Drama in the market
Drama in the market! For an industry known for its slow pace of change, the last few months has seemingly rewritten the rulebook in the Construction insurance market. In about of pre-and post-January 1 turmoil, there have been large scale withdrawals from writing Construction business and there is the potential for more to come. And just recently, we have had the impact of two major LNG construction losses emanating from Darwin, Australia to digest.
Some context It is important to examine the context and recent history of the Construction market to help make sense of what is playing out before us. The insurance market had grown strongly over the past 10 years, with plentiful capacity provided by a mix of traditional and new carriers, supported by capital markets looking for solid returns from new growth areas. Not surprisingly these dynamics, when taken together, did result in a soft market; however, insurance is very cyclical. While for many younger underwriters a hard market is something that they have not yet witnessed, for the more experienced practitioners it creates an opportunity to demonstrate their unique, stand-out skills in challenging conditions.
HIM and California wildfires The first winds of change (literally) arrived in 2017 with hurricanes Harvey, Irma and Maria (HIM), together with unprecedented number of typhoons in Asia. Insurers very quickly implemented rate increases for construction projects in the affected areas but with no discernible changes outside of these geographies. In fact, outside of those affected by region, the international Construction market had not seen any tangible change in rates or conditions for many years.
Understandably, these losses, together with the claims produced by the California wildfires, prompted insurer and reinsurer reviews across the highlighted regions and it became clear that further sizeable claims would cause significant financial difficulties for some insurers.
Lloyd’s review While many insurers and Lloyd’s syndicates were relieved that they missed the large losses, it prompted a more stringent business review from Lloyd’s across all of its affected syndicates1, referred to extensively elsewhere in this Review. In some cases, this has now been extended to all insurance classes.
Technical losses More significantly has been the notification of a number of technical losses and potential claims that were reported during 2018. Estimates vary from US$5 – 7 billion and range in type, from collapses in hydroelectric dams to the latest LNG losses referenced earlier.
Biggest change in market conditions for decades These claims, together with changes in underwriting practices at many of the global Construction markets as well as stricter legislation in Lloyd’s, has produced what has been described as the biggest changes in the Construction market seen for decades. Many of these insurers do not consider a 5% to 10% rate increase across the board to be sufficient; instead, they are adopting not only a short term strategy of rate and deductible increases, but also a longer term plan of coverage restrictions and a more sustainable underwriting approach to increase profit margins rather than just rely upon premium income. The “Exiteers” Over the past few years any adjustment in capacity has mainly been through mergers and acquisitions that have occurred between companies; for example, ACE and Chubb and XL Catlin and AXA. However, lately we have seen more dramatic reductions through the closure of certain Lloyd’s syndicates (Beazley, Hardy, Talbot) who have left the Construction sector due in part to changes in Lloyd’s governance. Tokio Marine & Nichido Fire Insurance Co. Ltd., in Japan, that owns the Lloyd’s syndicate Kiln, was the first to insurer to re-structure its construction underwriting, severely changing its appetite in the sector with a major reduction in capacity and closure of underwriting operations in Singapore. Qatar Re, a wholly owned subsidiary of Qatar Insurance Company, exited the sector as quickly as its original entrance, lasting only 18 months. Further cuts to underwriting capabilities affecting other major hubs In addition, other major changes are occurring and it is almost hard to predict when and where this situation will ever end. At the time of writing major insurers at Starstone, RSA and Zurich have made serious cuts to their underwriting activities, reducing their capacity, reducing their appetite for certain risks and have even taken the more disappointing strategy of reducing resource through redundancies or asking key staff to re-apply for jobs. All of the market changes have also had a major impact in a complete change of profile at regional hubs that have played a big part in the last five years, notably Dubai, Singapore, Sydney and, more recently, Miami.
The “Remainers” On a more positive note, there are new insurers that have emerged, notably Aviva who started writing International Construction business in 2018, Berkshire Hathaway who have also opened up a London operation and Rokstone, an MGA writing on behalf of other insurers. Furthermore, in an ever—developing world investment in new construction projects will always be high on the agenda of national governments, both in developed and developing regions. The recent increase in oil prices, together with a “must have” need for better infrastructure and transportation, will always require solutions and protection from losses that may affect the financial dynamics of this investment. It is therefore important to appreciate that key underwriters, such as Munich Re, Swiss Re, Allianz, SCOR, AIG, Chubb and Starr, remain committed to providing Construction-related insurance products, despite the potential for tough negotiations on terms and conditions compared to the last ten years.
In addition to those markets who have remained involved in the sector, other dynamics are still very relevant, such as the high capitalisation of certain markets such as Japan, Korea and, more significantly, China. It is also considered by some that the original underwriting centres of excellence in London, Munich, Zurich and Paris will be playing a more centralised role in order to provide more coordination and governance around underwriting strategies.
Challenging conditions set to remain throughout 2019 During 2019 we believe that the current market volatility will be sustained; underwriting guidelines will continue to be strictly controlled by both the leading treaty reinsurers and the senior management of each insurer, given the overall desire for improved, more sustainable returns. There is no question that the recent closures and restrictions in underwriting have cast a shadow over the Construction insurance industry and the concerns over more closures cannot be under-estimated.
Reduced capacity The global market capacity for Construction has reduced as a result of this volatility, with an estimated PML capacity now standing at approximately US$4.25 billion. This is still more than sufficient to accommodate most PML requirements, except for some of the increasing natural resources industry projects such as Liquefied Nitrogen Gas (LNG) plants and other petrochemical assets.
More focus on coverage We also predict more focus on coverage, with a tightening of conditions; deductible levels are also expected to increase to a level that might require the managing buyers’ expectations; all on top of anticipated rating increases of up to 25% over the next 12 months. However, the major reinsurers that have historically provided lead positions and major capacity for the construction industry will undoubtedly continue to do so, although the recent depletion of underwriting capability at Zurich should be seen as a serious possibility that could occur to any such insurer.
How long…? The big question is: how long will the market continue to harden for? Low interest rates in the financial sector have already seen new capital enter the insurance markets as a more viable form of investment. With rates increasing, should investment returns from other financial sectors remain unstable, it is a strong possibility that this capital will help feed capacity. This might result in a more competitive market and then the cycle could change once again.
David Warman is Deputy CEO & Global Construction Practice Leader at Willis Towers Watson in London.
4 https://www.lloyds.com/~/media/.../i...reviewer/market-presentation-may-2017.pdf