the first of the two runways to be finished by 2019 before the Maharashtra State elections. But work actually started only in 2021 due to various problems like protests by locals regarding compensation packages for land acquisition, Covid 19 lockdowns, financial issues etc. The airport is still to be completed and is expected to be opened only by May 2025.?

While policies with unrealistic completion periods are extended, the insurers may demand abnormally higher premiums for extension, particularly if there are claims. Pro rata extensions of policies become impossible. Shifting of policy at time of extension to another insurer is also not possible, as the new insurer may ask for premium to be paid from inception, even if he is willing to accept the risk.?

Insurers also face issues on reinsurance arrangements when policies are extended for long periods. The maximum length of period they can issue project policies is 7 years. Once the policy with extensions crosses 7 years, the insurers and reinsurers face problems on premium accounting and reserving. The engineering treaties may be on risk attaching instead of clean cut basis, so reinsurance is based on the year the policy incepted. This arrangement is fine as long the policy period is not too long, such as 5 years. Once it gets longer, the arrangement is exposed to strains like claims inflation from long tail exposure.?

An alternative to the current inflexible project insurances is Usage based project insurance (UBPI). This is similar to usage based motor insurance where customers may pay premium according to the vehicle usage and driving conditions. Unlike traditional EAR/CAR policies, where the sum insured is the completed project value upon which a fixed rate of premium is charged, in UBPI, the sum insured can be dynamic. One could peg the sum insured under UBPI, as the annual outlay of money invested on the construction, year on year as the sum insured or the usage against the total contract value of the project declared. The premium is then made adjustable every year based on the outlay and the construction work actually executed for the year.?It factors in the non-linearity of build up of executed contract values over time.

Since the outlay is a better proxy for the construction risk, it becomes equitable for both the insurer and the insured. The insurer gets premium according to the value at risk and actual risk run. The insured doesn’t pay unnecessary premium when value at risk does not increase as originally anticipated due to construction delays. This can possibly fix issues on the reinsurance front as the insurer and the reinsurer have a better fix on the project risk development over time and triangulate the exposures better.?

The traditional project insurances were developed in the last century, when analytical capabilities were limited. That is not the case today with AI assisted analytics being available for underwriting. The legacy project insurance policies are not fit for purpose in the modern day construction industry scenario. UBPI is long overdue.?