Nothing’s Easy in Hard-Working Contractors’ Market; Risks Include Inexperienced Workers, Inflated Costs and Inferior Materials

By | June 20, 2022

No other industry has weathered a global pandemic, economic changes, and a decade-long shortage of skilled labor better than the construction industry. Contractors have shown they are a hardy bunch, adapting to a hard insurance market, supply chain disruptions, skilled labor shortages and more.

That doesn’t mean adapting came easy.

“The construction industry mirrors many of the challenges we’re seeing in the larger economy, including supply shortages, labor shortages and structural demand shifts,” Christopher Day, president of Applied Specialty Underwriters, told Insurance Journal. “Even more, inflation in the construction industry is currently running 5 points higher than the overall economy.”

The construction industry lost more than one million jobs in March and April 2020 alone. But by May 2022 the sector saw employment exceeding pre-pandemic peaks in 32 states. Even so, the sector continues to face talent shortages as demands in housing and infrastructure grow. Job openings in April hit an all-time high, but the sector’s unemployment rate of just 3.8% highlights the scarcity of available experienced workers, according to the Associated General Contractors.

Material and labor shortages have caused significant price increases along with project delays, Day added. “We’re finding project managers are having to extend out their planning and resourcing further and further to make sure the labor and material show up at the site at the right time.”

At the same time, insurance costs continue to rise. Rates for construction risks in general trended up in 2020 and 2021 with some lines of coverage such as auto, excess liability and cyber rising significantly.

“It’s been a tough few years for insurance buyers in general, but I’d say maybe most of all for construction firms,” said Roger Cornett, president of CSDZ, a Holmes Murphy company, based in Minneapolis, Minnesota. CSDZ, acquired by Holmes Murphy in 2018, has been operating for 103 years exclusively in the construction insurance sector.

“There’s been a hard market for several years and I think construction probably felt the hard market most acutely in several areas,” Cornett said. “Whether that’s in umbrella excess liability, builder’s risk and property, general liability, auto liability for clients with large fleets of trucks; they’ve been getting hammered and have had to make some really tough business decisions on, ‘Do we maintain the same limit structure we had? Do we have to take higher deductibles and retentions?’ Just trying to optimize their insurance purchase to cover all the risks they’ve faced in the field.”

Brian McDonnell, managing principal of EPIC’s national construction specialty practice based in Concord, California, says construction has been in a perfect storm of challenging conditions over the past few years.

“Think about increases in material prices, the availability of materials, the ongoing labor issue, global warming and wildfires out here in the West, distracted driving, nuclear verdicts,” he said. The list goes on and on in terms of negative impacts to performance results for construction firms and their insurance carriers, he said. “It seems like every week here in Northern California, someone gets killed by a distracted driver,” McDonnell said. “So, who’s going to write a heavy fleet of 250 heavies with guys out there driving with [distractions] from all the technology and then add in cannabis laws.”

The good news is that overall, the insurance market remains resilient and still has significant capacity for best of class contractors.

“I would say in general, the insurance market is strong,” McDonnell said. “We have a lot of clients with a lot of work backlogs and the ability to perform on those backlogs which is remarkable considering all of the issues with the construction labor market.”

Growing Opportunities

With increased demand for new commercial and residential construction and upgrades and improvements to current U.S. infrastructure, the construction industry is poised to experience unprecedented growth, construction experts predict.

Applied Underwriters’ Day says demand has shifted away from commercial office and retail to more demand for warehouses, data centers and rental apartments.

Residential building is also in great demand in many states as well, according to Evan Aldrich, office president at CRC Group based in Redondo Beach, California.

“The multi-family and single-family rental markets are booming, particularly in certain markets,” he said. The office and hospitality sectors have been slower to recover than residential, but Aldrich too sees growth opportunities in the future for areas such as industrial, tech-driven sectors (data centers), and even healthcare facilities.

Jett Abramson, executive vice president, construction practice leader at Amwins Brokerage based in Scottsdale, Arizona, says one trend today is housing developers moving into the rental market, especially in the Southwest

“Developers are building single family homes, but not for sale, for rent,” Abramson said.

Customers 20 years ago demanded to buy the house but the customer of today actually prefers to rent because of the flexibility. “They want to be able to move out in a year or six months and go somewhere else,” he said.

Abramson believes that while home building is active, the sector seems to be slowing compared to last year. “I haven’t seen as many fresh starts this year, as we did last year but we’re still seeing a lot of them,” he said.

Aldrich agrees that the build-to-rent model is in demand. There was talk about this build-to-rent trend before the pandemic, but the pandemic accelerated it, he said.

“People didn’t love living with shared walls when they were locked inside their apartments for however long they had to quarantine, but at the same time … younger folks, they don’t necessarily want the responsibility of the single-family home, and 30-year mortgage, or they don’t have the means to buy in this environment,” according to Aldrich.

Residential real estate is very expensive right now, and it’s only getting more expensive with institutional investors coming in and investing in single family homes, Aldrich said. “A lot of our developers are investing in this segment, but it is really limited to specific venues at this point, places where land is more affordable” such as South Carolina, North Carolina, Georgia and Texas.

Federal Investment

Other bright hopes for the construction sector are the recently passed Infrastructure Investment and Jobs Act (IIJA), which directed $550 billion in new federal funding to transportation, water and power infrastructure, and the $1.9 trillion American Rescue Plan Act, which includes $10 billion for critical infrastructure. Projects should begin over the next six months and contractors of all sizes can expect to benefit from these funds.

But they will only be able to keep up if they can overcome the biggest hurdle — a shortage of skilled labor.

The April projection from the Bureau of Labor Statistics showed that there are nearly half a million job openings in the construction industry today; that is now greater than the 20-year high of 438,000 reached in April 2019.

