Construction market growth solid but risks rapidly evolving

The massive european and global construction market continues to grow and offer corporates and their insurers a rich vein of income. However, the risks are complex, fast evolving and demand professional and coordinated risk management. Insurance capacity remains plentiful and rates competitive, but risk and insurance managers can expect a tougher stance from carriers over time as margins narrow. Adrian Ladbury asked David Bowcott, Helena Fernández de Bobadilla and Bob Humphreys of Aon Risk Solutions to give their expert view of this huge market, recent trends and the outlook.

According to IHS Markit, total construction spend in Europe reached €2.3trn in 2017, a 4% increase over 2016, driven by a slightly higher increase in non-residential spend over residential. The growth outlook for Europe is positive due to sustained economic recovery. Spend is forecast to reach through €3.6trn by 2030 with an average growth rate of 3.6%.

IHS Markit estimates a global construction market of €9.4trn in 2017, a 4.4% increase over 2016. This increase was driven by an increase in infrastructure spend, with residential construction making a big impact too. The global growth outlook is positive as global economic conditions continue to improve. Global construction spend is forecast to be €17trn by 2030, with a ten-year average growth rate of 5.15%. “Globally, infrastructure has drawn the most attention, and IHS Markit is forecasting an average rate of 6% over the next ten years,” said Mr Bowcott,  global director – growth, innovation and insight of the global construction and infrastructure group at Aon Risk Solutions.

Data from IHS Markit shows that UK, Germany and France are the largest European construction markets, in that order, with total construction spend of €334bn, €290bn and €272bn in 2017, respectively. Other notable markets are Italy and Spain, with respective spends of €201bn and €160bn. While these markets are the largest, their growth outlooks are 3%, 2% and 5% respectively. Emerging construction markets in Europe – such as Norway, Finland and Turkey – have average growth rates between 5.5% and 6.5% during the next ten years.

Sweden is another notable growth market because of its recently announced €100bn public-private partnership (PPP) programme. “This will drive growth over the next five years with an average growth rate of 6%, though growth is forecast to slow down to 3% by 2030,” noted Aon.

So, what are the main risks in this huge market that risk managers need to deal with? What lessons do recent losses and claims teach us?

“Some of the top risks include increasingly narrow margins both at the prime contractor level and throughout the supply chain. Also, contractors are responsible for more risk contractually than before and, at times, struggle to properly address those additional risks,” said Ms Fernández, head of Europe, construction specialty at Aon.

“Additionally, deadlines are tighter and contractors suffer from a lack of experienced workforce, in the face of increasing demand. Tighter deadlines are also putting pressure on the design, leading to decreasing quality in design documents. All this places more burden on the contractor and any error can affect margins and the general performance of the project. Some of the most common causes of large claims are related design error, construction defect, workmanship negligence, and unexpected ground/site conditions (previously a risk the owner was responsible for),” added the construction broker.

According to Mr Bowcott, recent trends in the way large construction projects are organised that impact the apportionment of liability and the risk profile of a typical project include:

• More responsibility being transferred to the contractor – more projects are involving project finance, either PPP or private finance initiative (PFI)
• More responsibility for lifecycle risk
• Greater use of design build vs design-bid-build.

So, how do construction firms and contractors typically manage their risks?

Mr Humphreys, chief commercial officer at Aon construction, explained that this really depends on the firm’s size and their approach to risk management. “Some firms prefer to take a more transactional approach with the intent to transfer the majority of their risk to the insurance markets and/or their subcontractors for the lowest price. Those firms that take a more dynamic approach to risk management often have more of an appetite to retain more risk, giving them more control. These types of firms would typically feel more comfortable with higher retentions or use of captives, which is welcomed by the insurance markets. Firms that skew more toward the dynamic style of risk management also tend to manage risk from a more holistic view across their firm, while the transactional buyers tend to view risk specific to a business unit or geography,” he said.

