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Inside in Full: US construction in flux: Market assesses banking crisis, rising labor costs and a $1tn bill

US construction market participants have warned that the collapse of Silicon Valley Bank (SVB) and Signature Bank – and the potential for contagion to other regional banks – could impact both the demand for insurance protection and the loss profile of the class...

So far, the effects of SVB and the forced sale of Credit Suisse to UBS have been contained. However, construction executives expressed concerns about potential effects of a deterioration of the banking sector on both commercial and residential projects, and the knock-on effect on the insurance market.

On one side, as some developers use regional banks to fund their operations, contagion could lead to a decline in construction projects and demand for coverage, sources said.

In addition, a banking crisis could lead to a contraction in financing and available loans, which would potentially turn into higher losses in the sub-contractor default insurance class – which works similar to surety bonds – due to eventual contractor failures.

“[A potential contagion can] affect demand in the construction space and that can affect the exposure basis of our customers; that would affect how much premium we book and how much we grow our business,” said Vantage head of construction Jason Lamonica.

“So, the demand side is definitely affected by that.”



While the possible effects of banking contagion may just be warning signs so far, industry executives noted that the US construction sector is already feeling the pressure of higher interest rates.

Since H2 last year, the Federal Reserve has hiked interest rates by over 400 bps in an effort to tame rising inflation as the economy slowed down.

Sources noted that the higher cost of capital is changing the economics of projects, although this is mostly an issue in the private sector.

While publicly funded projects are also affected by higher interest rates, sources said public funds have continued flowing over the last months, making the increased cost of capital a bigger issue in the private sector than in public projects.

“We were already being approached before 2023, I would say fall of last year, with some of our luxury real estate developers around revisiting project pro formas,” said Aon construction and infrastructure chief commercial officer James Dunn.

“Updating insurance costs was certainly one of the things, but as they were reevaluating those financial pro formas for the asset, we were getting a lot of phone calls around: ‘We need to update our budgets’,” he added.

Overall, the changes in project budgets impact insured values in the construction space, similar to the trends seen in the property market.



Construction sector hiring

In late 2021, construction executives expressed concerns about the spike in prices of some commodities such as steel and lumber.

Sources said that higher prices are still an issue but as supply chain constraints ease, the problem in recent months has been mostly the volatility of costs rather than a constant rise in materials’ prices, which in turn creates volatility in the costs of insurance claims and loss trends.

“There's certainly not a consistent high price across the board,” said Lockton EVP national risk control services leader Paul Primavera.

“We're seeing a certain change at a project level for contractors, in which those materials are being ordered much earlier in the process than [...] historically.”

However, market participants also noted that labor costs are one of the prices that has continued with a steady upward trend, amid a skilled workforce shortage in the US and a change in demographics.

While this issue has been affecting the construction industry for years, some said it has been more acute recently as the industry has not been able to attract enough young talent to offset the executives who are retiring.




Aon construction and infrastructure head of casualty Cormac O'Connor said: “It's not just the price of labor, but the availability of labor.

“Sometimes it's a matter of geography. If you have a very high concentration, say, in the Gulf Coast, for major industrial projects there's a finite number of people that live in these regions or are willing to travel to those regions to work.

“The large industrial projects are seeing delays in terms of inflation just purely due to the availability of labor.”

All in all, the higher costs of materials and labor increase claims costs and loss trends in the US market.

Given the macro environment, rates in the construction class have showed mixed trends, market participants noted.

And while some rate increases have kept up with loss trends, the pricing dynamics in the US show a mixed outlook depending on the type of market or geography.



The $1tn+ infrastructure bill

While the banking crisis and labor inflation are areas of concern for the construction market, there are also reasons to have a bullish view on the sector.

The passage of a $1tn+ infrastructure package in Washington in late 2021 is fueling private projects and is expected to do the same for public construction in the coming months, sources noted.

The rise in infrastructure projects – both public and private – is expected to turn into additional demand for the construction sector and premium growth.

Around $550bn of the bill is to finance public infrastructure projects that have not taken place yet, as they involve a bureaucratic process that can take months, although sources say this year they could materialize in the form of public-private partnerships.

In addition, the bill includes around $280bn related to the CHIPS and Science Act – designed to draw semiconductor manufacturing back to the US – and around $370bn associated with the Inflation Reduction Act (IRA) and clean energy projects. Those two are already materializing through the private sector, sources said.

While CHIPS is expected to have an impact on Texas, Arizona and Nevada, the IRA effect will be more spread out across the US, sources said. California, Florida, Illinois, New York and Texas are anticipated to be the states that feel the most benefit.

“We are certainly seeing increased CapEx spending,” said Marsh’s US construction practice leader Rob McDonough. “We see great growth in the streets, road and bridge section, and we also think about larger broadband and mass transit projects, rail projects etc.

“Those would be some areas we see outpace growth for construction in 2023 and 2024,” he said, adding that EV manufacturing facilities and battery plants are other areas of expansion.

This spike in commercial construction is expected to outweigh the slump in residential projects, which have been affected by rising interest rates and a slowdown in population growth.

According to a report by Oxford Economics and Aon, construction projects in the residential sector grew by an average 7.3% a year over the decade to 2022, mostly fueled by work undertaken during the recovery from Covid-19 which boomed by 25.6% in 2021 alone.

However, Oxford Economics expects a reduction of $150bn in residential construction work over 2022 and 2023 before growth resumes in 2024.


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