It is not the best of times for the construction industry and its insurers. But neither is it the worst of times.
The construction industry continues to face labor shortages, rising costs, supply chain woes and lingering effects of the pandemic yet it is managing to stay on a growth path. Signs of recovery are most notable in the building of single-family homes, healthcare and communication industry facilities, and some infrastructure segments such as water and wastewater infrastructure, which has increased 9% in 2021 so far, according to FMI’s 2021 North American Engineering and Construction Outlook. Meanwhile construction projects for multi-families, lodging and hospitality, and office space have shown considerable declines, the report revealed.
Almost all areas of the construction industry are experiencing project delays.
Despite the market pressures of today, contractors remain somewhat optimistic about their short-term future.
According to the Associated Builders and Contractor’s Construction Confidence Index confidence for sales increased modestly in May, but confidence fell when it came to profit margins and staffing levels. “Contractors can expect healthy growth in activity through the balance of 2021,” said ABC chief economist Anirban Basu.
Associated General Contractors of America noted that many contractors are having a hard time finding qualified workers. Construction employment fell by 20,000 in May. It’s this lack of skilled labor that is top-of-mind for construction firms and their insurance partners, which is leading to delays and concerns over safety.
“Steadily worsening production and delivery delays have exceeded even the record cost increases for numerous materials as the biggest headache for many non-residential contractors,” said Ken Simonson, the AGC’s chief economist in their June release. “If they can’t get the materials, they can’t put employees to work.”
Simonson added that contractors are being told they must wait nearly a year to receive shipments of steel and 4-6 months for roofing materials. Supply chain delays mean contractors are unable to keep workers employed because projects are put on hold, he added. Those skilled workers will leave for a new job if there is a delay. Labor shortages are holding back what should otherwise be a much stronger recovery for the construction sector, Simonson added.
Gary Kaplan, president of construction for AXA XL, says the sector’s labor shortage concerns are not new but the effects of the shortfall are beginning to show up in insurance claims. He says unskilled workers are showing up as the number one cause for subcontractor default insurance claims, Kaplan said.
Kevin Libeg, vice president, construction, middle market business leader at Argo Construction, says builders have not been able to keep up with demand due to skilled labor shortfalls. “That raises concerns about the quality of work being done on construction sites,” Libeg said. “And the current supply chain issues, everything from material shortages to scarce shipping containers, to a shortage of truckers, everything in that supply chain has a significant effect on construction.”
All of that is leading to significant delays on projects. “We are getting requests for extensions at three to four times the rate that we normally see,” Libeg added.
Costs for construction continue to rise. The price for softwood lumber jumped 154% over the past year.
On top of the cost, the unavailability of building materials also makes it difficult for contractors to budget and plan. That can be worrisome from a risk management perspective, Kaplan says.
Contractors operate on “thin margins” on a normal basis, Kaplan said. “They only make 2-3% and they can’t really afford to have something cost five times what they thought it was going to cost.”
Planning is difficult because supply shortages are quick to change in today’s construction industry. “It seems like it’s something one week and then it’s something else the next week,” he said. “We’ve been worried about the supply chain throughout the whole pandemic and it’s really kind of weird that it’s showing up now.”
The insurance market is yet another challenge for the construction industry, according to Danette Beck, National Construction Practice leader, USI Insurance Services.
“It’s kind of a perfect storm — it’s the availability of labor and what that cost is, it’s the availability of materials and what that is,” she said. And then there is the cost of insurance which is “definitely transitioning into a harder market,” Beck added.
For years, construction saw a competitive insurance market, almost too competitive. “We kept saying that the market needed to get hard because it was so competitive, and at some point in time there was going to be a tipping point,” she said. “The pandemic certainly was that tipping point.”
But the pandemic didn’t cause the hard market pricing, Beck says. “We had some slowdowns and maybe some projects shuttered for an interim period, and maybe some funding of projects that got pushed off but the pandemic didn’t cause the problem of increases in pricing.”
