Fixation on rate will drive the sustainable recovery of the US construction sector

inline-icon-clock 5 MIN READ 25/06/20

Paul Jansen Director / Founder / Head of Construction
inline-icon-clock 5 MIN READ
Paul Jansen Director / Founder / Head of Construction

Fixation on rate will drive the sustainable recovery of the US construction sector

Like every sector of all economies, US construction has been hit by the global pandemic. Commercial and residential projects have been impacted differently, but neither has been entirely immune to government measures to prevent the spread of COVID-19. With pressures now easing as restrictions are relaxed, recovery is on everyone’s mind.


From the outset of the quarantine, the Department of Homeland Security designated residential construction an essential infrastructure business. That allowed work to continue unless state governments chose to override the federal judgement, which a few did. The shorter-term impact is not yet clear in every case, and construction activities remain limited in several states.


The ultimate impact on homebuilders will depend on the depth and duration of the recession which seems likely to follow the pandemic. Demand for new housing always falls during recessions, no matter what caused them, and the effect of the current crisis is unlikely to be any different. In any case, US demand for newly built single-family homes has already plunged, and is recovering only slowly. According to the National Association of Home Builders – Wells Fargo National Housing Market Index, after a relatively steady rise since the market recovery in 2012, the index fell 42 points between March and April 2020, to just 30, and had recovered to only 37 at the end of May, a level not seen for nine years.


Insurers underwriting construction business are obviously sharing the pain of this slowdown, as the number of home starts has tumbled and many existing projects have ben delayed. That can result only in reduced written premiums for 2020, even if the market makes a full and swift recovery. The longer the lockdown, the greater the decline will be.


Even prior to the pandemic, construction insurance had been entering a hardening market phase. Underwriters had effected across-the-board pricing increases in response to a sustained slump in insurer profitability and, more recently, the significant reduction in overall market capacity it caused. Underwriter appetite fell both for primary and excess residential construction risks.


We expect this rising pricing trend to continue in almost all classes and lines of business, including construction. Reductions in volume caused by the pandemic are unlikely to reverse the trend, since price adequacy for risks in the construction sector has been under scrutiny since at least 2018. A rate correction was necessary to ensure the market can achieve a positive return on capital.


Part of the need for price increases was driven by the seemingly relentless trend of increasing jury awards and other settlements with third-party claimants under construction-related legal actions. This trend too extends well beyond the sector, and has affected underwriters in most lines of business. No end is in sight.


It is unclear how these factors – sluggish demand, rising insurance prices, reduced capacity, and increasing claims – will interact to affect the fortunes of construction insurers in 2020, we have recent experience of the impact of housing-market recessions. Increased losses were widely expected to accompany the 2008-2012 slowdown, but our own results improved. The lower number of projects undertaken seemed to yield a greater focus on high-quality work, which was carried out by a smaller, more experienced construction workforce.


That outcome is obviously attractive to insurers and home-buyers alike. If the pattern is repeated during and following the pandemic, however, it is unlikely to reverse the rising price trend. The correction had been needed for many years before COVID-19 altered market dynamics, so a return to ‘normal’ is therefore unlikely to derail it.


Insurers’ intent to price for profitability, rather than market share, will of course have a significant impact on the outcome. It will be of paramount importance to achieve adequate returns for insurers active in US construction risks. Without such returns, more insurers are likely to exit the multi-billion dollar sector, which would create even bigger problems and higher prices after the virus has subsided. In contrast, should new entrants be attracted to construction risks as pricing moves towards viable risk-adjusted prices, they could temper the recovery. This happened in previous market cycles, but the rhetoric of new carriers has been solidly focussed on price adequacy.


The longer-term impact of Coronavirus on the construction class will vary dramatically based on the duration of the changes to construction schedules. If the disruption was to end tomorrow, the impact would be only marginal, with negligible impact on construction insurers. Some projects have been delayed beyond their estimated completion dates, and some supply-chain delays may linger, but we expect they will be manageable.


However, a reversal of the current trend to relax quarantine requirements, which could follow a ‘second spike’ in Coronavirus cases, would have a much wider impact. The risks that project remobilisation times are dramatically extended and supply chain issues multiplied could be complicated by the bankruptcy of smaller subcontractors. That would lead to significant delays which would be likely to creating serious project-completion issues for owners, general contractors, and subcontractors, and result in further subcontractor insolvencies and mothballed projects. A delay of a year or more, which would probably cause a broad and severe recession, would devastate the subcontractor base and probably cause loan defaults leading to bank repossessions, as happened in 2008-2012.


Fortunately renewed measures to halt the spread of COVID-19 in the US now seem much less likely, although recession seems probable. Despite the residual unknowns, the cost of insurance for US homebuilders, prices are set to rise throughout 2020. The result will be a leaner, stronger insurance sector in rude health to support clients into the post-virus future.


This article was originally published by Insurance day on 24/06/2020, see original post here.