The stronger the foundation, the longer a structure will last

Industry-wide uptake of Decennial Liability Insurance will mean lasting reform, yes. But before it becomes mandated, it’s vital we set the right groundwork first.

As part of its new Construct NSW reform agenda, the NSW Office of the Building Commissioner has recently released a Regulatory Impact Statement on its proposal to make Decennial Liability Insurance (DLI) mandatory for construction companies and property developers across the state. I probably don’t need to remind anyone how we ended up here, but for the sake of context, allow me to paint a little background.

In 2019, the construction industry was left reeling in the wake of the Mascot and Opal Towers debacle. Shoddy building practices, unscrupulous developers and the mass residential evacuations that followed really did expose the cracks — literal and figurative — in NSW’s regulatory framework. It’s fair to say our industry is still recovering from the impact that those incidents (and others like them) have had on consumer and investor confidence.

As some of you may know, at the time I wrote a thesis on the problem which was titled ‘The Solution to the Strata Living Crisis’. In it, I first proposed the introduction of DLI as a much-needed reform initiative that would act to protect people whose homes and apartments wind up plagued with major defects even after the builder responsible has either shut up shop or conveniently vanished into thin air. This then led to my appointment onto the ministerial panel to advise the State Government on the introduction of DLI into the NSW market.

Understandably, there are many people within our industry who are already expressing concern over this impending decree. Let’s not move too soon, nor too hastily is the general consensus. Which is why I also need to be clear: as both principal solicitor of Construction Legal and as someone who played a key role in the introduction of DLI, I agree with them.

What are the risks to making DLI mandatory now?

To its credit, Construct NSW’s Regulatory Impact Statement has identified certain perils in making DLI mandatory across the industry too soon, especially if the insurance market is not mature by 2028. We must, at all costs, avoid a situation where we have one insurer or two insurers dominating the market and dictating pricing for premiums. There are some sobering industry precedents for this.

Back in 2001, HIH was the only provider of certain niche insurance products and also held a lion’s share of the Australian market in builders’ warranty insurance[1] estimated at 30-40%.[2] While HIH offered the lowest premiums and easiest criteria for builders to obtain cover,[3] they collapsed and left $2 billion in construction work in limbo. When the other competitor insurance providers Promina, Dexta, and Allianz stepped in to offer similar cover, most industry players could not afford their premiums, leading to them departing the market shortly thereafter at the end of 2002.[4]

Internationally speaking, we know of another cautionary tale. In 2000, Spain introduced a mandatory strict liability DLI regime. At first, things looked optimistic. The decree led to an increase in the number of insurance providers offering DLI, with the likes of global insurance companies like ASEFA, MAPFRE, and CASER holding 60% of the market, and the rest being fragmented into smaller shares held by fifteen other insurance companies.[5] While this competition initially brought a dramatic decrease in premiums,[6] it was not long before two of the major insurers (and three major reinsurers) formed a cartel to increase minimum premiums and impose uniform contracting conditions across the market.[7] Over the six years that followed, total premiums skyrocketed from 15,056,000 € to 386,404,000 €.[8]

Now admittedly, it’s unlikely either the price-fixing or unethical practices that Spain experienced would arise in NSW given the ACCC’s strong regulatory oversight. Nonetheless, we cannot have a mandatory system where industry is monopolised by one or two insurers. So, what is the solution? My recommendation would be ongoing and open collaboration with the broader insurance industry to set out a realistic plan and timeline to bring more competition to the market. By 2028, our goal should be to see at least five to eight insurers with strong balance sheets offering DLI cover, with premiums set at levels that are both competitive and profitable. If this benchmark can be achieved, then it would be the right time to legislate DLI from voluntary to mandatory.  

Furthermore, to be effective for the construction industry, insurers need to understand that any DLI products they offer must have a shorter turn-around for approval. Under the current Home Warranty Insurance scheme, full eligibility for insurance takes an average 22 days for approval of cover – considerably longer than the majority of other project approvals that are extended within 72 hours.[9] 

Could increasing strata bonds over the short-term be a solution?

Construct NSW has floated the idea that increasing the strata bond amount will make DLI a more feasible business proposition and increase market take-up, which in turn will assist with maturing the insurance market in NSW.[10] It’s a proposition that makes sense eventually. However, it is my view that the strata bond should not start increasing until 2025, especially if only one or two insurers are available to offer DLI. 

Why? In short, the severe detrimental effects of COVID on the construction industry, which to this day, still linger.   Since the pandemic, developers have not been able to justify delivery of projects due to compliance costs and the increased cost of construction. At the same time, we are experiencing the highest level of insolvencies amongst builders and the slowest rate of approvals through our Councils. These three issues (together with inflation, of course) have compounded the affordability and housing crisis in NSW.[11] Adding more cost to development will only worsen this problem right now.

