‘Interest Only’ Project Finance


‘Interest Only’ Project Finance

Insurance instruments can provide valuable credit enhancement to capital risk, especially in environments such as, but not limited to, emerging and developing economies. Having mentioned ‘Interest Only’ financing in my last blog a description of this technique can only add weight to the intelligent use of the insurance markets as a valuable aid to project finance.

One of the major problems encountered with developing/emerging economies is that long-term capital for business development would be a preferred solution under normal circumstances, but the instability risks dictate short-term exposure. For certain types of project ( typically < USD 50 million requirement) where, for instance, there is a quality Western off-take to cover debt service, there is a technique that can be applied that utilises insurance products to change the country risk profile of the project and thus permit long-term financing on an attractive risk profile. This technique involves over-lending and traditionally works on the basis that the advance to the project includes an amount that is specifically used to purchase an asset, in the form of a deep-discounted instrument, to insert into the Balance Sheet of the borrower and which is pledged to the lender, and has a guaranteed maturity value equal to the total capital lending. The deep-discounted instrument is usually a stripped-USD Treasury or zero-coupon bond thus changing the risk profile of the borrower to that of the US Government for capital purposes. The borrower pays interest (albeit at a premium rate over a comparative rated borrowing, but much lower cost of finance than a straight borrowing) on the total borrowing through a lien over the off-take proceeds. (Please do not confuse this process with so-called leased assets that cannot be pledged)

The benefit of this structure is that all debt service by the borrower (which is all interest) is normally tax deductible, thus making the effective cost of money relatively cheap. Furthermore, so long as the borrower has no beneficial interest in any excess value of the US Treasury on maturity then it is normally possible to negotiate a tax exemption with the relevant tax authorities relating to the capital gains over the lending period. In reality all that has happened is that the lender has inserted a valuable asset, that can be pledged, into the borrowers Balance Sheet that otherwise would not be capable of providing suitable security.

The advantages of a stripped Treasury solution is the fact that it provides an “AAA” rated security which is easily disposed of in the event that the lending terminates early. What is not known is the discount price at the time of such disposal, or the value of the security/collateral at any point in time throughout the term. This can be a problem with booking such a transaction. Furthermore the current 10 year yield on US Treasuries is too low for such purposes making the over-borrow costs too expensive.

Let us examine how we might improve on this situation using insurance products rather than a stripped-bond.

There are a number of insurers that offer guaranteed growth funds in various guises currently producing yields in excess of 8% p.a. Many are investment grade credits and, over a 10 year term, tend to out-perform bond yields. What is more interesting is that many of these insurers are also now owned by major banks. If the lender were to use the over-lending amount to invest in such a fund and use the policy as the Balance Sheet asset with assigned rights to the total value of the proceeds (which are generally tax-exempt) then two prime advantages exist. Firstly, the value of the policy cannot reduce in value irrespective of market conditions as the price of units cannot go down in value. The only factor that can affect the value is if surrender occurs early in the term in which case there are likely to be early surrender penalties (around 5%). Secondly, as such a fund will normally out-perform bond yields, there is likely to be a profit which can be secured as a maturity fee. Therefore, for a reduction in credit rating from “AAA” to probably “AA” we have achieved a far more stable collateral value and with a probable profit.

This type of structure only really works for financings of 10 years or more but demonstrates that the insurance market can facilitate financings that otherwise would not have been possible on very attractive terms to both borrower and lender. Some guaranteed growth funds will also provide life assurance cover as part of the fund package thereby allowing the lender to assure the lives of key borrowers at no extra cost yet provides more risk mitigation.

We have successfully executed such structures where the lending bank has used its own subsidiary insurance company investment funds to generate the capital redemption amount thus accruing all of the fund fees and charges for their own institution.

Let us extend this type of structure one step further to provide some interest cover in the event that the off-take does not generate enough cash flow to service debt financing. Most of these guaranteed growth funds have an encashment facility which can be used by the policy holder to draw regular income up to a certain percentage of the profits of the fund. A very simple calculation will determine by what ratio the initial premium needs to be leveraged in order to secure the require exit value whilst providing the capacity to draw income for both the interest cost of the leverage, and any underpayments on debt service. This would be invisible to the borrower, and would not remove the liability on the borrower to make good any short-fall. However it would prevent the need to reclassify the risk on the original loan in the event of an interest payment default.

Let us now attempt to define the benefits to such a financing through an example of a privately (socially) owned food processing factory in a emergent economy that suffers from the aftermath of a period of undemocratic control where asset values are difficult to define, and the legal framework makes any form of security charge unacceptable. The company requires to modernise its facilities in order to comply with the requirements of its major (good covenant) Western customers. The company has exported over 70% of its production to these customers with hard currency payments for a number of years, and their customers are prepared to enter into long-term off-take contracts with the company. The cost of the required modernisation is $25 million which would require a term of 10 years to service with no capital repayments in the first 2 years. Political Risk insurance is available at 2.75% p.a. but only for 2 years with renewal options at the discretion of the insurer. The off-take commitments would provide at least 2.5 times debt service cover after operating costs over the term. There is no active bourse. Corporate tax rate is 48%. Local borrowing costs, if such funds were available, would exceed 16% p.a.

