Construction Insurance Pricing Reaches a Crossroad. Are Labor and Material Shortages and Climate Change to Blame?

Construction insurance pricing is being impacted by several risks of note that underwriters must review.

By: Alex Wright | February 1, 2022

Commercial insurance property prices have continued to soar in the face of ever-increasingly unpredictable natural disasters.

The higher cost and shortage of construction materials caused by the current global supply chain crisis and rising inflation have only exacerbated the problem.

Those are some of the key findings from recent whitepaper, “Why Commercial Property Insurance Prices are Higher and What Can be Done About It,” by Westchester, a Chubb company.

Climate change is causing increasingly more unpredictable, frequent and severe catastrophic events and losses, the report found. From January through September 2021, rising global temperatures contributed to 18 weather-related disasters in the U.S., with losses exceeding $1 billion in each case — a record high — according to NOAA National Centers for Environmental Information.

Furthermore, an estimated $42 billion in insured property losses were recorded in the first half of 2021 — also a 10-year high. And Q3 2021 estimated losses were an above-average $48.5 billion, Guy Carpenter has reported.

Among the most damaging events of 2021, said the report, was Winter Storm Uri, an extra-tropical cyclone that, in Texas alone, brought down the electricity grid, causing the country’s largest outage in almost 20 years.

More than 4.5 million homes and businesses were without power for several days, resulting in a record volume of property claims for burst pipes, collapsed roofs, spoiled produce, damaged equipment and business income interruption.

Altogether, insurers will likely be on the hook for an estimated $18 billion in damages, with half the claim costs coming from Texas, according to Karen Clark & Co. A further complication is demographic shifts to higher risk areas, for example, in coastal regions.

The problem, the report said, is that standard catastrophe risk models may not fully capture potential losses attributable to unusual weather events, such as the December 2021 tornado outbreak — one of the largest and deadliest events of its kind in U.S. history — Hurricane Ida and Winter Strom Uri.

Worst still, these models may create a false sense of security that is shattered when more extreme and unforeseen events occur.

Rising Commodity Prices

Accurately estimating valuations to ensure policyholders are paid quickly in the event of a loss is difficult enough in normal times with commodity prices and labor costs continually changing.

Matt Booker, executive vice president, Westchester Property and Inland Marine

However, with the COVID-19 pandemic restricting flow and availability of goods, and inflation hitting almost seven percent in December 2021 — the biggest one-year increase in 40 years — the cost of construction materials such as lumber, steel and gypsum have skyrocketed.

For example, the price for a standard 1,000 feet board of lumber jumped more than four-fold from $347 to $1,675 between May 2020 and May 2021, while the benchmark price for rolled steel shot up 215%, the Chubb report found. Overall, the cost of construction materials increased 23.1% in the 12 months ending in August 2021 and are projected to rise another five to 11% through August 2022.

This price volatility is making it increasingly difficult for underwriters to accurately and comprehensively value the replacement costs of construction materials and price coverage accordingly. Reflecting this, as of November 2021, it was estimated that commercial properties were undervalued for underwriting purposes by more than 30%.

The consequences of getting valuation wrong can be severe. If the true cost of asset replacement is undervalued, this can adversely affect the underwriting modeling outputs, resulting in less well-informed insurance decisions, business continuity plans and inadequate rates, not to mention claims adjustment and payment time, the report concluded.

Asset undervaluation may also result in the insured’s failure to set aside enough capital to cover their retained risks or have sufficient coverage limits.

At the same time, the report said building contractors are experiencing a pronounced shortage of workers, particularly in certain trades and regions where atypical property losses have occurred.

Aggregate contractor labor costs also increased 4.46% in the 12 months through August 2021 due to a lack of craft professionals, with an estimated 430,000 additional construction workers needed in 2021 to address demand and another one million more will likely be needed in 2022 and 2023, according to the U.S. Bureau of Labor Statistics.

If demand continues to increase, contractors will need to increase wages to attract these workers. And if an unexpected major storm hits a well-populated area, thousands of homes may need repair and replacement, pushing the costs of materials and workers yet higher.

Supply Chain Problems

Added to this, shipment delays and transportation disruptions are putting a squeeze on goods availability, the report said. As these supply chain problems are taking longer than expected to normalize, they may remain an issue well into 2022, thus resulting in further price increases.

Inflation and interest rates are two other big concerns: Historically, high inflation has resulted in weaker underwriting performance and reserve levels, while rising interest rates have deteriorated the value of fixed income assets, making it hard to keep pricing in pace with these volatile loss trends.

As a result of all these factors, the report said property rates have risen exponentially. For example, Chubb’s premiums climbed 12% year-over-year in Q3 2021.

To overcome these problems, insureds and their brokers need to give the underwriter accurate asset valuations of their properties and contents, engaging qualified parties to carry out more frequent and in-depth property damage risk assessments, factoring supply chain disruption and rising inflation.

“Carriers can tie coverage to reported values by using some insurance provisions such as co-insurance provisions, the Occurrence Limit of Liability Endorsement, and margin clauses,” said Matt Booker, executive vice president, Westchester Property and Inland Marine and author of the report.

“Underwriters can also access submitted building values by reviewing the dollars per square footage,” he added.

“However, this simple check does require the underwriter have proper information such as accurate square footage of the building, along with the construction and number of stories to account for other structures such as parking garages. Proper insurance to value for business interruption is just as important as property damages and business interruption worksheets are available to assist clients in calculating appropriate business interruption values.”

Risk Mitigation Steps

In addition, insurers and brokers must help clients to mitigate and manage the risk by taking proactive steps such as improving building and pipe insulation, retrofitting storm drainage systems and providing premium incentives to buy electrical generators for unexpected outages.

