The construction insurance market is growing increasingly distressed, even within the context of a generally tough insurance environment. Rates were already rising prior to the impact of Covid-19 and they have been turbocharged in the period since lockdown commenced. The effect of this hardening market is most often understood in terms of the cost of cover, but this is to consider only one half of the picture. As well as increasing rates, policyholders should expect considerable erosion in the quality and extent of the coverage they buy – and, more often than not, this erosion will not be adequately explained by either the broker or insurer at the point at which the risk is placed.
These problems are also affecting other sectors, but there are two factors that make them particularly challenging for construction companies. The first is the difficulties posed to the sector by the end of lockdown and return to work, which are far from straightforward on active construction sites. The second, is the way in which commercial contracts create a complex web of liabilities and obligations across contractors, sub-contractors and other elements of the supply chain.
Understanding the challenges:
We have previously explored the problems faced by the construction industry in the Professional Indemnity (PI) market, but other lines have also fallen prey to unforgiving macroeconomic conditions in recent times. Construction All Risks (CAR) insurance, for example, has witnessed increasing restrictions in cover and a doubling of premium rates over the past 24 months. Meanwhile, insurers’ severe economic losses following the Covid-19 pandemic, estimated by Lloyd’s to top $200bn, will only lead to further coverage erosion in the guise of new exclusions, higher deductibles, lower limits and more disputed claims. It is against this tumultuous backdrop that the construction sector must contend with two significant challenges.
Firstly, businesses’ operational changes in response to Covid-19 have altered their risk profiles. In some cases, these changes are so significant that current policies may fail to respond in full in the event of a claim. This problem is intensified for those construction projects in which various contractors and subcontractors, each with their own unique risk exposures, have sourced coverage independently – subject to separate terms and obligations. Even when wrap-up policies are employed, such as an OCIP or a CCIP (in which the project sponsor or lead contractor sources the coverage for all participants) these arrangements require all parties to comply with specified operational conditions to ensure certainty of coverage. Managing this mosaic of policies at a time of rapid and ongoing change represents a particular problem for construction companies of all types.
The second challenge – and one which is almost unique to the construction sector – is that new coverage restrictions can suddenly place firms in breach of commercial contracts that form the basis of existing projects. This can expose multiple parties. First, the contractor must ensure the appropriate cover is in place to comply with the insurance requirements contained within the commercial contract, which can be thrown by sudden reductions in limits or removal of cover for specific types of work. In addition, contractors might then expect to subrogate to subcontractors many of the losses incurred following a claim. However, to do so it is crucial that the subcontractor’s coverage also complies with master policy requirements. This is becoming more of a challenge under current market conditions, where substantial restrictions in cover are commonplace and policies become increasingly unreliable. As a result, contractors might find themselves unable to exercise their subrogation rights, leaving them ultimately liable for the loss.
Managing multiple overlapping policies while insurers are changing their terms and exclusions on a daily basis is akin to playing a never-ending game of 3-D chess. The sheer complexity of the task means that errors are almost inevitable and, in an increasingly tough claims environment, will lead to more disputes down the line.
Construction firms might rely on their broker to guide them through these challenges and to protect them from the effects of the troubled market. However, as we have demonstrated in our high-profile Broker Conflicts Report, up to 78% of some brokers’ income is derived from insurers, with only 22% coming from policyholder fees; this means that they rely far more on insurers for generating their revenue than they do insureds. Worse, much of brokers’ insurer-derived revenue is directly linked to insurance rates – meaning, that may stand to profit when passing on price increases. With this in mind, it’s clear that policyholders cannot simply ‘outsource’ insurance management to their brokers.
What should insurance buyers do?
Firstly, construction firms should (if you’ll excuse the pun) start from the ground-up. They should reflect on their insurance programs and develop a robust understanding of the key scenarios they want to be covered and the relevant structures of project and parties involved. All stakeholders must understand what coverage is contractually required for a project, and there should be a means through which they can communicate and collaborate on coverage developments and concerns; this is crucial where coverage changes might place a firm in breach of contract, or where additional disclosure obligations under the policy are likely to be required to maintain cover. Where there are rights of subrogation, firms should designate responsibility for overseeing the validity of the underlying policies that are placed.
Secondly, the other crucial area of focus in a hard market – of the type not seen for at least 15 years – is how to market your risk effectively. This involves improving insurers’ understanding of your exposures and differentiating it from those of your peers. Developing a bespoke risk prospectus is an effective way of ensuring that insurers will not view your risk as a commodity nor sell you a standard commoditised policy, and puts you in the best position to achieve improved, reliable coverage at a more competitive rate.
If you would like to find out more about what you can do to enhance your chances of securing reliable insurance policies, contact Mactavish and a member of the team will be happy to discuss some of our insights and success stories. You can also access more information on our services for those in the construction sector here.
Liam Donnelly, Analyst