The Evolution of Construction Financial Risk Coverage: From Bricks-and-Mortar to Loss of Profit

The Genesis of Construction All Risks (CAR) Insurance

The complexity and inherent dangers of construction projects required a specialized form of insurance to protect both the physical works and the financial interests of all involved parties. The foundation of modern construction insurance is the Contractors’ All Risks (CAR) policy.

The first dedicated CAR policy is generally traced back to 1929 for the construction of the Lambeth Bridge across the Thames in London. While early policies were sporadic, the CAR was further developed and widespread adoption of CAR insurance came with the economic recovery and massive construction boom following the Second World War.

The primary reason for CAR policy was to create a single, comprehensive policy protecting against the sheer volume of unpredictable events (“all risks”)—such as fire, flood, collapse, or explosion—that could result in catastrophic damage to the partially completed works. Construction companies and employers required this coverage due to three core factors:
1. Catastrophic Physical Risk: Projects are vulnerable to sudden, unpredictable events that can result in enormous costs to repair or replace the damaged physical property (Hard Costs).
2. Contractual Requirements: Standard contracts often mandate that a single, joint policy is secured to protect the interests of all parties—the employer, contractor, and subcontractors. This is a precondition for a project’s start.
3. Third-Party Liability: Coverage was needed for legal liability arising from the project impacting the surrounding environment or public, such as property damage to neighboring structures.

The Development of Consequential Financial Loss Coverage

The initial CAR policies were strictly focused on physical damage (Hard Costs—the “sticks and bricks”). The coverage for financial or “consequential” losses was a later, critical development driven primarily by the demands of financial institutions.

The involvement of banks and financial institutions was crucial in pushing the insurance industry to cover consequential losses. While the unfinished building could serve as the collateral for a
construction loan, banks often required comprehensive insurance to ensure the project could be rebuilt and their loan protected if the collateral was destroyed.

For large projects, financiers needed assurance that the borrower could meet ongoing financial obligations (like loan payments) even if the project was delayed by an insurable physical event. This need gave rise to extensions for these financial exposures.

Soft Costs and Early Coverage for Debt

As project financing became more complex, extensions were developed to cover financial obligations continuing during a delay:
Soft Costs, a term primarily used in the US market, refers to a broad category of expenses that continue or increase during a delay caused by an insured physical loss. Examples include architectural fees, permit renewal costs, legal fees, and, significantly, financing costs (loan interest). Initially, coverage for financial losses focused on these fixed charges and debt service. This protected the bank’s interests by ensuring loan repayment continued.

DSU and ALOP: The Modern Standard

DSU (Delay in Start-Up) and ALOP (Advanced Loss of Profits) are two names for the same specialized form of business interruption insurance for construction projects. They indemnify the owner for financial losses incurred because the project is delayed beyond the scheduled start-up date due to an insured physical damage event.

Today, DSU and ALOP are often used interchangeably to refer to the comprehensive cover that protects the project owner against the full financial loss (Gross Profit, Fixed Costs, and/or Debt Service) resulting from an insured delay.

UK/European vs. US Market Terminology and Application

As so often the case in the global insurance market there is a significant difference in how consequential financial loss is marketed and written in the European/London market versus the US market.

This historical difference in terminology and structure stems largely from how the insurance markets developed:

• London/European Market: The CAR and DSU/ALOP products evolved through specialized reinsurers and brokers focused on large, complex international infrastructure projects, leading to highly specific, stand-alone consequential loss policies.
• US Market: Coverage for financial loss developed more as an endorsement added to the standard domestic Builder’s Risk policy, which initially focused on the owner’s interest in the Hard Costs, resulting in the common usage of the term “Soft Costs” for the delay expenses.

