Rule number one in insolvency is to "secure the asset".

The recent catastrophes around the world have had a dramatic effect on the New Zealand insurance industry and the ability to obtain insurance.  In particular the Christchurch earthquakes have made it more difficult and costly to obtain insurance cover for some of the properties and goods we need to secure.  We asked Geoff Blampied, CEO, Aon New Zealand to provide some comments and advice on the subject. Geoff writes:

Global Perspectives

Firstly, we need to look at the Christchurch earthquake losses from a global perspective in order to understand the issues.  Christchurch has now suffered three major quake losses and numerous aftershocks with total estimated insured claims of $26 billion.  These claims are unprecedented and effectively funded from the total New Zealand premium pool of $3.5 billion of which only $250 million relates to earthquake cover.  By comparison it is interesting to note Japan's recent earthquake and tsunami has an insurance loss estimate of NZ$45 billion, yet their annual premium spend is NZ$130 billion, proportionally much less.

This comes at a time when most Australasian insurers are facing substantial financial losses as a result of multiple recent catastrophe events resulting from bush fires, hailstorms, and floods.  From a global reinsurance standpoint, although the Christchurch quake losses represent major events in their own right, further afield recent catastrophe losses include the Haiti earthquake, major flooding in Europe, the Chile earthquake, and USA storms. These events are placing significant upwards pressure on insurers' reinsurance costs, including reinstatement premiums.  As a consequence insurer's retentions are being increased and terms and conditions are being critically reviewed.

Christchurch Earthquakes

Set against this background, the earthquake losses in Christchurch have had severe reverberations with major international reinsurers and, in practical terms, reinsurance costs have skyrocketed for insurers with increases of up to 200-300% on previous years and major restrictions being applied on policy coverage. This is resulting in pressure for increased premiums.

We are also seeing reluctance by insurers to provide catastrophe cover for buildings built prior to 1935 in earthquake prone zones, particularly Christchurch and Wellington.  Many insurers will not provide any standalone earthquake cover at all in certain parts of Christchurch and some buildings are now simply uninsurable for natural catastrophes. The longer term position of insurers will ultimately be determined by their view of whether we have seen the last of major quakes in Christchurch for a considerable period or whether the current situation simply reflects a continuing seismic trend.

What can be done to optimise your insurance protection?

Firstly, the importance of having good quality insurance advice and having your insurance placed with a financially secure insurer has never been more evident. Clients who are well advised and insured are now seeing value. Those who are not well advised or insured are facing significant problems, particularly in the business sector.

You cannot assume that prior years' terms and conditions will be available at renewal. Insurers will continue to become more disciplined in how they price risk. They are carefully scrutinising risks and policyholders on a case by case basis, with those in high risk areas or with high risk characteristics facing more attention than ever before. Those in sectors with relatively low claims activity are likely to be treated more favourably, especially if they demonstrate a commitment to risk management, prepare well ahead for renewal negotiations, and explain and sell their risks effectively to their insurers.

From an underwriting perspective insurers are now looking for more information, including age of buildings, spread of risk, construction, land / soil structure, extent of strengthening work, together with seismic reports (if available). In that regard, it is helpful if insurance is arranged as part of a national scheme or a facility that presents insurers with an array of risks situated across the total country, rather than simply insuring Canterbury in isolation.

The strength and leverage of Aon's global network is becoming even more apparent in this environment. We are noting a variety of different requirements amongst insurers depending on their own internal approach to the Christchurch quake and, in our broking role, are spending a lot more time canvassing different market options both in New Zealand and internationally.  We strongly advise that you allow your broker plenty of time (at least 60 days) before renewal to prepare the necessary submission to present to insurers.

For many years New Zealand has enjoyed very low earthquake rates which were only a fraction of premium rates required in locations such as Japan and California. We do need insurers to remain financially strong and we do need catastrophe cover. Insurers in turn will need an adequate risk premium just to pay their revised reinsurance costs, let alone considering any recovery of the cost of their claims. We are now being forced into a more brutal reality when it comes to insurance costs and capacity availability for earthquake and natural perils. Most parts of New Zealand will still be able to arrange earthquake insurance but we should all be prepared for an increase in premiums.

In summary, the insurance ramifications from the spate of recent catastrophe claims will be significant and having good quality insurance advice to optimise your insurance protection is simply essential.

DISCLAIMER
This article is intended to provide general information and should not be construed as advice of any kind. Parties who require clarification on issues raised in this article should take their own advice.

