Canadian Underwriter
Feature

Building Success, Building Protection


July 3, 2015   by Carl Spensieri, Vice President, Environment, Berkley Canada


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The Canadian construction economy will see an estimated $159 billion in infrastructure projects reach project financing or commencement in 2015. The majority of the spending will centre on energy, transportation, healthcare and institutional construction.

In order to successfully design, build, fund and operate (DBFO) these Canadian projects, owners, designers, builders, operators and lenders are increasingly electing to partner and share in the risks and rewards by entering into public-private partnership (P3) agreements.

In Canada, P3s are clearly emerging as the DBFO mechanism of choice. In 2015, it is estimated more than 20% of infrastructure projects will be procured using the P3 DBFO model.

P3s seek to deliver best-in-class build quality and lower operating and maintenance costs over the full life cycle of the project.

At the same time, the P3 DBFO model allows private equity to fund a significant portion of the construction costs, thereby reducing capital burdens on governments.

Of course, with the increased complexity of infrastructure projects comes increased risk, including environmental risk. To better understand those exposures, it is helpful to consider some examples of environmental risk from the perspective of each project stakeholder.

PROJECT STAKEHOLDERS

Owner and operator

The owner and operator of a project are typically responsible for pollution at, or migrating from, the project site and arising out of the operation of the project, respectively. For example, an owner bears the cost for clean-up of existing pollution at the project site prior to or during construction (that is, the cost to excavate and dispose of existing contaminated soils).

While the cost associated with that clean-up is not generally insurable, an owner can transfer the risk of incurring additional clean-up costs arising from unknown pollution discovered during the course of construction by purchasing a fixed site environmental policy.

In addition, an owner can transfer the risk associated with claims for bodily injury or property damage associated with pollution at, or migrating from, the project site.

Owners can also transfer the financial risk associated with project delays arising from pollution. Specifically, an owner can insure loss of income or extra expenses (for example, interest on a construction loan) arising from a project delay attributed to pollution discovered during the course of construction or arising from construction activities.

Architect and engineer

Project designers may not have ownership or operational control of a project, but they often develop engineering controls, standard operating procedures and construction guidelines to manage existing pollution at a project site. Further, environmental consultants are often on site during construction to assist with contaminated media management and disposal.

In these situations, the distinction between professional services and contracting operations is blurred. For this reason, designers may elect to supplement their professional cover with contractor pollution liability cover for activities such as site supervision.

Contractor

Contractors are responsible for pollution arising from their contracting operations, including the worsening of existing pollution (for example, inadvertently using contaminated soil as backfill).

To address these risks, contractors typically rely on practice or project contractor pollution liability policies. These policies typically cover the contractor for bodily injury, property damage and clean-up claims arising from their contracting operations, including waste management (for example, improper disposal of construction waste) and transportation (for example, movement of fuels to and from the project site).

To minimize construction delays and facilitate recovery of construction delay costs, owners and contractors often agree to specific liquidated damages spelled out in a construction agreement. While liquidated damages are not (generally) insurable, a contractor can purchase accelerated clean-up cover to help mitigate or reduce the liquidated damages risk.

Specifically, accelerated clean-up cover affirms that clean-up will be undertaken using the fastest clean-up method. This cover gives the contractor the best possible chance of still completing the project on time, when construction is delayed because of clean-up.

Lenders

Lenders are not typically responsible for pollution at a project site or arising from project construction. However, in the event of default resulting in the lender taking ownership of the project site, environmental regulations may impose various levels of liability for clean-up.

In general, lenders have an opportunity to divest themselves of the project site within a reasonable period of time (under prescribed circumstances). That said, the regulator can issue a clean-up order against the lender if the project site is not divested within the prescribed period.

While regulatory relief provisions are useful, they do not address the commercial realities associated with a lender trying to sell a contaminated project site. Such a sale can often take a long time and require the lender to first complete clean-up (at its cost) to make the project site more commercially appealing.

To address this risk, a lender typically purchases a lender pollution liability policy that covers clean-up costs, as well as claims for bodily injury and property damage in the event of default by the owner.

Prior to the rise of the P3 DBFO model, each stakeholder purchased individual pollution policies designed to address the stakeholder’s specific risks. While this approach allowed for bespoke cover that aligned with each stakeholder’s tolerance for risk, the cost for each policy was often passed along as a cost to the project owner, increasing the overall cost of project procurement.

CANADIAN INFRASTRUCTURE PROJECTS

Roles and responsibilities

Today, the P3 DBFO model has emerged as the delivery mechanism of choice in Canada. While the model delivers many benefits, it also blurs and blends the roles and responsibilities of owner and contractor. Two brief examples bring greater clarity to this issue:

• Ownership: While a project site is legally owned by the project owner (for example, a government agency or institution), the contractor has an exclusive agreement to effectively control and manage the project site over a substantial period of time (typically 20 to 30 years), effectively transferring ownership responsibilities to the contractor.

• Financial risk: In exchange for access to private capital, the owner typically forgoes revenues associated with operation of the project (for example, tolls on a highway) or agrees to pay defined operation and maintenance fees to the operator (contractor) once the project is complete. If the project is delayed, the contractor then does not receive the anticipated revenue or fees and, as such, bears the financial risk.

Tailored cover

Given the degree of risk transfer between owner and contractor in the P3 DBFO model, it is not possible for stakeholders to make use of traditional pollution policies to address their risks. Put simply, the Canadian construction industry has evolved to the point where relying on traditional pollution policies is not an appropriate or prudent risk transfer strategy.

In response, the Canadian insurance industry has developed sophisticated pollution policies designed to directly address the unique pollution risks associated with infrastructure projects.

Today, all P3 DBFO stakeholders can benefit from tailored pollution cover provided under a P3 project pollution policy.

The policy typically includes fixed site environmental and contractor pollution liability cover that can be triggered by the project owner or the
contractor to pay for clean-up costs associated with discovery of pollution at the project site or as a result of contracting operations.

In addition, the policy protects all stakeholders, including designers, operators and lenders, against claims for clean-up, bodily injury and property damage arising from pollution. Finally, the policy can also cover extra expenses and lost revenues associated with delay in start-up arising from pollution.

Beyond offering very broad cover, P3 project pollution policies are designed to address the complex contractual requirements of P3 DBFO project agreements, construction agreements and lender agreements.

For example, the policy is designed to backstop contractual risk transfer provisions between owner and contractor, and address assignment provisions required by the lender and owner in the event the contractor defaults on a key obligation. The policy also addresses numerous logistical requirements (for example, stakeholder notification for prescribed events and severability of interest provisions).

Today, insureds and brokers have access to innovative insurance solutions designed to address complex risks and support a key part of the Canadian economy.