Housing starts across the country are at an eight-year high, as builders ramp up the construction of new residential homes. Non-residential construction of commercial buildings like office complexes and hotels also is on a tear, up 8.9% through most of 2015.
The rebound in the construction sector is good news for the U.S. economy as a whole—and it’s also a positive sign for insurance companies and agents serving this broad market, composed of general contractors and the constellation of subcontractors serving them. The most recent Future One Agency Universe Study confirms that construction is a key market, identified by agents as among those “holding the most revenue opportunity.”
But this market also presents dramatically complex risk dynamics.
The threat of huge losses has made standard insurance markets in many states less than eager to insure general contractors and even subcontractors. Typically, excess and surplus lines carriers are the only markets available to agents. And complicating matters further is the extreme volatility of the construction sector: When national unemployment increased to 9.7% at the outset of 2010, unemployment in the construction sector skyrocketed to 24.7%.
But hardy agents who want to create or build a book of business in today’s fast-growing construction market can do exceedingly well financially, given high commission revenue on very large insurance programs.
“Construction is the Ph.D. of insurance,” says Ron Hernbroth, senior vice president in the Pleasanton office of BB&T Insurance Services of California, who has spent his entire career serving the sector. “One does not tread lightly into it.”
A Tough Nut to Crack
Serving the insurance needs of the construction industry is a double-edged sword: It requires a fair amount of specialized skills for a market that can implode overnight. During a downturn, an agent can’t sit around waiting for housing starts to rebound—which requires producers to be both specialists and generalists, relying on more stable markets when boom turns to bust.
“Agents with a big book of construction business would not want to bet the farm on it, and most don’t,” says Robert Hartwig, president of the New York-based Insurance Information Institute, who notes that overall construction activity collapsed by 55% and new home construction alone fell by 72% during the economic downturn. “If an agent’s entire business is focused on this sector alone, trouble awaits.”
Diversification is critical for weathering rough patches, according to agencies that have a sizable book of construction business. Dirk DeJong, CEO of Furman Insurance in Pompano Beach, Florida, says about 60% of his 65-employee firm’s operations focuses on serving the industry. “It was tough here during the recession,” he says. “Construction is not real exciting when it goes backwards. We probably had a 30% reduction in premium.”
The firm preserved its workforce without any layoffs thanks to the other 40% of its business. “We’ve worked hard to prepare for the cyclicality of this market,” DeJong says. “We’ve analyzed our [construction] business over the past 45 years and can clearly see the rise and fall in activity. Things are really good now—we’re in the midst of an incredible boom here in southern Florida—but we know the good times won’t last forever.”
Construction activity is also on an upswing in central Kentucky, where Carolyn Reynolds, principal of Reynolds Insurance Agency Inc. in Richmond, says student houses and condos are going up around the University of Kentucky and at Eastern Kentucky University. “We’ve got two office locations, and both are doing well from the increase in building,” she says. “Students want to live off campus in apartments and retirees are downsizing into condos. Things have picked up considerably.”
What hasn’t picked up is standard market interest in writing the new business. “We’ve experienced quite a number of wind, hail and other catastrophic weather events like ice storms over the past three years,” Reynolds says. “A lot of the carriers that wrote general contractors say they will no longer take them as new business.”
This leaves few options other than the pricey E&S lines market. According to Reynolds, underwriters of apartment buildings estimate the premium for replacement costs in the event of building damage or destruction at $80-85 per square foot—when in reality, “it may have cost the builder $55-65 per square foot to construct the building,” Reynolds explains. “If the builder has had past claims, the costs are even higher.”
Fires and Floods
In Florida and California, two states especially at risk of catastrophic disasters like hurricanes and earthquakes, the insurance situation is much worse. “The standard markets vacated this area 25 years ago,” Hernbroth says. “That left the surplus lines carriers to absorb the brunt. Then, they lost their stomach in the wake of lawsuits from plaintiff attorneys representing large condo and townhouse homeowners associations. It got to the point where the market would no longer write framers, electricians and other subcontractors on a one-off basis.”
The market’s trepidation stemmed from the difficulties determining responsibility for construction defects that appeared years after a structure was completed. In California, attorneys have a 10-year period in which to file such claims. Hernbroth says “it’s the housing equivalent of ambulance chasing.”
“Attorneys would sit down with a homeowners association eight years after a building was finished and point out that they had less than two years left to sue for any defects,” Hernbroth explains. “They’d state that there was a very good chance that something had broken, and then offer to do ‘destructive testing’—removing parts of the drywall in the hunt for water leakage. If they found even a minor leak, they’d file a full-blown lawsuit going after everyone’s insurance—the roofer, the plumber, the window installer, and so on.”