The pricing is the result of continuing deterioration in auto losses, general liability losses and umbrella losses.
“Umbrella has taken a hit,” Beck said.
According to USI’s 2021 Commercial P&C Market Outlook, Mid-Year Update, the contractor umbrella/excess market continues to be the single most impacted line of business for a construction account outside of frame builder’s risk. The report noted that umbrella/excess “losses due to social inflation, third-party litigation financing, nuclear judgements, and distracted driving continue to deteriorate and cause profitability issues for insurance carriers.”
Andy Kurszewski, underwriting portfolio manager at Sentry Insurance, agreed, adding that social inflation and large verdicts particularly in the auto claims arena continue to pressure insurers in the umbrella markets. “I think much like our competitors, we still have concerns over the excess layers, umbrella layers,” he said. “We are still pushing for some rate on umbrellas, trying to get adequate premium there and have taken another look at the underwriting standards.”
Kurszewski says Sentry continues to offer umbrella policies in the construction sector but with tighter underwriting. “We are making sure we have the right answers and the exposures.”
Construction firms are finding an umbrella market that needs more attention to complete a project’s portfolio, says AXA XL’s Kaplan. The tough market has meant additional layers of coverage are needed to complete projects, he says.
Carriers that remain in the construction umbrella market have significantly reduced their capacity, sometimes from a $25 million limit down to $5 million to $10 million, he said. “So, when you do that across the whole tower, all of a sudden in your $300 million tower, you’ve only got $150 million or less of renewing capacity,” he said. “Brokers have been stressed out mightily as are the customers trying to find replacement capacity to get those limits back to where they think they need them,” he said. “In general, the excess market, which we’re not part of, received 80% increases as standard.”
Overall, Kaplan says most liability lines in construction are experiencing similar trends although not as severely as in the excess market. “The only liability line where the limits came up was in primary casualty — the GL and auto — because the excess markets were refusing to attach, where they had in the past,” he said.
Beck says she no longer sees insurers pricing umbrella on the underlying exposures and underlying premiums, which is historically how it was done.
“Now they’ve got umbrella underwriters that are pricing out what they need to make for that risk and so it’s changing the way that you approach umbrella,” she said. “You almost have to reverse engineer how you approach the market and go to the umbrella markets first and talk about what you need … wildfire coverage, or a $10 million lead, or whatever you need from and underlying [limit or policy] … in order to get to where pricing is adequate.”
Another line experiencing challenges in some regions is builder’s risk, where, according to USI’s 2021 Commercial P&C Market Outlook, project delays requiring extensions have become increasingly difficult.
Frame construction projects are very difficult for the builder’s risk market. “Requirements for water and fire mitigation technologies as well as site security are becoming mainstream, even for noncombustible projects,” the USI report said. “Market support and capacity for frame remains volatile, especially for larger frame projects located in urban environments or cities that saw an increase in social unrest.”
In a construction industry like today, where labor shortages, supply chain issues and consumer demand are changing, construction insurance specialists worry about how contactors will change, too.
One concern underwriters and brokers share is making sure contractors stick to what they know best.
“We are seeing the phenomenon, again, of commercial contractors moving into residential work, which always makes me nervous because it’s just a different product type,” Beck said. “It’s a different subcontractor base, different philosophy, different types of construction.” And a different type of insurance, she added.
“There are markets that do not write residential and so when I start seeing that type of phenomenon happening, I think that they may be getting into trouble.”
The same concern arises when she sees new projects where in the past there would have been three or four bidders, but now there are 15 for one project. “We don’t see it often, but when it starts happening where there’s multiple bidders, and they’re all scrambling to get the one project … they may be desperate and are just doing it to keep their payroll going but they are not necessarily capable of doing the work.”
Todd Germano, managing director of North America of Optio, the group company that includes Cove Programs, Ascent and Bay Risk, shares Beck’s concerns.
“We’re on the lookout for contractors that are trying to overreach and do things that they don’t have competency in,” Germano said. “That’s a big piece of our underwriting component: geography and type of business familiarity.”
