13 November 2024
Construction and Climate Change: The Challenges of Uncertainty
The effects of climate change has resulted in risks becoming more unpredictable. In the past, knowing the historical frequency and severity of extreme weather events gave underwriters enough information to predict the likelihood of similar losses in the future. The past was a guide to the future.
Climate change has forced a change to that approach. As the warming atmosphere alters weather patterns, the future no longer echoes the past. This creates a new level of unpredictability, which means actuaries can no longer solely rely on the predictive power of their large, historical datasets.
As the warming atmosphere alters weather patterns, the future no longer echoes the past.
Project impacts
The changing weather has already had a big impact on construction. It affects where the building takes place and influences the design criteria. Most critically for insurers, extreme weather can cause serious delays, extensive property damage and other forms of loss. When insurers are not as comfortable with the likely frequency and severity of these evolving risks, the result is that they have to increase the cost of insurance as a contingency measure to ensure that they have sufficient capital should a claim arise. In some circumstances this uncertainty may mean exiting particular markets or declining to cover specific perils going forward.
Wide-ranging major events like hurricanes can affect huge swathes of an underwriter’s risk portfolio. Meanwhile, ‘secondary perils’ are also being re-evaluated. These localised events (hail, floods, convective storms, wildfires, freezes, droughts, heatwaves and others) are particularly worrying for insurers because they seem to be exacerbated by climate change. They’re becoming more frequent, more intense, and less predictable.
Climate scientists don’t know exactly how the effects of climate change will play out, but they do know that they will cause problems that haven’t been adequately foreseen. We often talk about the impact of extreme heat on the workforce, but what if groundwater changes unexpectedly? Or how will sustained freezes impact new green concrete products coming onto the market? Such unknowns inject further uncertainty into insurers’ cost-of-risk calculations - and push prices up.
Coverage availability
Meanwhile, insurance remains essential for multiple reasons - not least because the funding parties demand it. Although lenders’ requirements haven’t expanded to include additional types of coverage at this stage, they will continue to insist on comprehensive coverage. Unfortunately, the breadth and availability of insurance may become somewhat restricted as insurers protect themselves from broadening exposures due to climate change and as major events impact their bottom line. Clients that agree to lenders’ long-term operational insurance commitments may find that the cover they need is no longer available in a few years’ time or may come at a greatly increased cost. Clients may need to purchase additional cover to meet existing commitments in an insurance environment that has changed with the weather.
Currently, insurers are considering higher-risk locations much more carefully when calculating prices. They may then adjust prices accordingly, restrict the terms of coverage or do both. Case-by-case restrictions may be policy conditions or warranties that exclude specific named perils from coverage (such as flood or hail) or deploy higher deductibles or sub-limits.
When restrictions on limits or perils are significant, it is sometimes possible to purchase standalone ‘carveout’ cover from specialist insurers. For some excluded perils, parametric products have become relevant and popular solutions.
Case Study | Worldwide Weather Delays Construction
UK: Rail tunnels flood. An enormous London rail construction project, Crossrail, suffered a serious disruption when heavy rainfall and flooding significantly impacted the construction schedule.
USA: Winter freeze cuts power. Texas suffered an abnormal winter freeze that knocked out power supplies to more than 4.5 million electricity users. All affected projects ground to a halt.
Germany: Steel deliveries delayed. Steel supplies in Germany were disrupted after floods damaged rail infrastructure, causing damage of EUR1.3 billion and delaying multiple projects.
Australia: Wildfires send workers home. Construction crews were sent home during rampaging bushfires when the level of air pollution was 26 times higher than the hazardous baseline, inflicting serious project delays.
Danube: Drought affects Shipping and agriculture. In 2022, the Danube experienced a dramatic fall in its water levels which affected agricultural and cargo shipping along its route.
Scenario testing
Individual circumstances make a difference. The retention under any insurance policy is based on the client’s risk appetite and how the insurance market responds to the risk. That makes it important to determine, very early on in the course of any project, both what level of risk retention may be required by insurers and what level of risk the client is able and willing to bear.
Insurers will expect historical data to have been analysed and defined return periods factored into the design criteria of both the temporary and permanent works for any project. Increasingly, they also expect the impact of climate change to have been factored in. Currently we see insurers looking for any proactive adjustment to the historical data but in the future, we can expect more questions on the exact modelling scenario utilised to adjust the design criteria.
Who pays?
It is critical at the contracting tender stage to determine who’s taking on the additional risk created by climate change. Insurance must be structured to reflect the responsibilities agreed in contracts, as determined through negotiations between developers, contractors and designers. Climate change impacts make that negotiation more difficult, as all parties naturally try to hand off increasing risks — for example, the risk of the weather causing serious delays to completion. Contracts often mention contractors being alleviated of risk if the conditions are ‘unexpected’ or ‘beyond that which an experienced contractor could foresee’. Such terms are dangerous grey areas during disputes but become even more problematic when climate change alters risk conditions.
The contractor market, especially in the UK, is currently volatile. Risk costs can mean the difference between profits and losses. It is essential to understand in advance the additional or exacerbated risks driven by climate change and to ensure they are knowingly accepted by or shared between the project partners, mitigated or managed where possible, and transferred away where possible and sensible to do so.
Wherever you are in the world, it’s critical to work with a team of risk specialists who understand not just the insurance market but also the specific characteristics of the risks in your sector, as well as the changing weather and its impacts. Gallagher helps clients understand risk, the risk management and transfer processes that are achievable, and what is reasonable in proposals from the insurance market. This approach removes uncertainty for our construction clients, making climate change a smaller challenge to overcome.
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