Which subcontractor was at fault was less important than which one had the highest financial limits of insurance, Hernbroth says—“assuming the carrier was still in business.”
The lawsuits would drag on for months and years in many cases, resulting in exorbitant legal defense costs. To solve the dilemma, California was the first state to introduce Owner Controlled Insurance Programs (OCIPs) in the late 1990s.
The unique insurance policy is designed to cover virtually all liabilities and related losses arising from a construction project. Rather than the general contractor and the subcontractors purchasing their own separate insurance policies, the owner of a property, or in some cases the general contractor, buys the OCIP, which names all the parties as additional insureds. Subcontractors must formally enroll in this wrap-up program for the OCIP to be activated. While the owner or general contractor puts up the initial premium, the subcontractors participate in these costs based on the amount they used to pay for their own insurance.
The new insurance concept prompted the E&S lines market to return to the business. “We’ve got about a dozen surplus lines carriers now to draw from on the primary side, and maybe four or five that provide the excess insurance,” Hernbroth says. As for the standard markets, “once burned, twice shy.”
DeJong says much of the same hesitancy among standard insurers is in play in southern Florida. “They’ll insure commercial construction of warehouses and large manufacturing plants, but they’ll have nothing to do with condominium and apartment construction because of the risk of defects and aggressive litigation,” he says. “It’s just too volatile. Carriers know they’ll get hit whether or not their policyholder is at fault. Why roll the dice?”
Fortunately, the E&S lines market has picked up the slack in the Sunshine State. “We have a new per-project insurance policy for condo associations that require contractors to pay premiums over the 10-year period in which a construction defect is insured,” DeJong points out. “That assurance has increased the industry’s willingness to provide cover.”
In Kentucky, Reynolds says a handful of standard carriers will write general contractor risks, but only after taking a deep dive into the insurance applicant’s loss history and business practices. “I’m not going to sugarcoat it—this is a very tough market,” she says. “We’re now seeing problems with regard to ‘green’ buildings, which a lot of people here want.”
The well-insulated houses and buildings may end up being too tight, reducing air circulation, she explains. “If a house can’t breathe, mold can develop,” Reynolds says. “The homeowner then goes after the insulation contractor. That’s made it difficult for that trade to find standard market insurance—a problem it didn’t have before.”
Contractors in other states that don’t have problems are likely to have them in future, Hernbroth says. “I received a call last week from an agent in the Midwest who had heard that I write OCIPs, and he said construction defect lawsuits there were on a steep rise,” he explains. “They never had them in past, but now it was becoming a problem. That tells me the infection is spreading.”
But standard carriers like Liberty Mutual Insurance and Travelers counter that they continue to write construction accounts on a regular basis and are always open to working with agents on providing insurance solutions.
“We work with many general contractors, but construction is a very complicated and complex industry,” acknowledges Mike Myers, division underwriting manager at Boston-based Liberty Mutual. “We recognize this fact and have assembled a group of specialty underwriters who get very involved in the details of each account. They’re experts in the market and work closely with the specialty claims and risk controls specialists we also bring to the table.”
Independent agents and brokers who want to build a book of construction business must be willing to learn the many nuances of the building trades and the insurance markets that serve them [see sidebar].
As agents learn the ropes, DeJong and Hernbroth strongly urge them to develop a comprehensive knowledge of construction contract law. “You have to be able to read contracts because the devil is in the details,” Hernbroth says. “An OCIP is not an off-the-shelf general liability insurance policy. You have to tweak them.”
But this is one niche where hard work can pay off. “I’d say the best thing to do is find someone who is an expert in this area and learn under them until you, too, are an expert,” Hernbroth says. “Not a lot of people can handle the challenge. But the cream always rises to the top.”
Russ Banham, a Pulitzer-nominated business journalist, has been an IA contributor for more than 25 years.
To learn the construction market, the International Risk Management Institute (IRMI) is a good place to start. Each year, IRMI brings in about 1,500 construction project owners, general contractors, subcontractors and insurers to explore ideas and techniques to improve risk management and fine-tune insurance coverages. The institute also offers a robust curriculum addressing the construction industry.
And it may be advisable for agents to get their feet wet in serving the sector before diving in. In this regard, Chris Murphy, chief underwriting officer, construction services at Travelers, advises starting with surety insurance. “If a young agent can become schooled up on surety, it’s a good entry point into the rest of the business,” he explains. “But it does require some knowledge and expertise.”
Murphy recommends that agents reach out to the National Association of Surety Bond Professionals, which is both an association and educational resource for surety bond producers and allied professionals. —R.B.