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HUB International 2021 Outlook

Construction Industry

 

Transforming Uncertainty into Opportunity

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Prepare for Bumps in the Road Ahead

To rebuild balance sheets and improve profitability, contractors must keep work environments safe and maintain balance between risk management vs. opportunity.

Entering 2020, contractors were cautious about their business prospects.

But no one was prepared for the across-the-board disruption caused by the pandemic or the hangover effect that's likely to carry on into 2021.

“[The pandemic has] left balance sheets battered, making the big challenge (among many) facing contractors into 2021 that of regaining their financial health.”

Construction and its workers were deemed essential (a term whose interpretation varied from state to state) and allowed to continue working in most of the country. But the economic shutdown delayed many projects that had been in the bidding or final stages. Significant material/supply chain disruptions jeopardized schedules and operations. Contractors also were hit when subcontractors couldn’t report to jobs, either because their people were exposed to the virus and subject to quarantines, or because they were unable to meet health guidelines.

As a result of the upheaval, some analysts expect the U.S. construction industry to contract by 6.5% in 2020 and by 2.0% in 2021. The story has been similar in Canada, with a 7% contraction expected in 2020, with another 2% pullback in 2021. It’s also left balance sheets battered, making the big challenge (among many) facing contractors into 2021 that of regaining their financial health. There is growing concern about backlogs and maintaining a healthy pipeline of new construction projects as we move into 2021.

As the industry works to rebuild in 2021, insurance renewals are likely to be tough as underwriters consider stressed financials and other issues and trends that pose risks to the sector’s recovery, short- and long-term. The challenges here will be heightened by a hardening insurance market, where rates trend higher as availability tightens. In this environment, contractors should expect their insurance brokers to be their partners and advisors in anticipating the risks ahead and shaping the strategies to manage them effectively. The goal? To emerge from this period stronger and with the best possible story to share with clients and insurers.

We currently see three trends and issues in development that will impact the construction industry into 2021 – if not beyond.

“Continuing financial pressures, aggravated by the uncertainties over PPP loan resolution, represent additional, and perhaps unprecedented, systemic risk to the industry heading into 2021, particularly given financial and operational risks arising from contract performance default.”

1. Contractors’ financial health under pressure

The industry is working with weakened balance sheets and compressed profit margins due to the pandemic’s impact. Many contractors had to cover unbudgeted labor costs as they tried to catch up on jobs delayed due to numerous virus-related reasons. While many subcontractors began the year in a relatively strong financial position, they also were hit with unbudgeted COVID closure costs and schedule delays. Another worrisome issue is the uncertainty over the level of forgiveness – and the impact on balance sheets – that contractors can expect arising from Paycheck Protection Program (PPP) loans extended under the federal CARES Act. The construction industry received $64.6 billion in loan approvals across 466,221 applications for an average of $138,560 per loan.

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Continuing financial pressures, aggravated by the uncertainties over PPP loan resolution, represent additional, and perhaps unprecedented, systemic risk to the industry heading into 2021, particularly given financial and operational risks arising from contract performance default. From the perspective of subcontractor defaults, general contractors that opted for Subcontractor Default Insurance (SDI) instead of surety bonds to cover losses on subcontractor performance could find themselves in a weakened financial position. Under the traditional SDI model, general contractors assume sole responsibility for the subcontractor prequalification process, and typically assume a significant “first loss” deductible as part of their SDI program. Subcontract surety bonds, on the other hand, involve third-party pre-qualification and typically transfer all of the financial risk to the Surety.

Contractors and subcontractors should count on their brokers to keep them on top of developments in the SDI and surety markets. Both surety and SDI carriers are typically less rate-driven than other lines when under increasing claims pressure, but instead restrict capacity, tighten policy terms and increase deductibles. Risk selection is another important factor in a hardening market as insurers tend to become choosier in whom they agree to insure. For subcontractors, it points out the need to self-market by sharing a good risk management track record with safety successes. For general contractors, it’s important (for any type of insurance) to demonstrate how quality, as much as safety, is managed on the job site. Quality has always been an important differentiator for contractors, and is now emerging as an important insurance underwriting (risk selection) factor as well; more sophisticated brokers can provide guidance on how firms can improve their quality tracking and measurement systems.