While I commend the NSW Government on its recent efforts to combat housing affordability, some reforms have not really hit the mark. For example, the June 2023 new planning rules offering developers access to a 30% higher Floor to Space Ratio (FSR). When the conditions surrounding this offer are considered in detail, the bonus FSR is only available for developments over $75 million and where stock is held for 15 years and offered at discounted rental.[12] This means the majority of developers would not qualify, leaving only the likes of tier-one developers to benefit.

It is thereforemy recommendation to hold the bond at 2% until at least 2025 to allow the industry to recover from the ramifications of COVID. And as I laid out above, it will also require ongoing collaboration with the broader insurance industry in good faith to set out a realistic plan and timeline for bringing more DLI coverage to market, which in turn will allow a safe transition to mandatory status. 

Should Class 2 buildings be exempted from mandatory DLI?

The Regulatory Impact Statement also proposes to exempt any Class 2 buildings (i.e. three storeys or less) that are covered by the Home Building Compensation Fund (HBCF) until DLI is made mandatory. While I support this exemption for the most part, I thought it pertinent to examine the pros and cons.

On one hand, there’s a valid argument for removing the HBCF exception. Historically, the HBCF has operated at a loss, costing the government $138.4 million in funding to iCare in 2017-18 to reimburse prior year losses.[13] As of June 2019, there was a forecast deficit of around $650 million that needed to be funded.[14] Multi-unit dwellings had the highest average claim (around $50,000 to $150,000 per year) and highest premium rate.[15] While the reforms in 2019 increased the premiums for multi-unit dwellings to break-even levels, claims on previous policies continue to cause the HBCF to run at a loss in the short to medium term.[16] 

Notwithstanding the above, before we remove Class 2 developments under three stories from the HBCF regime, there’s a need for market maturity and competition. Currently, there is only one insurance provider offering DLI in NSW.  So, if for example they decline to offer DLI to Class 2 developments under three stories for whatever reason (and I am not saying for one second they would), this would leave consumers who purchase apartments in those developments without any insurance coverage.  For this reason, I recommend that government retain the HBCF cover for Class 2 developments under three stories until the insurance market can properly mature. Yes, it’s true builders and developers will continue to face higher premiums (approximately 6-7% versus 1-2% under DLI), but the risk of no protection for consumers should be the principal concern at this stage. And once we consider that the cost of construction for developments under three storeys is significantly less than high-rise developments, the burden of the premium at this level is not too intrusive.

Some final thoughts…

While I consider myself and my firm one of the most enthusiastic proponents of DLI and its ability to ultimately safeguard and strengthen our construction industry, serious caution is needed before we declare it mandatory in NSW. History tells us what happens if there are only one or two major insurance providers dominating the market. Our focus for the next few years should be ongoing and open collaboration with the broader insurance industry to set out a realistic plan and timeline to bring more competition to the market.

We should also hold off raising strata bonds until the impacts of COVID have fully dissipated so as to ensure further costs are not added to the already increasing price of construction. Perhaps this question can be revisited by government this time next year. If you will forgive the somewhat obvious building analogy, whenever you’re setting out to build something you wish to last, then ensuring it has stable foundations really is the first crucial step. And the same is true now for uptake of Decennial Liability Insurance.

[1]              Australian Government Treasury, 19 June 2015, section 3.1

[2]              Richard Grellman, ‘NSW Home Warranty Insurance Inquiry Final Report’, 30 September 2003, p 14.

[3]              Ibid, p 14.

[4]              Grellman p 14.

[5]              Francisco Marcos, ‘Why There Might Not Be Many Damage Claims Arising from the Spanish Property Insurance Cartel?’, 20 September 2010, p 5.

[6]              Ibid, p 6.

[7]              Ibid, p 514.

[8]              Francisco Marcos, ‘The Spanish Property Insurance Cartel’, 14 December 2011, p 513.

[9]              Grellman p 21.

[10]             Regulatory Impact Statement (RIS), ‘Mandating Decennial Liability Insurance’, June 2023, p 51.

[11]            In December 2022, annual growth in the rental value index was at 10.2% and low-income earners were spending on average of   50% of their income on rent (Corelogic, 2023.

[12]            This Construction Legal article discussing the issue in detail and can be found here:

[13]             Review of the NSW HBCF Final Report, November 2020, p 26.

[14]             Ibid p 26.

[15]             Reviewing the efficiency and effectiveness of the NSW HBCF Issues Paper, April 2020, p 30.

[16]             Ibid, p 3.