Major projects and uninsurable events

By Larissa Burnett.

Key Points:
In the current uncertain insurance market, Government has been required to share the risk of uninsurable force majeure events occurring on major Public Private Partnership (PPP) projects. The allocation of these risks is a complex process that requires balancing the interests of the parties in the context of the particular project, as well as the conditions in the insurance market at the time.

In some past major projects, such as the Sydney SuperDome and the Olympic Stadium, the private sector has agreed to bear some of the risk of the occurrence of force majeure type events which are not covered by insurance.

However, since September 11, 2001, the collapse of certain insurance companies in Australia and the general deteriora-tion of the global insurance markets, the risk of the occurrence of an uninsurable force majeure event has become increasingly unacceptable to financiers and is borne partly by Government in privately financed infrastructure projects.

For example, the detailed proposals for the Cross City Tunnel project were submitted about five weeks after September 11 and those bids were heavily qualified in terms of the impact on the financial markets of those events and the potential outbreak of war.

Subsequently, during the negotiations with the preferred tenderer, the availability and cost of insurance (particularly for tunnels) and the extent of cover became the most difficult issues to resolve.

The insurance market and hence the risk allocation on the NSW toll road projects has improved a little since then. However, uninsurable events remain a risk that equity and debt are not willing to bear.

In the Cross City Tunnel and Westlink M7 (formerly known as the Western Sydney Orbital) projects, the occurrence of an uninsurable risk which has a material adverse effect on the ability of the consortium to repay debt or to make anticipated returns to equity, gives rise to the right of the consortium to make a claim under the material adverse effect provisions of the concession.

This material adverse effect regime provides for a negotiated outcome which is intended to restore the consortium to the position it was in before the event occurred (or at least to its base case position). A number of outcomes are available to the parties, including

• amending the project documents;
• varying the concession term;
• varying the financial or other contributions of the parties; and
• adjusting the toll regime.

However, in the case of an uninsurable event in the recent toll road projects, a variation to the financial contribution of the Government is not to be considered other than in circumstances where no other solution can be found – it is the remedy of last resort.

In these projects there is a differen-tiation between the uninsurable events for which Government bears the risk during construction phase and during the operation phase. The reason for this is that the construction phase, project-specific insurances, which can be put in place at the time of signing the project documents, can cover the entire construction period. Consequently, the risks which are insured, and those which are not, are known.

However, in respect of the operation phase, insurance will not be put in place for some years and it is not possible for the parties to ascertain what will be the state of the insurance market at that time.

During the construction phase the uninsurable risks are narrowly confined to events which are accepted as being uninsurable in the market. These can be categorised as:

• War risks including war, invasion, act of a foreign enemy, hostilities between nations, whether war has been declared or not, civil insurrection and military usurped power.
• Nuclear perils including ionising radiation or contamination by radio-activity from any nuclear waste or combustion of nuclear fuel.
• Political risks including confiscation, nationalisation, requisition or damage to property by or under the order of any Government.

In the Cross City Tunnel project which was documented closer to the events of September 11, 2001, than the Westlink M7 project, terrorism was also a risk which the consortium was not prepared to bear as insurance was no longer available in the market.

However, things have progressively changed in the market for terrorism insurance and in the Westlink M7 project, the risk allocation contemplates that in time insurance may be available for terrorism and if so, the private sector will bear (and insure against) that risk.

The allocation of the risk of the occurrence of uninsurable events during the operations phase of the project is a complex one. Generally, in the recent toll road projects, during the operational phase in addition to war, nuclear and political risk, an event will be considered to be an uninsurable event for the purposes of the material adverse effect regime if it is:

• an unanticipated physical event;
• which is beyond the reasonable control of the consortium and their contractors;
• which could not have been prevented by the consortium or their contractors taking action which a prudent contractor would take;
• which directly results in loss or damage to the toll road or prevents the toll road being open to the public; and

for which either:

• no insurance is available at the time;
• insurance is available but the terms are out of the market; or
• the loss suffered is greater than the amount recoverable under any insurance policy effected for the risk.

However, there are certain exceptions to the Government bearing this risk, including:

• insurance failing to respond due to an act or omission, negligence or breach on the part of the insured;
• insolvency of the insurer;
• if the event itself arose as a result of a breach or negligence by the insured;
• failure by the consortium to adequately insure; or
• the loss suffered by the consortium arising as a result of the requirement to absorb deductibles commonly applied under insurance policies.

In addition to the risk of the occurrence of an event which is uninsurable, the risk of obtaining and maintaining adequate insurance to manage other risks is becoming a risk which the private sector may be unwilling to bear.

For example, in the recent Spencer Street Station redevelopment PPP project, in certain circumstances the risk of the costs of insurance is shared by the private sector and the Government, through an adjustment to the service payments or other rights, if the cost of insurance increases by more than 30 per cent.