The abuse of on-demand guarantees continues to take its toll on increasingly ailing local construction industry
25 November 2013 | Non-life | Commercial | Brian Africa, PCBS
The losses suffered by short term insurance companies, particularly construction guarantee underwriters and credit insurers as a result of the liquidation of Sanyati Holdings and Cosira International (recently incorporated under the now liquidated First Strut Group), continue to bring about far reaching consequences within the construction sector. Now more than ever, industry stakeholders are questioning the ability of underwriters to issue and reinsure demand guarantees.
The recent Supreme Court of Appeal ruling allowing Eskom to enforce the demand guarantees provided on the Hitachi Power project, has only further served to dent reinsurer sentiment in terms of the feasibility of reinsuring local ‘mega’ infrastructure projects going forward.
Monetary losses associated with failed construction projects have increased dramatically over the past few years. It is therefore unsurprising that investors continue to opt for risk transfer vehicles in the form of demand guarantees that most effectively reduce risk exposure.
However, while these guarantees certainly have their place in the construction sector, they are at the same time inherently flawed. In this respect demand guarantees successfully manage to circumvent the fairness principle associated with quantifying loss before a claim is lodged.
Too often investors fail to understand how poor corporate governance and misuse of these guarantees not only derails the infrastructure project in question, but have a significant and far-reaching impact on the industry as a whole. Here the call-up of demand guarantees creates an enormous challenge for construction material manufacturers, and reinsurers to financial services providers such as short term insurance companies in particular.
It needs to be understood that performance guarantees are not insurance products. Any losses suffered by a guarantor as a result of the payment of any claims will be recovered from the contractor. This often ends in the liquidation of not only the contractor in question but a whole string of associated businesses, bringing about a high number of often unforeseen job losses.
What needs to be emphasised is the vital role short-term insurance guarantee underwriters play in providing the small and emerging contractor segment with access to guarantees. These types of financial products are not ordinarily available to emerging contractors through traditional providers such as banks, which implement a one hundred percent collateral criterion.
It has now unfortunately reached a stage where delays, disruptive labour disputes and poor project and financial management has eroded the positive perception garnered during the 2010 World Cup.
In addition demand guarantees have now come under severe scrutiny due to their onerous conditions and the extent of losses associated with unfair claims. This has in effect only further compromised the economy as foreign investors are finding it increasingly difficult to obtain demand guarantees from South African contractors.
In the interest of developing a sustainable construction industry, it is high time that stakeholders understand the ramifications of abusing on demand guarantees. If not addressed, these abuses will likely only lead to further instances of price collusion within the sector, successfully causing irreparable damage to an already fragile emerging contractor market.
