China’s One Belt One Road initiative means billions of dollars’ worth of infrastructure projects are up for grabs – but firms with flawed risk management could come unstuck.
With the Chinese economy growing at its slowest pace in almost three decades, the government has turned its focus to the infrastructure sector to spur on the world’s second-largest economy.
It appears to be working: In 2016 the industry grew by 17%, up from 12% in 2015.
In fact, China now spends more on economic infrastructure annually than North America and Western Europe combined, according to a 2016 survey by McKinsey Global Institute. And the government is far from running out of infrastructure projects to spend money on. It plans to pump RMB1.8 trillion ($261bn) into roads and waterways and RMB800 billion into new railway tracks and upgrades, at the same time as starting the construction of 15 major hydroelectric dams and power stations.
Of course, a crucial driver of this investment is the One Belt One Road initiative, which aims to improve connectivity across China and with the rest of Eurasia. The project has seen many companies in China’s construction sector venture to countries along the
‘Belt and Road’ route, with the total value of overseas contracted projects reaching RMB1.6 trillion ($244bn) in 2016, an increase of 18.1% over the previous year, according to the Ministry of Commerce in China.
But such rapid expansion into new territories – many in unstable environments – is not without risk. And underinsurance issues could see some firms fail.
JLT Specialty Asia managing director, construction, Stephen Boddington says this highlights the need for solid risk management processes to understand a country’s political, economic, cultural, legal and regulatory environments.
“China’s construction industry has certain ways of operating and contracting, and when you step outside of that environment, everything’s different and you need to adapt to the local practices. You’re not only stepping out of China, you’re stepping into developing countries in many cases, and it’s never certain as to how those issues are going to be applied.”
Boddington also points to pre-contract delays, site access and unknown climatic conditions as additional risks that are often exacerbated for Chinese construction companies heading to new countries.
He says things that are taken for granted in a company’s ‘home country’ can turn out to be critical issues. For example: “Is the country’s infrastructure up to a standard, or will site access potentially slow down the project?”
Unfortunately for some, comprehensive risk and feasibility reports can be difficult to conduct, an insurance buyer from a Chinese construction company told StrategicRISK.
“There’s a lot of pressure to win projects and risk management can often seem like we are hindering that process,” he says. “Risk management is still very much in its infancy here, with most of the focus being on insurance. On top of that, most insurance decisions
are made on price, rather than quality of cover.”
This kind of viewpoint doesn’t surprise JLT China strategic business development director Song Yadong. “Several years ago, Chinese [construction] companies did not pay attention to political and credit risk insurance – they wanted to keep the risk themselves,” he says.
But several large losses, pressure from lenders and the economic downturn have led to changes. “The best way for Chinese companies to protect themselves from political and credit risk [in One Belt One Road countries] is to buy political risk and credit insurance (PCI),” Yadong says.
PCI typically covers risks such as expropriation, nationalisation, political violence, currency
inconvertibility, currency non-transfer and arbitration. “Construction companies should consider [buying] PCI because most of the [One Belt One Road] countries are developing. Their political status is not stable and also, sometimes, their economic status is not very good,” he adds.
A major issue for many companies when they enter into a construction project abroad is obtaining finance or facilitating finance for the owner. In fact, many lenders insist that contractors take out PCI in order to secure a loan. “The issue with the construction contract and its insurance requirements is that it may not necessarily be reflective of the risks that are present in the project,” says Yadong. “So insurance procurement
for construction projects – and, in particular, those in unknown countries – needs to be broader than what’s in the contract.
“You need to step aside and say: ‘What are the real risks which are facing this project as opposed to what someone put in the construction contract?’”
Chinese companies with prudent risk management will come out on top in the country’s infrastructure boom, says the insurance industry. Such an outcome would be in insurers’ interests.
A recent Swiss Re report said the insurance premium potential from One Belt One Road
infrastructure projects in the years to 2030 is about $27bn, of which $16bn could be for insurers in China. “Most demand will be for engineering and property, followed by liability and marine insurance,” says Swiss Re Corporation Solutions China chief executive Jingwei Jia.
Zurich Shanghai branch general manager and head of Zurich China liability, Charlie Chai, says: “With the further execution of China’s One Belt One Road policy and overseas direct investment, huge premium is expected from project-related exposures.”
It seems that many players are set to benefit from the construction boom. But only time will tell how quickly – and efficiently – the billions of dollars’ worth of projects will play out.
Regional managing director, construction, JLT Specialty Asia
Single project professional indemnity (SPPI) insurance helps project owners and contractors mitigate construction design risks. While in mainland China, design responsibilities are passed to provincial design institutes, Chinese contractors or project sponsors operating overseas on the Belt and Road will assume these tasks. SPPI cover therefore provides complementary coverage to ‘core’ construction insurances by indemnifying the insured parties for the consequences of design errors that may
otherwise be excluded.
Without SPPI insurance, contractors and project owners are exposed to financial losses arising from design defects. In a recent case, a Chinese contractor in Australia assumed engineering design responsibility for constructing a new coal mine. The project suffered design and fabrication problems and the contractor is being sued by the project
owners for $17m.
Despite the advantages of SPPI cover, Asian contractors do not buy this insurance voluntarily, and only do so if there is a contractual obligation.
Given the position of Asian contractors, project owners should always seek professional
advice when drafting project contracts to ensure SPPI is included where design responsibility rests with the contractor. More importantly, owners should ensure that the policy has a reasonable limit of indemnity, a period of insurance which reflects the extent of design liability under the contract and ‘broad-form’ wording that matches the individual project exposures.
Another option is a new insurance product called Principal Controlled Professional Indemnity (PCPI). This allows project owners to seek indemnity directly under the policy in the event they suffer loss arising from a design defect, rather than establishing the contractor’s legal liability in a court of law. The PCPI policy is also advantageous to the project owner where the contractor or consultant(s) have limited their liability under
contract, as such limitations will not prejudice the indemnity available under the policy.