Meeting the construction challenge

Ever seen a snake try to swallow a wallaby? That is one way to imagine what’s happening in construction markets right now. Insurers are rightly cautious, but solutions may be at hand

THE CONSTRUCTION SECTOR is a closely watched bellwether that has struggled with many of the problems arising from the pandemic and its economic hangover. Headlines about the sector can make for grim reading. Rates of external administration in the construction sector are consistently near the top of the table versus those in other parts of the economy and have hovered at or above pre-COVID levels in recent months. Higher interest rates have punctured demand, leading to a decline in the number of loans for both new home construction and purchases, which now hover around their lowest levels in the past two decades. At the same time, Producer Price Index (PPI) data shows that the costs of many construction materials are still rising, placing further pressure on the viability of some projects.

“The whole housing supply chain is struggling to keep up with demand,” says Paolo Lavisci, program manager for Resilient Timber Homes at WoodSolutions, which provides information about timber and wood products to professionals, companies and individuals involved in design and construction. “There is a terrible danger in this form of economic friction because it runs counter to the basis on which the supply chain made its assumptions and decisions, including on pricing,” he says. “When delays cause the costs of materials or utilities to increase, and labour shortages add to the equation, this results in a larger pipeline of [construction] work than the system can handle, which is the main ingredient in the ‘profitless boom’ [underway].”

Despite nascent signs that inflation, labour shortages and supply chain delays are stabilising, punch-drunk insurers are adopting a much more cautious approach to construction risks and requesting greater detail around clients’ financial position, their contracting regime and how they are mitigating against inflationary pressures. “Brokers need to recognise that construction risks, particularly on annual ‘floater’ policies, are a moving feast – these are not set-and-forget policies,” Ross says. Builders themselves are desperate for new sources of income and are constantly looking for innovative ways to increase their revenue. Some won’t hesitate to bend a few rules, and brokers need to be aware of this danger. “Despite policy parameters that are set at commencement or renewal, builders can, and do, wander off-piste in construction durations, value of construction – resulting in underinsurance – and, where an opportunity presents, type of construction too,” Ross says. Unless brokers are on top of the dynamic environment that can accompany annual construction insurance client risks, this can result in problems for clients, brokers and insurers. He recommends brokers give clients an A4 laminated sheet of policy parameters to essentially attach to the fridge with a magnet for easy referral. These types of reminders, along with regular client communication, can assist in reducing exposure. MECON has other specific products designed to meet the changing nature of a volatile market, such as optional cover for escalation in fixed price contract values and durations, dubbed Builders Advantage Endorsement. Alongside this, it has added cover called a Project Duration Extension Endorsement to all annual renewed and new business policies to provide three months additional cover where the maximum project duration specified in the policy is inadvertently exceeded.

The snarling of the system and lack of profits have squeezed out a number of industry players, leaving even fewer companies to cope with the challenges. Data from the Australian Security and Investments Commission (ASIC) shows that in the financial year to June 2023, some 2,213 construction companies entered external administration, up a whopping 72% from 1,284 in the prior 12-month period and around double the next-highest number of administrations, which were seen in the accommodation and food services sector. “The liquidations have largely been blamed on supply chain delays and rampant inflation, particularly against fixed-price contracts,” says Glenn Ross, chief executive of MECON, a specialist underwriting agency for the construction and mobile plant industries. High-profile insolvencies include those of Porter Davis, Probuild, Pivotal Homes and South Australian builder Qattro. Some of these casualties can be linked to lesser capacity in insurance markets as appetite for risk has rapidly diminished. “The Porter Davis liquidation is such an example. Many partially completed risks were left vacant, malicious damage and theft occurred, and finding insurance was a tough call for brokers,” Ross says. Understandably, insurers have reacted to these tough conditions. “The effect of this on global market capacity has been a significant reduction in available capacity – at a time when more capacity is required – and a reduction in risk appetite for some types of construction risk,” Ross says.

