These are unprecedented times in Construction & Engineering insurance. The loss experience and loss ratios of virtually every major carrier seems to have resulted in a total shake up in underwriting philosophy and potential uncertainty over jobs.
Nat cat losses add to the strain 2019 continued where 2018 left off in the Construction & Engineering market; 2020 is expected to follow this trend, with those losses that occurred in 2018 mostly being settled for their original reserves. Unfortunately, the damage had been done - Natural Catastrophe (nat cat) losses in the insurance industry globally, including forest fires, flooding and earthquakes, added significantly to the strain already being felt within the Construction and Engineering market. It became apparent that this class of insurance did not - and does not - produce sufficient income to be self-sustainable to many insurers. Serious flooding in the Middle East in 2019 and early 2020 has once again re-written the “underwriting guidelines”, with some areas now considered nat cat zones. This undoubtably will have a further “knock on” effect on rates and deductibles in these areas.
Erratic and uncertain underwriting During 2019 the market continued to show signs of erratic and uncertain underwriting. Unfortunately, there was little relief to the overall loss experience, although the major loss that occurred at a major LNG project in Australia has yet to be concluded, according to our sources. Estimates as high as US$3 billion was being rumoured, although it is suspected that even in the event of a negotiated settlement (if the amount is lower) this will still produce a significant market loss. In 2019 the Construction industry premium spend was estimated to be US$11.4 trillion and by 2020 to be US$11.9 trillion. By 2025, the global spend is expected to rise to US$14 trillion and by 2030 to US$15.5 trillion. This includes China’s “Belt and Road” initiative from 2015 to 2030, which is estimated to be US$7.5 trillion out of an estimated US$ 20 trillion and represents over third of Asia spending. Russia continues to invest in the energy sector, with over US$150 billion worth of projects planned. The premium spend is estimated to be US$21.9 billion, representing approximately 3% of global commercial insurance market with Europe, Middle East and Africa representing the largest part of the global premium spend for the sector. The London market which is the largest single market, is estimated to receive 23% (or US$5 billion) of all global construction premium.
Amortisation of Construction premium Importantly, Construction premiums differ from other classes because whilst taken up front, are amortised over the construction period of the project and these are now appearing to take longer, often up to 7 to 8 years. This has increased the analytical work required by Construction and Engineering underwriters and its modelling to forecast and project long term losses. Terms and conditions, including rates, deductibles and coverage, differ from project to project and within the energy sector itself. Concerns over modulization, fire proof painting and overall quality controls remain uppermost in underwriters’ minds, together with default risks associated with the industry, such as commissioning (explosion) and for design, workmanship or materials.
Significant rating increases In 2019 rates increased on average by 75% across the Energy sector globally, although higher increases were seen for risks in areas where underwriters have concerns over supply chain and risk management. Deductibles also increased, often by 100% for the critical areas of technology risks, commissioning and natural perils. Coverage continued to be scrutinised by all reinsurers, especially Defects (Design, Workmanship and Materials), Corrosion, Cyber, Flooding and in certain territories, Terrorism and Sabotage, which remains excluded under a Construction/Erection All Risks policy. Information on supply chain, quality assurance and risk management became more relevant in order to achieve the best terms and conditions.
Changes in underwriter appetites During the latter part of 2019, insurers began to show a significant change in underwriting appetite and approach, noticeably dominated by more centralised control authority by Global Line of Business Chief Underwriting Officers. Product line underwriters showed more hesitation in agreeing new opportunities without referral to senior management, engineers, or both. This trend of referral has continued into the first quarter of 2020 and it seems clear that losses in 2018/2019 caused many insurers to evaluate their guidelines on projects and in regions that could be exposed to major perils.
Reduction in regional market participation Globally, one of the most noticeable changes was the reduction in active participation and capacity provision in the key regions of Dubai, Singapore, Miami and, for domestic risks, Australia. Even the previously considered strong domestic markets in South Africa, Turkey, Germany, Brazil and similar competitive areas showed signs of reduced capacity. There were no new Lloyd’s withdrawals, although the Construction consortium that represented a viable alternative to the major markets who would lead a project was heavily affected; whilst these syndicates still lead risks, they now do so for small to middle-market projects only. 2020 treaty renewals produced a further shake up in capacity, where global PML capacity reduced to approximately US$3.8-4 billion on a best risk basis. It should be noted that insurers are definitely not using their full capacity for the vast majority of risks; on the contrary, they are only using a percentage of their “best risk” capacity, thereby reducing the global availability by a high margin.
