The U.S. construction industry continues to suffer as the U.S. and global economies stagnate. The housing market remains depressed, unemployment is above normal levels, and credit is more challenging to deploy. With the exception of a few pockets of growth, overall contract volume remains low, and contractors report that margins remain under intense competitive pressure.
Most prognosticators are predicting continued stagnation, and contractor backlogs generally reflect this fact. On the bright side, construction employment has improved slightly since February 2011, and certain submarkets (apartments, healthcare) have seen the positive impact of additional volume.
Reversing an earlier trend, unprecedented catastrophe property losses have impacted insurers’ results for 2011. The Japanese and New Zealand earthquakes, floods, wildfires, and tornadoes in the U.S., and an inland hurricane in the Northeast produced significant losses in the insurance and reinsurance industries. Current industry estimates place the impact on profitability at about five percentage points.
Insurers have also been impacted by the anemic interest rate environment and have been unable to offset underwriting losses with investment income. Several carriers have publicly stated their need for increased rates, and others are poised to do the same if broader industry support materializes.
Workers’ compensation results continue to provide a drag on industry results, with insurers paying out an additional $.17 in losses on each premium dollar. Increased medical costs, loss development, and reduced payrolls are increasing insurers’ combined ratios, projected to reach 122 percent for 2011, up from 118 percent in 2010. After years of rate and premium decreases, rates are no longer sustainable, and the realities of rate increases are occurring in most states. The middle to large contractor is seeing most of the significant increases compounded by a trend in increasing experience modification rates, especially in California. Larger contractors with larger deductible programs are seeing on average 1 percent to 2 percent fixed cost increases.
On November 4, 2011, California Insurance Commissioner approved new workers’ compensation insurance advisory pure premium rates for policies that renew January 1, 2012 or later. This decision is a substantial increase in the price employers will pay for workers’ compensation insurance:
- The average pure premium rate approved for January 1, 2011 was 4.66.
- The average pure premium rate approved for January 1, 2012, is 6.34—an average rate increase of 35.87%!
The market is clearly firming in chosen segments and geographies, and while most would hesitate to predict a “hard” market, pricing is under pressure. These pressures are being moderated by a healthy industry surplus, reaching a record $565 billion in March of this year, then fell back by 1 percent by late June. Accounts with good loss histories are still able to take advantage of a very competitive insurance market.
For 2012, we expect the construction insurance market to be in transition toward increased rates. However, until the market experiences sustained underwriting losses, material decline in surplus and capacity, and a tightening in the reinsurance market, the market will continue to be stable and available for consumers.
Insurers continue to weather the recession as evidenced by their continued surplus growth.
We have noted continued constriction around terms and conditions for collaterized payment obligations. Posting collateral under large-deductible programs continues to be difficult for large contractors as many struggle with shrinking balance sheets in the wake of the drastic decrease in project activity following the financial crisis in 2008.
As a result, a short list of approved providers for letters of credit and increased fees has given more weight to options like cash and marketable securities. In order to mitigate these increases, a loss and collateral analysis is a vital step during the renewal process when evaluating loss-sensitive options.
Consistent application of a general liability policy’s additional insured coverage grants and claim interpretation continues to be a frequent challenge for contractors. In many jurisdictions, the trend continues to tighten anti-indemnity statutes and link these restrictions to the utilization of additional insured coverage. This has resulted in many contractors not being able to trigger the typical risk transfer tools when loss situations arise.
In October 2011, California enacted additional legislation that limits the type of indemnity agreements which can be utilized between parties. Effective January 1, 2013, the bill voids indemnity agreements within nonresidential construction contracts for:
- A contractor’s “active” negligence.
- Claims arising out of design provided by the contractor seeking indemnity.
- Losses that result outside the subcontractor’s scope of work.