Not surprisingly, Aon is finding that more contractors globally are turning to technology and data strategies to manage risk more effectively. Technologies like building information modelling, the internet of things, artificial intelligence, computer vision, augmented and virtual reality, robotics and the like are being used by contractors. “There is a wave of effective technologies coming to the market and all project stakeholders are struggling to identify the best technologies to implement on their jobs,” said Mr Bowcott.

Aon also notes that some contractors are using funded retention strategies to drive adoption of better operational practices. For instance, subcontractor default insurance often uses large funded retentions to align the contractor with the carrier. Once those funded retentions are brought off risk, they are returned to the contractor and progressive contractors use that money to bonus the front-line staff managing the risk of subcontractor default. These strategies are being used beyond subcontractor default insurance, explained Mr Bowcott.

Project finance is an important element of major construction projects and the type of finance is closely linked to the insurance needed for the job.

Ms Fernández explained that the financing of a project depends on the delivery model. For PPP/PFI projects, the concessionaire is responsible for funding the project via debt/equity. For engineering, procurement and construction contracts, either the owner or the contractor can be responsible for financing the project or managing the cashflows, depending on the asset type and project location, she said.

“The party responsible for financing the project would typically also be responsible for procuring the insurance, as this is usually a requirement of the lenders. Given the financial risk of PPP projects, lenders’ insurance requirements are usually more demanding than other types of projects. Some projects have the person responsible for the risk procure the insurance, on the premise that those managing the risk are in the best position to negotiate and place the insurance required,” added Ms Fernández.

The sheer scale of this market and relatively positive growth outlook means there are plenty of insurers keen to write the business. This means that it is a keenly priced market and has been for some time.

“The construction insurance market continues to be extremely aggressive,” said Mr Humphreys. “Capacity in this sector has continued to increase over the past five to six years and this has had a significant impact on rates, which have been driven downwards. The estimated worldwide onshore capacity is currently in the region of $4.5bn on an EML basis, based on S&P A- or AM Best equivalent rating. Five years ago, the estimated capacity was $3bn, which means a 50% increase. This trend reflects across all sectors within the onshore construction industry, and projects are experiencing the full benefits of the soft market. The capacity increase is due to new markets entering the marketplace but also existing markets substantially increasing their capacity,” he continued.

Another important development has been the emergence of a truly global marketplace, added Mr Bowcott. “Regional hubs provide support to domestic markets and these hubs have developed greater expertise with increased underwriting capacity, including Dubai, Singapore and Miami. It is therefore important to engage in a market strategy that includes access to both the regional market and the London and European markets, which continue to provide important capacity – having the perfect mix between those markets to have the best available structure and support,” he explained.

Aon believes that contractors’ all-risks and erection all-risks policies are still a profitable line for insurers, but margins are getting narrower. “In general, we expect markets to continue being aggressive for the next 12 months, but with a more ‘selective’ approach depending on the risk profile of the project. The market outlook for other key construction policies, such as professional indemnity, is getting clearly harsher. The claims loss ratio of a client´s programme will most definitely determine their terms,” said Mr Bowcott.

The broker pointed out, however, that construction risks are long tail, so claims typically impact three to four years after policies have been issued. This explains why construction market trends are usually behind other short-tail line of business, such as property, he said.

One area of concern for Mr Bowcott is performance security. “We are seeing mounting concerns that there could be a construction capacity contraction occurring and this is in the face of growing demand for construction. If capacity can’t keep up with demand, it could lead to a credit contraction – making it harder to obtain current terms for performance security products like surety and subcontractor default insurance,” he explained.

Mr Bowcott also said there has been more attention on safety and risk management in the construction sector during recent times.

“In the last five years, there has been a large influx of new technologies available for contractors that help improve safety on site. Adoption of these technologies is moderate thus far, but we expect it to accelerate as pressure increases on contractors to provide a safe workplace, especially when competing for skilled labour,” he concluded.