Lockton | Market Update

Construction - U.S.

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The U.S. construction insurance market continues its downward trend amid reduced net written premium and modest underwriting losses. Despite the anticipated decline in investment income, the market for commercial insurance remains soft. Among major markets, certain insurers have been the focus of speculation regarding their financial health, including AIG, XL, Hartford, and Liberty Mutual. It is important to note that all of these insurers continue to remain on Lockton’s approved list.

Looking ahead, the insurance market faces several challenges as rates decline and losses develop in the backdrop of a worsening economy with construction feeling most of the pain.

Insurance Market—Challenges for 2008 and 2009

The U.S. property/casualty industry’s net profit plummeted 57 percent to $13.9 billion in the first half of 2008, driven primarily by premium erosion, deteriorating underwriting results, and weaker investment returns. In addition, the industry’s performance was negatively impacted by significant underwriting losses in the mortgage and financial guaranty segments, driven by the fragile state of the housing and mortgage markets across the country. Annualized after-tax return on equity fell to 5.4 percent for the first half of 2008.

Net Premium Written fell slightly to $222 billion through the fi rst half, driven by across-the-board softening in most personal and commercial lines; leakage of premium to non-U.S. insurers; and growing interest in alternative forms of risk transfer.⁽¹⁾

As previously noted in the Spring edition of the Lockton Construction Update, the combined ratio during the last two years was very profitable for the insurance industry mostly due to the mild hurricane seasons. However, we are beginning to see market conditions deteriorate. A.M. Best reports the property/casualty industry experienced modest underwriting losses through the first quarter of 2008 after posting underwriting profits over the previous two calendar years. The industry’s overall combined ratio deteriorated to 99.2 during the first half, up from 93.0 posted in the same period of 2007.

Regulatory and legislative risks look to continue its active pace into 2008. 2007 was one of the most active years for the industry on Capitol Hill which included a record number of Congressional hearings on a multitude of issues. Additionally, some states continue to attack the right of insurers to use certain well-established underwriting criteria, despite the fact that such criteria are accurate predictors of future loss and result in a rating system that is more equitable for all policyholders.

And recent court rulings related to construction continue to emerge and will adversely impact coverage for contractors.

The Appeals Court in the State of Washington found the 2004 ISO Additional Insured Endorsement edition did not extend coverage for completed operations.
The California Supreme Court in Crawford v. Weather Shield Manufacturer—ruled a subcontractor has a contractual duty to defend a builder despite a jury determination that the subcontractor was not negligent. While favorable for builders, this is not the case for subcontractors.
California Assembly Bill 2738 will apply to all residential contracts entered into on or after January 1, 2009 and fundamentally alters contractual risk transfer. Contractual indemnity between the general contractor and subcontractors within these contracts will only be enforceable to the extent caused by the negligence of the subcontractor. In addition, the law imposes regulations on residential wrap-ups whereby the builder will not be able to enforce any contractual indemnity on residential projects insured under a wrap policy. The Bill also requires that the pricing of the wrap up insurance and the specifi c coverages need to be contained within the bid documents.

Construction Trends

New construction starts in August reduced 3 percent, according to McGraw-Hill Construction Forecast & Trends. The nonbuilding construction sector (public works, utilities) slowed after July’s strong performance, while residential construction continued its painful decline. On the bright side was improved activity for nonresidential construction which boosted 17 percent to $255.7 billion.⁽²⁾

What Do The Numbers Really Reveal?

The estimated non-residential building during the eight months ended in August increased 5 percent to $169,153 billion—see Year-To-Date Construction Starts chart below. However, looking at the numbers reveals more disturbing trends for the non-residential and residential construction sectors:

Projects are delayed or scrapped due to lack of construction fi nancing.
Continued decline in commercial construction down an average 20 percent.
Residential continues its abysmal decline at 38 percent.

