builders warranty insurance · 2012-12-12 · builder disappearance or insolvency that are to a...

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to the

Victorian Legislative Council Standing Committee on

Finance & Public Administration on the

Builders Warranty Insurance 15 January 2010

79 Constitution Avenue

Canberra ACT 2612 Tel: (02) 6249 6366 Fax: (02) 6257 5658

Housing Industry Association Limited ACN No 004 631 752

Northern Australia Queensland New South Wales ACT/Southern New South Wales Hunter Victoria Tasmania South Australia Western Australia/Asia

Head Office Canberra

15 January 2010 The Secretary Standing Committee on Finance and Public Administration Council Committees Office Department of the Legislative Council Parliament House East Melbourne, Victoria 3002 By e-mail: [email protected] Dear Sir/Madam, Inquiry into Builders Warranty Insurance The Housing Industry Association Ltd (HIA) provides the attached Submission which it hopes will assist the Committee in relation to its Inquiry into Builders Warranty Insurance. HIA has expertise in this area. It is Australia’s premier construction industry association, representing over 40,000 industry members throughout Australia. Many of HIA’s members construct new homes in Victoria and are compulsory purchasers of the Builders Warranty Insurance product (BWI). HIA also has a half share in a joint venture company, HIA Insurance Services Limited, which acts as an insurance broker and is active in arranging BWI policies. Please contact me if you have any query or wish to obtain further information on any point. Yours faithfully, Housing Industry Association

Glenn I Simpson Senior Executive Director [email protected] 0419751180

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Contact Details

Glenn I Simpson

Senior Executive Director

Housing Industry Association Ltd ACN 004 631 752

Address: 79 Constitution Avenue, CAMPBELL ACT 2612

Ph: 041975 1180

Fax: 026257 5658 Email: [email protected]

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Table of Contents 1.1 Introduction ..............................................................................................4 1.2 The Nature of Statutory Builders Warranty Insurance. .......................6 1.3 Intent and Original Purpose of Builders Warranty Insurance............7 1.4 Home Warranty Insurance in Victoria ..................................................7 1.5 Past Fluctuations in the Market .............................................................8 1.6 Competition Issues ................................................................................10 1.7 Regulation Issues....................................................................................11 1.8 Consumer Protection Issues .................................................................11 1.8.1 What is appropriate consumer protection?................................ 11 1.8.2 Is Builders Warranty Insurance ‘Worthless’? ................................. 13

1.9 Industry Regulation Issues.....................................................................14 1.9.1 Does Builders Warranty Insurance Provide Effective ‘Industry

Management’?.............................................................................................. 14 1.10 Other Regulatory Issues ........................................................................16 1.11 Conclusion..............................................................................................16 ATTACHMENT 1..................................................................................................18

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1.1 Introduction HIA is the premier industry organisation in the home building sector of the

Australian economy, and represents some 44, 000 members throughout

Australia. It employs a professional staff of some 350 persons and forms its

policies through an internal democratic system of Regional, State and

National committees made up of its members serving in a voluntary

capacity. Its policies are very thoroughly considered and are not

expressed lightly or capriciously.

HIA has made submissions to a number of past inquiries on this topic,

including the Australian Senate inquiry in 2008.

The inquiry by the Standing Committee on Finance & Public Administration

of the Victorian Legislative Council has the following terms of reference:-

To inquire into and report on:

• the effectiveness of the current mandatory last resort Builders

Warranty Insurance scheme in providing necessary and

appropriate consumer protection and industry management;

• the specific role of government agencies in their

effectiveness in managing and representing Victoria’s

registered builders under the current Builders Warranty

Insurance scheme;

• any possible alternatives to the current Builders Warranty

Insurance Scheme in Victoria; and

• any related matters.

HIA notes that these terms of reference are very similar to those of the

Senate Economics Committee in 2008. Those terms of reference were:-

Australia's mandatory Last Resort Home Warranty Insurance

scheme, including:

a) the appropriateness and effectiveness of the current mandatory

privatised last resort Builders Warranty Insurance scheme in

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providing appropriate consumer protection and industry

management.;

b) the reasons for and consequences of the ministerial decisions

relating to the removal of consumer protection provisions in

respect of Corporations Regulation 7.1.12(2);

c) the ramifications for the future supply of this insurance product

following the draft recommendation from the Productivity

Commission report released in December 2007;

d) any potential reforms and their costs and benefits which may

lead to appropriate consumer and builder protection and

improved housing affordability; and

e) any related matters.

