Chapter 1: Understanding the hardening market

With prices for CAR and EAR insurance rising for the first time in many years, Patrice Nigon asks: ‘How did we get here?’

The soft phase of the cycle within engineering and construction was so prolonged, a hard insurance market is a situation that many in the industry have little to no prior experience in. In discussions related to pricing for typhoon-exposed business, there is increasingly a need to communicate that price was not the issue: There is simply very little capacity currently available.

The increase in commercial insurance rates on line within the construction and engineering is following a broader global trend, and it is a long time in coming after many years of rate erosion. It is important to understand how we got here, so that we can build a market that is altogether more sustainable and less volatile going forward, to the benefit of all parties.

Growing claims severity

Among the factors that led to today’s hardening market is a change in claims experience, with a shift towards more severe losses. In the past, engineering and construction was not a volatile line of business – the largest claims were in the region of $50m to $100m. In today’s market, it is not unusual to experience losses in excess of $1 billion. This has fundamentally changed the nature of the business, particularly as engineering is a long-tail line of business.

There are a number of reasons for increasing claims severity. One is the growing size and complexity of projects – new construction methods are constantly enabling us to break new ground and execute methods of construction that may have been unthinkable even a decade ago. However, with these feats of engineering (see box-out examples) come bigger and ever-more complex exposures.

Take the skyline of the City of London, which boasts a series of magnificent buildings with unusual nicknames such as the Shard, the Gherkin, Walkie Talkie and the Cheesegrater. These buildings – many of which went up in the last decade – made use of highly sophisticated, cutting-edge technology to quite literally achieve new heights in architectural design. But when you insure projects like this, there is an element of entering the unknown, which makes underwriting even more complicated.

As claims severity has increased it has become apparent that many within the sector had been overoptimistic in their pricing. Put simply, they had not charged adequate premium to put into reserves to pay for the losses that would not materialise for several years after the project had begun. As a result, we saw a market correction begin to take place, with some of the more opportunistic carriers deciding to cut their losses and exit as performance deteriorated.

This boom and bust attitude towards engineering and construction insurance is one of the factors that contributes to the volatility of the business. As capacity floods into the sector, it creates a soft market.

A boom and bust cycle

It is easy for new entrants to make mistakes, given that losses can take time to materialise and because engineering and construction is such a specialised class of business with so much variety, and very real potential for severity losses.

Newcomers have a tendency to pursue market share at the expense of profits, and during the first two or three years this tactic can work well and the business can generate strong results. It is generally not until a few years down the line that it becomes apparent the business has been underpriced and that’s when losses start to hit the balance sheet.

When results deteriorate, carriers may decide to cut their losses and pull back capacity or exit the market altogether. Over the past two to three years, in particular since Lloyd’s began its Decile 10 performance review, we have seen a number of syndicates exit the engineering and construction space.

This has sparked a contraction of capacity, causing insurance rates to harden and leaving insurance buyers and brokers navigating a challenging market in which premiums are going up and capacity is becoming harder to secure. These market conditions have been exacerbated by the COVID situation and the uncertainty surrounding the ultimate cost of claims emanating from the pandemic, leading carriers to prioritise growth in short-tail classes of business that offer the benefits of immediate profitability.

And so this pattern of behaviour continues until the next generation, when history may once again repeat itself. To avoid this kind of volatility and the challenges of a hardening market, it is essential that engineering and construction is no longer considered a niche play which can simply be turned on and off depending on prevailing market conditions. Carriers in this space need to take a long-term view and become credible partners while brokers have their part of play in emphasising the importance of experience over price.