Challenges in construction – raw material shortages and price increases

Construction costs rose significantly in 2021 as global demand bounced back from pandemic-induced recession. Supply-side issues in the form of raw material supply chain bottlenecks and labour shortages added to inflationary pressures. For example, price inflation for new, non-residential building construction in the US reached 17% in March this year, much higher than overall inflation in the economy. This year, the war in Ukraine has amplified inflationary pressures by further exacerbating supply chain disruptions and scarcity of specific raw materials.

For insurers, price increases can lead to unexpectedly severe claims, particularly in long-tail business, multi-year policies and non-proportional contract features. Over time, contract mechanisms in different countries and lines of business have been developed to mitigate and prevent extreme impacts of inflation. In engineering insurance, for instance, standard practice is to adjust premiums based on final contract value. An escalation clause can ensure that if a contract value exceeds a set threshhold during project execution, insurers have the right to renegotiate terms and conditions.

In the coming years, price increases in the construction sector could indirectly impact claims. Scarcity of and higher prices for raw materials, alongside wage inflation, can increase incentives to innovate more efficient construction technologies. On the other hand, they may also encourage use of less expensive and often inferior materials from a fire and integrity standpoint. This can mean lower production and construction quality and, in turn, potentially much higher claims in property insurance. For example, combustible cladding can be visually identical to, but far less expensive than non-combustible cladding for buildings. In the event of a fire in a building with combustible cladding, however, the losses can be much higher. Price and wage inflation could also see contractors hire lower-cost and less-skilled construction site labour. This could result in lower-quality buildings, with possible implications for liability and property claims.

Today’s geopolitical tensions have increased uncertainty around price developments in the construction sector. Insurers need to be able to distinguish between short-term spikes and long-term trend rises in prices. They need to establish a strong monitoring control framework and to react quickly to ensure profitability. At the same time, they need to also consider that increases in insurance prices can themselves contribute to higher inflation in the construction sector.