Rising materials costs pull insurance rates higher

Looking to put COVID-19 firmly in the rear-view mirror, UK construction has been booming this year. Monthly output quickly peaked above pre-pandemic levels in March 2021.¹ Since then, however, the sector hit a bumpier road. Demand for construction materials has outstripped supply, dialling up prices and lead times. Reinstatement values have followed suit leading insurers to apply above-inflationary increases to material damage classes.

Higher demand for construction materials – which has not been confined to the UK – is also only part of the picture. At the global level, supply chains have been fragmented as a result of the pandemic. The shipping industry is “far from recovered” from the disruption wrought by COVID-19, the Construction Leadership Council (CLC) noted in July, with congested routes, container cancellations and higher costs still being experienced. The blockage of the Suez Canal in March only exacerbated the issue: analysis by business insights provider, Dun & Bradstreet, and software firm, E2open, suggested that construction would be one of the industries most impacted by the incident; and the UK, one of the most impacted European countries.²

Supply-chain issues in the UK have been compounded by Brexit, which has seen increased red tape, customs checks and trading difficulties, leaving UK builders more reliant on domestic production. A shortage of HGV drivers has also added to the headache: members of the Building Merchants Federation warned of disruption and delays in their ability to transport goods across the country.³

This long-standing issue (the UK needed 60,000 more HGV drivers even before COVID-19 and Brexit) has been compounded by an exodus of European drivers post-Brexit and during the pandemic, as well as the cancellation of 30,000 HGV driving tests during lockdowns in 2020, according to the Road Haulage Association (RHA). The shortage still stands at 100,000 drivers, the RHA said in an October letter to the Prime Minister, and measures implemented by the Government to support critical supply chains, “do not go far enough to tackle the crisis and protect the UK economy in the months ahead.”⁴

Pressures mount with main contractors most at risk

Stockpiling of construction materials, a reduction in manufacturing capacity and stock rundown during the pandemic, oil price recovery and the drive to renewable/low-carbon – and potentially more costly – electricity generation are also adding to the upward pressure on prices. Massive government-funded infrastructure projects around the world – such as HS2 here in the UK – may also be draining the market of supplies.

Each of these factors in themselves has the potential to stoke inflation; together, they have the potential to “feed off each other” to cause significant and sustained inflationary pressure, said cost management specialists, Turner & Townsend, in its Summer 2021 report into the UK construction market.⁵ With input price inflation already running at its highest in more than 24 years, construction firms will be hoping such predictions are wide of the mark.

Overall, prices for products and materials have increased by a reported 10% - 15%, according to the CLC. Most timber-based products have seen increases of 20% to 50%, but OSB and other sheet materials are up over 100%. Other products used in housebuilding and domestic maintenance and repair have also seen significant prices hikes, including roofing products, insulation, landscaping products, blocks, sealants/PVA, kitchen carcasses, plastics (e.g., drainage and some windows) and bagged cement.

Main contractors appear to be most at risk of being caught out by materials shortages. Depending on the provisions of the contract, they may be left to bear some or all of any cost increase, particularly on fixed-price contracts, along with potentially liquidated damages in the event of delayed completion without an extension of time. Homebuilders have fared somewhat better, benefiting from a general uptick in house prices through COVID induced demand and the unprecedented ‘race for space’ along with the governments stamp duty holiday, which has helped soften the impact of higher materials prices. However, as the stamp duty holiday ended in September 2021 and the Bank of England has signalled potential interest rate increases in 2022, it’s unclear what the future may bring for house prices.

More to come?

Additional challenges are on the horizon. Recent rises in commodities prices could add fuel to the inflationary fire, especially if these become another supercycle.³ New health and safety regulations also have the potential to impact construction materials supply. Currently making its way through parliament, the Building Safety Bill will strengthen the construction products regulatory regime with the establishment of a National Regulator for Construction Products.⁶

The bill will also establish a new Building Safety Regulator to oversee the design and management of buildings with a focus on ensuring the new regime for higher-risk buildings is enforced effectively and robustly.⁷ As part of this, clients must be able to demonstrate that their suppliers have the necessary skills, knowledge and experience in building safety.³ The regulations will apply retrospectively, applying to all buildings constructed up to 15 years before the changes come into effect.

The inflationary impact of health and safety concerns are already apparent in the market for fire-compliant cladding with demand increasing following the Grenfell Tower fire. The cost of cladding had reportedly risen 5.2% in the year to April 20214 and could continue to increase.⁸

Materials prices push insurance rate increases

As a result of higher prices, reinstatement values for construction materials are rising and pressure is growing on insurer claims payments. Insurers are responding by seeking to apply above-inflationary increases to material damage classes, including Contractors All Risk, Property Damage, Business Interruption, and Third Party Liability. Indeed, material damage has moved ahead of the traditional concern with injury cost inflation in pushing rate increases, the first time this has happened in sometime.

In these extraordinary and complex times, it’s more important than ever to engage with experience and expertise when it comes to choosing the best insurance cover. The construction insurance specialists at Gallagher offer a one-stop-shop of specialists offering holistic products and solutions, tailored to the specific needs of construction projects and contractors – regardless of size.

References

1. GDP monthly estimate, UK: June 2021, Office for National Statistics (12 August 2021): https://www.ons.gov.uk/economy/grossdomesticproductgdp/bulletins/gdpmonthlyestimateuk/june2021#the-construction-sector
2. ‘The Suez Canal: Looking beyond the surface to access the full economic impact’, Dun & Bradstreet and E2OPEN: https://www.dnb.co.uk/content/dam/english/dnb-solutions/the-suez-canal-looking-beyond-the-surface-to-access-the-full-economic-impact.pdf
3. “HGV driver shortage hitting construction supply chain”, Construction Enquirer (14 July 2021): https://www.constructionenquirer.com/2021/07/14/hgv-driver-shortage-hitting-construction-supply-chain/
4. Letter to Prime Minister (25 October 2021): https://www.rha.uk.net/Portals/0/News/Letter%20to%20Prime%20Minister%20October%20FINAL.pdf?ver=2021-10-25-152534-017×tamp=1635171936513
5. UK market intelligence: Strong, safer, more expensive? Building safety in a market on the rise, Turner & Townsend (Summer 2021).
6. ‘National construction products regulator established’, Designing Buildings (7 July 2021): https://www.designingbuildings.co.uk/wiki/National_construction_products_regulator_established
7. ‘Building Safety Regulator’, Designing Buildings (5 August 2021): https://www.designingbuildings.co.uk/wiki/Building_Safety_Regulator
8. Cladding remediation costs, RICS (25 January 2021: https://www.rics.org/uk/products/data-products/insights/cladding-remediation-costs/