17.1.1 Traditionally, central government has chosen not to take out commercial insurance against insurable risks, as the premiums payable have not been seen to represent good value for money compared to self-insurance.
17.1.2 Local Authorities and other public bodies however typically do ensure their larger buildings in the commercial insurance market, though often this is with high deductible levels.
17.1.3 The position is different under PF2, because insurable risks are transferred to the Contractor which may have limited free financial resources, particularly if it is an SPV. Moreover, the need to ensure continuity of service means that self-insurance by such a Contractor for the full range of insurable risks is, generally, not appropriate. The Senior Lenders will usually take the same view and not expect nor wish the Contractor to self-insure. To achieve an acceptable credit quality for their loans, Senior Lenders will, in fact, frequently require more extensive insurance cover for the Contractor than that required by the Authority. Nonetheless, the Authority should not rely on the Senior Lenders to look after the Authority's own insurance interests, and it is essential for the Authority to seek professional insurance advice on what insurance requirements should be imposed on the Contractor at an early stage in the procurement process (before issuing the tender documents) and during subsequent negotiations.
17.1.4 The main issues which the Authority will need to consider with its insurance advisers are:
• whether and the extent to which the Authority should require the Contractor to take out and maintain certain insurances as a means of managing particular risks (see Clause 17.2 (Insurance) and Section 17.11 (Standard Required Insurance Schedule), and how these may change over time (see Section 17.2 (Authority's Requirements) and Section 17.5 (Reinstatement and change of requirement after an Insured Event))
• ensuring that the proceeds of any claim under any required insurance are used correctly by the Contractor (see Section 17.6 (Application of Insurance Proceeds));
• Authority control of litigation where the Contractor is the principal party insured (see Section 17.7 (Control of the Defence on Litigation of an Insured Event));
• whether the Authority should share significant increases and decreases in the market-wide cost of maintaining the Contractor's operating period insurances (see Section 17.8 (Insurance Premium Risk Sharing Schedule));
• what should happen if a risk for which insurance is to be effected and maintained in accordance with the required insurance schedule in the Contract becomes uninsurable (see Section 17.9 (Risks that become Uninsurable));
• what should happen if any required insurance term becomes unavailable (see Section 17.10 (Terms and Conditions that become Unavailable)); and
• whether any special case applies whereby it is likely to be better value for money for the Authority itself to cover some risks by way of indemnity rather than require the Contractor to insure them in the market (see Section 17.1.6 (Introduction)).
17.1.5 Insurance lies at the heart of the Contractor's risk management strategy and, in turn, efficient risk management lies at the heart of the value for money benefits of PF2 that derive from long-term asset ownership and stewardship by investors. The Contractor's approach to insurance is inseparable from its approach to asset design, construction, choice of materials and maintenance regimes etc. Accordingly, Authorities and their advisers should take care not to disturb the transfer of this integral package of risks, nor to disturb incentives that ensure these risks are efficiently priced and managed. Moreover it is essential that the Authority's insurance requirements and associated contractual provisions are clearly stated in the tender documents and that bidders are required to price these matters within their responses.
17.1.6 While it will normally offer good value for money, and sensible risk allocation, for the Contractor to be responsible for taking out and maintaining the Required Insurances there are some types of project with particular risk characteristics where the Authority should consider allowing certain risks/cover not to be taken out and providing indemnities itself to cover the position.1 Types of projects where this may be appropriate are those where there is:
• a dispersed asset base,
• greater ability to recover losses from third parties, and
• a reduced risk of catastrophic loss.
By way of example:
• material damage and business interruption insurance may not be needed on a street lighting project (where the Contractor will simply take the risk of replacing street lights which are damaged);
• on local authority road projects the Authority may find it offers value for money to cover material damage and related business interruption risks in the operational phase by way of indemnity;
• in sectors where there may be a shallow/inefficient insurance market the Authority may consider retaining the risk of damage (e.g. specialist Assets or Assets used in hazardous situations such as certain MOD Assets); or
• where an extensive programme of projects is being centrally procured by Central Government the Department should consider covering material damage and related business interruption risks in the operational phase by way of indemnity.
It is not considered appropriate risk transfer however for construction period risks to be covered by the Authority or for third party or other insurances, apart from material damage and related business interruption, to be covered. The scope of the indemnity will have to be carefully considered (for instance to decide whether senior debt service should be covered through an "Excusing Cause" regime and to avoid covering the Contractor for defective works or PI risks) and a number of complexities arise. It is therefore proposed to take this forward initially on a pathfinder basis. Accordingly, any Authority wishing to pursue this must prepare a business case for such arrangements and seek approval for it from HMT.
17.1.7 Subject to the possibilities identified in Section 17.1.6 (Introduction) above, the Authority's insurance requirements in Clause 17.2 (Insurance) will represent a minimum degree of cover which the Authority expects to see maintained by the Contractor. It is, of course, for the Contractor to determine the overall insurance programme to be implemented, consistent with the Authority's and Senior Lenders' respective requirements. To ensure delivery of value for money, the Contract should incentivise (or, as appropriate, require) the Contractor at all times to:
• ensure full integration between the insurance programme and their overall risk management strategy,2
• make cost-effective trade-offs between lower deductibles and increased insurance premiums (within the constraints specified by the Authority and Senior Lenders);
• procure insurance from good quality and cost-effective suppliers; and
• look only to the Authority for cover in relation to unavailability of insurances as a last resort.
17.1.8 Under exceptional circumstances it may not be value for money for the private sector to bear all the risks associated with placing an insurance programme itself (e.g. in the event of (i) non availability of insurance or (ii) significant market wide increases in insurance costs) and it is likely to be better value for money if an Authority provides a limited level of protection under specific circumstances (see Section 17.9 (Risks that become Uninsurable) and Section 17.8 (Insurance Premium Risk Sharing Schedule)). Factors which should incentivise the Contractor to manage risks effectively and discourage the Contractor from seeking protection from the Authority, unless in exceptional circumstances and as a last resort, include the following:
• the Contractor remains liable for deductible related losses;
• in the event of uninsurability and an uninsured risk materialising, the Authority may have the ability to terminate the Contract; and furthermore, the amount payable by the Authority to the Contractor upon such termination will be the same as that payable upon termination in the event of Force Majeure (i.e. equity payment limited to par value less Distributions paid to date (see Section 23.3 (Termination on Force Majeure)); and
• in respect of the operating period insurance premium risk sharing arrangements, protection is limited to general market wide changes in insurance costs. Furthermore the Contractor takes an increase of at least 5% of the amount of the original insurance as his risk as well as 15% of any relevant change in insurance cost in excess of a "nil-change" band (see Section 17.8 (Insurance Premium Risk Sharing Schedule)).
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1 The Authority will need to consider any balance sheet issues arising from indemnity cover and ensure that their indemnity cover does not constitute the carrying on of insurance business subject to regulation by the Financial Services Authority. Crown bodies however may not be subject to regulation by the FSA.
2 For example, for a schools project, a Contractor should consider whether sprinklers should be installed, taking into account the lower cost of insurance which is likely to arise as a result.