They also need to ensure their business continuity plans address all natural hazards to protect their most exposed and critical assets and focus resources and capital on mitigating the impact of these exposures on their properties, by using risk modeling.

“Insurers can help confirm models appropriately reflect the current state of climate and not overly rely on historical data from periods, which may not match current climate conditions,” said Booker. “They can also make sure that their model output aligns with their own claims experience.

“Furthermore, insurers can clearly identify causes of loss that are under-modeled or non-modeled for a particular peril region and take action to address those deficiencies. The accuracy of the data that goes into a model is critical for coming up with meaningful conclusions.”

Risk managers and property owners also need to enter into long-term agreements with building contractors to ensure the availability of construction materials and their services in the event of a natural disaster. This requires understanding the main supply chain risks, identifying when and how they change, and actively managing them, such as the increase of storage and inventory at warehouses.

Ultimately, though, all stakeholders need to collaborate and look at these problems in greater detail and develop more accurate and real-time data on building conditions, local drainage systems, real estate and housing development needs, and other loss exposures. &

Alex Wright is a UK-based business journalist, who previously was deputy business editor at The Royal Gazette in Bermuda. You can reach him at [email protected].

Why Insureds Might See an Uptick in M&PL Claims

George Schalick, Jr., Senior Vice President of the Management and Professional Liability Division, Philadelphia Insurance Companies

The current soft market might come as a bit of a surprise as it does not track with previous underwriting cycles and economic conditions. Afterall, many privately held and non-profit organizations struggled during the early days of the pandemic with shutdowns and rapidly declining revenues. But the Government assistance programs, like the Paycheck Protection Program loans, helped keep many afloat during the tough times.

“During COVID many organizations stopped doing business until they were able to sort out all of the health and safety challenges,” Schalick said. “They were forced to lock down, but then all the government assistance programs allowed them to keep people employed. The increased volume of claims we anticipated we would see coming from the lockdowns and restrictions that were imposed upon businesses in the U.S. didn’t manifest at first.”

“Just because there wasn’t an onslaught of reported claims at the beginning of the pandemic, doesn’t mean the circumstances that would give rise to a claim being reported didn’t occur. Courts and the judicial system were closed or slowed and now that they are back open, we’re starting to see the circumstances that occurred during the COVID lockdowns becoming claims today,” Schalick said. “Litigation is progressing.”

Added to the delayed pandemic litigation is a concern over newer claims that might be filed as the country inches toward an economic downturn. Though a recession was avoided in 2023, experts think a soft dip could occur in 2024, with 76% of economists saying there’s a 50% or less chance of an economic downturn this year — that almost always results in more management liability claims.

“During the Great Recession in 2008, we saw an almost immediate spike in claims because of the economic conditions and the pressure it placed on organizations. They were making personnel changes with significant belt tightening almost immediately.” Schalick said.

What’s in Store for M&PL Policy Rates in 2024?

Despite an uptick in claims and increased economic uncertainty, management liability rates haven’t increased, resulting in market-wide pricing levels that may not meet the increased pressure of rising settlements and jury verdicts.

“Rates are going the other direction and settlement values are not falling,” Schalick said.

The mismatch between rates, claim frequency and severity is, in part, because carriers experiencing the dramatic soft market in the public D&O market are seeking premium gain in the private and non-profit market.

“In the public company market, the rates have been decreasing significantly. The rates were increasing in the private, not-for-profit market, and rightfully so, but there’s a desire to supplement overall mid-size D&O for carriers who also write private not-for-profit, and they see that as an opportunity to aggregate premium,” Schalick said. “So the always competitive landscape in the private, not-for-profit market has dramatically increased in the last 18 to 24 months.”

Still, companies of all sizes and types should be concerned about management liability rates in the future. Legal system abuse is resulting in increases in both the amount of litigation and the size of verdicts plaintiffs are receiving.

Certain areas of the country are particularly vulnerable to this type of legal system abuse. As a result, insureds in these localities are likely to be vulnerable to rate increases.

“The environment is so positive for the plaintiff that forces premium increases so carriers are able to stay in that market long term,” Schalick said.

Why a Tenured Carrier Partner Can Help Insureds Navigate An Uncertain Market

It’s clear that insureds are facing an uncertain M&PL market over the next few years. Fortunately, carriers with a long history in the M&PL space will be there to offer stability.

Philadelphia Insurance Companies has been supporting this market for 35 years. PHLY is committed to offering long-term rate stability, even as economic and claims trends start to push premiums upwards. They have an appetite for all sorts of companies, large and small, for-profit and nonprofit alike.

“We’ve been at this game for a long time and are one of the most tenured underwriters in this space,” Schalick said. “We like to stay very consistent.”

PHLY has worked with both for-profit and non-profit on management liability policies. With dedicated M&PL teams throughout the company’s 13 regions, PHLY provides the support agents and brokers are looking for on behalf of their clients. The teams know their regions well and can respond to local trends. They’re also dedicated to making the renewal process as easy as possible for their partners and policyholders.

“We have real confidence in our results, so we focus a lot on making the renewal experience as painless as possible for all agents and insureds,” Schalick said.

The company is also investing in tools to help insureds avoid losses. Earlier this year, they launched a new online risk management platform, PHLYGateway, which offers resources for insureds on how to create an employee handbook and trainings on issues such as recognizing workplace sexual harassment and discrimination.

If insureds have questions, they can consult a Best Practices Help Line, provided via the platform. That way, they can get on the spot risk management guidance to help them prevent claims.

To learn more, visit: https://www.phly.com/mplDivision/managementLiability/default.aspx.

This article was produced by the R&I Brand Studio, a unit of the advertising department of Risk & Insurance, in collaboration with Philadelphia Insurance Companies. The editorial staff of Risk & Insurance had no role in its preparation.