Can tough love rebuild the construction market?
The contractors' liability insurance market in the UK is going through wrenching change...
In the last six months alone, insurance premium rates have significantly increased after a prolonged soft market. Smaller risks in particular are struggling to attract cover. And some exposures, particularly in fire cladding and fire prevention such as compartmentation systems, have become virtually uninsurable.
As Interserve, Dawnus and Paragon Interiors follow hard on Carillion's heels into administration, we look at why the construction industry has been brought low and how some 'tough love' from insurers could help restore its reputation and prospects.
Over-capacity emboldened clients to drive down pricing
Historically, there has been over-capacity in the contractors' market with too many companies chasing too little business. This has enabled clients from both the private and public sectors to pressure contractors into reducing their pricing. The result has been a squeeze on margins so fierce that the top 10 contractors' margins fell below 0.5% in 2018.
This pressure has not only affected margins, but also the assumption and allocation of risk. Following the 2008 banking crisis, contractors that considered themselves adept at delivering complex civil engineering projects bid aggressively to win large engineering, procurement and construction (EPC) contracts, such as waste-to-energy projects, after other work dried up. There was a tail wind blowing as the UK government pumped money into waste-to-energy. However, many firms found themselves signing up to contract terms they did not fully understand to deliver complex industrial projects they did not have the skills to co-ordinate.
They often found the supply chain was more complex than they had anticipated and inputs, such as household waste and biomass in the case of waste-to-energy, were more varied than the contract terms envisaged. Inadequate management resulted in project after project being delivered late, over budget or unable to meet the performance specifications written into the terms of the contract. As a result, the waste-to-energy sector has acquired such a poor reputation that firms of all sizes now struggle to attract finance..
Risk shift from client to contractor
However, responsibility cannot be laid entirely at the contractors' door. Clients, and in particular government, can also be considered partly to blame for the current parlous state of the market.
After the financial crash, a national policy of austerity created an extended period in which the UK government effectively sought to procure assets below sustainable levels. The construction industry was not the only sector to suffer, with the impact also being felt in other areas such as the prison system and parts of the transport network.
Undoubtedly, this focus on cost over value was damaging to many parts of the economy, but in the construction sector it was further exacerbated by more recent events.
Grenfell was the nadir
Since the tragic summer's night in west London in 2017 when a blaze destroyed the Grenfell Tower, a whole raft of systemic issues within the construction industry has come to light.
These issues include the widespread use of cladding panels chosen primarily on cost rather than performance grounds, the use of insulation that falls short of building regulations, and fire compartmentation systems that were never installed. Rather like the Edinburgh schools tieback issue in 2017, in which shoddy construction resulted in a wall collapsing and 17 schools temporarily closing due to safety concerns, Grenfell seemed another tragic case of 'out of sight, out of mind'.
There is plenty of blame to go round. Ultimately, Grenfell demonstrates how terrible the consequences can be when an industry and its supply chain attempt to deliver against unrealistic contract terms on behalf of a customer prepared to condone a regulatory system that lacks clarity and a building inspection system that lacks independence and rigour.
How can the insurance market make a difference?
The insurance industry is not without blame here either. Underwriters have taken on risks created by professionals who have specified products now known to be unfit for purpose. We have provided cover for private companies employed to inspect construction work in progress, or certify a final building as being fully compliant with regulations, despite questions circulating for years about the independence of such entities. This means, quite legitimately, that a great deal of the costs to rectify these issues have been borne by the professional liability market.
But having learned the error of our ways, we have no obligation to carry on accepting these risks. In the same way that the construction all-risks market subjects projects to a thorough survey regime, greater insurer due diligence can be brought to bear in contractors' liability. More granular examination of the professional and commercial risks assumed by contractors would mean excluding some risks. But it would also support contractors to enforce higher standards, and therefore pricing, on others.
It is even possible that a lack of financial guarantees from willing insurance partners could bring an end to poor practice in the broader construction market as it did in the waste-to-energy sector.
As insurers, we always seek to work closely with clients. If, as a market, we have to play tough in order to help contractors achieve better pricing and risk allocation, this might not be a bad thing. At Beazley we are now taking the lead in forming an industry working group to ensure a more joined-up approach and to drive best practice going forward.
The contractors' professional liability market is broken. In finding ways to fix it we will ensure that we are able to perform as a strong and stable partner through hard times as well as good.