The legislation also allows for contractors to request that a subcontractor either provide a separate defense or pay for the contractor’s defense through potential existing counsel. These restrictions also apply to insurance coverages (additional insured endorsements) that attempt to transfer these type risks. A complete copy of the final approved bills can be located at the following link: http://www.leginfo.ca.gov/pub/11-12/bill/sen/sb_0451-0500/sb_474_bill_20110912_enrolled.pdf.
As many states, such as California, move to a more comparative type indemnity approach, it is vital that appropriate additional insured endorsements are part of a viable risk transfer program. In today’s insurance marketplace, many carriers are attempting to limit their exposures within their additional insured endorsements by:
- Tightening the trigger of the additional insured coverage.
- Reducing the amount of total policy limits that may apply to the additional insured coverage.
- Restricting when an additional insured endorsement will apply on a primary and noncontributory basis.
- Limiting the additional insured products-completed operations status for a time less than the statute of repose.
The utilization of any of these limitations drastically affects a contractor’s ability to transfer its risk. Given the large array of different endorsement forms available within the industry, the use and acceptance of appropriate additional insured endorsements by contractors need to be managed on a continuous basis. These coverages also need to be coordinated with any applicable anti-indemnity statutes that may impact their effectiveness during a loss.
New Markets and Products
Subcontractor Default Insurance
Several new providers have emerged to compete in a marketplace that had no competition until recently.
New players and aggressive pricing reflect the wrap-up market for both commercial and residential projects. Smaller residential projects will continue to be more prevalent as insurance restrictions on residential construction remains a factor for both general contractors and trade contractors. Owners and lenders prefer the coverage certainty of extended completed operations that covers the state statute of repose.
The trend of many jurisdictions reducing the ability to transfer risk may increase the use of wrap-up coverage.
New entrants are competing vigorously for builders’ risk business, creating capacity and broadening coverage forms to gain market share. Excess and surplus capacity remains high as carriers seek to replace premiums lost when construction slowed and projects stalled.
The environmental market is actively seeking business from smaller clients, reducing minimum premiums, and offering broadened terms and coverage.
Several new entrants into the residential market are characterized by customized policies, including warranty coverage to fix the problem without the trigger of a lawsuit to initiate coverage.
The fight for talent in the construction insurance market has led to considerable movement among both insurers and brokers. Look for this trend to accelerate as the shrinking market makes organic revenue growth more difficult.
Construction Industry Sector Trends
|Market Sector||2012 Forecast||Economic Drivers|
Sources: FMI 2011 U.S. Markets Construction Overview/Lockton Construction Services
New Accord Certificate Form—Update
In September 2010, ACORD made changes to their Certificate of Insurance Form 25 and is consequently limiting the flexibility of carriers and brokers to customize the “Notice of Cancellation” provisions. Many contracts entered into by contractors contain restrictive notice provisions that were traditionally enforced by referring to information contained on the certificate. But certificate language alone did not affirm cancellation terms and, in fact, disclaimed any such changes.
ACORD sought to clarify and restrict the ability of brokers to customize or modify this form, and insurance carriers, citing legal and regulatory concerns, began refusing to modify the standard form to meet the needs of contractors and their customers and contracts. Simply put, if it was not on the policy, it could not be evidenced on the certificate. This caused significant dislocation for contractors and brokers, and most major carriers have become more flexible in response to their clients’ needs.
Recently, the limited Certificate Notice of Cancellation wording has come under review by industry associations such as ConsensusDocs, which is looking to insert in construction contracts the caveat to the extent commercially available from the insured’s current insurance company. This will be debated further and open to interpretation and could lead to more misunderstanding and problems if not clarified up front between parties to a contract.
The insurance industry remains resilient through one of the most difficult market cycles, plagued by the protracted soft market and weak economy. Overall, there are reasons for optimism as American innovation, creativity, and entrepreneurship continue to be among our country’s best assets. Businesses are showing profitability, balance sheets are improving, and cash levels are high; however, they cannot grow their businesses until they are more confident of sustainable economic growth.