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Fixed-price repair model 'becoming untenable' as costs rise

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Fixed-price property repair contracts entered into by insurers and contractors, which have been the market standard for decades, are becoming “increasingly untenable” due to surging costs in a volatile economic environment, an Axa XL claims specialist says.

Under fixed price contracts, both sides agree on a price upfront, allowing the contractor to set an exact budget and the insurer to have certainty about the project’s cost.

But Axa Senior Claims Specialist for Property & Construction Sherrie Morton, based in Sydney, says with rising material prices and labour shortages the model does not allow sufficient flexibility.

“I believe the fixed-price model is becoming increasingly untenable; this is based on my experiences over the past year resolving dozens of property damage claims and working with a wide array of building contractors and tradespeople,” she says in an article posted on the Axa website.

Ms Morton proposes the solution could be cost-plus contracts, where the contractor gets paid for all the project’s expenses plus either an agreed-upon profit, usually defined as a percentage of the contract’s total costs, or a fixed fee.

“For contractors, the primary benefit of this model is that it insulates them against rapid and significant cost increases, as we’re currently experiencing,” she says. “For insurers, the ease of calculation is a primary benefit.”

The insurer, rather than the contractor, assumes the risk if costs rise significantly after the work begins, but the change would be in the best interests of clients, and addresses other concerns.

Ms Morton says a contractor working under a fixed-cost arrangement that sees expected profits disappear or that the project will generate a loss will naturally start cutting corners or walk away, leaving clients to contend with lesser quality work, a longer timeline or both.

“While our experiences with cost-plus contracts are limited, the evidence shows that when prices are changing rapidly and delays are common, they can deliver a better outcome for all parties,” she says.

"Building owners benefit from higher quality work accomplished with fewer delays, contractors are guaranteed a reasonable profit, and, in most cases, the insurer ultimately pays less to resolve the claim.”

Australian Master Builders Association information shows reinforcing steel prices increased 43% in the past year, steel beams rose 41%, structural timber 39%, plywood 29% and electrical cable 27% due largely to logistical hurdles and bottlenecks.

Labour shortages and high housing and renovation demand in Australia are also driving pricing increases.

The article is available here.