- By Jason Baston
- 08 August 2022
This article examines the practical impact of materials and labour cost increases on UK construction all risks (CAR) insurance.
What is construction all risks (CAR) insurance?
CAR insurance protects employers, contractors or subcontractors for the costs incurred following physical damage to the project works, and where the policy allows, for delays in construction following an insured event.
Why is inflation affecting premiums?
Insurance premiums are generally calculated by applying an underwriter-determined rate to project turnover or construction cost. A greater base cost will therefore result in an increased premium.
In November 2021, the Royal Institution of Chartered Surveyors (RICS) reported a 40-year high in construction materials costs.
The key drivers behind this increase were reported as follows.
- Increased global demand in the construction sector
- Logistical and production issues associated with the COVID-19 pandemic resulting in unprecedented materials shortages
- Trade and labour availability in the UK following Brexit
- Significant lifestyle changes triggered by the COVID-19 pandemic (largely related to home working) driving an increased demand for domestic repair maintenance and improvement projects
- Major projects, such as HS2 and Hinkley Point, contributing to increased demand in the UK market
Additional issues include the alleged stockpiling of materials by firms seeking to avoid the effect of material shortages. The UK government has also made it clear that it sees publicly financed construction activity as an effective vehicle for economic stimulus, hence increasing demand through infrastructure projects. We must now also factor in the dispute between Ukraine and Russia, which will have a negative impact on material supplies and energy, which will impact all businesses to varying degrees.
To be specific, the highest cost increases were in the following materials:
- Particle board (44.8%)
- Concrete reinforcing bars (43.6%)
- Fabricated structural steel (35.9%).
Suppliers across a range of materials were effected by price increases of 5-20% in February 2022. Steel remains highly volatile with British Steel announcing a £250/tonne increase in March 2022 due to volatility in commodity and energy prices and significant disruption to international trade flows – made worse by the ongoing situation in Eastern Europe. With additional restrictions being placed upon new orders, material supply chains will face further pressure, causing lead times to increase.
What about the increasing cost of claims?
There is anecdotal evidence showing that the cost of construction claims in 2022 is circa 20% up from prior year. These increases in CAR claims costs have resulted in the medium to long-term projects underwritten by insurers in the latter stages of the ‘soft’ market becoming even more unprofitable. The resultant effect is a restriction in appetite to take on new high-profile risks, should inflationary pressures continue to be the norm.
Construction activity is also a fertile area for liability claims for injury or property damage, normally insured under third party or employer’s liability insurance policies. There is also a persistent inflationary pressure on these claims, but this is an area outside of the focus of this article. This is perhaps more of a concern in 2022 given that the UK labour market is in flux and shrinking due to political decisions and the increased difficulty of crossing borders.
How is the UK Construction insurance market looking?
The past few years have seen a significant change in market conditions within the UK construction insurance sector. Following a prolonged period of soft or softening market conditions, an increasing claims trend has forced insurers to correct unprofitable underwriting positions. For some this has meant withdrawal from the sector, for others we have seen a reduction in the amount of underwriting capacity they are prepared to commit. This reduction in competition has resulted in an increase in premium rates, a narrowing of coverage and a more challenging environment generally, with at least one UK insurer admitting that their appetite to write UK Construction business remains volatile.
Major sports projects provide an excellent example of how the UK construction market has hardened over recent years. A major stadium rebuild undertaken towards the end of the last decade secured combined CAR &TPL insurance at a premium rate of below 0.10% applied to the project value. A similar project commencing in more recent times has been placed at closer to 0.35%. Combined with the premium rate change, the more recent project will also have more restrictive coverage and higher excesses, especially in relation to water damage.
What other areas of increased costs should insureds consider?
Alongside the contributory labour and materials cost increases, some modern methods of construction (MMC) can also result in greater remedial costs that originally planned for. For example, damage to prefabricated modular units may be more expensive to repair in-situ than the original off-site construction cost. Such cost concerns were discussed in our previous article here.
Another growing area of concern for increased costs is the use of cross laminated timer (CLT) as a structural element. While CLT has many advantages when used in the construction process, there are still a number of unknown variables when this type of element is either water or fire damaged, which from a quantum perspective may have no correlation to the original costs.
How does a CAR policy deal with the question of increased costs and/or inflation?
CAR policy wordings must be carefully reviewed and well understood to ensure that the protection provided accounts for such increasing costs if and when a claim arises. We asked Reubin Iqbal, Head of Construction at GRS Loss Adjusters, to provide his thoughts:
Please remember that at all times the coverage in any specific case will be dependent on the precise nature of the (i) loss event, (ii) circumstances of repair and remedial works and (iii) policy wording in question.
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Escalation clause
When incepting a CAR policy, the insured is required to declare the estimated project value, based upon which the premium is calculated. There can be a significant period between the original cost estimate being finalised and any remedial woks being completed following a loss, which can result in inflationary cost increases to above the original estimate. This is arguably more the case for the reasons outlined above. This extension to coverage provides that the insurers will agree to increase the original sum insured by a fixed percentage over the lifespan of the project, normally circa 15% (or as agreed). This may be sufficient for shorter projects but may not be adequate for projects where inflation can compound over a number of years. -
Increased or additional cost of working
This extension provides additional protection to insureds where the project has been delayed following physical damage covered by the policy. The policy will pay an additional limit, where necessarily and reasonably incurred, to minimise or prevent the interruption to the project as a consequence of the damaged covered by the policy. -
Additional cost of construction
This extension covers the insured in circumstances where, as a result of insured damage, there is an increase in the cost of unbuilt works. For example, a long delay following a fire may mean that material prices increase over that provided for in the original contract price. Again, this cover is subject to policy limits and any other bespoke conditions. -
Expediting expenses
Cover is available for the additional cost to expedite the remedial works to the damaged property. This will normally cover additional plant hire, overtime labour costs, express carriage charges and the like. -
Local authorities’ reinstatement
Planning and building regulations change and it is not inconceivable that they may do so between the initial construction of contract works and their remediation in the event of subsequent damage. This extension will indemnify in the event that these circumstances lead to increased cost.
Constant monitoring of the adequacy of the estimated contract value (ECV) should be an even more important part of a broker’s role in the lifetime of a project, especially one planned to last for several years. For these longer and more complex projects, materials and labour price increases can affect the insurance policies in place and the associated premiums. Brokers should be speaking to their clients on a regular basis and always checking whether the original ECV is still adequate. If not, insurers should be approached for the ECV to be amended to an adequate level. Significant price increases may require additional market capacity. At all times it is fair to say that paying an additional premium to have the correct ECV is far more preferable to having an inadequate sum insured and suffering the possibility of under-insurance.
What should I do to ensure that my CAR policy provides the proper level of protection?
- Speak to your broker to understand what coverage your CAR policy provides for cost increases and ensure that it meets your expectations
- Ensure that your policy wordings are optimised for cost increases
- Deal with expert brokers and loss adjusters that specialise in construction risks
Miller can provide a free review of your current policies to ensure that they are optimised for current construction and insurance market developments.