As a banker this is an attractive project, and if this was a company located in a stable Western democracy this requirement would be a reasonably trivial project finance possibly using a combination of export credits, leasing structures, equity placement, term loans, etc. Given the environment in which the company resides, and through no fault of the company, the required financing using conventional finance solutions is practically impossible, especially with the lack of term political risk (primarily business disruption) cover. Even if a two year rolling facility were negotiated the company would be restricted on what it could do knowing that there was a possibility that the facility could be called if the political risk cover were withdrawn. Furthermore the combination of high interest rate charges and insurance premiums would make the cost very unattractive in terms of cash flow and investment strategy for the borrower.

We need to change the risk profile in order to structure a financing that will provide a financial environment that can reasonably be supported by the borrower, and will be an acceptable credit to the lender. Having determined that we can achieve the tax exemption for a stripped-Treasury solution on condition that we advance 10 year term funds we establish that the deep discount price is 44¢ thus requiring $22.5 million of over-lending. Let us assume after all costs and fees the total advance is US$ 50 million. Using a real template from a suitable guaranteed growth fund using a conservative 7.5% growth (8.5% yield) our $22.5 million will grow to US$50,659,488 after 10 years after all costs. As this yield is only nominally above bond yields it would be reasonable to suggest that expectation would be for a higher return. I should mention that once the gains in any years are rolled into the capital amount the guaranteed amount by the insurance fund is the new capital amount. We have now moved most of the capital risk to a friendly domicile and enhanced our credit rating to investment grade.

We now need to structure the interest payments. As we have an investment grade covenant on the capital repayment the interest rate can be set at a level which reflects this partial credit enhancement. If we assume that an “AA” rated lending would be LIBOR+1%, the covenants from the borrower’s customers would warrant no more than LIBOR+2%, and we can achieve cover for political risk inclusive of business disruption and force majuere albeit on a renewal basis at 2.75% on exposure adding 21 bps to the cost. Therefore we calculate that LIBOR+2.5% would provide an attractive return to the lender.

Banker’s Perspective

Loan:               US$ 50,000,000

Term:              10 years, bullet repayment at maturity secured by major insurer

Interest:          3 month LIBOR+2.5%, payable quarterly in arrears

Security:          “AA” covenant on capital, Quality off-take covenants for interest,

“AAA” rated political insurance for disruption of business

Fees:                US$ 2,500,000

Bonus:             Uplift on Guaranteed Growth Fund policy proceeds

Borrowers Perspective

Loan:               US$ 25,000,000 for modernisation, US$ 22,500,000 asset purchase

Term:              10 years, interest only

Fees:                US$ 2,500,000

Assuming for simplicity of illustration that US$ LIBOR was 5% throughout the term which would result in a total repayment by the borrower over the 10 year term of US$37,500,000

Equivalent Cost of funds pre-tax;     8.6% + Insurance Premium of 21bps

Equivalent Cost of Funds post-tax:   4.5% + Insurance Premium of 10bps

As can be clearly seen the introduction of insurance products has made an otherwise difficult transaction into a very attractive proposition for both the borrower and the lender. Furthermore there is the goodwill element between the bank and borrower for future business as the emergent country stabilises. As a footnote, the fund management fees indicated by the example were US$18,383,979 thus making this financing substantially more rewarding for all financing parties than an alternative conventional lending.

There is a further level of sophistication to this solution which reduces the initial capital risk to the lender, but requires more attention to the capital risk at the ultimate exit. If it is anticipated that the instability of the country of the borrower will significantly improve over the financing period, and the insurance fund is a consistent performer, then it is possible to reduce the over-borrow amount by gearing the amount placed into the insurance fund at a much lower cost (capital and interest of the gearing amount guaranteed by the insurance fund and thus LIBOR+1% is achievable) benefiting from the yield on the growth of the gearing amount less the interest cost). We have successfully geared at 3:1 with good results but a full explanation of the dynamics of this enhancement is beyond this blog discussion.


The superior nature of Syndicated Insurance for Construction Projects


The superior nature of Syndicated Insurance for Construction Projects

Syndicated Insurance is not so much an insurance solution – more a global comprehensive risk management tool for qualifying construction professionals. The application to major construction projects was developed by myself and John Curran, an expert in construction risks insurance, to provide banks with a quality event risk package in order to facilitate rapid financing at a lower cost to developers. It took 2 years of negotiation, cajoling and proving in whole or part with construction professionals.

It would also be reasonable to acknowledge David Barnes, Executive Director of Construction Risks at Willis in London who championed this product within Willis.

Having been asked to explain Syndicated Insurance I would suggest that this blog is for the spectrum of construction finance professionals as I must assume a reader knowledge of the conventional process of construction finance and construction risks insurance. Thus this blog will outline the features, scope, comprehensive nature, and benefits of Syndicated Insurance for construction projects.

The objective of this approach was to provide a totally comprehensive, all-inclusive insurance package that would include, and commit the lead underwriter to provide all requirements throughout the debt service period regardless of when, in the project timeline, certain requirements need to be activated. This provides security to a lender that all event risk requirements are guaranteed throughout the debt service period. 


The ultimate global comprehensive and integrated insurance solution, designed with project finance specialists to address principal and bank requirements with unparalleled service and risk management delivery

Specifically designed to incorporate all development risk mitigation requirements for the larger contractor, property developer, and construction professional 

Flexible in its application – select what is required in the most applicable form – with consistency in delivery and cover 

Aligned with concepts such as long-term finance initiatives to offer long-term indemnity up to 30 years to satisfy bank finance requirements, and maintain a consistent bank risk profile, even during delays and disputes 

Comprehensive inter-laced cover with a single, major underwriter to emulate the way that bank’s syndicate the debt financing component thus simplifying risk assessment, cover, claims and disputes

A comprehensive solution for the construction professional throughout the world with valuable new features not currently available with any other product

Non-collateralised bonding facilities available to limit unnecessary use of working capital – the financial and security benefits are immediate and considerable 

Many of the difficulties encountered in construction litigation are avoided, significantly reducing the possibility of lengthy disputes, or project delays 

Added value benefits include 3 or 5 year fixed pricing with a share of insurers profit, loss control and evaluation services provided without charge, 24-hour helpline World-wide including collateral warranty advice and claims services. 

