Chapter 5: Over-optimism in CAR and EAR markets

Construction all-risk insurance (CAR) and engineering all-risk (EAR) insurance premiums have not reflected the underlying risk of projects in recent years, with overcapacity and strong competition in the underwriting market putting downward pressure on rates.

Despite this, losses in the CAR and EAR fields are becoming more severe. Risk management in CAR and EAR continue to improve and evolve, but new technologies and complex risks have led to a rising volume of severe claims.

Insurance market capacity for CAR and EAR rises and falls across the market cycle due to “overoptimistic” carriers that do not charge adequate premium to pay for losses that might only materialise years after the project had begun. As a result, some of these carriers would decide to cut their losses and exit the market as performance deteriorated.

Hence, risk managers need to evaluate their choice of carrier carefully, and take into consideration the carriers’ experience and longevity in the sector. Patrice Nigon, head of construction and engineering, APAC, at Swiss Re Corporate Solutions, says risk managers need to be realistic about the long timeframes of their insurance, and the complex nature of risks.

What’s different about CAR and EAR risk considerations

CAR and EAR risks are also very different from typical property insurance. “In property, you cover for one year, and if and when there is an accident, the cover is triggered. In engineering, you underwrite a project and the losses can happen in three or more years.”

He says insurers and risk managers “need to develop and apply specific actuarial methodology that helps you look at past years’ events and be able to project the future. Only when you can do this, can you really have a flavour of your portfolio performance.”

Additionally, the profile of the project must be considered as roads, dams, hospitals, subways, and other types of engineering or construction work have markedly different risk profiles. “Location also poses varying risks, and is an important factor,” he adds. “In China, for example, a development in the south is exposed to typhoons, and the west is more exposed to earthquakes. So, you need to be accurate in forecasting the future risk scenario.”

Bigger concentrations of risk

Inflation also needs to be taken into consideration, as future inflation is not guaranteed to run at similar levels to past trends: “When inflation sets in, your ultimate losses can be severely increased,” says Nigon.

The size of the project can also lead to larger claims, with today’s bigger projects commanding larger claim amounts. “Ten years ago, a project in the region of $800m was considered large scale; now large scale projects are worth $3 billion,” he adds. “Correspondingly, this means the size of the very large losses has increased, and that can create actuarial ‘shocks’ in your portfolio.”

Dealing with construction and engineering projects means coping with plenty of variables. Underwriters with a history in the insurance industry tend to take a long-term approach to risks.

“The long-term players are the ones who can, with a good level of comfort monitor the development of their portfolios. In the past, some insurers had been guilty of “over-optimism” before exiting the market, leaving companies exposed and having to handle the losses.”

Overall, Nigon says there has been a decrease in the number of EAR and CAR claims, but an increase in the severity of such events.

Improvements in risk management

Risk management and project management processes have improved “significantly”, he says, but premiums have fallen due to market capacity, meaning bigger financial losses for insurers following major claim events.

Nigon says the construction, engineering and risk industries have made strides in the risk management of tunnel projects, with lessons learned after the collapse of three tunnels during the construction of the Heathrow Express Link in 1994.

“What came out of the Heathrow tunnel incident was a massive loss, but a documented guideline called the Joint Code of Practice for Risk Management of Tunnel Works. We later created the offshore code of practice for the offshore wind farm sector.”

Safeguarding EAR and CAR projects

Nigon believes risk and insurance managers have an integral role to play in safeguarding EAR and CAR projects. He says they should select insurers with a long history in EAR and CAR, to avoid being exposed by carriers exiting the market. Being left without cover can lead to financing issues and cause projects to grind to a halt.

“The EAR and CAR insurance market is ‘stop and go’, with a lack of capacity, followed by too much capacity, and a lack of capacity once more. My advice is for risk managers to look beyond immediate financial considerations, and to work with the well-established insurance and reinsurance companies as they offer stability and continuity.

“This is an exposed line of business that needs to be done by specialised people in underwriting, reserving, and claims. This makes the difference between being the capacity leader or the technical leader. Stability is critical. If a project cannot be insured, bankers will not provide the financing.”

Engineering and Construction Best Practice

The Offshore Code of Practice versus The Tunnelling Code of Practice

Following the costly collapse of three tunnels during the construction of the Heathrow Express Link in 1994, The Joint Code of Practice for Risk Management of Tunnel Works in the UK (TCOP) was set up through a collaboration between industry bodies representing both insurance and civil engineering groups.

The code’s stated objective is “to promote and secure best practice for the minimisation and management of risks associated with the design and construction of tunnels, caverns, shafts and associated underground structures”.

It has promoted best practice in risk management around the world and has been well adopted on tunnelling projects, including London’s current Crossrail project.

Under the TCOP, there is a risk management checklist for each stage of the project, from design and procurement to the construction phases. With Crossrail, lead insurer Swiss Re Corporate Solutions, implemented a risk engineering programme.

Lessons learned through the creation of TCOP were later useful as Swiss Re launched the Offshore Code of Practice (OCoP), a reference document for risk managers in the offshore wind farm sector.

Swiss Re has been instrumental in calling for the adoption of a Code of Practice for the sector to improve risk management processes and mitigate against major loss events.

About the author

Patrice Nigon

Head, Engineering & Construction APAC, Swiss Re Corporate Solutions

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