Insurance premiums are cyclical and vary over time with the market's perception of the probability of particular risks crystallising. These perceptions are subjective and can change rapidly over a relatively short period of time. Hence changes in market sentiment causing a material impact on insurance premia, in either direction, are quite probable over the course of a 25-year PFI/PPP contract. As a result most PFI/PPP contracts contain provisions that cater for the scenario where insurance premiums are significantly different to the flat level assumed when the Unitary Charge was set at financial close. The normal approach is sharing of both upsides and downsides between the Authority and the Contractor.
At the time of writing this guidance, the insurance market is probably at its cyclical low, which means local authorities are likely to benefit financially from the insurance premium risk sharing provisions in their Contracts. This is partly because more organisations are offering insurance for PFI projects than was historically the case: PFI is seen as a better risk than it once was. As a note of caution, premiums are likely to increase again in time, so Authorities will need to account for this in their budgets.
The WIDP Contract (Schedule 10 Part 5) contains provisions for sharing "exceptional" changes to insurance premium risk during the operational period. Exceptional changes are defined as changes greater than 30% of the assumed base cost. Outside these tramlines the Authority bears 85% of the cost or benefit. The risk sharing is based on a two yearly review cycle.
Under the WIDP Contract (Schedule 10, Part 5), the Contractor is required to instigate the Insurance Review Procedure and the Authority's Contract Manager should be proactive in pursuing this. A key aspect of that procedure is the production of the Joint Insurance Cost Report, prepared by the Contractor's Broker for the Authority and Contractor.
Authorities should work with their advisers to check the accuracy of the calculations presented in the Joint Insurance Cost Report. Given the current scope for significant savings, it is vital that the Insurance Review Procedure in the Authority's Contract is properly applied. For instance:
• if certain risks have become uninsurable and therefore the Contractor has not had to pay insurance premiums in respect of those risks, there should be a corresponding adjustment to the Base Cost; and
• if the Contractor has put a number of insurances in a portfolio to generate savings on the Base Cost, Authorities should challenge any calculation that seeks to give the benefit of that portfolio saving to the Contractor.
Given the specialised and complex nature of the insurance markets, the Contract Manager should seek specific insurance advice at the start of each Insurance Review Procedure. In addition the Contract Management Manual should highlight the First Insurance Review Date and the frequency of later reviews, as defined in the Contract.