Cover Synopsis

Contractors “All Risks”Includes full cover for works, temporary works, materials & plant, whether owned or hired whilst at the contract site, in transit to or from the site, or temporarily stored away from site

Financial Risks – Takes the pressure off the Balance Sheet by avoiding the unnecessary use of working capital and bank bonding – Annual bonding facilities for Performance, Bid/Payment, Maintenance/Retention, Highways Act and other commercial guarantees

Advance ProfitsEmployer and contractor indemnified against consequential losses following contract delay – Exceptionally wide cove including interest on loans and loss of rent

Building DefectsUp to an initial 12 years’ cover with options to roll – initial technical audit uniquely leads to an automatic option to purchase for all projects – electrical and mechanical services can be included – enhanced value to completed construction sites – immediate compliance with requirements such as the Latham report objectives and anticipated EU directives – includes post-development efficacy of new technologies

Professional IndemnityLiability arising from architectural surveying and other agreed professional activities – High premium discount for modest voluntary excess – wide subrogation waiver agreement

Public and Products LiabilityIncludes contractual liability and indemnity to principal – World-wide coverage – optional excess levels

JCT Clause 21.2.1Automatic annual facility – No individual Surveys – No specific contract underwriting

Directors’ and Officers’ LiabilityComprehensive cover for the obligations of Directors and Officers to meet existing legislation, company and employee reimbursement – World-wide coverage – no excess option

Employers’ LiabilityIncludes cover for labour-only sub-contractors, hired or borrowed persons, all other self-employed persons, and authorised work experience schemes. World-wide coverage

Property DamageA wide range of financial protection opportunities for completed off-site properties occupied by you or leased to other parties – consequential loss – contents and other assets

Fidelity GuaranteeNo mandatory system of check – generous discount for voluntary excess options – automatically includes money and goods for first and third party fraud

Motor FleetIncludes courtesy vehicles – third party claims management – automatic repair authorisation – no excess option

Terrorism & Civil CommotionIncludes Terrorism, Riots, Strikes, Civil Commotion and Malicious Damage including fire

Brown FieldIncludes latent defects arising from assuming certified brown field sites for development including asbestos and heavy metals

Environment ImpactIncludes environmental pollution as a direct result of development works

Political RisksFor International projects where the political environment dictates the need for comprehensive cover against Expropriation, War & Terrorism, and Force Majeure



Responds to obligations arising from all standard conditions of contract including:

  • JCT – Joint Contract Works Tribunal
  • ICE – Institute of Civil Engineers
  • GC/Works/1 – General Conditions of Government Contracts
  • Other International contract conditions

Cover is provided in the joint names of the Contractor and/or Principal for unforeseen events causing damage to the works, temporary works and materials, whilst:

  • In transit to, or from, the contract site and while temporarily stored off-site
  • Own plant and hired plant
  • Site huts, Employee’s Tools and Equipment


  • Removal of debris following loss or damage to the contract works
  • Professional fees in connection with reinstatement of the contract works
  • Cover for completed buildings pending sale, including show houses and their contents
  • Cover for loss of or damage to temporary works and other equipment during any maintenance period
  • The cost of recovering immobilised construction plant from any site
  • Cover in respect of the liability to meet loss of income claims made by a plant owner following damage to any plant hire

The Policy will automatically reinstate the sum insured following a loss.



Increasingly developers, banks, investors, local government and private sector employers are demanding the provision of guarantees, which will ensure that, in the event of insolvency, the costs they incur completing a development will be met.


  • The Performance Bond makes available to the employer a sum of money, normally 10% of the contract value in many parts of the World rising to 100% in countries such as the USA, which will facilitate completion of the contract should contractor insolvency occur.
  • Deed or Tender Bond – against withdrawing from a contract and that a Performance Bond is available.
  • Advance Payment Bond – against non-completion of a contract, including repayment of monies advanced by the employer.
  • Retention Bond – replaces the retention fund.
  • Maintenance/Retention Bond – against non-performance of maintenance responsibilities thereby releasing the retention fund.
  • Highways Act Bond – to local authorities against non-completion, to their satisfaction, of roads and sewers within developments.

These bonds can be provided through insurance companies. The advantage over banks, who also issue bonds, is that insurance company bonds are generally unsecured, whereas banks require collateral. Furthermore, bank-bonding facilities form part of a general overdraft facility, which could cause excessive borrowing requirements.

Insurance bonding facilities are off-balance sheet with consequential beneficial impact on statutory accounts.



Contractor and Principals’ loss of:

  • Rent Receivable
  • Interest Receivable on net proceeds of project
  • Interest Payable on project loans
  • Increased Cost of Works

all as a consequence of a delay emanating from an indemnifiable loss under Contractors ‘All Risks’.


Loss of Rent – Rental income which, but for the damage, would have been received during the Indemnity Period.

