Brazil is preparing for the 2014 FIFA World Cup and the 2016 Olympics. Even more significantly for Brazil’s long-term future, a major infrastructure programme covering energy, railways, roads, ports, and airports is expected to cost R$246.4 billion (2011-2014). Such projects require long-term funding to close the debt/ equity equation and the need to mitigate uncertain regulatory, governmental and legal environments, as well as risks of physical damage, loss of income streams and liability. Insurance has a key role to play in this exciting stage of Brazil’s economic development, offering robust risk mitigation through the construction and operational phases, and materially enhancing project bankability.
Before describing some of the key features of an appropriate insurance programme, it is important to trace how contract structures have evolved internationally. The old structure was the simple one of public entity, contractors and architects/engineers. This mutated via France and Britain’s Channel Tunnel project into the more complex structure typical of the Project Finance Initiative (PFI), devised to promote private expertise and investment in such projects.
Under PFI the private sector builds, finances, maintains and operates an asset which is used in the delivery of public services. In return the public authority pays a monthly charge which covers both the repayment of the capital investment and the ongoing service costs. The Project Company/ Special Purpose Vehicle will seek finance, typically with an 80%/20% debt/equity split. To date, these have all been on an adversarial basis between the parties. Bitter lessons were learned on some high profile projects in the UK, demonstrating the limitations of such relationships. As an antidote to these difficulties, BAA brought in the Partnership Agreement for Heathrow Terminal 5, which succeeded in the parties working collaboratively to share the pain and the gain. It will be interesting to see if this approach becomes a feature of projects in Brazil.
Article taken from Brazilian Bussiness Brief, April 2012.
The major insurances required through the construction and operational phases are outlined below:
Because lenders will, for debt repayment, only have recourse to project revenues, they will be particularly interested that a robust insurance programme is taken out and maintained, including important features as follows:
• minimum financial ratings of insurers/reinsurers.
• Multiple Insured Clause. The Contract Works policy, for example, requires the project company, the contractor, subcontractors and the lenders to take all reasonable precautions. Under this clause, failure by the contractor does not affect lenders’ rights under the policy.
• Loss Payee Clause.
• insurance and reinsurance assignments. These requirements must satisfy the local law and regulatory regime.
Delay in Start Up (DSU)/Advanced Loss of Profits (ALOP) Insurance
Lenders may require this cover, which is:
• only available from local insurers and local reinsurers in Brazil as a special acceptance.
• generally a requirement of Project Financiers
• perhaps the least understood of the required insurances.
It covers net profit, debt servicing, rent, take or pay obligations or fixed costs/debt service of the project owner (and increased cost of working to avoid or mitigate such a loss), arising from a delay in completion caused by physical loss or damage indemnifiable under Marine Cargo, Contract Works or Sabotage and Terrorism/Political Violence policies.
It generally applies to projects where completion is not date certain, but also to those which have to complete by a fixed date. Obvious examples in Brazil of the latter are the 2014 World Cup and the 2016 Olympics. Here, in the event of a fire at a stadium, the DSU policy may pay the increased costs of hiring a replacement stadium and reduced income because of inferior seating capacity/ media facilities.
The insured’s insurance adviser should, prior to binding, ensure that the insured fully understands how to substantiate a DSU claim, especially the two key variables:
1. the period of insured delay, especially the date on which, but for the delay in completion from the insured peril, the project would have commenced operations. This may not be easy if completion could separately have been delayed by an uninsured event, for example, a strike or late delivery of materials.
2. the cash value of the loss. Unlike Business Interruption (where there will be business records making proof of loss relatively easy), DSU relates to future income streams, possibly for a unique project. Insurers will generally be reluctant to indemnify for a pre-agreed daily amount.
Prior to binding:
• possible benchmarking against financial performance of similar completed projects.
• ‘in principle’ basis of indemnification signed off by all parties.
During the project period, progress reports allowing all parties proactive awareness of the likely project completion date should solve many problems.
Lenders’ insurance adviser
Lenders will appoint an insurance adviser to approve the proposed insurance programme prior to financial close and to monitor ongoing compliance until the loan is paid off. Early dialogue between the project company’s insurance advisers and the lender’s insurance adviser should avoid expensive retro fitting of the insurance programme & delays to financial close.
Conventional third party liability insurance policies only cover legal liability for sudden and accidental pollution. However, Brazil’s environmental legislation requires the polluter to pay regardless of fault. Lenders are taking an increasing interest in this issue. Specialist policies cover gradual pollution and related exposures.
Typical bonds are bid, performance, advance payment, warranty and completion bonds (for construction companies), and judicial/tax bonds (for construction/non construction companies).
Political risks insurance (PRI)
Where the projects involve concessions, licences, purchase agreements or other contracts with the host government, they are vulnerable to suits for breach of contract, nonpayment, political violence, currency inconvertibility and inability to export dividends or funds, expropriation or other government interference and regime change. PRI mitigates impacts of such interference/other events on project assets, valuations, capital structure, and cash flows.
Reinsurance operations in Brazil: key changes
Reinsurance in Brazil was operated as a monopoly under IRB for 68 years. Of the three categories of reinsurer now permitted (local, admitted and eventual), local reinsurers have first refusal for 40% of the risk.
It is necessary to obtain the agreement of the main industry regulator, SUSEP (Superintendência de Seguros Privados), that local reinsurers have declined to accept their 40% and to the use of non-standard features such as reinsurance assignments.
Insurance practice in Brazil and international market: policy wordings
Standard policy wordings for projects in Brazil will be cheaper but may not offer comprehensive cover or be acceptable to lenders.
Brian Elliot is a senior consultant within the Construction Practice at Marsh, a global leader in insurance broking and risk management. To contact Brian please email: firstname.lastname@example.org
Article taken from Brazil Business Brief, April 2012.
Topics: Contracts and Insurance & Risk