Discussing the continuing prospects for financial stress in the sector, a recent CreditorWatch Business Risk Index cited rising insurance costs as one contributing factor, particularly affecting small construction businesses. Since most construction-type businesses cannot operate without insurance, they have no choice but to pay higher premiums, which leaves some operating on a knife-edge. “To compound the issues being faced by the construction market at a time of considerable financial pressure, insurers have had to increase rates and deductibles in order to remediate the losses they have been sustaining in this sector,” Ross says. Construction risks that would have found insurance capacity in the past are now left unable to secure insurance either locally or globally. “Brokers are struggling to place insurance on traditionally poor-performing or marginal risks, such as partially completed constructions which are the result of builders liquidating or contracts that have been stalled due to lack of finance, or civil risks in weather-exposed regions,” Ross says. But not all signals are pointing in the wrong direction, and some are hoping the worst may be over. Construction insolvencies in the September 2023 quarter topped those in same period a year ago but by a less alarming margin of only 26%, for example. Rating increases across the construction insurance sector had been expected to continue largely unabated in 2023 following a rise in reinsurance costs after the flooding events of 2022 but have proved less steep than expected. WTW market analysis attributes this trend partly to greater competition due to new capacity entering the market locally as well as from London and other overseas markets. These entrants are targeting clients with a positive claims record who can demonstrate lessons learned, have embedded positive and strong risk management processes, can articulate their strategy, and have a well-presented risk profile. For general contractors, the local market has seen the most easing, with rating plateauing in some cases. Supply chain issues are less dire than during COVID, and while materials costs are substantially higher than a year ago, the rate of increase has peaked and is levelling off. Year-on-year gains in house construction costs were over 20% in the September 2022 quarter but slowed to just 3.9% a year later, below the average rate of inflation.

WoodSolutions is an industry initiative designed to provide independent, non-proprietary information about timber and wood products to professionals, companies and individuals involved in design and construction. The website is comprised of technical publications and design guides and educates users through podcasts, webinars, professional seminars, expert advice and online learning tools. Together with industry bodies, technical associations and suppliers, WoodSolutions works to inform users on all aspects, benefits and requirements of building and designing with timber and wood products. Through a nationwide support network, WoodSolutions aims to create the next generation of architects, designers, engineers, woodworkers, builders and consumers.

Find out more

MECON Insurance is a specialist underwriting agency dedicated to the construction and mobile plant industries. We partner with insurance brokers to deliver tailored solutions for a wide range of clients and industries. As a niche underwriting agency, our cornerstones are service and product. With our experience, technical knowledge and commitment to service, we respond quickly to help you get more clients properly insured. Our policies provide broad, practical and useful cover, resulting in easier claims assessments and more certain claim outcomes. We provide insurance for risks throughout Australia and New Zealand, as well as overseas operations for locally based clients.

Find out more

Another reason for caution is the effect of climate change on the market and the increasingly obvious lack of capacity to be found in the traditional boom-and-bust insurance operating model that the industry has relied on to date. Under normal market conditions, insurance policies might eventually adjust to a massive backlog of buildings, higher materials costs and labour constraints. But the new challenge of higher-intensity and more frequent weather events that insurers need to be able to deal with throughout the year means that regular market mechanisms can’t cope. The Insurance Council of Australia points to the impact this will have on future insurance affordability. “The ICA also reports that Australians are five times more likely to be displaced by a natural disaster than someone living in Europe, which is leading also to an underinsurance problem,” Lavisci says. For these reasons, the ICA has been strongly advocating for measures that reduce risk and moderate pressures on premiums, including improved building codes and extension of household-level resilience programs such as home raising and retrofitting to make new and existing buildings more resilient. “There are … proactive ways we can tackle this problem, and a resilient timber home is a viable one. Code-compliant timber frame construction is comfortable, energy-efficient, robust and resilient when subjected to adverse and extreme conditions, including those associated with floods, bushfires and cyclones across Australia,” Lavisci says. He cites the example of the construction of buildings in bushfire-prone areas. “Although there are still some misconceptions about non-combustible materials intrinsically performing better than a timber structure in a bushfire, there is sound evidence to the contrary.” Compliance with strict requirements for bushfire-resistant construction resulted in a house in Rosedale needing only minor repair after a fire in 2020 destroyed or severely damaged 18 nearby homes, some of which were built with non-combustible structural components. There are also excellent examples of well-designed and built timber homes that can be resilient to floods, and durable, while being easily and cost-effectively repairable. “All these initiatives provide additional reasons, and support, for Australia’s real estate and insurance industry to take immediate action and contribute to the reduction of disaster risks by means of specifying and insuring resilient timber homes,” Lavisci says. WoodSolutions is also having success with its timber-building program as a low-carbon approach to large-scale buildings – part of a long-term strategy to meet environmental challenges. “A timber home is part of the solution to tackling climate change because it will store embodied carbon for its entire life cycle,” Lavisci says. In a similar manner, climate change adaption and mitigation will give rise to opportunities. New coastal and flood defences will be required, as well as sewage and drainage systems. Commercial buildings and plants will need upgrading, and ageing infrastructure will need to be upgraded to cope with more extreme weather events.

