'The challenging economic climate is a significant concern for the construction insurance market'

Last month the Construction Leadership Council (CLC) set out plans to mitigate the impact of steep inflation hitting companies in the construction sector.

There is a myriad of factors at play here, from the Covid-19 pandemic, Brexit ramifications and climate-related challenges for Scandinavia timber production to transportation problems (both shipping and road). These have all contributed to what the CLC has called a “perfect storm” affecting the construction industry.

The difficulties incurred by manufacturers, a drop in productivity and problems with transportation have all resulted in material prices soaring. Any hopes of things settling down have been dampened by the Ukraine conflict and consequent restrictions on Russian gas and oil sales in Europe, as well as the implementation of sanctions affecting the availability of raw materials from Russia. Moreover, attempts to address concerns of global inflation through quantitative tightening by raising interest rates now affect all tiers of the construction and property development chain including the financing for current and future projects.

The Royal Institution of Chartered Surveyors reported a fivefold increase on the percentage uplift on tender prices from 2020 to 2021 (increasing from -0.9% to 4.8%), while in January 2022, Construction News reported nine out of 10 large projects were behind schedule. Of those projects, almost quarter with a value of more than £100m ($122.4m) were delayed more than 250 days. All of these issues increase construction costs.

Insolvency challenges

Against this backdrop, the number of building contractors becoming insolvent has notably increased. Compared with the same period in 2020, in November 2021 there was a near-80% increase in insolvencies affecting construction companies. This is a trend that is predicted to continue.

The economic situation has raised challenges for the insurance sector, particularly regarding the handling of contractors’ all-risks (CAR) insurance claims. The market has seen an increase in claims under “delay in start-up” insurance cover for employers as projects are delayed. Employers seeking to complete projects where the main contractor or a key sub-contractor has become insolvent have had to appoint replacement companies and, in some situations, the employer has needed to terminate the main contract and enter into a completely new arrangement with one or more companies. These situations further delay the projects and increase the construction spend.

As a result of contractor insolvency on an ongoing project, either a new CAR policy or an amendment to the ongoing cover will be necessary. The new or amended CAR policy will need to be tailored to reflect changes in the parties involved, revised scheme of contract works and the presence of now completed works or “existing structures” by the previous now insolvent contractor. Complications can arise with the delineation with the scope of the contract works package required to complete the project, as employers and administrators/liquidators seek to reach agreement on the scope of works completed and agree wrap-up deals.

Compared with the same period in 2020, in November 2021 there was a near-80% increase in insolvencies affecting construction companies. This is a trend that is predicted to continue

As part of their role, administrators and liquidators will explore recouping monies from existing CAR insurance claims the contractor may have presented when trading and thus become part of those “interested parties” involved when agreeing settlement of a CAR loss. Per the provisions of the Insolvency Act, administrators and liquidators can request insurers provide full copies of information received and exchanged with the insured contractor, no longer trading. While not common, some CAR insurance policies may contain the proviso that insurers will not pay out on CAR insurance claims in the event of the insured entering liquidation or administration.

Prudent employers will seek to include provision for a performance bond as part of the pre-contract arrangement and in the situations where a main contractor does become insolvent, will look to trigger this to assist in bringing projects to completion. More recently, demand for bonds has unsurprisingly increased dramatically.

Rising claims costs

The other notable development has been an increase in the values of construction losses, as material, energy and labour costs increase. Delays in the delivery of materials will no doubt exacerbate this. When contract works losses occur, the sudden and unplanned nature of the insured events present even greater challenges on the beleaguered contract management team in sourcing replacement materials to repair the damage at short notice.

Delays can lead to prolongation and more challenges for the insurers and loss adjusters when considering claims for contractor increased “preliminaries” claims and costs submitted under the policy heads of cover “additional costs of construction” and “cost of unbuilt works”.

If a claim has the potential to be drawn out over a prolonged period, it is likely for the reasons discussed that costs will increase. More than ever, the policyholder will look to insurers and loss adjusters to settle CAR insurance claims in the most expeditious manner to assist in mitigating the aforementioned increasing economic and commercial pressures on them.

Insurers will be keen for the policyholder, brokers and their loss adjusters to work closely to effectively manage claims in the face of the material and skilled labour procurement difficulties that now exist. At the same time, insurers and their loss adjusters are likely to face more challenges in the technical handling of the claims, whether these be under contract works, third-party insurance policies or performance bonds.

Mark Simmons is head of construction and engineering for the UK and Ireland at McLarens