In particular, the first, third and fourth terms of the Council’s terms of

reference are almost identical to (a), (d) and (e) of the Senate terms of

reference. HIA respectfully submits that the findings of the Senate

Committee on these terms should be relevant and persuasive in the

Council’s inquiry.

In that regard, the Senate Committee (majority report) did not conclude

that the current builders warranty scheme was inappropriate or

ineffective. On the contrary, the Committee found that the scheme did

provide consumers with needed protection, and specifically rejected

suggestions that it be voluntary rather than mandatory. The Senate

Committee also rejected calls for this insurance to be a government

monopoly.

Instead, the Senate Committee made a number of recommendations for

improvement of the existing schemes. Most of these were matters for

States and not the Commonwealth to take up.

For the record, the Senate Committee recommended that – Recommendation 1 8.10 The committee recommends that all parties receive a copy of the insurance certificate, summary of product and dispute resolution procedures. The committee recommends changing the name of the insurance.

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Recommendation 2 8.22 The committee recommends that COAG and the Ministerial Council on Consumer Affairs (MCCA) should pursue a nationally harmonised 'best practice' scheme of consumer protection in domestic building. The scheme should include but not be limited to:

� disciplinary procedures and penalties; � clearer definition of defective work; � quicker and easier dispute resolution; � the proposed 'loss of licence' insurance trigger; � the HIA's 'guarantee of completion' and related proposals, � and better information for consumers (including information on

builders' licence record and average cost of premiums). Recommendation 3 8.28 The committee recommends that COAG and the Ministerial Council on Consumer Affairs should pursue a nationally harmonised scheme of detailed reporting of home warranty insurance. Recommendation 4 8.34 The committee recommends that home warranty insurance should be included in the National Claims and Policies Database.

HIA commends these recommendations to the Standing Committee on

Finance & Public Administration.

1.2 The Nature of Statutory Builders Warranty Insur ance. Statutory warranties and warranty insurance should not be confused as

being the same thing. The first is the legal responsibility of the builder

(statutory warranties) and the second (warranty insurance) is consumer

protection set up to protect against losses where the builder is unable to meet their legal responsibilities due to death, disappearance or

insolvency.

Statutory warranties are implied in legislation in each State and are the

responsibility and obligation of the builder to the consumer. Warranty

insurance is the safety net for consumers where the builder is unable to

meet these obligations and responsibilities in the three defined

circumstances.

There are many reasons why a builder may become insolvent.

Attachment 1 sets out some common problems, and explains why Builders

Warranty Insurance is needed.

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It is important that the scheme not be mistaken for a dispute resolution

vehicle. It is not appropriate for insurers to resolve disputes between

builders and consumers - this task must be the responsibility of the State

regulator/licensing body. When the two are fused in the same body there

is moral hazard, since a finding in favour of one party or the other will

have direct financial implications for the regulator. One of the major

reasons for the decline of the Housing Guarantee Fund in Victoria and the

NSW Building Services Corporation was exactly this confusion of roles.

Also, the differences between this form of insurance and other insurances

are important. Warranty insurance is not like workers compensation

(which allocates risk based on payroll size and claims history) or third party

insurance (which aggregates actuarially quantifiable risks to persons who

have no control over the occurrence of that event). In the case of

Builders Warranty Insurance, the policy cover is against events such as

builder disappearance or insolvency that are to a considerable extent

within the control of the builder themselves. This aspect needs to be

addressed by proper risk assessment as well as by existing licensing

controls.

1.3 Intent and Original Purpose of Builders Warrant y Insurance Builders warranty insurance was originally introduced as a voluntary

scheme in WA and SA. It was established fundamentally to protect

homeowners against the financial failure or death of builder and to

provide cover for losses attributed to underpricing or defective work. It

has now been operating successfully in WA and SA for in excess of 28

years. Following the collapse of HIH in 2001, the scheme was harmonised

across all southern states in 2002-3 to reflect the WA and SA experience.