“At a time of considerable financial pressure, insurers have had to increase rates and deductibles in order to remediate the losses they have been sustaining in this sector”

Glenn Ross, MECON

In Partnership with

Despite these factors, the number of actual dwellings under construction are close to record-high levels – only 2.3% below the peak seen a few months ago. A closer look at the data shows that while construction starts are indeed at their lowest levels since March 2013, current inventory is dragging as completions plumb depths not seen since March 2014. The massive number of starts during the low interest rate period are taking an inordinate amount of time to work through the system. Like a snake that swallowed a wallaby but can’t digest it, the system is gagging on a massive bulge of orders. There is very little new business due to the weak economy, and fewer projects than normal are reaching completion because of materials and labour constraints.

While climate change is a global issue for construction insurance, at the opposite end of the spectrum there are local issues that need to be considered. One example might be the increasing activism of the NSW Building Commissioner as the state’s government recognises the need to overhaul Australia’s exposure to defective buildings. Another is the emerging risk for construction insurers emanating from the Home Building Compensation Fund (HBCF) in NSW and its indemnity limits. Currently, the HBCF has a maximum payout for defects in residential buildings of $340,000, which is insufficient to cover most homes being built today.

“When delays cause the costs of materials or utilities to increase, and labour shortages add to the equation, this results in a larger pipeline of [construction] work than the system can handle”

Paolo Lavisci, WoodSolutions

Industry experts

Christopher Lee

MFAA head credit adviser, Finsure Finance and Insurance

Stewart Saunders

Heritage Bank

Glenn Ross

MECON

Paolo Lavisci

WoodSolutions

Industry experts

Paolo Lavisci’s experience with engineered wood products covers both hands-on and advisory roles in the design and construction of timber structures, project management, research, product development, teaching and training. Lavisci is manager of the WoodSolutions Resilient Timber Homes Program. Projects he has been involved in include the design and specification of multistorey timber buildings, developing models for prefabricated homes, and the design of CLT manufacturing plants. He has also authored a widely used book on the design of timber structures and funded the development of specific structural engineering software.

WoodSolutions

Paolo Lavisci

Glenn Ross brings over 30 years’ experience to his role as CEO at MECON Insurance. Prior to joining MECON Insurance in November 2003, Ross spent 15 years underwriting engineering risks in both Australia and New Zealand and 10 years as an insurance broker specialising in construction, plant and engineering insurance. During this time, he was also a risk manager at one of the top 20 multinational construction companies. He has a strong working knowledge of the industry, and his experience is assisting MECON Insurance in becoming one of Australia’s leading providers of insurance.