Interest Receivable – The Interest Payable for outstanding loans in relation to the Project which have to be extended or re-negotiated and/or additional loans which may have to be raised to finance other projects which would have otherwise been funded from the net income of the sale of the Project.

Increased Cost of Working – The additional expenditure necessarily and reasonably incurred for the sole purpose of avoiding or diminishing loss of Rent Receivable and/or Loss of Interest Payable and/or Loss of Interest Receivable which, but for that expenditure, would have taken place during the Indemnity Period in consequence of the damage but not exceeding the loss of Rent Receivable and/or loss of Interest Payable and/or loss of Interest Receivable thereby avoided.

Indemnity Period – The period of delay in the letting (or sale) of the Development in consequence of the damage beginning on the date upon which, but for the damage, rent would have commenced to be earned (or the sale of the Development would have been completed).




Physical loss, destruction of or damage to the property insured. This includes the collapse of the building caused by a fault defect, error or omission in design, materials, components or construction of the building, which remain undiscovered on the day of practical completion.

  • First Party cover. Insurers assume responsibility for immediate rectification thereby avoiding the need to rely for compensation upon litigation against a Third Party.
  • Policy fully assignable for the benefit of future owners, tenants and occupiers.
  • Twelve-year period to comply with legislation such as the Latent Damages Act 1986, automatically extendable for up to 30 years to provide cover throughout various national financing initiatives and bank financing requirements.
  • Technical Auditing carried out by Insurers and included in premium thereby avoiding high cost of appointing independent consulting engineers which has previously made cost of cover prohibitive.
  • Initial Technical Audit leads to a facility for all projects, which avoids the need to audit each project, thereby reducing the cost and greatly simplifying arrangement of cover.


  • Roof, Cladding, waterproof membrane, and underground services.
  • Electrical and mechanical services
  • Loss of rent, loss of profit and the costs of alternative accommodation.
  • Sum Insured includes demolition costs, Professional Fees, Regulatory Compliance and Inflation Provision.
  • Efficacy of new technologies post-completion
  • Premium Instalments



In respect of the Insured’s legal liability for negligence in the conduct and execution of their professional activities and duties involving design or specification, supervision of construction, feasibility study, technical information calculation, always under the direction and control of a qualified architect, engineer or surveyor.

In addition to meeting costs and expenses in respect of damages and defense of a claim or potential claim, the cover may also be extended to meet those expenses which you may incur as a result of any action you take to reduce the cost of a claim or potential claim.


  • Libel and slander
  • Loss of documents
  • Dishonesty of employees



Liability to third parties following accidental bodily injury, loss of or damage to material property or accidental loss of amenities, trespass, and nuisance arising out of your normal business and site operations.


  • Liabilities arising from defective design, specification or workmanship in respect of any structural materials or goods that you supply erect or repair.
  • Liability arising out of the use of mechanically propelled contractors’ plant on site.
  • Contingent liability arising out of employees using their own motor vehicles on company business.
  • Liability for loss or damage to premises which are leased or rented.
  • The Financial Loss Public Liability cover provides for financial losses but only arising out of loss of, or damage to, property. This Extension provides cover for liability in respect of accidental financial losses suffered by third parties where damage to property has not occurred.
  • Automatic Indemnity to Principals
  • Cross liabilities



Loss resulting from damage to property caused by collapse, subsidence, heave, vibration, weakening or removal of support, or lowering of ground water arising out of, and in the course of, carrying out the works.

 As there are various contractual clauses necessitating this cover, it requires each to be considered on an individual basis. This would not stop work on site commencing but it may mean after a risk assessment, that the final terms and conditions will be finalised subsequently.

The period of insurance cover will equate to the contract term.



Protecting Directors and Officers of the Company, and the Company itself, in respect of claims made against them for any wrongful act in their capacity as Director or Officer.

A “Wrongful Act” is defined as breach of contract, breach of duty, act, neglect, error, omission, mis-statement, misleading statement or breach of warranty of authority.


  • Shadow directorship
  • Costs of representation at official investigations into the affairs of the Company or its subsidiaries
  • Outside directorship
  • 12 month discovery period
  • Spouses of the Directors and Officers
  • Pollution defence costs



Provides against the cost of claims for bodily injury or disease, sustained by employees during the course of their employment, for which there is legal liability. Cover includes the actual damages awarded plus the cost and expenses incurred in defending a claim.

 An important feature of the Policy is that “employee” is widely defined and includes:

  • Labour only sub-contractors
  • Any other self-employed person
  • Employees hired or borrowed from another employer
  • Anyone participating in authorised work experience


  • Liability to employees and the public
  • Contractual liabilities and indemnity to Principal
  • Additional liabilities in respect of bodily injury or loss of or damage to property you assume under contract
  • Health and Safety at Work Act (1974), or national equivalent
  • Kidnap and Ransom



Comprehensive cover for all buildings upon Practical Completion. Cover is available for a single building or any number of buildings, with emphasis on flexibility to accommodate a diverse range of properties, resulting in tailoring cover to meet specific requirements. To obtain the optimum level of protection, a number of invaluable extensions are included as standard, removing unnecessary complication and outlay involved in purchasing additional policies, resulting in overlapping or duplication. Conversely, gaps in cover, which may only come to light at the time of a claim, are avoided.

  • Consequential loss – advance rental
  • Property owners & employers’ liability
  • General interests
  • Denial of access
  • Automatic reinstatement
  • Trace and access
  • Capital additions
  • Internal maintenance contracts
  • Loss of metered services
  • Loss of keys
  • Unauthorised use of services
  • Landscaped gardens



Loss of money or goods caused directly by an act of first or Third Party fraud, theft or dishonesty by an employee provided the loss is discovered within two years of the termination of the Policy or the period during which it occurred.

