Water Damage: What Happens When the Drips Become a Deluge?
Follow new CIREG guidelines to weather the transitioning construction insurance market
For many years, fire damage and other major losses — especially those pertaining to hydro-electric plants — raised most concern for construction insurers. But more recently there has been a significant increase in water damage losses on construction projects.
These losses typically have a similar profile. Connections fail in water systems during or following commissioning; for new-build projects these elements are only completed later in the programme so cannot fail early on. Failures often occur out of working hours and it is not unusual for water to cascade or percolate throughout buildings for some time before the escape is discovered, halted, and remedial works can begin.
This leads to significant damage to finished areas that require replacement and extensive drying out. Other common characteristics include programme delays, which are again exacerbated by the proximity to completion, leaving little time or contingency to reschedule works and mitigate disruption.
Importantly, these losses tend to stem from the escape of water from systems or apparatus, as opposed to water ingress through inclement weather or some other form of inundation.
- A 0.5mm leak could lose 20 litres of water every hour [note 1].
- In 2017, water damage cost more than £400 million [note 2].
- In the past 12 months, construction water damage claims in the London market have run into hundreds of millions of pounds.
Marsh JLT Specialty has identified a significant number of high-value internal water damage losses incurred by companies ranging from £2.5 million to £9 million.
Although these losses are not as severe as some fire or hydro-electric plant losses, they are far more frequent and may affect either the construction 'all risks' (CAR) or third party liability (TPL) insurance policies. CAR insurance is likely to be called upon for losses in the construction and defect rectification periods; whereas outside of refurbishment-type contracts, TPL insurance is usually applicable to losses in the defects liability period only.
Insurers are concerned that most of the losses are easily avoidable with the application of basic risk management. In that respect, it could be argued that the presence of insurance is actually reducing focus on best-practice risk mitigation.
Additionally, industry leaders are focusing increasingly on the impact of the built environment on the people who interact with it. This development is exemplified by the MIPIM 2020 theme, 'The Future is Human'. And it means that, while construction firms would be wise to consider how poor water-related risk management affects their bottom line, the impact on the lives (and livelihoods), of buyers and tenants should be given additional weight. In an age of 24/7 news and wildfire social media campaigns, failure to do so could affect reputations as well as balance sheets.
How are insurers reacting?
With construction insurance delivering unprofitable results for insurers, we have seen that insurance market transition. This has recently impacted several specific areas, professional indemnity being the most obvious example. However, since the start of 2019 the general construction insurance market has also been affected, with increasing premiums, excesses, and more restrictive terms applied. (These have recently been highlighted in our biannual insurance market updates, Constructive Insight.)
The most recent example of this market change is the release of a new water damage guidance note by the Construction Insurance Risk Engineers Group (CIREG). The first iteration of this document was issued in March 2008 and the most recent, fifth edition, was made available in November 2019. CIREG is an industry group representing construction insurance risk engineers and is also supported by a similar group representing UK CAR underwriters.
Causative factors that CIREG lists for the many recent losses include:
- A lack of awareness and insufficient risk management from design stage through to operation.
- Insufficient on-site management and assignment of responsibility.
- Absence of permit systems and other management systems, with water risks treated less seriously by contractors than fire or other safety risks.
- Poor workmanship and the use of inexperienced or untrained personnel.
- Inadequate verification of individual plumbers' installations through initial joint testing.
- Increased high-rise developments and vulnerable fit-out works.
- A lack of understanding of the myriad plumbing systems now available and the lack of bespoke training.
- Sub-standard pipework testing regimes.
- Inadequate mitigation and emergency planning delaying the response in protecting assets.
The document has major implications for both contractors and project owners. The principal recommendation is that all developments should have a water management plan (WMP), for both the temporary water supply during the project period and the permanent systems incorporated into the works. CIREG has identified the following minimum requirements for a WMP:
- Appointment of 'responsible persons' to manage the escape of water risk.
- A risk assessment process for mitigating exposures at the design phase.
- The selection of competent contractors.
- Quality control throughout material storage, installation, and testing.
- Mitigation measures, and identification, implementation, and maintenance of those mitigation measures.
- Emergency response plans.
- Regular review of the risk assessment and water management plan to ensure mitigation measures remain appropriate.
How will this affect my project?
The CIREG guidance states that a WMP should be prepared for all developments, but how realistic is it that this will be required or enforced by all insurers? For now, we expect that the new requirements are most likely to affect more significant projects where additional underwriting scrutiny is inevitable.
For these larger projects, the approach adopted will vary for each insurer depending on its loss experience and appetite for risk, although some insurers are already avoiding tall buildings altogether with one imposing a limit of eight-to-ten storeys. Also likely to arouse greater attention are residential projects where the issues highlighted above are more likely to occur and can lead to more substantial losses. At the most conservative end of the spectrum, insurers are imposing observance of the guidance note through some form of condition or warranty.
Smaller projects may be insured under a contractor's or developer's annual CAR policy, covering projects up to a specified value. This naturally leads to less examination of risk conditions than would be the case with a major project, which must be insured under project specific insurance.
The practical effects are likely to be as follows:
- Increased requests to provide more detailed underwriting information, especially in relation to higher value/risk projects.
- Mandatory requirements for WMPs – be prepared for underwriters to withhold quotations until this information is available.
- More prescriptive coverage in relation to water damage by linking indemnification to implementation and observance of WMPs and the introduction of automatic shut off valves.
- Increased excesses – these were previously £10,000–£25,000 for project-specific policies but we are seeing these increased to £50,000–£75,000.
Should the industry fail to address these concerns and losses persist, more stringent actions will likely be taken by insurers with much greater scrutiny on all projects, even those of much lower values.
How to improve your risk profile
Talk to your construction insurance broker about appropriate risk management for this peril. In the previous environment (which persisted for well over a decade), competitive pressure prevented the application of basic risk management standards for water damage. Despite recent losses and general unprofitability, a reasonable number of underwriters still operate in the UK construction insurance market. The current transitioning market may catalyse improvements in this area. By applying sensible risk management now, construction companies can assure their underwriter that escaping water damage is being mitigated appropriately.