Building Boom, Insurance Bust

It is a classic case of the glass being “half full” or “half empty” for Canada’s booming construction industry. On the optimist’s side, new housing starts and the pace of residential and non-residential construction have increased by leaps and bounds in recent years. From June 2001 to January 2003, output in the residential construction industry increased by about 25%, providing a major stimulus to the Canadian economy. Statistics Canada also reports that investment by governments and business in non-residential building construction reached a record $6.5 billion in the second quarter of 2003 due to an all-time high in institutional projects. While economic forecasts from the construction industry warn of a slowing trend in the coming years, the sector has demonstrated resilient growth recently, with housing starts jumping by 6.3% in June.

Then there is the bad news. The building boom over the last three years has highlighted a shortage of skilled trades and contractors and an increase in property and liability exposures, leaving the industry vulnerable to significant losses and sharply higher insurance rates. A hardening insurance market became a vise grip after 9/11, and the ensuing January 2002 reinsurance treaty renewal season. Capacity shrunk as several carriers exited specific lines of construction insurance, particularly wood-frame residential projects and “attached products” such as condominiums and roofing. Rates shot up, while insurers placed warranties, terms and conditions on coverage to clarify exposure and stress loss reduction strategies.

The result, depending on the sector of the construction industry, has been not just sharp rate hikes, but confusion about across-the-board underwriting practices and, in some cases, a lack of insurance at any price. Some key developments in the Canadian construction market have made things even worse. A series of huge fires at wood-frame construction sites – including two last year in Calgary that resulted in total damage claims of $80 million and a fire at a townhouse development outside Ottawa earlier this year – have spooked insurers. And fire is just one of the exposures.

RISKY BUSINESS

Whether the issue at hand is mold, health hazards on construction sites or leaky condominiums in B.C. and extensive remediation contracting, one thing is certain: insurers have lost much of their appetite for writing construction and builders risk insurance. Those that remain in the game are hiking premiums by 50%-300%, and placing terms and warranties on coverage with demands of proof of loss reduction and risk management strategies.

Tellingly, when the Insurance Bureau of Canada (IBC) created its market availability committee in February of this year, one of the first groups it met with was the Canadian Construction Association (CCA). Since then, it has met with the Canadian Home Builders Association (CHBA) and the Canadian Roofing Contractors Association (CRCA). “The numbers show that this is a risky business,” says Jane Voll, IBC’s director of policy development and a spokesperson for the committee. “When you look at the cost of risk in various industries, construction stands out.”

Voll says the purpose of the meetings between insurers and construction representatives was “educational”. She adds, “we want both sides to walk away with a sense that they have learned more about the nature of the risks and exposures. We can’t create a quick fix or bring rates down. But we can facilitate a discussion of the problems.”

Construction representatives are concerned that rates are being increased indiscriminately, with little concern for individual loss experience or other factors. “It hasn’t just been contractors with claims who have seen premiums go up,” says John Hill, executive director of the CRCA. “Firms with clean records are getting increases of 50% to 100% and beyond.”

“The two main issues now are availability and cost,” says Derek Holloway, a senior vice president, construction with specialty insurer Encon Group Inc. “The availability issue really speaks to roofing contractors and wood-frame construction sites, while cost is a concern right across the industry.” John Kenward, a spokesman for the CHBA, says rates are the biggest issue with members. “Premiums have skyrocketed and this has placed builders in a very difficult situation.” Some have had a hard time getting insurance at all. This is critical because builders must have insurance in place to get financing for construction projects.”

Serge Massicotte, chair of the CCA’s insurance committee, notes that, “it’s not just rate increases, but the fact that premiums are all over the place. There was a time when you could roughly estimate the cost to insure a project, but those days are gone. With insurers demanding different terms and charging higher rates, this could affect how competitive a contractor or builder is on a certain project.”

Construction firms also point to decreased policy limits, often from as high as $10 million down to $1 million, subscription policies involving multiple insurers on one risk and much higher deductibles are all common in the current insurance market. Capacity has evaporated, with fewer than half of the insurers writing construction risks than three or four years ago. In specific risks, such as wood-frame construction, it is often down to one or two markets. Some are also concerned about the reintroduction of “claims-made” policy wordings in construction policies.

LOSS CONTROL

There are no reports on the extent insurance rates have increased for construction companies and contractors, but a study currently underway by the Canadian Mortgage and Housing Corporation (CMHC) is scheduled for release in September. The CMHC is surveying construction companies, lenders, insurers and other groups to find out about premiums and risks in the building industry, according to the corporation’s director of policy planning, Eric Tsang.

Insurance companies and brokers say they understand price is the primary concern of construction firms, but urge them to look at the scope of coverage being afforded. “This is a time when contractors run the risk of accepting deficient coverage in preference for lower cost,” says Simon Fenn, senior vice president and national construction leader for Marsh Canada.