Construction Market

The market continues to be soft as rates reduce for most all property and casualty lines of coverage with Workers Compensation and General Liability receiving the largest reductions from 10 - 20 percent on average. Broader coverage terms and lower deductibles are more prevalent and negotiable. Rate decreases vary by contractor type, safety, loss experience and geographic location.

However, the California Workers Compensation Insurance Rating Bureau (WCIRB) recommended an average 16 percent increase to the pure premium rates effective January 1, 2009. After consecutive rate reductions in California totaling 65 percent since 2004, the WCIRB justifi es the increase due to the growing trend in medical inflation. Even with the proposed increase, the average pure premium rate in California would increase from $1.68 per $100 of payroll to $1.95 which is still well below the $4.81 rate of four years ago.

Nationally, the underwriting process has become more detailed and financially driven. Submissions absolutely must have complete and credible information along with detailed explanations of large and unusual losses. Loss control surveys are also part of the underwriting process prior to quoting. A well presented and comprehensive submission will attract the most positive attention from underwriters.

Controlled Insurance Programs/Wrap-Ups

The CIP wave of the past five years has subsided due to the economy and sub-prime mortgage crisis. This varies by region with California the most impacted by the economy and overbuilding. This is in contrast to Texas and New York which still see a demand for residential and high rise construction, respectively. Condo projects have been delayed or shelved because of a lack of financing or lender restrictions. There has been some recover in recent months, although in general this is driven by smaller projects. The condo conversion market has also slowed significantly; however, more of these projects are strategically building as apartments and delaying the conversion to condos to take advantage of the surge in the rental income market. Mixed Use projects continue to be the exception and are more active and viable.

The Wrap-Up insurers continue to be aggressive with even more players in the liability only market. Including Builders Risk, Environmental and Professional Liability coverages rounds out the Wrap-Up package and depending on the construction type and site location, these markets have also been extremely competitive.

On select commercial projects, some owners and general

contractors are opting for traditional or non wrap-up insurance again due to the competitive market. Owners can also purchase Owner’s Interest Liability which provides excess liability coverage over the general contractor’s policy and subcontractor’s policies for the vicarious liability of the owner for exposures during construction and upon completion of the project for completed operations. This excess coverage is similar in concept to the Owner’s Protective Indemnity Insurance that provides excess professional liability over A&E policies.

Conclusion

Given the current status of many of the insurance carriers, contractors will need to be well positioned to both evaluate and possibly engage traditional and alternative markets. The construction market continues to be within a state of uncertainty and change in regards to both identifying and evaluating exposures of project design and delivery methods. Contractors need to continue to evaluate their contractual obligations, especially from the emerging construction methods and project delivery tools.

Currently the insurance markets are not well prepared to begin offering insurance solutions to many of these emerging issues. Thus, contractors should continue to remain diligent in their management of their contractual obligations and ultimate exposures—as workable insurance solutions are created within the industry.

The insurance industry faces a significantly more challenging environment for the remainder of 2008, due to a combination of deteriorating rate adequacy, loosening terms and conditions, a more challenging investment climate and hurricane losses. As stated before, regardless of the cyclical volatility of the U.S. insurance market, disciplined risk management should remain steadfast to avoid complacency during softer markets.

As noted in our overall Market Update, the increased catastrophe losses and investment declines will put pressure on insurers to raise rates.

Please contact your Lockton Representative for further information regarding any information contained in this market update.

	James L. Knoop, ARM Senior Vice President, Unit Manager Irvine, CA Tel: 949.252.4409 E-mail: jknoop@lockton.com
	Paul Primavera Senior Vice President, Claims Washington, D.C. Tel: 202.414.2620 E-mail: pprimavera@lockton.com
	Jody Wright Senior Vice President, Construction Department Manager Denver, CO Tel: 303.414.6002 E-mail: jwright@lockton.com

(1) Insurance Information Institute 2008
(2) McGraw-Hill Construction Forecast & Trends, August 2008