MECON

Glenn Ross

Lorem ipsum dolor sit amet, consectetur adipiscing elit. Tellus in penatibus condimentum malesuada ante vulputate nisi, arcu leo. Amet urna sapien purus vestibulum fermentum a. Cursus metus massa donec sed varius. Nunc enim sit morbi lacus, molestie et nunc. Nullam sed facilisi id malesuada. Ante purus velit, quam scelerisque ultrices scelerisque donec. Velit egestas vel ornare pellentesque ridiculus. Mauris tempor augue quis mattis suspendisse feugiat commodo posuere. Faucibus massa adipiscing nullam elit, ac vel accumsan. Phasellus eget ac dignissim fermentum ac placerat elit, metus. Nulla porttitor ante egestas molestie quis quam. Pharetra magna sit mauris tellus gravida rutrum libero sit. Justo orci cras euismod proin massa lorem ut. In non tellus phasellus faucibus ullamcorper nullam odio dui et.

Heritage Bank

Stewart Saunders

MFAA head credit adviser, Finsure Finance and Insurance

Christopher Lee

Glenn Ross

MECON

Paolo Lavisci

WoodSolutions

Industry experts

WoodSolutions

Paolo Lavisci

MECON

Glenn Ross

Insurance costs contributing to construction woes

Paolo Lavisci

WoodSolutions

Glenn Ross

MECON

Glenn Ross

WoodSolutions

Paolo Lavisci

Insurers more cautious about construction

Published 04 Dec 2023

Dwelling completions drop to lowest since 2014

Total dwellings under construction vs starts and completions

Source: ABS Building Activity, Australia

Mar 20

25,000

50,000

75,000

100,000

125,000

150,000

Total dwellings under construction (houses and other residential)

Dwelling units commenced (seasonally adjusted, houses and other residential)

175,000

200,000

225,000

250,000

Dwelling units completed (seasonally adjusted, houses and other residential)

Jun 20

Sept 20

Dec 20

Mar 21

Jun 21

Sept 21

Dec 21

Mar 22

Jun 22

Sept 22

Dec 22

Mar 23

Jun 23

*record high; **lowest since March 2013 quarter; ***lowest since March 2014 quarter

***

Rate of HOUse construction cost increases slowing down

Growth in house construction prices, Mar 2021 to Sept 2023

Source: ABS Producer Price Indexes (PPI), Sept 2023

100

120

140

160

180

Mar 21

Jun 21

Sept 21

Dec 21

Mar 22

Jun 22

Sept 22

Dec 22

Mar 23

Jun 23

Index no.

Quarter (% change)

Annual (% change)

Sept 23

A gigantic logjam of housing

Shortage of builders exacerbates capacity problems

Both local and global issues at play for construction

Environmental challenges call for new measures

“When the fund is found to be insufficient, owners are turning to the construction policy that was in force at the time of construction and seeking indemnity for – what is usually – defective workmanship,” says Ross, pointing out that many of these claims can be lodged years later. In addition, high-value, multimillion-dollar residential buildings can be charged a premium for HBCF cover that nears or equals the $340,000 maximum payout available to the owner under the fund. “A $17 million residential building will pay $178,000 for $340,000 in cover, and a $31.7 million building is required to pay $340,000 for $340,000 cover – [this shows that] the parameters of the HBCF require review,” Ross says. Regardless of whether risks are local or global, the stakes are high for the construction industry and those who insure it. The world’s needs are changing quickly, and analysis shows that construction is set for a sustained period of strong growth. This is expected to be driven by factors such as a surge in government spending on infrastructure, along with rising populations and the global drive towards a more sustainable world. Oxford Economics forecasts that the construction market will grow by 40% over the 15-year period from 2022 to 2037. There is no doubt that there are short- and long-term challenges – be they economic pressures; shortages or rising costs of key equipment and materials; climate-related concerns; the ongoing lack of skilled labour; regulatory issues; longer lead times; delayed schedules or cost overruns – and some sectors of the industry are more at risk than others. But the broader outlook is more positive than it has been.

RSS

Sitemap

About us

Conditions of Use

Terms & conditions

People

Specialty

Best in Insurance

Resources

Risk Management

News

RSS

Sitemap

About us

Conditions of Use

Terms & conditions

People

Specialty

Best in Insurance

Resources

Risk Management

News

RSS

Sitemap

About us

Conditions of Use

Terms & conditions

People

Specialty

Best in Insurance

Resources

Risk Management

News