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The shift began with the onset of the financial crisis in 2008, when infrastructure projects in Canada became a means to stabilize the fragile economy. With global markets experiencing a downturn and many countries going through a recession, contractors from other parts of the world began to target construction projects in Canada when they couldn’t find work in their home country.
Today, construction companies in Canada continue to face strong competition on any project they tender a bid on. Since it can be hard for a construction firm to differentiate its capabilities from its competitors, the focus for many is to find new ways to cut costs, even though material and labour costs aren’t going down.
“The squeeze is on a contractor’s profit margins. To maintain it, they need to manage a project as efficiently as possible. The challenge is that with construction projects, by their nature, you’re often inevitably going to have a problem that you weren’t anticipating,” said Derek Reedie, senior underwriter, property and construction at QBE.
The increased pressure on construction companies to complete work faster while on a tighter budget has reverberations for course of construction (COC) insurers.
“We have to make sure that we’re dealing with the contractors who really understand an accelerated schedule. We need to have confidence that they can stay on top of the project, and that they’ll work safely,” said Reedie, pointing to the three factors which constrain any construction project: time, money and quality. “On a fixed price contract, with large penalties for missed deadlines, the price is fixed and the time is fixed. That means the only variable you can really change is the quality of the work.”
The profitability of COC policies, which cover damage to a building under construction from perils like wind, fire and water but also extends to damage resulting from poor workmanship, has been particularly affected by these developments in the construction industry.
“You bind a policy for a new project and you need to wait, two, three, four years to see if it makes money or not. A lot of insurance companies focus on their calendar year results, and blend their construction project results with their property portfolio results. With this lens, the deterioration in the COC book would not be evident, as the property book results can be quantified much faster,” explained Reedie.
If you write a property policy on January 01, by January 01 of next year, you know if you’ve had a loss. In contrast, if on that same date you write a COC policy for a project, you need to wait for two, three or four years until the project is complete to know for sure whether it went off without a hitch.
The profitability of Lloyd’s COC book globally has deteriorated year over year for the last five years. QBE’s experience is that the COC results are developing worse than expected as the projects near completion and this mirrors Lloyd’s experience as a whole.
One factor is that, as a construction project reaches completion, there are higher values at risk. As a result, the effect of any event, such as weather, on the quantum of the loss incurred increases. In addition to this, there is a trend of increased losses at these latter stages which are at least partially being brought on by the poor quality of work performed earlier in the project.
“The claims being experienced are generally pretty run-of-the-mill claims. So, the question becomes, are we not collecting enough premium or is it risk selection?” said Reedie. “My thought is, it’s an element of both. However, on the macro level, it does primarily come down to pricing. We’re not getting enough premium for the risk.”
Rates have dropped by 30 or 40% over the last decade, even more so when compared to the last hard market cycle.
“Does pricing need to go to back where it was at the height of the last hard market? I hope not. But somewhere between today’s pricing and that of 10 years ago is the right number,” said Reedie.
Despite this, QBE is committed to construction as a class and said it is still interested in writing construction project policies. The company will be selective in the projects they write and their participation will be dependent on their perception of the adequacy of the rate.
