2020 brought many industries to a standstill, including construction. This was due to the COVID-19 pandemic causing major disruptions in the shipping of raw materials.
This led to manufacturing issues, ultimately resulting in a shortage of materials. The situation did not improve in 2021, in particular with the incident on the Suez Canal, the consequences of which, could last for years. More recently, the war in Ukraine, in particular, has caused energy shortages; energy being required for the manufacture of construction materials.
This situation may cause concerns for insurers, who could be facing an increase in claims against construction professionals in particular, primarily due to the resultant price increases.
Shortage of materials: from temporary to a structural issue
It is no secret that COVID-19 disrupted all manufacturing circuits but the disruption was not expected to last this long. Whilst the French Government predicted that shortage of materials caused by the pandemic would not last beyond the third trimester of 2022, it is still very much present and has even worsened with the global events of 2021 (the Suez Canal crisis) and 2022 (the war in Ukraine, the rise of COVID-19 infections in China).
Construction professionals have no visibility of the end situation which should reach its pinnacle by December 2022. This is due to the war - Russia supplying 80% of French aluminium needs (used for carpentry) and Ukraine being one of the most important exporters of steel in Europe.
The main consequence of the shortage of materials: a significant increase of construction costs
Prices have been continuously increasing for the past months, with no end in sight of the resulting inflation:
- The cost of materials is currently subject to high volatility, increasing the cost of construction projects by 40% to 50%.
- Whilst quotes issued by manufacturers used to have a one month validity duration, it has been brought down to 15 days in light of important fluctuations of raw materials prices.
- Since January 2020, steel prices have increased by 80%, aluminium by 60%, and concrete by 7%.
- Cost of transportation has quintupled since 2020.
- The increase in energy prices (because of the war in Ukraine) will seriously impact the price of manufacturing construction products.
As a result, construction professionals can no longer control and manage their construction projects. Presently, three quarters of all construction programs in France are behind schedule due to delays in the delivery of materials. Given the urgency of the situation, the French Construction Federation has called on the government for assistance, absent which, an important number of companies are expected to file bankruptcy in the short term.
The impact on the insurance landscape
In construction programs subject to financial guarantees of achievement and guarantees of delivery (the purpose of both being to finance the completion of works mainly when the insured promoter of a given construction program is in financial default, i.e. financially unable to complete the works), the promoter shall determine the cost of construction prior to selling the lands, as well as the cost at which it will sell the program (i.e. including its potential margin).
However, the continuous upward variations in the cost of materials could possibly result in the cost of construction being higher than the cost of sale. This will lead to the promoter’s financial default and the application of the abovementioned guarantees with the insurer having the obligation to finance the works regardless of their cost.
The increase in prices could also lead to construction companies trying to save costs by any means, by using cheaper materials or by implementing inappropriate construction techniques. This could result in defective works triggering other types of insurance contracts such as damage to works coverage (taken out by the project owner) and decennial/civil liability coverage (taken out by construction companies).
Alternatives available to construction companies but which could also possibly generate claims
As alternatives to the shortage of materials, construction professionals could turn to other solutions, such as:
- Reconditioning solutions.
- Using renewable energy sources.
- New construction techniques using new materials, such as bamboo, chaff, composite concrete, etc.
- Limiting the use of materials by adapting construction processes. The use of prefabricated insulated panels saves significant quantities of wood.
Although these solutions could possibly thwart the shortage of materials issue, experience shows that it could lead to other insurance claims due to the construction professionals’ lack of experience with said solutions and/or lack of expertise of the new techniques.
Whilst the shortage of materials could lead to a multiplication of insurance claims, the use of the abovementioned alternatives raises concerns from an underwriting perspective as the ‘non-standard’ construction techniques involved, generally come with high risks. As a result, insurers may tend to provide exclusions of some of these ‘non-standard’ techniques or simply refuse to cover them (when they accept, the insurance premium is usually significantly affected).
It follows from the above that, regardless of the construction technique implemented by the insured, difficult times may be lying ahead for insurers who will necessarily have to adapt to this – possibly – long-term crisis.
One of the solutions may be, whenever possible, to strengthen the underwriting process in order to properly assess the covered risk.