Capacity changes There were significant capacity changes in many major insurers such as AIG, Allianz, Chubb and Zurich, while Samsung Fire & Marine and Mapfre withdrew from global Construction underwriting, reducing the capacity by US$150 million compared to 2018. The market changes were no better demonstrated than by Munich Re’s decision to merge its two Operations writing Construction business, being Corporate Insurance Partners (CIP) and Munich Re Fac. Meanwhile, the merger between AXA and XL also led to a consequential reduction of capacity.
Less enthusiasm for leading business More importantly, clear evidence emerged of a distinct reduction in the number of leading underwriters prepared to commit meaningful capacity and spend quality time in maintaining a lead position. Other significant changes included AIG withdrawing from Construction insurance in Latin America, while rumours continue to circle regarding AIG’s global approach to this class of insurance.
Emergence of new MGAs On a positive note, whilst Managing General Agents (MGAs) have never been active within the Construction and Engineering insurance sector (apart from those MGAs specialising in insuring construction plant and equipment), new MGAs began to emerge writing Construction business on a selective basis. Rokstone, which was set up in early 2019, was joined by other MGAs such as Castel, Connect Re and Agile Partners writing this class. While not offering significant capacity, the participation of these MGAs is a positive step forward in maintaining the London market as a Construction insurance centre of excellence.
Chinese market remains competitive Chinese insurers continue to offer capacity for International projects, although where there is no Chinese interest this capacity is greatly reduced. Conversely however, if a project has Chinese involvement, the capacity that can be obtained can be very significant. The actual amount available varies from opinion to opinion but an overall capacity figure of around US$1 billion cannot be ignored.
Stricter approach to underwriting Towards the end of 2019, all insurers showed a stricter approach to underwriting, with greater emphasis on full technical information, a financial substantiation for Delay in Start Up insurance and a deeper review of risk engineering in each project. After the January 2020 reinsurance treaty renewal season, it became obvious that this more diligent approach had taken a further upward turn. Quotations offered on new business were subject to a short window of validity; when dates expired, it was not unusual to discover that the quotation was no longer valid and had increased. Similarly, many existing insurance policies requiring extensions to the insurance period have seen higher than normal extension additional premiums and increased deductibles. Only those projects that had firm and clear automatic extension provisions contained within the placement document could be safe in knowing what the extension would cost. Without such provisions, those policies are potentially open to difficult negotiations, especially those that have high loss ratios.
Outlook for 2020/21 For the remainder of 2020 and into 2021, we fully expect the trend of toughening conditions and stricter underwriting to continue. We also expect rates to rise for all sectors of the Construction portfolio, particularly for the more technical industries such as oil, gas and petrochemicals, and more specifically projects containing prototypical scaled up or unproven technology. This sector has always produced strict underwriting and a strong focus on reduced cover and possible increased deductible levels.
Impact of COVID-19 The Construction sector could slow down from the impact from COVID-19 and of course, travel restrictions could severely affect project locations, hindering the process of construction projects and introducing fresh layers of compliance. Contractually, delays at this stage - and any liability thereof - can be addressed with updated schedules together with the reallocation of work and resources and the implementation of alternative measures. With many materials being imported from China, the main provider of the global supply chain, any shortages as a result of COVID-19 may have an impact on Delay in Start Up premiums/rates if insurers believe that Force Majeure clauses cannot be triggered.
We believe that volatility in the Construction insurance markets in all sectors will continue, that rates and deductibles for some of the higher exposed industries could also continue to increase and that insurers will remain selective. It is very apparent that all Construction and Engineering insurance and reinsurance companies no longer write for premium income but instead for profitability. Those insurers that have remained in Construction will clearly see the benefit of increased premiums and better terms and conditions; we would hope and believe that this transfers into more profitable underwriting and a more stable market. Capacity will remain unchanged and could even see a slight increase, bolstered by capacity from MGAs and those markets who have confidence in underwriting construction and engineering insurance. This is especially the case for the energy sector, if the catastrophic loss and insurance claims record improves.
However, if the already reported loss record deteriorates, and those losses that may have been incurred but not yet reported fuel further high-profile claims, the market will almost certainly maintain its current volatility during the remainder of 2020.
David Warman is Deputy CEO & Global Construction Practice Leader at Willis Towers Watson in London.
