Insurances in construction contracts are a risk management & risk transfer mechanism which forms integral part of the construction contracts. In every construction contract, some risk is borne by the contractor and some are borne by the employer. The risk allocation between the contractor and the employer depends upon the type of construction project as well as on the type of contract signed between the contractor and employer. Generally, the contractor’s risks are following:
- Loss to the work or material due to natural calamities or any other reason.
- Loss or damage to plant, machinery or equipment
- Personal injury or death of contractor’s employees or workmen
- Personal injury or death of other people
Insurance provisions are made in the construction contracts to cover these risks. The compliances of these insurance provisions is mandatory for the contractor. In case, the contractor does not provide insurance to cover these risks, then it is obligation of employ to deduct the amount of premium from contractor’s payments as per the provisions given in the contract and shall ensure the compliances. Sometimes, an additional penalty, as stipulated in the contract, is also imposed to the contractor for non- compliance of the insurance provisions.
In this article we will discuss most common type of insurance policies. The common insurance policies for construction projects are as follows:
- Builder’s Risk (Course of Construction) Insurance
- Contractors General Liability Insurance
- Errors & Omissions Insurance / Professional Liability Insurance
- Workers Compensation Insurance
- Commercial Vehicle Insurance
- Contractor’s License Bonds
- Construction Bonds
Let us discuss each type of insurance policy in detail.
Contractors All Risks (CAR) Insurance/ Builder’s Risk (Course of Construction) Insurance
Contractors All Risks (CAR) Insurance also known as Builder’s Risk Insurance or Course of Construction (COC) Insurance covers all structures during construction. During the course of execution of project relating to construction of building and civil engineering works, certain unforeseen accidents could occur resulting in considerable ﬁnancial loss to the contract works, construction / or the principals arising from damage to the contract works, construction of plant and machinery as well as Third Party Claims. The Contractors All Risks (CAR) Insurance protects the interests of the Contractors /Principal against such losses.
Contractors All Risks (CAR) Insurance includes the coverage of following:
- Location Risks: Fire, Lighting, Theft, Burglary & Housebreaking.
- Testing and Commissioning Risks*: Failure of Safety Devices, Leakage of Electricity, Insulation failure, Short circuit, explosion.
- Act of God: Storm, Tempest, Hurricane, Flood, Inundation, Subsidence, Landslide, Rockslide, earthquake.
The exclusions to this policy are generally as follows:
- Handling Risks: Impact from falling objects, Collision, Failure of Cranes or Tackles etc.
- Risk of Human Element: Carelessness, Negligence, Faults in Erection/Construction, Strike & Riot, Malicious damage, Terrorism.
Contractors General Liability Insurance
General liability insurance covers the risks related to third-party injuries and property damage. This Insurance is designed to protects contractors financially from amounts they become obligated to pay due to damages or medical payments because of bodily injury, property damage or personal/advertising injury to third parties occurring during the policy period caused by or relating to the contractor’s work. The contractors should take this coverage for their own protection. Sometimes it is a mandatory requirement for contractors to take such insurances to get accepted for the project.
General liability insurance policies usually cover a broad range of damages, including:
- Faulty workmanship
- Job-related injury
- Advertising injury / defamation
Contractors or developers may actually be required to have a minimum level of liability insurance either by law in some countries or it may be a mandatory requirement to win certain contracts. It is recommended that the companies who complete many design-build projects definitely take liability insurance in case they are sued for mistakes.
Errors & Omissions Insurance / Professional Liability Insurance
professional liability insurance also known as errors & omissions insurance, is a type of insurance that provides coverage for contractors and consultants against claims arising from errors or mistakes in their work. The error or mistake may occur due to negligence or any other reason. This type of insurance coverage is mostly helpful in consultancy services.
Generally, a contractor professional liability insurance policy covers financial losses but not property damage or bodily injury claims.
Professional liability insurance generally covers claims of:
- Inaccurate advice
Even if a contractor has not done any mistake, the client can still sue them if they believe the contractor or consultant has made a mistake. Without coverage, the contractor or consultants will have to pay expensive legal defense costs out of pocket.
Workers Compensation Insurance
Workers Compensation Insurance protects the contractors when their employees are injured while on the job. It does this by covering the following costs in case of any such incident occurs:
- Medical expenses
- Missed wages
- Ongoing recovery costs related to an injury
- Legal fees in case of lawsuits by workers injured while working.