Practical Application and Difficulties

While DSU and ALOP policies provide essential protection, practical difficulties often arise in the claims process:

• Establishing Causation: The primary difficulty is proving that the delay was directly and solely caused by the insured physical damage, rather than by concurrent, non-insured causes like contractor mismanagement, faulty design, or permit delays. Insurers require a clear link between the physical event and the extended project timeline. Nowadays this question is often looked at by specialist timeline experts, together with legal advisors, and of course the traditional loss adjuster and insurers.
• Quantification: Calculating the precise amount of anticipated loss of profit (Gross Profit) is complex, as it relies on projections for a future event (the project operation). Disagreements often arise over the projected revenue, fixed costs, and the correct application of the indemnity period. The quantification of the financial consequential losses nowadays is ordinarily looked at, subject to size and complexity, by a specialist forensic accountant, familiar with construction delay claims.
• Time Excess: Unlike physical damage policies with a monetary deductible, DSU/ALOP policies apply a Time Excess (e.g., 30, 60, or 90 days). The policy only pays for loss of profit/costs incurred after this waiting period has expired. This vital coverage ensures that catastrophic physical damage does not lead to financial ruin, securing the future profitability of major construction and infrastructure projects

Challenges in Practice: Forensic Accounting and Loss Determination

While DSU and ALOP policies provide essential protection, practical difficulties often arise in the claims process. Forensic accountants, like those at MDD, often assist insurers, adjusters, legal professionals, and other experts in the correct determination of the financial losses sustained by the insured as a result of the delay.

Complexity in Determining Causation and Loss

The key difficulties in practice include:

• Concurrent Delays: A project often has a single Scheduled Commencement Date (SD). However, during construction, numerous events may lead to delay, some caused by covered risks (e.g., fire) and others by non-covered risks (e.g., contractor performance issues or permit delays). This results in a single delay caused by various reasons, necessitating detailed analysis to isolate the portion the policy should respond to.
• Validity of Projections: Quantifying the loss is complex because the project has not started, and the actual financial results it would have achieved are unclear. The economic environment often changes significantly over the construction period, rendering the original budget or plan invalid. Loss determination must account for these changes, whether they result in the insured potentially achieving more profit or, conversely, that the original projections were far too optimistic due to changes in market prices, economic circumstances, or geopolitical factors.
• Identifying Additional Costs: Determining which ongoing costs were incurred additionally due to the delay and which would have been incurred anyway (as necessary project fixed costs) requires granular analysis.
• Avoiding Duplication of Payment: A significant technical issue arises when a policy provides coverage for:
  1. Loss of Gross Profit (lost revenue minus costs not incurred)
  2. Debt Service (loan payment consisting of interest and capital repayment)

This combination can potentially lead to a duplication of payment for the following reason: The gross profit the business would have generated includes the net profit, which is precisely the source that would have been used to pay for the loan interest and capital repayment. Careful policy wording review and loss quantification are essential to prevent the insured from being indemnified twice for the same underlying financial commitment.

Other complex areas that often result in detailed discussions include the impact of take-or-pay agreements or the imposition of liquidated damages. These specialized subjects warrant dedicated articles to fully explore how the policy often responds or what difficulties these pose in dealing with delay claims.

How can MDD help with Construction claims

As the world’s premier forensic accounting firm, MDD has a wealth of expertise in assisting contractors, developers, investor groups/ owners, architects, engineers, and other industry professionals with claims related to construction disputes, defect claims, builders’ risk, project cost reviews, and surety matters.

We have an international presence with operations across 40+ global offices and have been in the business since 1933, so you can trust our forensic accountants to help:

• Examine builders’ proposed business plans and budgets
• Review detailed planning documentation and loan agreements
• Examine all contracts and measure resulting loss of earnings
• Apply various techniques to validate the accuracy/reasonableness of business forecasts/budgets
• Compare start-up operations with similar construction projects
• Analyze and categorize contractor billings, job cost reports, supervisory reports, potential overruns and other relevant documentation
• Analyze damage components, including equipment costs, increased payroll, general conditions, home office overhead, soft costs, and contractor lost profits
• Examine construction activity logs and record logs in support of timeline/critical path analysis done by other consultants
• Provide expert and consulting witness testimony when necessary MDD’s global construction practice is led by George Uhl, and he is supported by team members in every global jurisdiction. For more information about our team, click here.

By Markus Heiss

The statements or comments contained within this article are based on the author’s own knowledge and experience and do not necessarily represent those of the firm, other partners, our clients, or other business partners.