The issue of warranties, used by insurers to stipulate what kind of loss control procedures should be in place at construction sites, is a concern for project owners and contractors. On most construction projects, owners hire several sub-contractors and use standard contracts to govern the work agreements. These contracts have to reflect current insurance wordings and interpretations. Some specific warranties and wordings that have emerged include off-hours site security, fire break spacing, use of open flame, fire hydrants, storage of building material, clean up of refuse (no burning at site) and road accessibility for fire trucks.

Voll says the IBC has been working with the construction industry to harmonize wordings and clarify warranties. “I think we have made some progress here,” she says. “The warranties have been introduced for specific reasons, but not all companies have exactly the same wording.” In this respect, Fenn says that construction firms have to be made aware of the warranties and what they mean in terms of potential claims. “For example, if a warranty states that a watchman has to be on site during off-hours, and that watchman does not show up and a fire starts, a claim could be denied. Brokers also need to be aware of warranties and physically present and explain them to their clients before binding coverage on their behalf.”

Most of the warranties apply to the major sources of loss in recent years – roofing and wood-frame residential construction (several fires were caused by blow torches and other open flame tools, particularly on roofs). But, Massicotte argues that what makes sense in a residential project may not apply to a large commercial or institutional construction site. “We want to ensure that the application of these warranties is pract
ical and reasonable,” he adds. “If you look at something like fencing off sites, that may be good for a residential development, but it may not be feasible for a public works or commercial project.”

Still, Massicotte says warranties and tighter terms placed on policies by insurers are not a bad thing for the construction industry. “I guess you could call it a forced risk management strategy and most firms are starting to get it,” he says. Holloway notes that many of the warranties in construction insurance existed in the 1980s, but disappeared in the lenient underwriting climate of the 1990s. Today, they have resurfaced and his concern is that these warranties do not simply evaporate again when the market turns. “It seems to be the way our industry goes, they may get dropped again when results get better for insurers. I certainly hope that doesn’t happen,” he says.

PACKAGING

In the face of rate and coverage challenges, several sources point to common sense strategies for construction firms to follow. One is to get into the insurance submission process as early as possible – not always an easy thing to do with last-minute construction deals. And, even then, insurers may not respond until close to the attachment date, according to brokers like Fenn. Nevertheless, he suggests construction companies submit a detailed package to underwriters as soon as possible.

Another issue that construction companies should heed is selection of brokers. Massicotte says he sees plenty of sub-contractors “who have hired a general broker to put together insurance and there are clearly exposures they are not covered for”. The construction association wants to work with the insurance industry in developing a certification program for brokers with expertise and knowledge in construction risk.

Some, however, have pursued different approaches in their insurance solutions. For example, more construction firms seem to favor “wrap-up” policies, which include coverage for all sub-contractors working on a particular project. More submissions are coming from project owners for single project coverage and many are looking for a full insurance package that includes wrap-up, builders risk, contractors commercial general liability (CGL), course of construction and certain professional liability covers.

In more difficult lines of construction, there may be some emerging solutions as well. Encon Group is putting together an insurance facility for wood-frame construction projects, which Holloway says should open soon. Already, he says, calls have been coming in for coverage.

SELF INSURED

And then there is the alternative market. Quebec’s provincial roofing association recently created a reciprocal. This self-funded liability insurance program will cover members for losses up to a certain limit. Other provincial roofing associations, such as Alberta and B.C., are considering similar options, according to Hill.

The alternative market is not a solution the broader construction industry is contemplating right now, says Massicotte. “The problem is the nature and size of the losses. Sure you could have a $100,000 self-funded program, but what difference will that make in a multimillion dollar loss?” he says.

Fenn also questions the staying power of an alternative market solution. “There have been a few success stories, but these hard markets don’t historically last for too long. By the time a group is ready to form a reciprocal, the market may have stabilized. I think we have to focus on more comprehensive detail in our submissions to represent our clients better to insurers. That message is getting through to construction companies, but it is a huge industry so it may not reach all as quickly as we would like.”

NEAR RELIEF?

For optimists, there is a sense that the construction insurance market is turning a corner and that the worst is behind them. “I certainly don’t think things will get worse,” says Voll.

Others are more pessimistic. Massicotte says “insurers are continuing to take a very hard line on availability, coverage and pricing issues”.

Kenward also does not understand how recent losses can have such a drastic impact on cost and capacity in the insurance industry. “Can across-the-board changes in rates and availability really be actuarially justified by a few fires?” he asks.

Some repeat the familiar refrain that insurers are simply trying to recoup recent losses suffered in the stock markets. This argument would hold more water if Canadian insurers were big investors in equities, which they are not. An industry portfolio with about three-quarters of its holdings in bonds is taking its hits mainly from low interest rates. In a strange twist, these same lower interest rates are helping to fuel the building boom in the construction industry.

Most agree that the market for construction insurance will begin to ease when property and casualty insurers return to healthier margins. The big question is when. Some say a bigger question is whether the rate relief of a softer market will result in the abandonment of important and hard-earned risk management practices.