Types of annual construction policies – contracts commenced vs annual turnover basis

Insurance covering building works is vital to the construction industry. Contract works insurance protects against unforeseen damage and loss in the course of a construction project, and the scope of that cover is set out in our product fundamentals which may be viewed here.

It is critical that policyholders understand how cover for these policies is arranged and in the context of this, how they declare risk exposure to insurers.

In this article we look at contract works written on either a “contracts commenced” or “annual turnover” basis. Contracts commenced and annual turnover basis are methods determining the coverage duration of material damage policies. These approaches define when cover begins and ends, the terms of coverage applicable at the time of loss, and they respectively have different implications for beneficiaries.

Contracts commenced

Projects written under this methodology are covered from commencement to completion – including the respective defects liability period (even if the project is completed after the expiry of the Period of Insurance). Considering projects declared with the view of losses responding in later years, contracts commenced cover is also referred to as “run-off” in the construction insurance market.

Below are items to be mindful of where cover is arranged on a “contracts commenced” basis:

  • Premium structure: Premiums are calculated on the estimated total value of projects expected to commence during the 12-month policy period. Adjustments are made to reflect the actual number and value of projects that commenced during the policy period at the expiry of the policy period.

  • Cash flow considerations: Contracts attaching cover can present cash flow challenges due to the upfront payment for the full value of works, which could be substantial, however is often paid upfront by clients as a preliminary cost in the contract.

  • Cost stability: The insurance cost for the project doesn’t change during the project life unless, the contract value increases.

  • Coverage: The policy terms and conditions are fixed for the duration of the project and cannot be modified or cancelled by insurers for any reason which ensures compliance with contractual conditions during execution of the works.

  • Retroactive coverage: No cover is provided for projects which commenced prior to the inception or renewal of the policy even if the Insured does not change insurers. Works which commenced prior to inception are covered under the previous period of insurance.

Annual turnover

This method offers cover for all projects in progress at the commencement of the policy period and any new projects that start during the policy period.

As distinct from policies arranged on a contracts commenced basis, the coverage here ceases at the end of the policy period. This anticipates cover “transferring” to the terms and conditions of the replacement policy.

Matters to consider on policies arranged on an annual turnover basis include:

  • Premium structure: Premiums are based on the portion of the project completed within the policy period. This is calculated on the annual turnover comprising all active contracts during the policy period.

  • Cash flow considerations: This methodology offers more flexibility in terms of cash flow. The premium is based on actual annual turnover, leading to a potentially lower initial premium compared to contracts commenced cover. This means that where annual turnover is relatively stable premium will be less volatile than where a business may have a large number of commencements in an annual period which will all have to be paid up front.

  • Cost stability: The cost of insurance cover may change during the project life. If pricing is trending down, this could save you money – but if premium rates increase, renewal could cost you more than the previous year. This cost could be difficult to recoup where a fixed price contract has been entered into.

  • Coverage scope: Coverage may be broadened or restricted during the life of the project depending on market trends, insurer appetite and client’s claims experience. These factors will influence policy renewal, and where poor histories materialise, more restrictive cover may impact contract compliance.

  • Coverage transferred: Cover for all projects that are in progress at the start of the period of insurance or commence during the period, as long as the project fits within the agreed business description and projects are approved by the insurer.

Feature Contracts commenced Annual turnover
Premium calculation Based on full contract value of all projects to be commenced in the period Based on estimated annual construction turnover
Premium payment Paid in advance at beginning of policy period based on whole project value of each project Paid in advance at beginning of policy period based on estimated annual turnover
Simplicity More complex to prepare declaration given some contracts may not be awarded at time of renewal Simpler to administer
Adjustment Completed at the end of the period, total contract value (Ex GST) of any project which commenced to be declared Completed at the end of the period, turnover associated with any works undertaken to be declared
Predictability Predictable insurance costs Unpredictable insurance costs
Coverage Covers only projects commenced in the policy period Covers all projects underway or commencing during policy period
Run Off Not required as project commenced covered up until completion irrespective of policy expiry Run off cover would need to be arranged where either policy was not renewed or where policy terms were amended to “contracts commenced” basis

In summary, the choice between these two approaches to material damage cover hinges on project characteristics, contractual requirements, and risk tolerance. There are advantages to both approaches and policyholders should discuss with their risk advisor which policy better suits their individual needs. Again, considerations of cashflow (particularly given the significant insolvencies in the construction industry – see our article here) project timelines, and market trends are critical.

The Bellrock Construction Team can provide guidance on the most appropriate approach. Please contact one of our experts via the form below should you require assistance.

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