An “employee” is widely defined and includes:

  • A person under a Contract of Service or apprenticeship with the Insured
  • Trainee under work experience schemes
  • Directors under a Contract of Service who have a shareholding in the Company
  • Temporary employees provided by staff agencies excluding computer staff, warehouse staff, drivers and others where special consideration is required
  • Staff retired on a pension still working on a consultancy basis


  • Auditors’ fees in substantiating the amount of claim, or amending or re-writing computer programs or security codes following fraudulent use.
  • No compulsory requirement to prosecute defaulting employees.
  • Defaulting employee not required to be identified if proven loss was caused by an employee.
  • Cover provided on each and every basis not restricted to an aggregate.



All types of vehicles ranging from private cars, commercial vehicles, special type vehicles or motor cycles or hauliers.

This cover can be diverse to include:

  • Normal Commercial Fleets
  • Industrial Fleets
  • High Performance Cars
  • High Net Worth – Collection of valuable vehicles
  • Plant equipment licensed for road use


  • Unlimited third party property damage
  • Unlimited manslaughter defence costs
  • Full cover for trailers whilst attached to vehicle
  • Courtesy vehicles
  • Automatic repair authorisation
  • No Excess Option



Indemnifies the Insured for the Ascertained Net Loss sustained as a result of direct physical damage to or physical destruction of Insured Assets arising directly out of Terrorism, Riots, Strikes, Civil Commotions or Malicious Damage including fire damage and loss by looting. For the purpose of this cover, an act of terrorism means an act, including the use of force or violence, of any person or group(s) of persons, whether acting alone or on behalf of or in connection with any organisation(s), committed for political, religious or ideological purposes including the intention to influence any government and/or to put the public in fear for such purposes.



Provides full indemnity against any latent problems associated with certified brown field sites including asbestos and heavy metals



Provides for cover against environmental impact of accidental spillage or other non-negligent events that cause environmental problems



This is a truly International product and thus, for countries for which such cover is required,  provides a comprehensive Political Risks section that covers the full spectrum of risks such as Expropriation, War & Terrorism, and Force Majeure.


Expropriation – indemnifies the Insured for the Ascertained Net Loss sustained as a direct result of the Insured Events of Expropriation, Selective Discrimination, Forced Abandonment, Forced Divestiture, Cancellation of Concession Agreement, Cancellation of Export Licences or Imposition of Export Embargo

War & Terrorism – indemnifies the Insured for the Ascertained Net Loss sustained as a result of direct physical damage to or physical destruction of Insured Assets arising directly out of the following Insured Events: Political Violence, Civil War, Revolution, Rebellion, Insurrection or any Hostile Act by a Belligerent Power or Terrorism, Riots, Strikes, Civil Commotions or Malicious Damage including fire damage and loss by looting during the occurrence of or following an Insured Event, provided that such physical loss or damage occurs during the Policy Period at the location(s) of the Foreign Enterprise

Force Majeure – indemnifies the Insured for its provable and ascertainable Net Loss resulting from, due to, or in consequence of any cause beyond the reasonable control of the Insured including Business Interruption as a result of emergency partial or total closure of any road or railway line or port of navigable waterway or airport by or under the lawful order of the police, local or national authority or government, or the electricity, water or gas supply authority, and Third Party Blockade (or Quarantine) which means the politically motivated use of military force, or the direct threat thereof, of one or more third party sovereign nations.


 What are the real benefits to a developer of this package?

  1. A single policy, segmented into chapters relating to the various categories of risk, on one common legal platform with one major rated underwriter, and from which qualifying construction professionals can select their requirements safe in the knowledge that there is no expensive crossover cover, nor unforeseen gaps.
  2. Known cover for all aspects of the development (regardless of the date of required cover activation) from the beginning of the project at a known cost, and not subject to any detrimental market changes throughout the development period.
  3. Latent Defect and Advance Profit features not currently available under any known construction development insurance.
  4. Developers can dispense with the need to negotiate lengthy warranties, and to scrutinise the terms of professional appointments.
  5. As the insurance package is not on a “claims made” basis but is, rather, for a fixed duration and level of cover from the outset, there is no need for the developer to concern themselves with the maintenance of insurance cover by professionals and the contractor nor with the continuity of the professional team in existence into the future.
  6. Many of the difficulties inherent in construction litigation (particularly as the apportionment and extent of liability) can be avoided. This substantially reduces the possibility of lengthy disputes.
  7. The sales process is substantially simplified and the need for additional documents and negotiations is kept to a minimum.
  8. Development financing becomes simpler and quicker as the lender does not have the concern of ensuring that all required risks are adequately covered and on what terms as this package provides a fully uniform and inter-laced insurance platform with only one substantial underwriter, and in a language suitable for bank professionals. This makes financing substantially simpler.
  9. The latent defect aspects of this policy provide for a far wider scope than currently available, and cover is available for up to 30 years before new inspections are required making this a significant sales aid.
  10. All of the above and more at a probable lesser cost than could be achieved using conventional insurance with less cover.

How will this insurance package affect the bid process?

