17 April 2025
Construction projects: Adequacy of Sum Insured
In recent times, we have all observed signs of economic turbulence: from the ongoing impact of the invasion of Ukraine, which has escalated inflationary pressures, to political shifts both at home and abroad, and changes in the insurance market cycle. These events leave many wondering if the only certainty today is, in fact, uncertainty. However, insurance, when properly managed, can offer protection against some of these risks.
Construction projects, by their nature, are subject to fluctuations in labour rates, commodity prices, and overall construction costs. Over the long term, owners and contractors typically become adept at forecasting these costs. Save for the complexities of lump sum contracts, it is rare for construction projects to be completed on time and without exceeding the budget. However, certain variations are usually anticipated or deemed acceptable.
That said, unexpected events, such as the imposition of trade tariffs or sudden shifts in inflation that affect your business or suppliers, may bring into question the adequacy of the Sum Insured you have selected in the event of a loss.
Built-in protections and considerations
Most project policies come with built-in protections. For example, there is typically a 10-15% escalation allowance for cost increases above the estimated contract value. Additionally, strategic procurement of labour and materials from diverse suppliers and locations can help absorb cost increases, reducing the overall impact on your project budget.
However, there are some key factors to consider:
· Material Alterations Clause: Most project policies contain a material alterations clause (with variations across insurer and broker forms). You must comply with this clause throughout the policy term, and it differs from your obligation to disclose a material fact, which usually arises when making a policy amendment.
· Escalation Allowance Application: During market hardening, some insurers have pushed to apply the escalation allowance to each line item of the contract value breakdown, rather than applying it as a blanket increase across the entire declared total value.
· The Principle of Average: Insurer-drafted forms often include the principle of average, which applies to any under-insurance exceeding an allowance. In simple terms, this means that if prices rise unexpectedly and your Sum Insured isn’t adjusted accordingly, you could find yourself only receiving a proportion of the payout in the event of a loss.
· Indemnity Basis: Some insurers may indemnify on an original cost basis, rather than a replacement cost basis. This could leave you underinsured if the cost of replacing assets exceeds the original cost.
Time to review your Sum Insured
In light of these considerations, we strongly advise that you review the adequacy of your Sum Insured to ensure it reflects any recent changes in the project or the broader economic environment.
Discussing potential adjustments with us now will help mitigate the risk of under-insurance and prevent unnecessary uncertainty before or after a claim.
Let's talk
Arthur J. Gallagher (UK) Limited is authorised and regulated by the Financial Conduct Authority. Registered Office: The Walbrook Building, 25 Walbrook, London EC4N 8AW. Registered in England and Wales. Company Number: 119013.