1.4 Home Warranty Insurance in Victoria The privately underwritten Domestic Building Insurance Scheme was

introduced in May 1996, replacing the previous government scheme

administered by the Housing Guarantee Fund. On 1 July 2002 it moved to

being a last resort scheme, as agreed with NSW according to a ‘10 point

plan’.

Building Advice and Conciliation Victoria (BACV) was established by the

Victorian Government in 2002 as a one-stop shop for building disputes. It provides free advice and conciliation services and is jointly delivered by

Consumer Affairs Victoria and the Building Commission.

Eighty per cent of disputes conciliated by BACV are successfully resolved.

Disputes which cannot be resolved by BACV can be taken to the

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Victorian Civil and Administrative Tribunal (VCAT). According to evidence

presented to the Senate, the number of building matters initiated in VCAT

has declined from over 1000 in 200-01 to 824 in 2006-7.

The Building Practitioners Board (BPB), a statutory authority, is responsible

for registering builders and other building professionals in Victoria. It

checks that applicants have the appropriate qualifications and

insurance. As in NSW, financial assessment of builders is effectively

delegated to insurers. The BPB has disciplinary powers to suspend or

cancel a licence or impose penalties. The Victorian Government advised the Senate that it is currently reviewing

its builder registration and disciplinary framework with a view to better

protecting consumers against problem builders.

1.5 Past Fluctuations in the Market The current withdrawal of Lumley and CGU from the market, and the

action of the NSW Government to step in and take over underwriting in

that State, is a significant development. However, this situation is not new

– from time to time in the past insurers have left and entered the market,

and the market has coped. HIA is of the belief that there remains adequate capacity in the Australian insurance market to provide cover

for builders in Victoria without the need to emulate NSW.

For example, March 2001 saw the collapse of HIH Insurances Limited

(which of course had no association with HIA). HIA and some insurers had warned in advance of this collapse and that the home warranty

insurance cover being offered by HIH was unsustainable at the policy

premiums charged, which indeed proved to be the case.

The collapse of HIH Insurances, virtually overnight, destroyed that market

for a wide variety of Australian risks. As a result of the HIH collapse and the

reluctance of insurers to remain in or enter this market, the Victorian and

NSW Governments reviewed the operation of their schemes through the

mechanism of the Standing Committee of Consumer Affairs Ministers, in

an effort to ensure that the scheme remained relevant and viable.

This involved a significant public review process including a Report from

Prof. Percy Allen commissioned by the Standing Committee of Consumer Affairs Ministers, a Response to the Allen Report by the Standing

Committee of Officials of Consumer Affairs, and a Review for the NSW Government by Mr Richard Grellman. These reviews gave very detailed

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consideration to the issues concerned and formulated a consistent theory

of how consumer protection was advanced by such legislation.

A 2005 inquiry into housing regulation in Victoria by the Victorian

Competition and Efficiency Commission (VCEC) considered home

warranty insurance among other things. Its main conclusions on Home

Warranty Insurance were:

� the crisis in availability of insurance which occurred in 2001-02 had

ended;

� the market for insurance was competitive and there was no sign of

insurers making excessive profits;

� • insurers had responded to concerns that insurance eligibility

demands were preventing discouraging people from entering the

industry;

� • the number of registered builders showed little change in the

period 2000-2005;

� • owner-builder trend data did not support claims of a major shift to

unregistered builders to avoid the insurance;

VCEC supported continuing privatised last resort insurance, arguing that

'this [first resort/last resort] debate is almost academic, because private

insurers are unwilling to offer such "first resort" cover'. It recommended

some improvements:

� better information to consumers;

� a code of conduct for insurers; and

� better dispute resolution services.

Importantly, each of these reviews talked about improvements to the

system of dispute resolution in the home building industry and the role of

the regulator. The Senate Economics Committee in 2008 also addressed

these matters. However these aspects of the reforms as yet have not

been delivered.

