BLUEPRINT GLIMMERS OF SUN FOR CONSTRUCTION WHILE CLOUDS GATHER FOR INSURANCE CARRIERS CONSTRUCTION PRACTICE THE CONSTRUCTION INDUSTRY

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1 CONSTRUCTION PRACTICE BLUEPRINT March GLIMMERS OF SUN FOR CONSTRUCTION WHILE CLOUDS GATHER FOR INSURANCE CARRIERS The construction industry and the insurance industry have in common a future full of uncertainties, struggles and competition where every penny counts. While 2011 was initially thought to be the year when some degree of normalcy would return to both industries, we found in fact that the recession/depression had more legs than expected. Maximizing opportunities in challenging times will require communication and cooperation among risk managers, brokers and carriers. THE CONSTRUCTION INDUSTRY On the construction side, some forecasters predict that 2012 will be marginally better, but it s clear that big segments of the industry will not recover for an extended period of time. Residential building, the key driver in growth until 2007, has shown small signs of improvement. In 2012, slowly improving economic and underlying housing market conditions will encourage a modest 7% increase in construction starts to 435,000 units. The Mortgage Bankers Association indicated that the increased lending was led by insurance companies, who, during the fourth quarter of 2010, originated more commercial mortgages than any quarter since (Source: McGraw-Hill Dodge Construction Outlook Report) At the same time, lending by banks has essentially remained flat though that might be changing as there appears to be increased interest in funding opportunities. For example, J.P. Morgan Chase has approximately a billion dollars of construction loans in its pipeline, a threefold increase from 12 to 18 months ago, according to one report. (Source: McGraw-Hill Dodge Construction Outlook Report) In 2011 The American Institute of Architects (AIA) reported some increase in billings, but it was small and there is little indication that billings will substantially increase in To put this in perspective, design billings typically translate into increased construction activity 9 to 12 months later. Lending restrictions continue to impact the construction sector for both private and public sectors. These restrictions are also affecting both large complex projects and smaller projects, including commercial and institutional categories. At the same time, there are pockets of activity which give some cause for optimism, including health care, multifamily residential (apartments) and technology. There has also been a notable increase in discussions on alternative project delivery approaches, including private public partnerships. This trend appears to be gaining momentum as both state and federal governments struggle to fund needed infrastructure construction. On a broader basis, uncertainty on the political front, particularly as respects government spending on construction, continues to dampen expectations, and many expect little change until after the November elections.

2 Limited opportunity has created extraordinary competition for new construction projects. Many construction firms are responding by pursuing projects in new regions of the country and in new segments. In addition, many firms have turned their attention to the public works market where bidding is the norm, resulting of course in a significant rise in the number of bidders. This, along with fewer but much larger jobs, has increased joint venture activity as contractors look to complement their skills and geographical range to differentiate themselves and reduce risk. Lending restrictions continue to impact the construction sector for both private and public sectors. These restrictions are also affecting both large complex projects and smaller projects, including commercial and institutional categories. At the same time, there are pockets of activity which give some cause for optimism, including health care, multifamily residential (apartments) and technology. Fewer jobs also give rise to a trend towards more difficult contract terms with more liability being pushed down on contractors and sub contractors. This in turn requires more rigorous contract review to understand what may be beyond the reach of traditional insurance policies. We examine these trends in the remainder of this update and encourage dialogue between the contracting parties early in the process to ensure clarity of risk allocation and provide appropriate tools to address those taken. Finally, from a risk and contract perspective, construction defect claims and changing legislation, particularly in regard to Anti Indemnity statutes, will create challenges for all contractors as carriers adapt to these changes and amend policy terms. THE INSURANCE INDUSTRY The insurance industry is facing, to name a few, lower investment income returns, loss ratios over 100% (2011 being the worst year on record for natural catastrophic events), civil unrest in the Middle East and the deepening economic crisis in the Eurozone. As a result, insurance carriers are pushing for rate increases across most lines of insurance. This will be more prevalent for risks with high frequency/ severity claims across all lines and catastrophic insurance in Tier 1 locations for property. We expect 2012 to be a transition year with rate pressures motivating frequent dialogue with the markets on expectations and to allow all construction players to plan for potential costs differences in the future. With this background, Willis surveyed its Associates on construction accounts renewing at the end of 2011 and the first part of 2012; there are clear indications that the rate changes mentioned are not specific to lines of business but are broadly across most lines of coverage. Those results parallel our expectations by line for INSURANCE RATE FORECAST Rates for property and casualty continue to trend upward, but by no means are we calling this a hard market. Incumbent carriers continue to push for rate increases. Guaranteed cost programs (policies without retentions) are experiencing the highest rate increases. Loss-sensitive programs are receiving slightly lower rate increases. Some consumers are procuring higher retentions to offset the rate increases. 2 Willis North America 03/12