The earthquakes in Canterbury created a disaster on a scale not previously seen in New Zealand during our lifetime. Christchurch will be rebuilt and when it gets into full swing it will be the biggest building project in New Zealand history. Treasury has forecast that the cost of the rebuild will be circa NZ$40 billion. Fortunes will be made out of the rebuild, but like any boom, history tells us there will be some spectacular failures along the way.

In this article we will explore the issues facing construction companies waiting for the Christchurch rebuild, the chances of another large construction company collapse and some advice on how you as a professional advisor or construction industry contractor can help protect your clients or yourself from another construction company failure.

Issues facing the rebuild

The rebuild of the CBD hasn't started. The government announced the Christchurch CBD will be reconstructed around 10 major anchor projects. The city centre shows little evidence of activity or rebuild projects having been commenced. Private developers are waiting for the anchor projects to get started before they erect their buildings because of concerns of not being able to attract tenants to a building surrounded by empty sites.

Increased competition. A number of large offshore companies have indicated they will tender for some of Christchurch's anchor projects. For example a MOU has been signed between Arrow International, one of New Zealand's largest construction companies and global construction giant China State Construction Engineering Corporation Ltd targeting the anchor projects in Christchurch.

Labour shortage and small supply chain. Christchurch still needs to find another 17,000 workers, including carpenters, joiners, electricians and plasterers, before the rebuild reaches its peak. It is estimated the rebuild will need a total of 35,000 construction related workers. The shortage of skilled labour could result in poorly constructed buildings that could leak or fail.

Rising costs. Escalation in construction costs is already exceeding 10% per annum in the residential market, as a direct result of material shortages. This is likely to spill over into the commercial sector.

High compliance costs. The cost of constructing commercial property in the Christchurch CBD will be very high as the new buildings will require deep and expensive foundations. The draft plan wants to restrict CBD buildings to a maximum height of 7 storeys. The end result is that landlords will have to charge very high rents to get the same yield they had before the earthquake. Tenants may not accept these high rents and elect to keep their business in the suburbs.

Cashflow constraints while waiting for rebuild. Construction firms are desperate to hold on to their good workers and supply chains in anticipation of the rebuild. They have huge overheads to absorb while they wait for the profitable work to start. Initially, it looked as though the rebuild would peak in 2015/16 but it now looks as though it will be in 2016/2017. The flow on effect is that construction firms may have to accept a lower margin for another 12 months to keep their employees busy.

Insurance fraud. The vast sums of money involved in the rebuild and recovery create an unprecedented opportunity for fraud and corruption and we are now seeing large scale frauds being uncovered. International experience shows that, regardless of the country in which it occurs, fraud and corruption activity increases significantly following natural disasters.

What is the likelihood of another Mainzeal?

To answer this question we need to consider the common causes of construction firm failures. From our experience these usually involve:

• Tight margins
• Insufficient capital
• Lack of skills and experience
• Leaky buildings and non-compliant construction
• Over-investment in fixed assets
• Inability to manage growth
• Competition
• Lack of understanding for procuring products/supply chain
• Inaccurate estimates and tendering
• Poor pricing decisions
• Poor quality control
• Unsafe construction sites

How can you or your clients better protect themselves?

• Be familiar with the remedies under the Construction Contracts Act
• Keep good records and contract files
• Register on the PPSR a specific security over material supplies (a great defence if charged for a voidable transaction)
• Suspend work if not paid, or consider the adjudication regime
• Perform due diligence on developers or head contractors before commencing work
• Research/credit check developer or head contractors before starting/signing contract
• Get personal guarantees
• Moneys held in Trust accounts
• Set credit limits - enforce them!
• Search the directors on the companies office to see the number of liquidated companies (history)
• Be aware of phoenix companies and obligations of successor companies to give proper notice
• Get sign off from a quantity surveyor, architect or engineer before paying invoices/completing variations
• Review trading terms
• Get advice if you suspect the head contractor is insolvent. Any suspicion of insolvency can be detrimental when facing a voidable transaction claim from a liquidator

Conclusion

When you compare the list of the most common causes of construction company failures to the issues facing construction companies in Christchurch, it appears that there is a high chance of another significant construction company collapse.

As a first precaution we would advise you to look at the list we have provided to help protect yourself or your clients.

McDonald Vague has considerable experience advising clients in the construction industry. If you or one of your clients is facing financial difficulties in the construction industry please contact Tony Maginness or one of our other Partners.

DISCLAIMER
This article is intended to provide general information and should not be construed as advice of any kind. Parties who require clarification on issues raised in this article should take their own advice.