Balancing opportunities with risks has always been the central challenge for contractors, and never more so than now.

“As mask requirements and social distancing efforts ebb and flow, COVID safety practices on the job could be inconsistently enforced.”

2. The need to respect the continuing risk of the pandemic

Moving into 2021, new waves of outbreak will make the coronavirus a continuing operational risk for the industry. As mask requirements and social distancing efforts ebb and flow, COVID safety practices on the job could be inconsistently enforced.

Given the ongoing shortage of skilled labor, though, firms shouldn’t let their guard down. On-the-job exposures will likely trigger workers’ compensation claims. Then, too, there’s a warning in the growing number of class action lawsuits for “willful employer misconduct” under Part B of workers’ compensation policies. The claims allege that employers allowed unsafe working conditions during the pandemic. The pandemic will continue to haunt supply chains as well, with knock-on effects impacting both budgets and schedules well into 2021. Contractors are being reminded of the difference between an “efficient” supply chain and a “resilient” one.

Comprehensive recommendations on COVID safety measures for construction work, including engineering and administrative controls, are available on the Occupational Safety and Health Administration (OSHA) site. Brokers can also provide guidance on how firms can ensure COVID safety is integrated with other site safety measures

“Tech innovation and deployment have helped, streamlining the construction process, while positively impacting worker productivity, safety and quality.”

3. Technology drives productivity benefits, as cyber risks grow.

The immediate financial costs of the coronavirus crisis aside, the construction industry hasn’t performed well on a global basis: it represents 13% of the global GDP, but productivity growth has actually declined over the past 40-plus years, and nearly 30% of every construction dollar is lost to waste and rework. More recently, tech innovation and deployment have helped, streamlining the construction process, while positively impacting worker productivity, safety and quality. Although still in the early days of this technology evolution, the industry is poised for some serious change over the next three to five years. Drone use, for example, has skyrocketed by 239% year over year, literally reaching new heights that human workers safely can’t, and providing on-site security to offset the $300 million to $1 billion in annual construction equipment theft, and re-imaging activities like surveying and quantity offtake estimating.

But many of the advances – from drones, with their real time monitoring and data collection, to automated on-site and back-room processes and digital tools for managing resources – also leave the door open to cyber risk. One study found 75% of construction industry respondents had experienced a cyber incident. There’s been a notable uptick in cyber claims, and construction is particularly vulnerable to social engineering. This involves a cyber criminal impersonating senior management or important vendors, using business email compromise (BEC) tactics and effecting the release of large sums of money or information that can be monetized.

The industry needs to do a better job balancing the benefits of technology with the downside of cyber risk. Having security policies and procedures in place help, providing they are followed and not circumvented. A knowledgeable broker can assist on resources that may also be of value. Firms should periodically undergo audits of their cybersecurity environments, for example. They also should get guidance on their cyber insurance policies as they may not be adequately covered. Many contractors buy policies where cyber is blended with their professional liability insurance. That’s dangerous as the protection offered is very limited versus a stand-alone cyber policy. Decoupling cyber for broader protections will also result in better terms and conditions, though underwriting scrutiny is stepping up in a hardening market and rates may increase by 30% to 40% in 2021.

 
The 2021 Recovery Challenge

Like most other business sectors, the construction industry is looking with uncertainty at a 2021 that will continue to be affected by the pandemic. Until a vaccine is widely available, firms will need to act decisively to stabilize their balance sheets, be mindful of the measures that will keep their people safe, and effectively manage the on-again-off-again closures likely to continue wreaking havoc with project budgets and schedules. Balancing opportunities with risks has always been the central challenge for contractors, and never more so than now. Partnering with an experienced broker may prove invaluable in this process, ensuring that your firm’s story is pitched well to the insurance marketplace, pairing you with the right carriers, right-sizing coverage and tightly managing costs – in 2021 and beyond.

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