The U.S. construction sector continues to see strong growth in various sectors and geographies but higher interest rates, higher building costs, and a decades-long shortage of skilled labor are contributing to a “cautiously optimistic” outlook for the rest of 2023 into 2024.

Insurance costs are among those that are rising, which insurance professionals say means that they must find creative ways to structure and negotiate their risk management and insurance programs, including anticipating project delays, changing lending terms and increasingly complex contracts.

Despite challenges, overall construction spending and insurance demand continue to rise, especially in the nonresidential sector. And insurance brokers report that markets are responding to the need.

“The bright spot is that we are ‘building’ and we are building a lot,” said Danette Beck, the head of industry verticals and national construction practice leader at USI Insurance Services. “At USI, there was only one sector, Class A office buildings, that wasn’t growing.”

Beck says that in some areas of the country, residential construction has slowed but overall residential remains a growth area. “I don’t have anything but a positive outlook from a construction economy standpoint,” she said.

Construction spending totaled $1.9 trillion at a seasonally adjusted annual rate in April 2023, that’s up just 1.2% from March’s spending rate. Spending is up by 7.2% from April 2022, however, according to the Associated General Contractors of America (AGC). Spending on private nonresidential construction has increased 31.2% from April 2022, the largest year-over-year gain in more than 15 years.

According to the AGC, nonresidential spending increased for the year in every category with the largest segment, manufacturing construction, jumping 8.6% in April 2023. That has more than doubled over 12 months, rising 103.8%.

Commercial construction — comprising warehouse, retail and farm structures — climbed 23.7%, while highway and street construction rose 21.4%, in the past 12 months.

Private residential construction is the only segment that declined — 9.2% for the past year. Total residential spending was dragged down by single-family construction, which declined for the 12th month in a row, falling 24.7% since April 2022.

Not all residential has slowed. AGC reported that spending on new multifamily construction has increased 24.9% since April 2022, the largest rise since 2016.

Beck cautioned that the construction sector’s bright spots could fade if contractors don’t remain diligent about the types of projects that they sign on to and make sure they have enough workers to complete their jobs.

“I don’t know how many clients, especially large clients that I’ve talked to over the last 10 years, have said, ‘I could hire 100 people and put them to work tomorrow if I could find them,'” said Dan Dias, commercial risk advisor for San Diego-based broker, Cavignac. “They just can’t find them.”

The Associated Builders and Contractors (ABC) reports that the construction industry in 2024 will need to bring in more than 342,000 new workers on top of normal hiring to meet industry demand, and that’s presuming that construction spending growth slows significantly next year.

The construction unemployment rate dropped to 3.5% in May. Unemployment across all industries increased from 3.4% in April to 3.7% in May.

“The construction industry unemployment rate is now below the economywide unemployment rate, and there are plenty of available, unfilled construction jobs,” said ABC Chief Economist Anirban Basu.

That puts more pressure on construction firms as the overall cost to hire qualified labor continues to rise. Average hourly earnings for production and nonsupervisory employees in construction — covering most onsite craft workers as well as many office workers — jumped by 6.0% over the past year to $34.07 per hour.

Construction firms in May provided a wage “premium” of nearly 19% compared to the average hourly earnings for all private-sector production employees.

“Demand for construction workers remains strong, outside of homebuilding,” said Ken Simonson, the AGC’s chief economist. “Contractors continue to report their primary challenge is finding qualified workers, not finding projects or most materials.”

Beck says the ongoing labor shortage makes it more important than ever for contractors to make sure they are still running a solid risk management process so that they can stay financially healthy.

More subcontractors fail in a recovering economy than in a recessionary economy, Beck said. “You want to take on as much work as you can but if you’re not diligent about how to manage that work, then you could potentially get yourself into a financial problem where you can’t pay your employees or you start getting behind in paying suppliers.”

Property Costs

Construction is not immune to rising property insurance rates.

“We’ve had to spend a lot of time with our clients talking about their fixed property and their builder’s risk placements,” said Roger Cornett, leader of Holmes Murphy’s construction team. “Rates have skyrocketed, deductibles or retentions have increased, sometimes doubled or tripled and capacity is limited.”

The cost of cement, timber, steel, glass and paint have all increased over the last year, in some cases by around 50%, said Blanca Berruguete, global industry solutions director for Construction, Allianz Global Corporate & Specialty, when commenting on a recently released report (see page 32).

