A profound shift in the U.S. property development sector has emerged in recent years, and it’s shaking the very foundation upon which buildings are constructed. The changing attitude of insurance carriers toward construction materials has been pivotal, leading to rising costs and significantly reducing coverage options for U.S. property developers.
Although inflation has fallen significantly since its peak in June 2022, we’re not out of the woods. The Consumer Price Index rose 0.6% in August, its biggest monthly gain of 2023, causing a wobble of confidence in the economic climate claims of further volatility and interest rate rises.
In property/casualty insurance, we’ve seen the damage that high inflation can do, especially when it comes to claiming for construction materials. Over recent years, we’ve seen how high-profile claims related to fire incidents have brought certain construction types, notably frame constructions, under the insurance industry’s scrutiny. Indeed, builders' risk insurance rates have surged to five times, and in some cases, nearly 10 times the cost of insuring projects using alternative materials. In such a market, insurers are competing for capital with less risky assets to help avoid any potentially expensive losses. The solution lies in developers seeking alternative construction materials which pose a lower risk – and that’s easier said than done.
Rewind approximately 10 years, and the insurance landscape looked quite different. A substantial 200,000-squre-foot project, primarily wood stick frame or "podium" construction, could be insured through a single carrier. With average frame construction costs ranging from $135 to $150 per square foot, insurance requirements were much less daunting.
Fast forward to the present day, and we see rates for residential building frame construction in places like New York City reaching peaks of $600 per square foot. Even in tertiary markets, prices have inflated to more than $250 per square foot, a staggering 50%-70% increase from what developers were accustomed to a decade earlier.
Historically, from ancient Chinese merchants dividing goods among multiple vessels to modern maritime incidents such as the grounding of the container ship Ever Forward outside Baltimore, the principle of risk distribution has remained a constant. This principle, however, is manifesting differently in the present P/C landscape. Insurance carriers that once posted limits on projects valued at $100 million, are now capping their involvement at $50 million for specific construction types. This creates a situation where carriers that used to compete for business are now sharing portions of the same risk and in turn removing downward pressure on premiums.
For developers, an ever-evolving challenge has emerged: reconciling the growing costs of construction with the heightened insurance expenses associated with specific construction types. Fluctuating material prices further complicate matters, especially when suppliers can't fix prices even weeks ahead of project initiation. For example, lumber costs have fallen by nearly two-thirds in just 18 months with the current price of lumber sitting at just below $500 per thousand board feet, down from approximately $1,300 per thousand board feet in early 2022. Such uncertainties make it a Herculean task for developers to accurately project costs and make informed decisions.
Frame construction's perceived low fire retardance has led to its estrangement by several carriers. Similarly, joisted masonry, which combines wooden framed joists with brick, is being viewed skeptically. This skepticism has tangible repercussions: When the largest insurer of multifamily residences in New York's five boroughs halts underwriting any more joisted masonry constructions, it's a wake-up call for the industry.
Certain limitations set by carriers may seem arbitrary at first, but there’s often a rationale rooted in history. For example, the cessation of asbestos and lead paint use in multifamily buildings by 1979 provides context for why some carriers would insure only post-1979 constructions. For renovation projects, especially older buildings, it’s becoming evident that carriers may demand exhaustive architectural, engineering and geotechnical reports before underwriting. Such due diligence can lead to cost-saving revelations or, at times, deter investment in potentially risky properties.
On the brighter side, carriers still find favor with best-in-class materials. The allure of steel and concrete apartment buildings remains undiminished for underwriters. As a result, the insurance rate escalation for such structures is relatively muted.
In this intricate interplay between construction choices and insurance nuances, experienced insurance brokers play a crucial role. By gathering comprehensive information about a proposed development, they can address carrier apprehensions, advocate for their clients and ultimately secure the best insurance rates.
To navigate the future of construction and insurance, developers, insurers and insurance brokers must collaborate more closely than ever, ensuring projects rise from the ground up with a solid foundation of safety, innovation and financial prudence.
Here are some tips to secure the most resilient, cost-effective coverage for construction projects.
Ensure your insurance coverage aligns seamlessly with all other risk management strategies you have in place. The harmony between them is essential.
Don't accept insurance terms at face value. Use an experienced insurance broker to engage in proactive negotiation with insurance underwriters to get terms that are most beneficial for you.
Work with your broker to present your risks in a light that appeals to underwriters. Sometimes, it's all about perspective. The better your risks are perceived, the better terms you can secure.
Be proactive. Instead of reacting to circumstances, anticipate potential changes or risks and act ahead of time. A proactive approach often leads to better risk management and insurance outcomes.
Jack Cowie IV is senior vice president – real estate with the Varney Agency. Contact him at [email protected].