- Funeral costs and death benefits
Workers’ compensation insurance is required by law in some countries.
Commercial Vehicle Insurance
The construction projects require a lot of commercial vehicles. The vehicles may be owned or taken on lease by the contractor. The vehicle insurance is mandatory by law in every country. The contractor has to insure his/ her vehicles against high vehicle repair costs, medical expenses, or lawsuits resulting from auto accidents.
Liability Coverage – This protects the company and employees from expenses associated with accidents caused by employees.
Physical Damage Coverage – This covers damages to company vehicles after a covered collision. This could also include comprehensive coverage, which protects against stolen vehicles, damaged from vandalism, or destruction from natural disasters.
Medical Payments Coverage – This coverage helps to pay for injury-related expenses resulting from a covered incident, including medical bills, hospital fees, ambulance costs, and funeral expenses.
Uninsured Motorist Coverage – This type of coverage covers damages and injuries caused by uninsured drivers. This is necessary because it is your personal liability coverage that covers damages and injuries that you cause to others. If you get into an accident with someone who does not hold this coverage, you still want to be covered from high medical or repair costs.
Contractor’s License Bonds
A contractor license bond is a legally binding contract that protects the clients against the contractor’s non- performance and is sometimes mandatorily required to obtain a contractor license. The client or the public may claim for financial compensation if the contractor doesn’t fulfill the terms of the bond. This is different from construction bonds which are required specifically for public projects.
When obtaining a contractor license bond, contractors enter an agreement with the entity requiring the bond, called the obligee, and the surety company. The surety company guarantees to the obligee that the contractor is financially capable of paying a bond.
For fixing the accountability of the contractor towards the client or public, the mechanism is such that, the contractor enters into an agreement with the client, called the oblige and the surety company. The surety company guarantees to the oblige (client) that if the contractor will be at default against the contract, then the contractor will pay the amount as per the bond and he is financially capable of paying the bond amount. In case the contractor does not follow the terms of the contract, then the client or public can make a claim against the bond and the contractor will be bound to pay.
Typically, the insurance companies offer bonds. The cost of the bond to the contractor usually depends on the contractor’s historical track-record of income and their credit score. The better track record a contractor has, the less expensive the bond will be for them.
A construction bond protects the client if the contractor does not fulfill his/ her obligations as per the contract. The contractor is required to submit certain pre specified amount to the client in the form of bank guarantee, fix deposit, term deposit or in any other form as stipulated in the bid document. If the contractor does not follow the contract, then the client may recover his/ her losses from the construction bond. There are many types of construction bonds, some of which are mentioned below:
Bid bond, also sometimes called bid security or earnest money is deposited by the contractor at the time of bid submission. It guarantees that the contractor is serious about the bid and he/ she will submit the performance security and enter into the contract if he will be awarded it. In case the contractor does not submit the performance security and does not turn up for contract signing after award of the work, then the client has a right to forfeit the bid bond or bid security.
A performance bond, also known as performance security, is a guarantee that the contractor will fulfill their obligation as per the contract. The performance bond is submitted at the time of contract signing and if the contractor does not follow the contract, then the client may recover his/ her losses from the performance bond.
Payment bond guarantees that the contractor will pay their sub- contractors, laborers and suppliers.
Maintenance bond is submitted by the contractor to make sure that they will maintain the property of the client for a specified amount of time as stipulated in the contract. Sometimes, some specified amount as per the contact is deducted from the running payments of the contractor to ensure that the contractor will maintain the property as per the contract. This amount is retained by the client and is called retention money. If the contractor does not maintain the property as per the contract, then the client may recover the maintenance charges from the maintenance bond or retention money.
Supply bonds ensure that the contractor will make supply of materials as per the contract.
Insurances are integral part of construction contracts. These are the instrument of risk management and risk transfer and are mandatory requirement as per the contract. The insurances cover various risks and protect the client as well as the contractor against such risks. There are many type of insurances required in construction contracts. The type of insurance required and amount of coverage is stipulated in the contract. A contractor should take various insurances as per the contract because covering various risks is in the best interest of the contractor as well as their client. If a contractor does not take insurance as per the contract, then a provision is made in some contract that the client shall deduct the insurance premium from the payments of the contractor and buy insurance as per the contract. Normally, the insurance is in the joint names of the client and the contractor.