After the HIH collapse, there was one major insurer to underwrite an

additional 45 per cent of the builder market. As a result, further

competition was imperative from both a service delivery and affordability

point of view. HIA Insurance Services worked with the insurance industry

to encourage the entrance of new insurers to the home warranty market.

This was successful. As a result, the industry for a period of years enjoyed

strong competition with secure insurers such as Vero, QBE, CGU and

Lumley operating in all relevant States.

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The withdrawal of CGU and Lumley should be looked on in this historical

context of market fluctuation. It still leaves Vero and QBE operating and

providing a competitive marketplace, and the possibility of entry of other

insurers into this market remains open.

It is very important to maintain that competition, in the interests of

Victorian consumers. It is competition and the rigour involved in the

insurers’ underwriting practices that has led to this significant difference

between premiums under private insurance and the Queensland scheme,

and significant savings to consumers in States outside of Queensland.

1.6 Competition Issues If Victoria were to contemplate following NSW and taking over the

underwriting of the scheme, the nature of the scheme would be

fundamentally changed. Competition would occur in tendering to the

State, but not in relation to individual policies. In these circumstances, an

important issue for the Government to consider is whether premiums are

to be set on a commercial basis having regard to the risk profile of

individual builders or whether all builders are to be treated as equal risks

and charged premiums based solely on the value of work done. We

understand that in NSW, SICorp has engaged actuaries to assist in

developing the underwriting criteria for the new scheme.

HIA considers that the Victorian Government should not contemplate a

scheme which entitles builders to any level of warranty coverage they

want regardless of risk, turnover and performance. Already in NSW,

unrealistic expectations have been raised.

It is important that individual builder ratings are maintained to reward

good (low risk) builders who operate sound and well capitalised

businesses, and ensure that they do not cross-subsidise poor risks. Equally

importantly, a flat (one size fits all) rate might promote an environment

conducive to undercapitalised businesses undertaking larger volumes of

work, funded through anticipated future cash inflows. This, in itself, would

present an unacceptable business risk to the Government’s underwriting

arrangements.

Factors including gross margin, net tangible worth, costing systems, debtor

collection and creditor position can point to an inherent level of risk and

potential solvency threat. Ultimately, consumers pay the cost of this

warranty insurance and accordingly, risks need to be properly priced to

avoid upward pressure on policy premiums.

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Over recent years, most builders have managed their businesses in a

positive way, ensuring profits are retained so that adequate capital exists

for less buoyant construction periods. Builders have been rewarded

through the benefits of better business practices and results, and also from

a differentiated premium which acknowledges those results. Maintaining

risk based premium settings provides an important and ongoing incentive.

1.7 Regulation Issues Claims management is also a key matter for the Government and for

home owners. HIA contends that Consumer Affairs Victoria’s responsibility

for consumer protection/dispute resolution and the scheme’s obligations

to address policy liabilities must be kept at an arm’s length to

appropriately balance the interests of the consumer and the warranty

(insurance) fund.

The independent role of the Building Advice and Conciliation Victoria in

resolving disputes is very valuable function. Such a body gives

confidence to both builders and consumers that their disputes will be

arbitrated by an independent umpire with no financial stake in any

particular outcome.

1.8 Consumer Protection Issues

1.8.1 What is appropriate consumer protection? The Working Party of the Standing Committee of Officials of Consumer

Affairs which reported on the Percy Allen Review in November 2002 saw

the appropriate measure of consumer protection in this area as follows:

“insurance cover or a guarantee or the like to complete a house that

is being built or to rectify any defects which are normally the builder's responsibility as articulated in legislation or a formal contract when the

system has broken down and the builder is unable or unwilling to carry out this work” (at p.25).

That is, the Officials advising Consumer Affairs Ministers advocated a last

resort insurance scheme as part of a balanced approach involving

contracts, licensing and insurance.

The Working Party went on to propose the following:

“Scope of protection

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Whether this cover/guarantee is provided by a public or private

system, for a certain value of building work, it should, if possible, provide for consumer protection due to:

i. Non-completion of contract due to: � death; � insolvency; � disappearance; or � termination of contract for fault on the builder's part.

ii. Defective construction when the defective work was performed by

a builder who is: • dead; • insolvent; • disappeared; or. • where the builder simply refuses to rectify the faulty building work.

