Product Fundamentals: Delay in Start Up Insurance
What it is DSU and why should you consider it?
Delay in Start Up Insurance (DSU) (alternatively known as Advanced Loss of Profit or “ALOP” insurance) covers the policy holder for defined financial consequences resulting from a delay in completion of a project that arises from an insured physical damage event. In this article we discuss the purpose of DSU insurance and highlight some of its key features.
Construction Projects invariably operate on a tightly programmed schedule – often set out in meticulous detail on a “Gantt Chart”. Delays in completion of project works can cause significant financial costs to the project owner and the project value. In most cases a project owner will need to borrow significant sums to finance a project, but income required to repay the accumulating interest and debt, fund OPEX and CAPEX expenditure; or to provide a return on the investment, will not come on-stream until the project is complete. The timing of completion is often of great importance to the economic viability of the project.
For example, a property developer engaged in constructing or renovating a large commercial building will depend on tenant’s payments of rent to service the loans required to complete the works. If damage is caused to the works and this results in a delay in scheduling and completion of the works with the consequence that contracted tenants cannot take up a lease of floor space on time, then the project owner is likely to face increased financing and interest costs; and risk arising from breach of contract with the tenant or face claims brought by other downstream contractors, who in turn are likely to have their own liquidated damages or contractual delay claims. OPEX and CAPEX costs are likely to continue but a delay in receipt of rentals may push the developer into a position of financial default.
Financial losses of the above kind will not be covered by a “Material Damage” insurance policy as a such a policy is likely to cover only the physical loss or damage, but not consequential loss caused by knock-on delays while work is undertaken to rectify the damage. DSU was developed to address the concerns of principals and project financiers in relation to the financial risk associated with the delay in commencement of operations (and revenue generation) arising from a construction project.
DSU Insurance has grown steadily since originating in the 1980’s, driven in part due to the significant increase in value of “mega projects”, for example construction of hundreds of kilometres of gas pipelines to transport coal seam natural gas from coalfields in central Queensland to ports on the Queensland coast for export; or construction of extensive rail and commuter services.
Demand for DSU insurance has continued to rise in the last decade. This can be attributed to state authorities increasingly procuring major projects via the private sector through PFI/PPP contracts and private sector financiers protecting their financial interests via DSU insurance. Australia’s unpredictable weather patterns and other operational hazards increase the chance of a delay. Accordingly, principals are turning to DSU solutions to mitigate these financial impacts in the delivery of projects.
The intention to pursue a DSU solution needs to be considered during the planning phase of the project, as there is seldom a one size fits all solution – each project will have its own financial pain points for consideration in designing an appropriate DSU program to complement the project.
There are a number of key elements to be considered.
- DSU cover is only triggered by a delay in completion to a project due to an indemnifiable loss under the material damage policy.
- A DSU loss can only occur once the project has been delayed beyond the original Scheduled Opening Date (SOD), although the event that caused the delay may have occurred many months previously, during the construction period.
Scope of cover
- Gross Profit: Projects with variable costs such as manufacturing and service organisations where the profit was to be used to service debt obligations.
- Loss of Revenue: Projects with high fixed costs such as hotels and power stations, where revenue is required to service debt and non-variable fixed overheads.
- Loss of Rental: Projects being developed where the main income derived is rental income - such as property developers.
- Holding Costs: Projects where delays result in high costs such as interest payments.
- Additional Increased Cost of Working: In in addition to the above covers, increased cost of working (AICoW) may be incurred to speed up remedial action in an effort to reduce or avoid the delay to the project and in consequence reduce or avoid the loss. This expenditure would be met by the DSU insurance provided it was incurred for the purpose of avoiding or diminishing the loss.
- Public Utilities (water/gas/electricity) failure to supply
- Denial of access or closure by public authorities
- Damage at supplier’s or customer’s premises which cause delays in materials being supplied
- Infectious disease, murder, and suicide at the premises (COVID19 cover is now unavailable)
The party who is likely to incur a financial loss if completion is delayed is usually the beneficiary of the policy. This is usually the principal of the project; however, financiers may also seek to be the loss payee of any DSU cover. Though less common, contractors can also be an insured if they can demonstrate the impact on their business following a loss. Liquidated Damages can be insured in circumstances where the liquidated damages can be quantified and reflects the financial losses the principal is seeking to recover under the liquidated damages regime.
This is the period that the DSU insurance will provide cover for. This period should start from estimated Scheduled Opening Date and should cover the maximum rebuild period envisaged following a total loss of the project (from an insured event).
The sum insured should reflect the total maximum financial loss which could be incurred during the indemnity period.
The policy excess is usually measured in time rather than a fixed monetary amount. Therefore, no loss is paid for delays until the total delay exceeds the period of time stipulated. Thereafter all insured losses arising from delays become indemnifiable.
Reinstatement of cover
DSU policy sum insured is an aggregated limit – that is, should a significant DSU claim trigger the policy, a new DSU policy may need to be arranged to cover any further delays from insured events during the rebuilding period. Whilst a reinstatement of the sum insured can be negotiated the unique circumstances that usually surround a claim which triggers a DSU claim means that reinstatement premiums will be considered and charged based on the merits of the specific loss incurred. In many circumstances, reinstatement will be unavailable or prohibitively expensive.
- The event indemnifiable under the material damage policy.
- The delay exceeds the policy excess
- The delay causes a resultant financial loss to the insured.
Sequential vs concurrent events
There can only be one DSU claim during the contract period however the delay may be made up of several events occurring during the insured period. The delays suffered from multiple events will therefore be aggregated to one overall claim relating to loss beyond the Scheduled Opening Date.
Delays must be sequential for them to be aggregated. For example, a delay to the podium works resulting in a delay in formwork that sits on the podium would be aggregated to form a single DSU loss.
Concurrent events such as a collapse on one side of the site and a fire on the other would not be aggregated if the repairs are undertaken independently only the longer delay of the two would be included within the DSU claim.
Delays can also occur to a project from events that are not covered by the material damage insurance such as industrial action, slow progress, redesign delays, project enhancements, late supply of materials or inadequate funding.
The overall project delay may be from both Insured and uninsured delays. The DSU insurance will only respond to the insured element of the delay and the uninsured element of the delay will be excluded.
Final claim settlements will also be subject to the deduction of any concurrent and/or uninsured delays and the application of the policy time excess.
Actual quantification of a delay claim covered by a policy can be complex. In the event of a claim under the DSU insurance, the original project schedule (Gantt Chart) will usually be accessed and reviewed for accuracy by a forensic accountant engaged and paid for by the Insurers to assess the actual delay and therefore financial loss sustained by the insured. It will consider seasonal and market fluctuations in the business performance. Insurers will only reimburse the principal to the extent that they have in fact suffered loss.
The costs of preparation of a claim on the policy are reimbursed by the insurer if a claim payment is made.
DSU can be used by principals and contractors to provide additional financial comfort to financiers and other stakeholders to alleviate risk associated with construction of new projects. It is also worthwhile noting that DSU can be arranged to cover losses arising from marine transit claims – where delay in delivery of equipment to site occurs (particularly road headers, tunnel boring machines and critical equipment) due to a marine loss during transit from the supplier to site.
Bellrock has designed, negotiated, and implemented DSU solutions for our clients in the construction industry, as well as financiers and development managers to transfer risk to the insurance market. Our team are experienced in the technical management of DSU claims when they occur. Should you have any queries please reach out to the Bellrock team to discuss your project.