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Inflation: The impact on insurance for the construction industry

As inflation rates soar in many countries, construction companies need to consider the impact of rising costs, persisting supply chain pressures, and raw material shortages on their insurance program.

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By Gaurav Kapoor , 

Global Strategy and Operations Leader, Construction Practice

06/23/2022 · 5-minute read

How rising prices are affecting the risk transfer and insurance programs of construction companies

As inflation rates soar in many countries, construction companies need to consider the impact of rising costs, persisting supply chain pressures, and raw material shortages on their insurance program and make any needed changes to remain resilient amidst a changing environment.

Project-specific coverages or programs are most likely to be affected by a high inflation environment. In most parts of the world, two main types of project-specific coverages are exposed to inflation:

  • Property: Construction material damage insurance or contract works
  • Casualty: Third party liability (TPL) insurance

Both of these coverages generally have a pricing basis that is linked to the insured project’s estimated contract value (ECV). In an inflationary environment, increases in raw material, labour, and various essential inputs (such as fuel, utilities, and interest costs) are likely to have a direct impact on the ECV of a project.

What are the considerations for construction companies?

Project-specific insurance coverages are usually structured around the ECV at the start of the project. The ECV will usually drive a few considerations around the coverages:

  • Premium: Project-specific coverages are typically rated against an exposure base of ECV, and are adjusted at the end of the project, depending on the final contract value. As inflation increases a project’s contract value, construction companies are likely to see a correlating increase in the premium. High inflation may also impact the availability of supplies and result in delays to completion timelines due to difficulties sourcing materials, which could also lead to an indirect increase in premiums.
  • Construction material damage or contract works: The sum insured through property-specific coverages is typically based on the ECV. High inflation that leads to sizable increases in a project’s overall cost could lead to the sum insured becoming insufficient. This could happen both in the event of a total loss or if average clauses exist in the policy wording (as this could reduce the amount of a claim payout). Note that there are certain policy extensions that might help mitigate this exposure. Some policies are placed on a limit of loss basis, where the sum insured is lower than the ECV, with coverage limits decided by the project stakeholders, typically based on an estimated maximum loss through their own internal review or from that of a third party. Significant inflation that causes the price of certain materials to increase at various stages of the project timeline could skew the original calculation of an appropriate limit.
  • Third party liability: Casualty coverages typically include limits of liability that are procured according to risk tolerance and expected exposure from potential third-party claims. In some parts of the world, these limits are also aggregated within a project term specifically in respect of products liability. Although price inflation does not directly impact the third-party risk profile of a project, judgments from lawsuits and third-party claims, known as social inflation, could see a significant increase. Increases in rebuild costs through price inflation where third-party property is damaged or destroyed should also be a consideration when limits are set. In such an environment, a single claim could erode a liability limit much quicker than in a low inflationary environment.

How does inflation affect insurers?

Insurers have traditionally considered inflation and the potential for cost increases when it comes to construction projects. The current inflationary environment — with triple-digit increases for certain materials — has become difficult for insurers to navigate, especially when looking at projects that are still in progress. When projects have claims, calculating an adequate reserve for an adjuster could be a challenge in situations that are not total losses. In this environment, Insurers can be expected to seek answers to multiple questions, including:

  • What is the lead time for securing key equipment for the project?
  • How is the overall project timeline affected by ongoing supply chain issues?
  • How often do we need to adjust the ECV during a project timeline?
  • Has inflation been factored into the initial contract price?
  • Will my deductibles/excesses be adequate to cover attritional losses during the latter part of a project’s term?

Collaboration and transparency are key in addressing inflation risks

All stakeholders, from construction companies to insurers, should take a collaborative and transparent approach in order to help mitigate the effects of high inflation. Among other actions, consider:

  • Communicating around strategy for tenders/bids. Work with your construction insurance broker or advisor to help communicate mitigation strategies and risk management protocols around cost increases due to inflation to the insurers on each project. 
  • Review ECV on a frequent basis. Stay up-to-date on increases in contract values on a project as contracts are awarded. Inform your construction insurance broker or advisor about any increases so that they can advise on the potential need to update existing policies.
  • Understand your approach to risk transfer. For project polices with a limit of loss, carefully review the methodology used to determine an appropriate limit and run it again against the new contract value. Engage with your construction insurance broker or advisor to consider the potential impact of any discrepancies.
  • Review your policies’ protection clauses. Insureds can secure extensions of cover (such as cost escalation and inflation protection) to help mitigate inflationary effects. Work with your construction insurance broker or advisor to determine the availability of protection clauses and understand how they might help you mitigate your risks.

Today’s inflationary challenges can have a significant effect on both construction projects and their insurance coverage, underscoring the importance of reviewing your policies to identify potential underinsurance issues and address them immediately.

In order to develop an insurance program that meets your needs, it is important to involve your broker or insurance advisor as early in the process as possible, so they can help you assess the potential impact of your contractual obligations on insurance program design and allow sufficient time for terms to be negotiated.

If you have any questions about how to manage the impact of inflation on your construction business, get in touch with our team today.

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Maarten van Haaps

Head of Construction, Marsh Specialty

Based out of Melbourne, Maarten heads up Construction for Marsh Specialties in the Pacific region, leading a team of 36 full time Construction colleagues excluding our Claims specialists.

Specific construction experience includes risk analysis; design and placement of one off and annual insurance programs; contract analysis of Engineering Procurement Construction (EPC) Contracts and Finance Agreements and extensive experience in PPP projects from bid phase through to practical completion of the project.

This publication is not intended to be taken as advice regarding any individual situation and should not be relied upon as such. The information contained herein is based on sources we believe reliable, but we make no representation or warranty as to its accuracy. Marsh shall have no obligation to update this publication and shall have no liability to you or any other party arising out of this publication or any matter contained herein. Any statements concerning actuarial, tax, accounting, or legal matters are based solely on our experience as insurance brokers and risk consultants and are not to be relied upon as actuarial, accounting, tax, or legal advice, for which you should consult your own professional advisors. LCPA 22/304

“Marsh Pty Ltd (ABN 86 004 651 512, AFSL 238983) (“Marsh”) arrange this insurance and is not the insurer. The Discretionary Trust Arrangement is issued by the Trustee, JLT Group Services Pty Ltd (ABN 26 004 485 214, AFSL 417964) (“JGS”). JGS is part of the Marsh group of companies. Any advice in relation to the Discretionary Trust Arrangement is provided by JLT Risk Solutions Pty Ltd (ABN 69 009 098 864, AFSL 226827) which is a related entity of Marsh. The cover provided by the Discretionary Trust Arrangement is subject to the Trustee’s discretion and/or the relevant policy terms, conditions and exclusions. This website contains general information, does not take into account your individual objectives, financial situation or needs and may not suit your personal circumstances. For full details of the terms, conditions and limitations of the covers and before making any decision about whether to acquire a product, refer to the specific policy wordings and/or Product Disclosure Statements available from JLT Risk Solutions on request. Full information can be found in the JLT Risk Solutions Financial Services Guide.”