This cover/guarantee includes work evident and identified before the death, insolvency or disappearance.

iii. Defective work when the builder has failed to comply with a direction by the licensing body to rectify.

iv. Defective work which is the responsibility of a builder whose licence is cancelled or suspended but the builder is not dead, insolvent

or disappeared.

v. Court awarded loss for defective work or incomplete work when the builder has failed to respond to a court award.

Setting the value and type of building, for which this protection is afforded, should be a matter for the individual jurisdictions, bearing in

mind the different values for houses and variation in cost of building in the different jurisdictions. However, it is considered that the social cost of the problem is sufficient to warrant that this insurance should

be mandatory for all housing and preferably for high-rise housing.”

It is a matter of record that the current schemes, outside Qld, do not

embrace all of these aspects. In particular, HIA’s submissions at the time

drew attention to the need for effective, even-handed dispute resolution

procedures.

HIA recommended to the Productivity Commission that “A new and properly designed ADR process that separates contractual disputes from

factual disputes over defects may provide relief without imposing

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additional regulatory burdens on consumers and builders.” HIA considers

that this is still a valid concept that is worthy of further exploration.

HIA also suggested to the Senate the concept of a ‘completion

guarantee’. This idea formed part of its Recommendation 2 (above).

HIA continues to endorse this concept.

If such effective procedures had existed in the past, consumers would not

have had to resort to legal actions against builders to decide where fault

lay, and many of the complaints about the current scheme would have

been avoided. The complaints, rather than directed to the nature of the

insurance scheme, should rather be directed to the lack of effective

dispute settling procedures.

If HIA’s submission to the Productivity Commission were accepted, it would

bring the current model much closer to what was recommended by

Officers in 2002.

1.8.2 Is Builders Warranty Insurance ‘Worthless’? Critics of builders warranty insurance have repeatedly stated that builders

warranty insurance is ‘worthless’ and ‘junk insurance’. This assessment by consumers is apparently based on a mistaken analogy with home or

motor vehicle insurance, with an expectation that every ‘accident claim’

should be immediately paid by the insurer regardless of fault. Needless to

say, this totally misunderstands the nature of builders warranty insurance.

Last resort builders warranty insurance currently performs as a safety net,

where consumers are protected against losses which stem from

insolvency, death or disappearance of the builder. This is certainly not

‘worthless’. Consider, for example, the position of home builders who

contracted with Avonwood Homes which collapsed in the late 1990s.

Avonwood was insured by HIH/FAI. Avonwood went into liquidation with

about 800 homes under construction, which were later completed under

warranty insurance. There were also about 6000 homes still in the warranty period for which the insurers now carried the risk of defects. Due to the

subsequent collapse of HIH, taxpayers ultimately picked up much of the

estimated total cost of $35m. The consumers who had their homes

completed (at a cost of $35m) without incurring additional cost, are

unlikely to consider this insurance ‘worthless’.

Consider also Real Property Constructions Pty Ltd, a Queensland building

company which collapsed in March 2008. The Queensland Building

Services Authority (BSA) has estimated that the cost of completing its

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outstanding home building contracts will exceed $20 million, a cost which

will be fully met by compulsory home warranty insurance. That is $20m

that the affected consumers will not have to pay, a sum which is funded

by builders warranty insurance premiums.

It is noteworthy that, although this collapse occurred in Queensland under

its government-operated first resort scheme, exactly the same

compensation would have been paid by private insurance in other states

under their last resort schemes. This is just the sort of catastrophic

occurrence that builders warranty insurance was set up to deal with, and

clearly illustrates the value which consumers receive from it. It is also

worth observing that, as BSA reinsures most of its insurance risk with the

private insurance industry, the risks and losses are in the long term carried

by private insurers under all builders warranty insurance schemes,

including Queensland.

In addition, premiums for builders warranty insurance have fallen

dramatically since 2002, demonstrating the value to consumers of a

competitive market.

