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The construction industry is second only to restaurants when it comes to risk and volatility. With the financial industry in shambles and some of the largest insurers at risk, buyers have to reconsider how best to protect their company, says Michael S. Culnen, president of C&H Agency in Totowa, N.J. He suggests ways to evaluate insurers and manage renewals and a proactive insurance negotiation process to get the best coverage for construction-related risks.
The construction industry has always ranked a close second to the restaurant business in terms of risk and volatility. But in the forever-changed world of 2009, our industry is coping with the fact that the insurance companies, which historically protected our assets, and the banking industry have become unstable.
It used to be that we would buy insurance from an A-rated carrier and move on to face the risk that awaited us in the field and at the estimating desk. Today, with the financial industry in shambles and even the largest insurance companies at risk, insurance buyers have to reconsider how to best protect themselves.
Figuring out how to mitigate those risks has become a business imperative. The majority of contracts that contractors sign contain specifications for bonding and insurance that require financial strength and stringent compliance so bank and taxpayer dollars are not overexposed to the risks associated with our industry. If contractors fail to provide the proper insurance or bonding qualifications, then they will, in fact, be in default of their contracts, causing immediate loss to production and, ultimately, profits.
So how should contractors protect themselves from the dangers of failing institutions? There is no one simple answer, but there are answers.
Start with the rating industry. When you purchase insurance, it is critical to verify current ratings for all carriers you are considering. Then, cross-reference those ratings with your most stringent contract requirements.
Resist the temptation to stop there. Instead, monitor the ratings on an ongoing basis so you are proactively researching possible breaches in contracts that may be caused by insurer rating changes. Technology provides easy access to insurer ratings, which should be as routine as checking your voicemail.
Manage the renewal process. Like many issues in the United States, insurance is about credit. Either you are a creditor to the insurer or it is a creditor to you. In order to protect your assets, the insurer needs to be a creditor to you. So, if it loses its rating, it is the insurer's capital at risk and not yours. This is accomplished, again, through a careful renewal process. It is critical to manage your financial data accurately so historical numbers and trends can be utilized in conjunction with backlogs and runoff rates. This will allow you to successfully balance your credit/creditor position without compromising your rating structure on any lines.
Be proactive in your contract negotiations. Often, we forget that insurance is a contract just like any other contract and it must be negotiated. Be sure that when you negotiate the terms and conditions of the insurance contract that you manage to structure the policy language so it provides as much protection as possible in the event of a rating change.
For instance, minimum earned premiums or minimum deposit premiums are common areas of exposure as well as short-term cancellation fees. All of these items are risks and exposures that need to be managed in the renewal process and eliminated through contract negotiations to protect your organization from risks beyond your control.
If your program is one that requires collateral, it is especially critical that the language within the collateral agreement be flexible. For example, if you enter into a large-deductible or retro program that requires collateral and you must change insurers shortly after your company has posted the collateral, you risk being left with orphaned collateral while seeking new coverage—unless you negotiate flexible contract language.
Carefully examine the costs. Much like collateral, payment terms are paramount. The risk you must be cognizant of is letting your subcontractor or supplier get ahead of you; therefore, the better the terms you are able to negotiate, the more risk you can avert in these troublesome times. It is not the interest rate or loss-of-interest returns that puts companies out of business; it is the loss of principal. It is vital that you structure your payment terms in a fashion that allows for capital preservation.
When companies that are seemingly too big or too successful to fail actually near failure, then you know prudence has to become part of your modus operandi. These are basic concepts that stand the test of time and will position your organization to weather contract defaults due to insurer rating changes that are beyond your control.
Michael Culnen is president of C&H Agency, an insurance and surety agency based in Totowa, N.J., that is dedicated to the construction industry within the New Jersey tri-state area.