Traditionally, as part of the procurement process, each contractor would factor into their bid the cost of obtaining insurance and obtaining any necessary bonding for their obligations. Contractors with fewer claims and who are more reliable would have access to cheaper insurance which, in theory should give them a competitive advantage. Under this policy the developer would be advised of the insurance cost differentials associated with each bidder and the developer would then use this information in assessing any bid. In this way the developer has total control on insurance costs.

What is different about the latent defect cover under this policy?

In its simplest form the latent defect cover addresses what should be available to purchasers, i.e. full rectification of any and all defects for a period up to 30 years without inspection and subject only to a satisfactory claims history. This cover is flexible in that the developer can provide say, 12 years, as part of the purchase contract with the purchaser having the automatic right to continue such cover on an agreed basis thereafter.

Can the insurance premium be broken down into its component parts for allocation purposes?

Apportionment of premium is essentially a mute point to the developer as it is a project cost, whoever initially bears it. The mechanism of this insurance product reduces the overall cost of insurance, and thus project cost. However each risk component can be separately costed for apportionment purposes.


This sophisticated product can only be realistically negotiated, placed with underwriters, and administered by the likes of Willis, Aon, and Marsh. For example Willis, with 300 offices in 74 countries and 14,500 associates serving clients in some 180 countries, have the capacity to provide the following added value services to ensure a quality service to construction professionals:

  • A specialist construction division with staff throughout the World from surveying and/or construction loss adjusting background.
  • Specialist construction claims staff enables a pro-active stance on contentious or complex claims. Integrated computerised systems enables instant access to claims information;
  • Contract conditions – advice on all insurance implications and assistance with negotiating the most effective and beneficial wording for each specific project;
  • Risk Management – advice in compliance with local legislation such as CDM – Health and Safety at Work Act (1974) and general loss control;
  • Production of a service plan which would obligate Willis to implement all elements of service from pre-renewal meetings to site surveys on a specific time scale by way of a detailed bar chart;
  • 24 hour helpline throughout the World including collateral warranty advice and claims services;
  • Dedicated legal services from your usual supplier.

Small Print

  • The very nature of this product means that it is available to qualifying professionals prepared to engage in a technical audit for qualification purposes. This audit is for a developer or main contractor and should only need to be conducted once, irrespective of the number of construction projects.
  • A first time developer is unlikely to qualify if using standard JCT or equivalent contracts. However a non-qualifying developer employing a qualifying main contractor on a full Design and Build basis is likely to qualify.
  • The construction project needs to be agreed by a lender to be commercially viable.

I am happy to address any questions via  ‘leave a comment’ (at top) or by ’email’ (below).

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Aon and Willis provide syndicated insurance – at last!


Aon and Willis provide syndicated insurance – at last!

Last week Willis announced their initiative to provide syndicated insurance, referred to by the FT as ‘passive’ underwriting. Earlier this year Aon announced the same syndicated insurance methodology. I have seen criticism of this scheme but structured project finance specialists such as myself have been screaming for this methodology since the mid 1990’s.

The reports that I have read attempting to describe this offering do not fully appreciate why this is so necessary in the corporate sector, so a little background might be useful. Banks are in the business of asset risk, whereas insurance companies are in the business of event risk. When a prospective borrower presents a project to a bank, that bank will take the responsibility to evaluate the project and the financing requirement, including the associated inherent direct and indirect risks. The bank will then decide whether or not to fund the project. Little does the borrower know that the bank is likely to syndicate this funding with a number of other banks each taking a percentage of the financing based on the good judgement of the borrower’s bank. If funded through a private placement then this syndication will be invisible to the borrower.

The bank is likely to identify certain event risks, e.g. business disruption, for which it will need insurance cover. Using traditional methodology the borrower will then have an insurance broker approach the insurance underwriters to arrange cover for the various event risks identified. What comes back is a number of policies using different wording platforms, and even different legal jurisdictions. This does not instil confidence into the bank’s risk profile, and why banks generally do not give credence to what these various policies purport to provide. In the event of a potential claim which underwriter does the bank approach?

I would like to introduce 2 extracts from a MBA text book on structured project finance that I co-authored in 1999. Both are from one of the chapters called ‘The Role of Insurance in Project Finance’.

“Our own experience suggests that both insurers and bankers generally state that they are flexible and adaptable, but in practise usually confine themselves to tried and tested solutions. For example it took two years of negotiation, cajoling, and debate convincing insurers that the structure of our “One-Stop” Construction Risks product was a radical and valuable improvement in the provision of a reliable solution for the support of major construction project financing. If I had to identify the major factor in the reluctance to adapt to the inherent changing role of the insurer with such a product it was the degree of change in approach of providing a packaged integrated risk mitigation solution which is flexible, but contained to one major lead underwriter on one legal platform. In essence we did no more than to use tested principles of bank syndication and adapted it to the insurance market. The initial reaction of the bankers was “too good to be true”. The lawyers view was that it would remove at least 80% of construction litigation as many of the difficulties inherent in construction litigation and particularly as to the apportionment and extent of liability could be avoided, but they were not sure that bankers, or even developers, are ready for such a radical shift in thinking.

On the other hand we have produced an integrated insurance solution [with Aon] for a wide range of project risk mitigation including investor risk, cash flow risk, business disruption, all within a political risk envelope, for a Euro-convertible bond offering for a complex project in Eastern Europe which was only acknowledged by the bankers for what the insurance brought to the deal when the issue was very well received and became oversubscribed, whereas prior to the integrated insurance component there was no interest. In this offering the insurance component was an integral part of the Trust Indenture Agreement [a ‘first’ in an international securities offering] which made for a robust structure to which investors could relate and feel secure.

