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Four Construction Risks to Avoid in 2016

Several trends and recent events signal that a global recession may be on the horizon. The sovereign debt crisis in Europe continues to persist, the Chinese stock market has become volatile as its economy may be entering a prolonged slowdown, and low interest rates leave Europe’s central banks little room to avert a recession.

The volatility in the U.S. equities markets will likely become more pronounced and perhaps prolonged. Specifically, to the U.S. construction industry, activity is expected to continue to grow at a modest pace in 2016 thanks to continued low mortgage rates, an uptick in the new home market and the fact that the U.S. economy grew by 2 percent in 2015 (not exceptional, but positive when compared to most of the world).

Construction company owners and builders are cautiously optimistic, but will no doubt remain focused on reducing operational costs by improving efficiencies and embracing strategies with meaningful financial impact. With all this in mind, following are four construction trends to watch for this year:

  • impact of labor shortage on workers’ compensation claims;
  • evolving construction delivery methods;
  • demanding lender and statutory requirements; and
  • cyber security risks due to increased use of technology.

Labor Shortage

The 2008 recession forced many construction workers to leave the industry, resulting in contractors struggling to meet labor demands. Construction companies are having a hard time finding qualified carpenters, sheet metal installers and concrete worker, and struggling to fill salaried positions such as project managers, estimators and engineers.

This shortage is having a direct effect on workers’ compensation claims and premiums because fewer workers are carrying a greater portion of the workload and newer workers are less skilled or in need of additional training. Certain companies facing labor shortages could see losses increase by 30 percent on average, which could result in a dollar-for-dollar increase in the workers’ compensation experience modification.

Additionally, construction companies are at risk of lost revenues due to increased costs, inability to bid on new projects due to experience modification rate (EMR) qualifiers, lost time and expense, and project delays.

Evolving Construction Delivery Methods

Recent data from RSMeans indicates the design-build delivery model has gone from being used in a small minority of large, nonresidential construction projects to becoming the market leader in all types of construction projects during the last decade.

Compared to the traditional design-bid-build contracting method, where an owner is obliged to negotiate specific and separate contracts with multiple specialists, integration of the design-build functions under a single entity or team fosters collaboration and increases productivity. However, the move to a design-build business model has exposed more contractors to professional liability risks.

Many contractors have insurance policies that do not provide protection that is reflective of their activities and exposures, especially as it relates to design work. This exposure remains even when the contractor subcontracts the work to another entity.

In a recent case, a mechanical contractor that traditionally performed insulation work was asked to design and install an HVAC system in a high-rise office building. During an analysis of the contract and policy, it was revealed that the mechanical contractor had a potential professional liability gap because its commercial general liability policy excluded all professional liability exposures.

The contract value for the mechanical package was $7.5 million, including design work subcontracted for $500,000. The design firm was required to provide evidence of professional liability. A recommendation was made that the mechanical contractor procure its own professional liability policy with contingent design coverage.

Upon completion of the building, it was discovered that the HVAC system was improperly designed. As a result, the HVAC piping needed to be taken out and replaced with larger ducts and properly sized equipment. This incident resulted in a $1.25 million loss, which fortunately was covered under the contractor’s policy.

Increased Use of General Liability Only Wrap-ups

A major trend in the construction field is increased use of general liability (GL) only wrap-ups for commercial construction projects, as well as condominium projects. Typically, lenders require owners and contractors to provide general liability coverage during the construction period as well as completed operations coverage for the statute of repose. This period may range from two to 10 years.

To ensure contract compliance, GL only wrap-up programs should be structured to provide coverage with the appropriate policy limits for the construction period, as well as for the completed operations exposures for a period of 10 years or the applicable statute of repose, whichever time period is less.

In one case, a general contractor was required (along with all the subcontractors) to provide completed operations coverage for a period of 10 years as required by state statute. The general contractor wanted to contractually transfer as much risk as possible, but the anti-indemnification statutes essentially prohibited any transfer of negligence to another party. A GL only wrap-up program was implemented that was sponsored by the general contractor, providing coverage for the three-year construction period, as well as the 10-year statute of repose.

The program provided coverage for the general contractor and all tiers of subcontractors for the $52 million project. The GL only wrap-up was structured with all parties covered under one policy. This solution saved 35 percent of the project’s value, which amounted to $182,000.

Increased Cyber security Risks

Contractors are continually increasing their reliance on technology in an effort to improve services, streamline their workflows, reduce timelines, and meet owner and general contractor bid and contract requirements. This trend has resulted in increased cyber security risks.

Many construction companies, particularly small to medium-sized entities, do not fully understand the risks and potential impacts of a cyber breach. This is a major barrier to adopting a robust cyber security risk management strategy, including insurance coverage. Too often, management embraces a false narrative that their firms are not a target of cyber criminals, or that they don’t retain the sort of personal information (e.g., credit cards) that hackers find attractive. The thriving black market for confidential information makes no distinction between data stolen from large corporations versus smaller ones. In fact, the fallout of a breach is more likely to put a smaller construction out of business than a larger entity.

The process to assist contractors mitigate cyber security exposures should include:

  • evaluation of the current IT security plan, focusing on cyber and privacy liability exposures;
  • identifying the number of confidential records/data handled by the insured;
  • outlining the unique program benefits of cyber liability coverage (i.e., breach notification costs and IT forensics, credit monitoring, etc.); and
  • constructing/testing a cyber attack disaster recovery plan.

For example, a mechanical contractor’s laptop was stolen from the jobsite’s construction trailer. The contractor was concerned that confidential owner-related information, as well as its proprietary BIM construction and design methods, could be compromised.

The confidentiality agreement with the owner required that the contractor would be responsible for any potential breach associated with their activities. The breach exposure required that roughly 3,500 past and present employees of the owner be notified and their credit monitored.

The client was able to notify affected past and present employees immediately and provide credit monitoring services for a year. The company did not sustain any actual breach or release of their process documents. The $35,000 cost of notification and credit monitoring was covered.

Partnering with an insurance broker with proven expertise in cyber risk and privacy management is essential to a construction company’s ability to protect its products, processes, facilities and customers, and is critical for continued success.

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