3 U.S. REGIONAL OVERVIEW Western region is experiencing the largest rate increases; Midwest, Southeast and Northeast regions are experiencing the lowest rate increases. WORKERS COMPENSATION Nationally many carriers are increasing their rates. Key drivers are industry-combined ratios in excess of 110%, low investment return outlook for the next few years and medical cost inflation in the range of 5%-12%. While some of our construction clients are experiencing flat renewals, others are experiencing rate increases of up to 10%. Use of deductibles continues in an effort to achieve cost savings, but collateral needed by carriers as they hedge their counter party risks is driving buyers to consider alternative approaches, including guaranteed cost programs. GENERAL LIABILITY This line of coverage is showing the most volatility driven by construction defect exposures and various state litigation trends. At the same time there are a number of carriers underwriting this line, which tempers the rate increases most say are needed. GL requires a significant focus on achieving appropriate coverage as carriers have different forms. In particular, key coverages including appropriate Additional Insured endorsements, Other Insurance clauses, Amended Definition of Property Damage to address construction defect and business risk are all critical to achieving the best coverage possible. While the market for General Liability is global, U.S. underwriters still have a significant majority of the placements. EXCESS/UMBRELLA LIABILITY The majority of our 1/1 renewals experienced a flat to 5% increase. Some did experience greater than 10% increases but this was driven by losses. The carriers for this line are more varied than primary GL and include significant London and Bermuda-based capacity. Follow form excess policies are becoming more popular to assure coverage consistency from the heavily negotiated GL placements. Limits available are more than $500M if needed with most of the larger contractors carrying $25 to 100M. AUTO LIABILITY Renewals are stable at this writing. Most 1/1 renewals experienced flat to 5% increases. Markets are typically the same as GL and WC carriers. PROPERTY 2011 was a challenging year due to global catastrophes and the carriers resulting loss ratio, reinsurance rate increases and RMS 11.0 model impact to name a few causes. Many clients are experiencing increases of up to 10%. Flat renewals are considered a good result, and any price decreases are not to be expected. Claim history and CAT continue to be key drivers with rate. A few trends we are seeing from carriers include quotes with the following: Losses related to Contingent Business Interruption/Supply Chain, resulting in greater underwriting scrutiny CBI/CEE coverage excluding Flood and Earthquake in CAT areas CBI/CEE coverage being reduced overall Service Interruption coverage excluding Flood and Earthquake in CAT zones Ingress/Egress and Civil/Military Authority coverage being cut back Unnamed location limits being reduced in CAT areas 3 Willis North America 03/12

