This class of insurance can confusingly be referred to by a variety of names, each with its own acronym: loss of anticipated revenue (LOAR), advanced loss of profits (ALOP) or delay in start-up (DSU), to name but a few! For the purposes of this blog we’ll use the term DSU.
Whatever the name, the intention is the same. DSU insurance provides developers or project owners with added protection during the construction phase of a development. It indemnifies against loss of revenue suffered following damage to the contract works (and any existing structures) that causes a delay in completion.
As an alternative to lost revenue, the policy can be arranged to insure against additional project finance costs or additional costs of working, such as the provision of alternative accommodation.
Why buy DSU cover?
Project owners will usually rely on the building contract for protection against late delivery. The contract will normally pass this risk to the contractor, who will be liable for liquidated or ascertained damages (LADs) incurred as a result of the delay.
However, this form of risk transfer is normally conditional; some unamended Joint Contracts Tribunal (JCT) contracts will provide the contractor with relief where the loss arises from a specified peril. In these circumstances, the owner or developer will not have protection against revenue stream losses. Even where contractual protection remains in place, contractor insolvency may make this worthless.
It is for these reasons that owners, developers and funders are increasingly turning to DSU cover to provide protection.
How much cover is required?
When evaluating the level of protection, the project owner should first consider the length of the indemnity period (which should not be confused with the construction period).
The indemnity period is the period of time for which benefits are payable under an insurance policy. It should reflect the worst case scenario for delay in the event of catastrophic damage to the works. Although this can be defined in loan agreements, it is best determined by establishing the consequences of a significant loss occurring immediately prior to practical completion.
In many cases the indemnity period can be longer than the original construction period because of the added complications of debris removal, remedial works design, contractor remobilisation, re-ordering of components and any potential planning resubmissions.
Once the indemnity period is determined, the sum insured can be calculated by assessment of the likely losses which would be incurred during the period to the revised completion date (and the commencement of normal operations).
As detailed above, these losses can take many forms; loss of gross profit, additional financing costs, loss of interest on anticipated revenue, additional costs of alternative accommodation and so on.
It is not uncommon for the liquidated and ascertained damages (LAD) to be used as a guide to what this loss may be but there are important reasons why these may not be an accurate reflection of the employer’s actual loss.
For example, it may be necessary for commercial reasons to discount the LADs to a figure that is more acceptable to the contractor from a risk and reward perspective. In these circumstances the LADs will not encompass the full extent of the potential losses.
What happens in the event of a loss?
The DSU policy is triggered by losses during the construction period which result in delayed completion. Insurers will only indemnify for delays arising from that damage so any claim settlement will take into account the effect of any concurrent issues (such as poor contractor performance, late delivery of equipment, etc.) which have also impacted project completion. Often uninsured events take precedence over insured events and therefore accurate, and well documented, programme monitoring is important.
The policy must be carefully drafted to ensure that a claim can be made even where the project owner has rights of recourse against the contractor for LADs in the building contract.
There will also be a time based excess, expressed in days, which will render short term delays irrecoverable.
Who is covered under the policy?
The insured parties are normally restricted to the developer and lender. The contractor, despite having a potential LAD liability, has no insurable interest in the revenue stream and therefore cannot be an insured party under DSU policies.
However, this does not mean that the contractor must go unprotected. DSU policies can be arranged so that the insurer agrees to waive any contractual rights (for example the right to levy LADs) that may be subrogated to it from the project owner or developer. This provides the contractor with additional protection than the relief normally available under JCT contracts as the insurance coverage will operate on an “all risks” basis as opposed to that of defined specified perils.
Of course, the owner or developer may decide that it does not wish to extend the benefit of this waiver to the contractor in which case a subrogated claim from the insurer would remain a risk to the contractor.
If you require any further information, please call Stephen Shoosmith, Partner and Account Executive in Construction, on +44 20 7528 4870 or email him at email@example.com.