Our resultant observation is that both parties need to be brought together in a spirit of mutual understanding and co-operation if the bankers are to enjoy the value and benefits available through effective risk mitigation insurance tools, and insurers need to adapt to a more flexible approach to ever changing risk profiles. Furthermore there is a language barrier between these two sectors that needs to be overcome by both parties as misunderstanding plays a large part in the lack of integrated solutions.”

Aon and myself wrote the policy wording that we needed, and Hiscox took the lead underwriter role of the event risk requirements for the eurosecurities issue even though there were aspects of this package that they, themselves did not underwrite. They acted as a lead underwriter and placed all the risk within their underwriter community – invisible to us, just like a bank syndication – and only one underwriter for the bank to engage with.

“Project Finance Requiring Political Insurance

This is a very specialised area of insurance as, by definition, the project is in a territory that has less certainty of political stability and/or appropriate legal structure than one would like in order to secure an investment or lending position in the event of problems. Such political insurance is available to cover a whole host of possibilities such as:


  • Confiscation, Expropriation, and Nationalisation
  • Forced Abandonment
  • Transfer Risk
  • Refusal of host Government of Repossession and Disposal Rights
  • Contract Repudiation
  • War, civil war, civil unrest,  and terrorism


However there can be a number of interested parties that need cover within any one project, and there can be a number of different scenarios that require the security of a political insurance wrap in order that they are effective. This is further complicated by the fact that it is not always possible for any one insurer to assume the total insurance package thus various legal platforms for each insurable risk need to be interpreted and reconciled. It is our firm belief that the current practise with insurers will radically change over time such that one major insurer will assume a lead manager role, much along the lines of a bank lead manager, providing a single source of full insurance cover on one platform.”

It has taken some 13 years for this concept to mature, and I applaud Aon and Willis for their belief and understanding of the need for this approach. I hope that the banks welcome this approach with open arms.

Bank Trader Bonuses – should they be paid if the bank makes a loss?

Bank Trader Bonuses – should they be paid if the bank makes a loss?

I have been cornered at a number of dinner parties and other discussions in recent years to be grilled on the controversial and sometimes hostile subject about whether or not the traders, and indeed deal originators, within investment banks should be paid substantial bonuses if the bank itself makes a loss. Having signed-off on such bonuses in the past I know what it feels like when you see the size of the number, sometimes staggeringly large, staring at you on the page, (but then most would gulp at our daily turnover of around US$ 3 billion) so I have tried to rationalise the argument ‘for’ or ‘against’.

In the early days of such traders, (latter part of the 1970’s and first half of the 1980’s), it was commonplace that the bank provided the desk, the capital, the prestige name of the bank, and the support operations. Traders were only paid a nominal salary to live on but would be entitled to a flat-rate bonus calculated at up to 10% of the net profits they generated for the bank. These traders were never considered part of the ‘family’ within the bank, and were remote to the culture of the bank. They were commonly referred to as ‘intrapreneurs’. This was a reasonable strategy for the bank in that they did not have the exposure of substantial salaries to people who might not perform, and the modest salary incentivised the trader to make profits. Many types of companies today adopt this attitude, and it is certainly a better business model than the soccer players I refer to below.

A significantly exaggerated example of this, and well recorded in books such as ‘Liars Poker’ by Michael Lewis, was the trading environment of the then Solomon Brothers investment house which was a ruthless production line of traders who performed to required levels of profit, or were discarded and replaced at will.

An analogy could be a comparison with soccer players who have a limited period of productivity (typically 5 – 10 years) who are paid substantial remuneration whilst valuable, but are readily discarded once their star no longer shines. Headhunters in banking play the role of the soccer player’s personal manager in both initiating transfer of traders between banks, and negotiating any settlement required to be paid to the former bank to overcome notice periods, garden leave, poaching costs, etc. Traders do not have a career as such, they have a window of opportunity to make large amounts of money before they burn out, and their general philosophy revolves around this short-term opportunism.

To add to this unitary approach it should also be stressed that there are a number of separate product areas within an investment bank, and they have separate profit centres which become the accumulated profit or loss of the bank. In general there is no interlinking of these profit centres within the bank, nor interdependency on performance. Therefore I suggest that a trader who performs well is entitled to their bonus, irrespective of its size, as it only reflects the quality of the person as a realised income contributor. I must emphasise that the profit against which the bonus is calculated should be fully realised without any future exposure. Accrued profits, e.g. on transactions that still have future potential exposure, is a contentious subject, and needs to be agreed on a transaction-by-transaction basis. If a trader makes losses not only do they not receive a bonus, but usually they lose their trading seat – and possibly their future as a trader.

At a simple level would you expect a car salesperson to forego the commissions due on their sales if the car manufacturer makes a loss? Scale this up to a salesperson who sells a $40 million commercial airliner on which I am led to understand they can earn a commission up to 7% of sales value. And both of these sales people will probably have a far longer career than a trader.

At the end of the day the primary difference between other corporates and investment banks is the scale of the commissions/bonuses. To put this into context an investment bank can easily turnover as much in a few days as a major corporate turns over in a year.

Please note that this blog relates to business income generators, not the fat-cats who sit at the top and mostly still receive bonuses when the bank makes a loss – this is a completely different story.

Investment Banks – do the media yet understand them?

Investment Banks – do the media yet understand them?