“Obviously there has been a large uptick in the infrastructure projects with the passage of IIJA,” said Russ Stein, area executive vice president, RPS National Brokerage. “And definitely an increase in housing starts and multi-family projects.” Those are huge bright spots for construction, he said, but keeping up with the demand is going to be tough as the sector continues to experience shortfalls in skilled labor.

Along with higher costs for raw materials and supply chain fallout lengthening job duration times, it’s going to be a challenge going forward, he said. “I think the biggest fallout we’ve seen is the lack of skilled workers in areas where construction is really booming,” Stein said. “So, Sunbelt states, like Florida, Arizona and Texas, or even in New York, areas where they’re really starting to ramp up construction, the lack of skilled workers is leading to a lot more premises-driven losses,” he said, attributing the trend to the inexperience of workers.

Historically, construction defect claims have been the main concern and while those aren’t going away, the uptick in premises-driven claims has gained attention.

The construction industry has been battling talent shortages for more than decade. Attracting young adults to the sector is not easy, said Applied Underwriters’ Day. Day has praise for organizations like the Mike Rowe Works Foundation, which educates young people on the value of pursuing a skilled labor profession such as construction over a four-year college degree.

Another issue that is critical to the labor shortage in construction is amending current U.S. immigration policies, Day said. Current U.S. policies on immigration and a lack of consensus-based immigration reform is not helpful for the construction industry. “Immigration fuels the construction industry from the bottom up, which has been the case for over 200 years in our country,” he said.

Additional Risks from Labor Crunch

Charlie Lamberta, executive vice president, director of operations at Gallagher Bassett Specialty, says the sector’s lack of skilled labor can lead to additional risk in different areas including construction defect.

“If somebody’s not skilled or as experienced in performing certain tasks, that can lead to injury to others, or to themselves,” he said. “And it can lead to faulty workmanship.”

Add to that supply chain issues and material shortages, it’s possible that contractors may be forced to choose materials that are a step down in quality, or some alternate material. “It would not shock me at all to see a future increase in construction defect claims for all of those reasons.”

The bottom line is if contractors are using inferior materials and less skilled labor today, the chances of construction defect claims are increased, he said. “But we’re not going to see the effects of that for some time.”

Look no further than the 2008-09 Great Recession, Lamberta said. “That affected construction and construction jobs in a huge way. And what did we see? We saw more workers’ comp claims. We saw jobs that couldn’t be filled. We saw delayed construction jobs. And so, we saw an increase in frequency, in severity across comp, across liability and across construction defect.”

Inflation is already driving up loss cost trends for residential construction defect claims, says Day. “We think settlement cost loss trends for residential construction defect claims are increasing faster than inflation,” he said. “In addition to the increased cost of materials and labor needed to repair defective construction, we see building complexity/green construction, lack of workforce expertise, owner expectations and fiduciary obligations, and site complexity all as contributing trends that will drive construction defect claims higher.”

Unlike what is available for most liability classes via ISO Loss Costs, there is an acute absence of publicly available loss data for residential construction, particularly for exposures insured on a project-specific or wrap-up basis, according to Day.

“We see new capital jumping into this space with no foundational pricing methodology,” he said. “Even if you did have good foundational data, it is very hard to price a product when you have a 15-year development tail.”

For example, an insurance company may have charged for a product in 2022. “What happens to the legal climate and loss trend in those 15 intervening years before a claim is paid in 2036? This is too long for carriers to determine whether they are charging the right price today, and we don’t see investment return outrunning loss trend,” he said. “Most carriers who do have the historical residential claim data are not writing for-sale residential exposures.”

CRC’s Aldrich says that while construction defect is always a concern, the largest claims still revolve around bodily injury and premises operations losses, classes

historically underpriced and unaccounted for relative to the more widely discussed and litigated Product Completed Operations (PCO) hazard, otherwise known as construction defect. “We’ve had more than our share of eight figure employee injury bodily injury claims,” Aldrich said.

Excess Liability

After two-plus years of a turbulent casualty market mainly driven by rate increases and carrier-initiated displacement in the excess liability lines, there seems to be more moderation in the market, according to RPS’s recently release 2022 Q1: Umbrella and Excess Market Update, co-written by Stein.

“Through the first quarter of 2022 we still witnessed a lot of displacement, but now this is being driven more from brokers and insureds pushing to contain costs vs. carriers re-underwriting their books,” the report said.

Stein said there were more than 20 new excess casualty market entrants between 2020-2022 and these carriers, along with all of the existing capacity with lofty growth goals, started getting more aggressive on new business deals.

Abramson agrees that the excess liability market is starting to stabilize but very tough conditions remain for risker construction clients.

“We still have capacity issues on the tougher risks, risks with losses or big auto fleets, or contractors building condos in California — the toughest end of the spectrum,” he said. “But on the regular commercial construction, subcontractors with good loss history, there’s a lot of competition now in excess.”

Price increases are stabilizing after a perceived over-correction in the market during the last two years, according to USI’s 2022 P&C Mid Year Market report.

“New capacity continues to enter the market, increasing options and competition,” the report said. “The lower layers are still challenged with upward rate pressure and availability of limits. To help ease financial costs, the underlying limits and buffer layers may need to be increased or restructured.”

“We see the increased pricing and lower limit structure of the past three years slowly luring sidelined capital and new capital back to the excess casualty market,” says Applied Underwriters’ Day. “With a few exceptions, we see the casualty market functioning in an orderly and thoughtful way.” The biggest constraints on the excess casualty market are lack of underwriting talent to look at all the business, as well as a cautious, conservative reinsurance market, along with justified reluctance to entertain residential construction exposures, according to Day.

Topics Pricing Trends Contractors

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