1.9 Industry Regulation Issues

1.9.1 Does Builders Warranty Insurance Provide Effective ‘Industry Management’?

One aspect of private sector management of builders warranty insurance

is that the number of occurrences of such home builder collapses, and their cost, has significantly declined in the last 7 years in States with private

insurance. In HIA’s view, this is very substantially due to the risk assessment

carried out by underwriters and the limiting of insurance cover on the

basis of that risk. Arguably this has been a more successful way of

managing the industry than the Queensland licensing model.

Strong industry criticisms of builders warranty insurance have arisen from

many high-quality builders who were accustomed (pre-HIH collapse) to

obtaining a cheap annual insurance policy without proper underwriting

assessments. These builders were outraged to be told by insurers how

much building work they were allowed to take on in the light of their risk

profile under a series of job-specific policies. This was made worse by the

administrative problems which occurred in 2001-2 when Royal and Sun

Alliance (RSA) attempted to service all the previous HIH builder clients.

Builders pointed with enthusiasm to the situation in Queensland where any

licensed builder could obtain as much builders warranty insurance as they

required from the BSA, which in turn attempted to manage the risks

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involved through their administration of builder licensing, which included

financial assessments.

The Queensland system, while providing insurance cover to all who are

licensed, does not cull out poor and failed builders through refusal of

insurance. Rather, this culling is (in theory, at least) done through builder

licensing, which is also operated by BSA. This system does not necessarily

prevent a bad/poor performing builder from undertaking building work,

but rather seeks to fix the problem after unacceptable building work has

been done and the consumer adversely affected.

Builders Warranty insurance in Queensland offers the same premium to all

builders irrespective of the builder’s past work record, financial status or

business “health”. There is no price incentive to maintain a good building

record. As the BSA does not discriminate for insurance, the BSA has

introduced a range of complex reforms in recent years in an attempt to

address this shortfall.

While some builders in Victoria have been asked to provide Deeds of

Guarantee to obtain warranty insurance, that was done on the basis of a

risk assessment by the underwriter. While HIA does not support Deeds, we

acknowledge the fact that builders must have sufficient material and

financial resources to present an acceptable insurance risk.

Those builders who object to having to provide a Deed point to the

situation in Queensland where Deeds are not required. They are

apparently in ignorance of the fact that all directors of building

companies are personally liable under the Queensland Building Services

Authority Act to pay for insurance debts, costs of doing work and fines,

without signing a guarantee. The high degree of regulation has

associated administration costs for both Government and business, which

is ultimately borne by consumers.

The system in other States achieves the same effect, not through licensing,

but through curtailing builders’ access to insurance on commercial grounds. In those States, the decision on whether particular builders were

good insurance risks, or needed to secure some assets as a guarantee, is

a commercial decision for the insurer having regard to the circumstances

of the individual. Given a reasonable degree of competition in the

insurance market, this is not unfair or unreasonable.

A further reason for such complaints was again the false perception that

builders warranty insurance was insurance against workmanship defects.

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Accordingly, some believe, access to and the cost of builders warranty

insurance should recognise the good workmanship standards of (the very

many) builders who had not experienced a consumer claim against

them. From the insurer’s point of view this was largely irrelevant, because

it is the builder’s responsibility to rectify workmanship faults. More critical is

the financial stability and capital resources of the builder to ensure they

have ongoing capacity to meet these responsibilities. Builders that have

insufficient capital as a proportion of work outstanding, or have opaque

financial and management information systems, are not seen by insurers

as good risks. Such builders may therefore be limited in the risk coverage

which insurers were prepared to extend to them.

Compared with the industry pre-2001, home builders as a group are

significantly better capitalised and have better financial management

structures. Subsequently, far fewer home builders have suffered financial

collapse since 2002 as compared with the past. It has effectively ensured

one of the objectives identified by the Consumer Affairs Officers in 2002,

that of consumer confidence in the industry, has been largely achieved.

1.10 Other Regulatory Issues HIA notes that there has been a campaign on the part of the Builders

Collective of Australia and some individuals to paint the current builders

warranty insurance regime as ‘junk insurance’ and ‘misleading and

deceptive conduct’. These claims have been made in complaints to the

ACCC, VCAT, NSW CTT, and the Victorian Small Business Commissioner,

among others. In every case the complaints were investigated but not

upheld.