I read a somewhat cynical comment in the FT on 15th July that I cannot get out of my mind. It related to an Analysis article about Goldman Sachs and boldly states ‘they’re [Goldman Sachs] playing by the rules but they are very good at navigating as close to the regulatory wind as possible’. What do the journalists expect them to do?

Investment bankers have taken some serious knocks over the past few years. I am not saying that some of them did not deserve the widespread denunciation of their activities, but the media (reporters, journalists, their so-called experts, etc.) understood so little about investment banks that they delivered a grave injustice to all other investment bankers, by generally creating a feeding frenzy amongst the public, and a convenient escape route for politicians who had much to do with the economic demise of the UK economy. Can anyone remember a Labour government since WWII that did not leave us economically paralysed, and even in the hands of the IMF? I have been a banker long enough to remember serious bailouts of Governments – even when the general public had little or no knowledge of the economic dangers. And let’s not forget the then economic woes of the Eurozone struggling with the outcomes of political over economic sensibilities in an altruistic attempt to create a federal Europe.

One glowing example of this lack of understanding of investment banks was the reporting by Robert Peston during 2007/08, and whom we labelled ‘the Pest’ or with his partner-in-crime, Vince Cable MP, the ‘Ministry of Mis-information’. There is a saying in the English language about someone with a little knowledge, and Peston was certainly going to use his little knowledge to make his name no matter how incompetent the reporting. Indeed it became apparent after a while that the banks had found a way to feed him with what they wanted him to report, even if yet again the information was not credible – he would not know, and thus challenge his reporting credibility amongst those who do understand. The damage caused throughout the population by such uninformed reporting, both socially and economically, must be colossal. Knowing exactly what had happened within the investment banks, I found his reporting frustratingly depressing.

So what are investment banks and why do we need them? During the mid-1980’s they evolved out of the former Merchant Banks which provided the liquidity for global trade, and structured debt solutions for major projects throughout the world. However, capital movement around the world was somewhat limited thus frustrating economic growth through lack of available capital. Deregulation of the capital markets of the world in the mid-1980’s enabled rich sources of new capital, but it required very special and creative structured finance skills to satisfy the investment terms of these new investors with the financing needs of projects. For example we saw the global expansion of international securities, the design of structured securities products aimed at providing finance more aligned with the specific needs of a project, and the attraction of major global institutions and private investors to purchase such securities thus providing liquidity to the system that banks alone could not provide. It was instilled into me in those early days that our role was to match financing need with capital availability providing the expertise to both optimally structure the risk in the funding requirement, and to demonstrate our integrity to investors that would lead to the trust to provide the funding. Investment banks do not lend money (their income essentially comes from origination fees and trading profits), but they make it possible for investors to provide capital to funding requirements, (thus the Capital Markets) and facilitate the liquidity of capital investment to optimise the flows of investment capital.

Managing any self-respecting professional investment banker, whether deal origination/execution, support operations, or systems is a very special skill. These are not conventional people. They live on the edge of the box or totally outside of the box, and not willing to comply with boring rules of convention. This is the essential characteristic of their ability to be creative and productive in such an energetic environment where things happen in the moment with no dwell time to consider. They must have confidence and conviction supported with knowledge. If they have been through higher education, and succumbed to conventional wisdom during the process, they are unlikely to survive no matter how bright they are. The management of such people needs to provide a suitable working environment which contains the necessary constraints regarding risk and excess without trying to apply any conventional management techniques that will stifle performance. Like soccer players they are contained within the boundaries of the playing pitch, where they are encouraged to combine their individual talents to win the game within the constraints of the rules of the game.

For some years this new market worked very well especially in the arena of infrastructure and global business development which was a necessary part of global economic development. New products emerged such as asset-backed securitisation making it possible to provide ever increasing funds to satisfy mortgage demand, credit card finance, lease finance, etc. However, just as the Manhattan Project produced a new science of nuclear fission which could significantly benefit the world in the development of electronics, energy production, medical treatments, etc., in the wrong hands such innovation would have devastating results. If we can accept that history has many examples of great inventiveness being used with moral integrity to the greater good of many, and by the few intent only upon greed, avarice and power, then we can draw upon these flaws in human nature to describe the culture that emerged within investment banks over some 15 years.

For investment bankers pushing the boundaries is a way of life, to find ever more innovative ways to ensure the maximum availability of capital to service the ever growing capital demands of the world. Indeed Goldman Sachs is the most aggressive of the major investment banks, and their creativity is legend. Thus you could conclude that the missing ingredient was moral integrity. But where were the financial regulators in the early 1990’s when the few were screaming into the abyss that control of risk was being sacrificed in the name of profit – and the stakeholders in the banks poured praise onto the generators of these great profits. I find it somewhat disingenuous that financial regulators, who should have been proactive in maintaining moral integrity throughout those 15 years or so, are now reaping the rewards of large fines from the banks whilst normal households are struggling to make ends meet, partly as a result of their failure. And thus my concern at the comment in the FT.

Last year I was asked by a group of senior bankers and economists to produce a report describing the evolution of the problems within the investment banks, and suggestions of how their credibility (moral integrity) can be restored as there is no doubt that they are fundamental to maintaining global capital liquidity. Whereas this report was distributed around major banks it was considered too long for publishing. If there is enough interest in knowing what really happened then I will find a way to make it available electronically. As this is likely to cost me money there may be a nominal charge which I guess will be processed by the likes of PayPal (who will also charge me). However, the feedback from the intended audience, and a business school who studied a copy, suggest that this paper is required reading for those interested about the failure of investment banks from the inside.