4 BUILDERS RISK 2012 expectations for the builders risk market is different from that of the general property market. Capacity is still very strong; both domestically and internationally, while construction volume is still not at a level to support the capacity and appetite. Our 1/1 renewals support this fact, as most renewed with flat rates and expiring terms and conditions. As with property, claim history and CAT exposure will significantly impact rates, deductible levels and sublimits. PROFESSIONAL LIABILITY In the construction professional liability market, capacity continues to be strong with new players entering the market in This has helped create a continued competitive price market. However, there is pressure in the broader professional liability marketplace to increase rates, and some markets are seeking across-the-board rate increases on construction professional renewals. Based on competition from new players, rate increases may be hard to generate. In addition, we expect good demand for project professional liability from both contractors and owners. Lack of capacity and very high rates for project-specific professional liability policies for architects and engineers have created increased demand for the project-specific protective indemnity coverage for contractors and owners. The increasing focus on alternative delivery methods, such as IPD and 3P, will continue to drive the demand for customized professional liability project policies. Contractor Professional Liability renewals from December (2011) and January (2012) showed varied results. Some of our clients experienced rate reductions of up to 5%, some rate increases of up to 5% and some were flat. Clients experiencing rate reductions were marketed. Increases were not impacted by claim activity or change/increase in risk but were rather carrier imposed. ENVIRONMENTAL Competitive terms and pricing continue with respect to the base coverage forms of Contractors Pollution Liability and site-specific Pollution Legal Liability insurance. However, prices are up for select risks. Breadth of product offerings, capacity and underwriting appetite differ dramatically from market to market. In some cases, new forms are being developed or coverages are being added to existing pollution policies; in others, coverage terms are being limited. Given the plentiful capacity in the market, many insureds are implementing layered program structures. Increased writings and the development of longer-term policies placed in prior years continue to drive an increase in claim activity among the various product lines. PROJECT INSURANCE (WRAP UPS) Although insurer interest has expanded somewhat in the past two years, a few factors determine the number of markets that will be interested in any particular project. Specifically, sponsors are now asking more questions before placing their business and developing strategic partnerships with insurers which may have questions regarding their financial condition or are facing rating challenges. Since CIPs provide coverage for multiyear construction projects and include extended completed operations coverage for an additional 10 years or statute of repose, whichever is less, this becomes a key factor in determining the appropriate carrier for a project. Before discussing carriers in this market, a few key points are helpful in thinking of the project marketplace: The decline in numbers of major projects over the last year has increased competition. This is true in most types of construction. With a better understanding of litigation trends, including defective work allegations, liability policies have evolved to include coverage 4 Willis North America 03/12

5 through the appropriate state statute of limitations, which effectively closes a much discussed potential gap in older wrap-up programs. The current market will create more opportunity for publicly funded major projects, which in many cases, were not previously insured via wrap-ups. Current trends indicate that these larger jobs may now be considered for wrap-ups and/or project insurance to address a variety of perceived challenges, including funding, coverage consistency and support of disadvantaged businesses. Rate of Impact on Current Renewals Down more than -10% Down -5% to -9.9% Down -0.1% to -4.9% Flat Master Builders Risk Property Excess/Umbrella Liability General Liability Auto Liability.01% to 4.9% rate increase Workers Compensation 5% to 9.9% rate increase 10% or more rate increase 0% 50% 100% % of Responses 5 Willis North America 03/12

6 SUMMARY In spite of strong capacity, continued competition for market share and a still struggling construction sector, most carriers are pushing for rate increases. Due diligence is required on the part of risk managers for renewals and project-specific insurance. We are seeing many trends with the carriers, such as underwriters approaching each risk with more scrutiny, more home office referrals, and reinsurance costs are increasing. Willis recommends a detailed and strategic plan with clear objectives and goals when renewing and marketing your programs. We also recommend meeting with your carrier partners in advance of renewals to discuss in detail any material changes to the risk, exposures, key personnel, budgets, pipeline, etc. to ensure the most positive underwriting result. CONTACT To find out more about how Willis can help build a program for you, contact your Willis Client Advocate or: Tim McGinnis Willis Construction Practice tim.mcginnis@willis.com For past issues of our publications on other topics of interest, please visit the Willis Construction Practice website. Willis is the leading construction broker in the world. With more than 800 construction Associates in North America in 60 offices, we offer unparalleled expertise to the construction industry locally, nationally and globally. Our clients range from local contractors to international integrated firms. The observations, comments and suggestions we have made in this publication are advisory and are not intended nor should they be taken as legal advice. Please contact your own legal adviser for an analysis of your specific facts and circumstances. 6 Willis North America 03/12