The latest Report by the Senate Economics Committee also found there

was no basis to these misconceived claims, including some of a scurrilous

nature against a Senator which were proved to be completely false. It is

difficult to deal rationally with views that were not formed on the basis of

reason but on the basis of prejudice. The Committee should be slow to

give any credit to claims from this source.

1.11 Conclusion Builders warranty insurance as currently operating provides –

� statutory warranties and other rights which consumers can exercise against a defaulting builder;

� inadequate dispute resolution procedures which have led to

complaints that builders warranty insurance is not working properly;

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� an affordable solution to protect consumers where their builder is

unable to meet their legal obligations.

It is our position that a dispute resolution process is logically separate from

the warranty safety net process and that dispute resolution should be the

responsibility of the government regulatory body. It is also our position

that builders warranty insurance is best provided by free and fair

competition in the private marketplace.

At present, the private insurance market in Victoria is still working

effectively to provide the required level of statutory cover at an

affordable price. The market is informed as to the prices and the product

is a standard one so that comparisons and choices can easily be made.

Price competition in the private market is providing consumers with

significant savings on their home purchases compared with the position in

Queensland.

HIA considers that there is no justification in the Victorian Government

taking the provisioning of builders warranty insurance back under their

control, and HIA believes that the Government shares that view.

However, we consider that the Government should take a much more

pro-active position in regard to the introduction of a more robust and

accessible dispute resolution process for home buyers and home builders.

Disputes are essentially juridical in nature and are best handled by

governments, while insurance is basically commercial in nature and best

handled by commercial organisations operating within a competitive

marketplace. In sum, Governments should look after disputes and

insurers should look after the safety net.

Housing Industry Association Ltd

15 January 2010

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ATTACHMENT 1

Common financial risks in the housing industry – th e reason for Warranty Insurance

Economic Environment

Construction activity in the housing industry is very cyclical,

meaning periods of high levels of construction can be followed by

periods of depressed trading. Builder insolvency levels follow similar

trends. Boom activity precipitates the greatest number of

insolvencies amongst larger companies – higher activity levels can

lead to greater demand for material and labour resources. On the

other hand, smaller companies generally last through the boom

times but fail shortly afterwards - profit margins often become tighter when home construction activity starts to fall.

Common Features of Failed Businesses

The housing industry is highly competitive. Profit margins, purchasing power and overheads are three of the key factors that builders look

at when analysing their competitive position. Profit margin is often

reduced in order for builders to price their product competitively in

this highly competitive environment.

Boom cycles distort margins due to rising labour costs. Overhead

costs as a percentage of turnover are also affected as production

and cash flow slows down. Conversely bust cycles reduce margins

due to competition.

A common situation amongst failed builders is that they allowed the

market to determine their profit margins, rather than setting their

margins based on the financial needs of their business. Builders

often rely on financial figures generated for taxation purposes

instead of producing and relying on proper management accounts

information.

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Other factors that challenge building business solvency include:

Poor Job Costings Information

A lack of reliable job costing information will lead to individual jobs

being inappropriately priced. If jobs are not priced correctly, in

order to achieve a profit and meet overhead requirements of the

job, the business will go backwards and will have to utilise retained

profits to fund overhead costs, rather than investing the retained

profits back into the business to support future growth.

Inaccurate Job Costing Information

Often builders who become insolvent do not spend the time,

budgeting and planning for specific jobs to ensure a job will make a

profit. When actual costs are involved, the same builders do not

monitor these actual costs against the related job in order to

monitor overruns. Therefore the builder is not able to foresee a

problem on a particular job in advance and determine an

approach to solve the situation prior to the completion of the job.

Overstating Assets

Overstated balance sheet assets relating to work in progress and

realisable debtors (book debts for tax reasons from related

companies or principles are not working capital) mislead the true

position of the builder’s business. If assets are not realisable, the

cash flow of the business will be effected in a negative manner. As

a result the balance sheet should only contain profit generating

assets.

Monitoring Cash flow

Invoices relating to actual costs are usually not aged by the insolvent builder via an accurate aged creditors listing, restricting

the builder’s ability to properly monitor cash flow and to ensure

funds are available when invoices become due and payable.

