1. Project delays
2. Cost escalation/inflation
3. Supply chain
4. Contractor/subcontractor solvency
5. Contractual risk allocation
6. New technologies
The construction industry continues to face unprecedented levels of change which has and continues to fundamentally shift the insurable risk profile of construction projects. Whether these changes are being driven by COVID-19, climate change, or the imposition of increased government laws and/or regulations; there is no doubt that the landscape of the construction industry in Australia and globally is changing quickly.
Construction insurance must keep up
Construction companies and other project participants are adapting quickly to this new reality; they have and continue to implement strategies to better manage these evolving construction risks. However, there is anecdotal evidence to suggest that neither the risks created by this change nor the implications of the strategies implemented are being fully considered from an insurance perspective.
In this article, Lockton consider some of the more critical insurable risk implications facing the construction industry post COVID-19, together with preliminary recommendations as to how project participants can better manage the broad range of insurable risks on their projects.
Trend one: project delays
Delays during both the pre-construction and construction phases of projects are not uncommon in the construction industry during any era. Construction is inherently unpredictable; it involves numerous stakeholders, materials, an ever-changing project site and critical interdependencies that collectively create a degree of uncertainty not experienced in any other industry.
The potential causes of project delays are both numerous and various and include
changes in project scope and/or design;
imperfect cost estimation, planning and/or project scheduling;
failures in supply chain and/or on-site construction management;
weather related events; and
social and/or government driven events (such as pandemics).
Whilst the causes of these delays have not changed over the years, the impact in a post COVID-19 world have been far more pronounced; often creating significantly greater delays to both the tender and construction programs of projects.
How are insurers responding?
Project delays can have a pronounced impact on the availability, cost and coverage of the insurances for these projects; particularly during the current difficult (or “hard”) insurance market cycle. In these circumstances, we will often see insurers seek to amend their terms and conditions and in some extreme cases, not offer coverage at all.
It’s also important to note that some policies will also include a Cessation of Works clause whereby coverage ceases in circumstances where no construction work is undertaken after a pre-determined period of time (commonly 30 or 60 days) – which can come into play should there be any future temporary site closures (be these due to supply challenges, communicable disease, or other factors).
Trend two: cost escalation/inflation
The current cost escalation for the 2022/2023 financial year is forecast to be 8-10% for residential construction and 6-8% for commercial construction, with the costs of some building materials increasing by as much as 40%-50%.
Inflationary pressures in the construction sector are having a direct impact on project costs and on the solvency of contractors and subcontractors on lump sum contracts (note: we address contractor/subcontractor insolvency later in this article).
What does this mean for insurance policies?
Construction insurance policies will generally include some flexibility and coverage for both cost escalation and inflation on projects, however this coverage may fall well short in the current environment. It is important to regularly revalidate anticipated construction costs to ensure alignment with the insurance policy (and increase where necessary), including reviewing the sufficiency of Off-Site Storage limits.
Trend three: supply chain
COVID-19 has had a profound impact on the supply chain for most industries, including construction. Contractors and sub-contractors have faced significant challenges in obtaining visibility and/or managing the procurement of parts and equipment (particularly critical parts with long-lead items) from overseas suppliers and manufacturers. This has led to a raft of issues for construction projects in Australia, including project delays, critical program changes and cost escalation.
What does this mean for insurable risks?
In addition to the insurance issues directly caused by the current supply chain challenges addressed elsewhere in this article, the strategies that project participants are implementing to better manage this risk moving forward may also create unforeseen insurance issues. The use of alternative materials, suppliers and/or construction methodologies, such as modulization or off-site fabrication, could create insurable risks not initially anticipated nor fully covered by the existing suite of insurances.
Trend four: contractor/subcontractor solvency
Contractors and subcontractors operating under lump sum contracts with wafer thin margins and limited availability to cash or credit have been significantly impacted by COVID-19. In Australia, we have seen a number of high-profile insolvencies and it is expected that there will be further collapses as construction companies continue to struggle under growing financial pressure.
What are the impacts on insurance policies?
Insurances for projects are often procured by and directly linked to the contractors delivering the project. As such, once the contractor becomes insolvent, the insurances linked to that contractor will cease to cover those projects.
In these circumstances, owners and principals would need to seek replacement insurances which, if available, would be at an additional cost and likely not provide the breadth of coverage that the project originally enjoyed. Furthermore, there may be existing and/or new insurance losses that may be uninsured, potentially placing the project and the principal under significant financial stress.
Trend five: contractual risk allocation
As a result of the current challenges facing construction contractors (many of which have been described in this article), we are seeing a shift in the allocation of some key risks (including traditional insurable risks) back to the principal under construction contracts.
Principals and owner assumptions
Unfortunately, some principals and owners are mistakenly assuming that all or most of the traditional insurable risks they are now accepting under these contracts are fully insured.
How are insurers responding?
In the current insurance climate, we often see insurers seeking to impose higher deductibles, low sub-limits, restrictions/limitations in coverage or total exclusions for some critical insurable risks; such as floods, cyclones, pandemics and others. If the contractor is required to maintain the key project insurances; the principal may be unaware as to the extent they are uninsured for these key project risks.
Trend six: new technologies
Construction in the modern world has become increasingly complex. In order to manage the numerous and evolving risks facing construction, many construction companies are looking to adopt new technologies, products, systems and construction methods. These technologies can help companies remain competitive whilst also continuing to meet the growing list of government standards, consumer demands and principal requirements.
New insurable risks
Whilst new technologies can often dramatically improve the communication, safety, design and/or constructability of projects, they can also substantially change and/or produce new insurable risks; creating a new insurable risk profile for these projects. These new project risks should be tested against the existing suite of construction insurance solutions and either modified (and/or new policies procured/required) to ensure that these risks remain adequately covered.
For example, construction companies are turning to new software and systems to support functions such as design, supply chain and interface management through to the use of drones and autonomous vehicles and equipment. This greater reliance to on-line systems and cloud based technology opens up construction companies to greater cyber risks.
Ransomware attacks across all industries have increased substantially since the beginning of COVID-19.
Construction companies are not immune to cyber attacks that can lead to construction project delays resulting in substantial cost and lost opportunity to principals, contractors, subcontractors and other key project participants. Cyber risks are generally not covered under traditional insurance products; they require bespoke solutions from cyber specialist brokers and insurance markets.
Five questions to ask
Lockton recommends that both buyers and beneficiaries of construction insurance policies consider more carefully the following:
1. What are the unique “insurable” risks of the project?
2. What insurances should be procured for the project?
3. On what basis are the insurances procured (i.e. Annual or Project Specific)?
4. What are the covers, limits and sub-limits that should be included in the insurances?
5. Who should procure the project insurances?
We recommend that the key project participants fully understand the implications of the evolving “insurable” risks described earlier and ensure that these insurance policies incorporate as much certainty as possible.
It is also important that these parties continually test the adequacy of the insurance requirements and/or policies procured for their projects. Where deficiencies are identified, the insurances should be either modified to reflect this new risk and/or procedures put in place to address circumstances where these elements exceed any pre-described periods, amounts and/or percentage during project delivery.
Finally, we recommend that you engage construction insurance specialists who understand the unique risks of your construction projects and you place your insurance policies with financially stable insurers that understand the construction industry in Australia and have historically demonstrated flexibility when dealing with the issues addressed in this article.