“Frame construction is really difficult and large projects are having to go to the surplus lines and/or having to be layered with multiple markets,” said Dias. “Property will be especially challenging this year, so work with a broker that is engaging the market early for every type of risk as this side of the market is struggling.”

Project delays that might stem from supply chain issues or even labor shortages are adding cost as well.

Cornett says where delays are hitting contractors hard is in the cost to issue project extensions on their insurance.

“So that could be both in builder’s risk, but more frequently on their wrap up programs or otherwise known as OCIPs,” he said. “So the insurers, especially on the builder’s risk … they’d want more money. They’d want to charge more rate (on extensions) because they don’t want to extend that policy at last year’s rate, or two years ago.” Today’s rate will likely be higher.

“I have a client who’s building an entertainment complex that is unfortunately going to sustain a project delay of nearly a year due to simply waiting for an electrical substation, a transformer,” he said. “It’s a big deal and it’s our role and responsibility as a prudent construction-focused agency or brokerage to be talking to our clients way out ahead of those policy expiration dates and strategize so that we’re well armed when we go to that insurer to ask for a reasonable policy extension.”

A few years ago, the builder’s risk market was very different, Cornett added. “So it used to be, ‘OK, we’ll extend existing terms.’ But now, you’re basically renegotiating everything.”

“We have always spent a lot of time explaining safety programs, especially for work comp or their fleet safety practices for automobile, or their contractual risk transfer for general liability. Now we’re having to spend as much time or more so on the property to explain this marketplace,” he said. “Frankly, for most construction firms [property] was more of an afterthought, or at least on the back burner. Now it’s front and center in every renewal discussion.”

Financial Concerns

Another reason for the cautious outlook for construction firms is the possibility that an economic recession may hit.

“Lending practices have been under review on a broad basis to ensure banking stability and that plays itself out into construction firms and owners looking to secure loans for construction projects,” said Matt Walsh, managing director of Alliant Construction. The challenges for construction are most pronounced right now in the commercial space. “It’s very difficult to get a loan for a commercial office building right now.”

When lending is tight the market tends to see an uptick from insurance companies stacking collateral, he said. That ends up having a double impact on owners and contractors — the cost of the loan is higher and the insurers raise their security requirements to ensure portfolios are not subject to a financial downturn.

“There’s a lot of pressure coming from that segment to increase collateral requirements. And so that’s a discussion we have every day to make sure that we try to rationalize it to actuaries and do the best everyone can do to mitigate losses, and that comes back to safety,” Walsh said.

When losses do arise, Walsh advises, contractors and their specialist brokers need to think about the trends inherent in those losses: “What are the inflationary impacts on those claims, whether it’s the cost of the vehicle or it’s a jury verdict? And then how does that impact ultimately, lending practices, which are reflective of people’s balance sheets.”

Fundamentally, risk allocation in construction is the critical point, Walsh added.

Risk allocation plays itself out, first and foremost, in the contracts among all parties. “Ensuring that those are synchronized, that all of the parties are allocated risk upfront, very clearly, and whether they are looking at cost of materials or they’re looking at the duration of a project that might be impacted by climate change, all of those factors are very critical,” he said.

At the top of that list of factors is finding the labor necessary to build, Walsh added.

“Everybody needs to be practical and cognizant of risk allocations and ensure that the risks are being managed by all the parties that are capable of managing that risk,” he said.

At the same time, unforeseen challenges need to be reflected in the contracts to ensure that the best outcomes possible are achieved even when there is a lot of uncertainty on the path to project completion.

“Every item on that path can be impacted … if there are unfortunate worker injuries that throws off the schedule, or you can have quality issues that come up where you need to reconfigure work that’s been done,” he said. Then that impacts the entire project schedule. “The schedule is one of the most critical things and people from outside of the construction industry don’t necessarily understand how time impacts construction projects.”

Any sort of activity that sets that pathway off course, could be very challenging, and quickly slow the project down, he said. “That all impacts, too, the cost of finance per project because these projects are mostly financed.”

Even with rising costs, labor shortages and uncertain economic times ahead, the construction insurance market is favorable and moving in the right direction, Walsh added.

“There’s ample capacity to actually do the projects,” he said.