In conjunction with this, the same builder may not have a reliable

aged debtors listing which allows the builder to effectively manage the flow of funds back into the business, in a timely manner, to meet

creditor commitments. It is particularly important to track progress

payments because if these payments are not received by the

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builder, then the builder may find it difficult to fund the next stage of

the building development and pay creditors on time.

As a result, bBuilders should ensure all management information is

available to them so that they can assess the true position of their

business to ensure jobs are making a profit and debtors are being

recovered in a timely manner so that suppliers can be paid on time.

Financial Records

Failed builders often only produce financial information once a year

and usually well after year end. Often information is in the form of a

financial report which has been produced for taxation purposes. As

a result, the same builder is unlikely to have reviewed any financial management information during the year, to indicate how the

business is tracking and whether there are any financial issues to be addressed.

Other issues leading to Builder insolvency

� Investments in non-core business activity using cash flow rather

than earned profits.

� Uncontrolled under-capitalised growth.

� Lost production due to boom trading or adverse weather.

� A major contractual dispute – often with a client.

� Time delays.

� Cost Variations.

The Australian Bureau of Statistics Data directly states that 60% of

new businesses disappear within 3 years. Not all Builders become

insolvent or bankrupt - some simply shut their doors in order to meet

outstanding obligations rather than incurring additional costs. 90%

of business failures are attributable to poor management and more

precisely - poor financial management

The primary financial concerns for builders include:

1. Failure to plan properly before commencing construction

work;

2. Failure to monitor the financial position through monthly

management information;

3. Failure to understand the relationship between price,

volume and costs;

4. Failure to manage cash flow; 5. Failure to manage growth;

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6. Failure to borrow properly;

7. Failure to plan for some transition;

8. Failure to compare actual job results with budgets or

forecasts.

Often growth in the market will allow builders to have an increased

cash-flow for a short term period which allows them to build up their

business accordingly. However, a downturn in the market is

inevitable and as a result all efforts to increase activity during

previous periods may be pointless.

Usually, effects of an economic downturn are indicated in current

management accounts and financial information long before the

time the builder becomes insolvent. If the builder maintains

adequate management information, growth patterns should be

evident in order to pre-warn Builders of potential downturn in

growth.

Therefore, the major area of risk comes from growth and the

builders response to boom/bust conditions in the market.

There is widespread belief in the building industry that progress

payments alone, will fund growth. Growth in cash flow can only be

achieved through fundamental changes to the business or an

injection of capital.

It is also a common belief of Builders that greater turnover levels

lead to a more profitable business. Unfortunately, this is not always

the case, as the generation of more turnover is not always better for

business unless the increased turnover is adequately managed.

Successful management involves implementing strict disciplines

over margin and production so that turnover growth is funded out

of retained profits or additional equity. (This implies that jobs are

accurately costed through up-to-date construction cost estimates

and there is adequate provision for likely price increases during the

life of the job).

It is imperative that builders manage turnover growth to ensure

business expansion is supported by retained profits or additional

equity not working cash flow which could be to the detriment of

their business.

Builders should also review external information to ensure their

business is tracking in line with their competitors. The Housing

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Industry Association (HIA) is able to provide forecasted economic

data specific to the building industry to help builders better predict

the building cycle.

The most commonly asked question from builders is:

“…how am I actually assessed in terms of the financial and non-

financial information which I submit?”

The financial component relates to approximately 80% of the

assessment and approximately 20% of the assessment relates to

non-financial information. The reason for this is that the Home

Warranty Insurance policy only comes into effect as a result of the

insolvency, death or disappearance of a builder. As such the

primary risk to the Insurer, and the client, is the insolvency of the

builder, and therefore the financial performance of the builder is

the main focus of the assessment.

The non financial elements of a building business, (time in business,

complaint free trading and technical competence) can add

weight to the financial criteria, however in the absence of

adequate financial strength and performance, these non financial

factors alone will not be enough to qualify the builder for warranty

insurance.

builders warranty insurance · 2012-12-12 · builder disappearance or insolvency that are to a...

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