When contractors move into a new geographical territory or move into a different sector of the construction industry, that could be a red flag, Germano said. “We typically don’t want that, and we would underwrite around it and basically say, ‘we’re not comfortable’ and ‘you don’t have enough experience.'”
For instance, if a construction firm that is used to building in Pennsylvania suddenly shows up in Texas, that is a potential red flag. “There’s a whole host of things that you would be concerned about because, extensively the contractors that are stable players in that market already have the better subcontractors tied up,” he said. “So how are you going to get the work done? Who do you have to hire to do the work?”
Plus, there are state-specific regulatory and building codes contractors need to consider. “There’s a lot of things that can go wrong if you’re not familiar with the territory,” he said.
One recent example is the collapse of the construction firm Katerra Inc., which has filed for bankruptcy protection.Large investments from SoftBank Group Corp. and others helped Katerra grow fast but that growth proved difficult for the company as it faced building delays and issues in trying to perfect its construction modules, which include prefab parts and modular construction units.
Beck says some analysts say Katerra grew too fast. “They were trying to do too much, too quickly. That can get even the largest companies in trouble.”
Beck says today’s construction market is seeing project owners pushing more risk to their contractors during a time when contractors are having to do more with less. “But when you talk to the good contractors that will make it through this economic downturn, they are staying focused on the simple things … getting back to basics and not overextending.”
The good news for contractors is that insurance capacity remains available unlike in other hard market times, Beck said. “During the last true hard market there was a capacity issue; there were contractors out there that could not find insurance,” she said. That is not the case in today’s hard market. “It’s still competitive and there are alternatives like private equity and other alternative types of markets coming into the marketplace.”
That is not to say there are a lot of new options entering the construction insurance world either, she said. “But you’re seeing some carriers that only offered traditionally guaranteed cost programs and [now] they’re expanding into deductible programs,” according to Beck. “They’re looking at ways to shift their underwriting philosophy to match what the marketplace is starting to dictate, which means taking a little bit more risk in order to keep prices affordable instead of just relying on the insurance company to give you a first dollar cover.”
Also, the pandemic in conjunction with a difficult insurance market has pushed contractors to reevaluate their normal ways of doing business, Kaplan says. “I think the pandemic forced contractors to do their work differently and I think that was an improvement,” he said. “They brought in technology to automate some stuff that was pretty clunky.”
The adoption of technology by construction firms tended to be lower priority for operations prior to the pandemic, according to Kaplan. But COVID forced the sector to adopt newer innovative tools which improved safety, he said.
Michael Teng, assistant vice president of regional pricing, products, and underwriting at Sentry Insurance, says the pandemic has put the spotlight on workplace safety.
“In general, and a lot more so in the retail and the service industries like hospitality, but also in the construction industry, as far as just being aware of contagions, COVID and other communicable diseases,” he said. “And especially for contractors, that tend to have public exposures. They go into nursing homes, they go into private residences to do work. Certainly, there’s elevated awareness of the safety practices needed when you work in those public areas, and I think that’s a positive thing for the industry.”
That includes the use of telemedicine, which picked up significantly in construction, Kaplan added.
“We began to see a lot of contractors starting to utilize electronic badging so that they didn’t have to manually do logs when they’re checking people in,” he said. Contractors improved processes for how they sequenced workers entering jobsites.
“I think it is more efficient than it was before,” he added.
He also saw an uptick in wearables — wearable technology tools such as monitors so workers knew they were socially distanced or so that management could conduct back-tracing should a worker get sick. “The monitoring of the employees’ health overall, all those things they were forced to do to during COVID, continue to work and I think will stay because they’re seeing the benefits of doing them. That’s a good thing.”
At the time of this interview, Kaplan himself had just returned from an AGC in-person conference in Florida where he met with several hundred contractors. The general feeling was positive, he said.
“I think contractors are pretty optimistic, at least through next year,” Kaplan said. “I’m feeling pretty good, too.” After 42-years in the business, that’s good, he said.
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