Thinking the unthinkable

A contractor with adequate insurance has no cause for concern even if claims are being actively pursued. Right? Wrong. Many contractors may be horrified to hear that having insurance cover may not be the end of the story. Consider a scenario where the unsuspecting contractor is informed that the insurance company that was providing indemnity cover has become insolvent. (This is not simply hypothetical, as several non-life insurance groups have become insolvent in recent years.) What is the position of the contractor if this happens? The contractor may be comforted to learn that the aim of the Policyholder Protection Act 1975, as amended by the Policyholders Protection Act 1997, is to give a guarantee to policyholders that the obligations of the insolvent insurance company will be met, either fully or substantially, by the insurance industry as a whole. A corporate body called the Policyholders Protection Board was established to do this.

Unfortunately, the story does not quite end there, as not all policyholders or policies fall within the boundaries of the protection afforded by the act. If protection is not afforded by the Policyholders Protection Board, the insured contractor will find itself in the unsatisfactory position of being an unsecured creditor in the liquidation. This normally means that it will receive little from the liquidator.

It follows that indemnification from the insurers will not be available and what was thought to be an insured risk will in all likelihood end up being an uninsured risk. When considering claims and disputes arising in the construction industry, these are normally of a substantial nature. The impact of an insurance company going into liquidation could, therefore, be dramatic.

The Policyholder Protection Broad is financed by a levy on insurance companies. Who therefore can benefit? First, you must have an insurance policy with a firm to which the act applies. The act sets down the criteria, notably the carrying-out of insurance business in the UK.

The answer could well be to spread substantial risks over a number of different insurance groups. It may be worth discussing this with your broker

The next hurdle to consider is the class of policyholder and the nature of the cover. It is the duty of the Policyholder Protection Board to ensure that private policyholders, either individuals or partnerships, receive 90% of the benefits due under the insurance policy. If the partners are limited companies, the partnership will not be deemed a private policyholder under the act and will not benefit. As many contractors and subcontractors are limited companies, they could not rely on the Policyholder Protection Board to meet 90% of the contractor's liability. Regardless of the class of policyholder, the act must meet, in full, the liability of the policyholder in relation to "compulsory policies". These are those that satisfy the requirements of the Riding Establishment Act 1964, the Nuclear Installation Act 1965, the Employers Liability (Compulsory Insurance) Act 1969 and the Road Traffic Act 1988. Contractors' all-risks policies will not satisfy any of these pieces of legislation, and therefore cannot be said to be compulsory insurance policies.

It is not difficult to envisage a situation in which a contractor will find itself without insurance cover or comfort from the safety net of the Policyholders Protection Board. What then can be done to minimise the effect of an insurance company going into liquidation? The answer could well be to spread substantial risks over a number of different insurance groups.

It may be worth discussing this with your insurance broker. Although it does not occur very often, insurers can and have become insolvent, and the far-reaching consequences ought to be minimised as far as possible.