26 March 2024
Examining Split Insurance approaches for the Construction sector
In the insurance industry, a ‘soft market’ is generally described as a period of plentiful insurance capacity available to buyers; as a consequence, the terms offered by insurers are relatively generous in terms of coverage, price and deductibles. A ‘hard market’ is the opposite of this – shortage of capacity results in limited cover, higher prices and deductibles. It is generally accepted that these insurance market phases occur cyclically in line with other typical supply and demand curves.
A changing insurance market
The end of the last decade saw the construction insurance market hardening at different times and to differing extents around the globe as reinsurers responded to several very large high-profile claims, and a focus on the ever-increasing loss ratio on their book of construction business. Eventually, all insurance markets around the world experienced this hardening but to varying degrees depending upon regional dynamics of unfavourable underwriting profitability and reducing capacity.
The immediate period following the change of direction of the market can be turbulent and difficult for any insurance buyer and their broker. The ‘kneejerk’ reaction of many insurers can feel like an over-compensation in some cases. In addition, all the negotiating flexibility of the soft market has also disappeared, leaving buyers with a wide and varied array of quotes, each of which may not be appealing in different ways. The added complexity of this from a construction insurance perspective is that, for the larger, more complex projects we may need many, or even all of these reinsurers to agree to insure the project in some capacity in order to place the project to 100%. For the larger more complex projects or for difficult territories, those with significant natural catastrophe exposure, or those with significant Delay In Start Up (DSU) exposure, the insurance capacity needs of the project can come close to the finite capacity available in what is quite a niche global construction insurance market.
Lead terms for any construction placement are usually only offered to a certain percentage of the overall risk, hence why other insurers (‘follow markets’) are needed in order to complete a placement. Following the collation of quoted lead terms and selection of the desired lead terms, the aim of the broker is then to complete the placement to 100% based on the same terms. In a hard market, or for a particularly challenging sector, this is not always possible. Other quoting insurers will only offer their capacity to an insurance programme at terms acceptable to their own underwriting principles; they are often not agreeable to following the most competitive lead terms.
We’re pleased to say that things have settled down in 2024 to a large extent and we’re starting to see signs of more follow capacity entering the market but the fragmentation of offered terms and the challenges in aligning terms to complete an insurance programme to 100% still exist. Both currently and throughout this preceding period we have been advising our clients on the benefits and negatives of going ahead with ‘split’ (sometimes referred to as differential or verticalised) placements.
The role of split placements in your insurance programme
There is no doubt that when it comes to claims resolution and settlement, the most efficient approach is a single uniform insurance programme with 100% capacity, all provided on the same terms and conditions. This is by far the most common approach which our clients take to their insurance programme. However, where any insurance programme receives a very diverse set of offered lead terms, the insurance buyer and their broker need to think carefully about the next steps and the desired completion strategy. The optimal answer may not always be to go for the cheapest lead terms or even the most commercially attractive lead terms; which may seem counter-intuitive, but forging ahead in attempting to complete the programme to 100% at these terms can be detrimental to the overall results. In difficult cases, or difficult market periods, other insurers may well abstain from offering any capacity at the selected lead terms and stick to their original quoted terms which leaves brokers and their clients with a challenge to overcome.
Where any insurance programme receives a very diverse set of offered lead terms, the insurance buyer and their broker need to think carefully about the next steps and the desired completion strategy.
Where consistency of terms is desired or required, it can sometimes be a wiser option to look to the 2nd or even the 3rd most competitive quotes and analyse the spread of terms across the insurers to determine a more balanced target. This may bring several key insurers onto the programme at terms which are more competitive than they originally offered, but not so far away to encourage them to stick to their original position. This is not a straightforward task and is very much subject to the experience and ongoing reactive response of your broker; skills which are very important in the current marketplace. Once a critical mass of capacity is achieved, other follow insurers are more likely to agree to join the programme.
In the event that alignment of these terms is not possible or where a buyer does not seek uniformity of terms, it is our job as insurance consultants to advise on the pitfalls of a split placement and what the negative outcomes of such a response can be. The benefit, of course, is that you are taking the most competitive elements of each quote individually and applying them to the programme. How this may affect the policy claim response is another matter. Clients also need to consider the challenges of presenting the structure and coverage of the final insurance programme to the other construction entities with an interest in the insurance policy. As a contractor buying the Construction All Risks (CAR) insurance, you will need to evidence the cover to the Owner and vice versa. Representing a split placement within a single document can be incredibly convoluted and may not elicit a positive response from your counterparties.
Navigating the differences in Split placement agreements
Below we list out the key ways in which the offered terms may be divergent and the effect that applying differential terms to your placement may have:
Price
The key driver to a split placement usually, and the easiest element to split across the programme. Given that the premium paid will be an amalgamation of the % capacity committed applied to each reinsurer’s price, this is easy to calculate to a final premium payable and this does not normally affect claims response (assuming no reference to loss ratio within the policy terms). Future extension endorsements may not be straightforward given the differing starting point for the additional premium to be charged, but at least the claims response is not affected.
Deductible
Anything which purely relates to cost can be fairly easily absorbed into a split placement as the calculations can be made to identify the answer. Per our comments above, how this is represented to your project team and your counterparties can be more complex.
Coverage
This will be the area in which a split placement is likely to cause buyers issues. Anyone who has been through a significant construction claim will be aware of the level of complexity that can arise when applying the terms of a Construction All Risks (CAR) policy to a major loss event. Varying the level of cover across the programme is inevitably going to delay the claim response; not only due to its complexity but also in having to negotiate the response with each reinsurer individually where their exact offered terms affect the claim payout.
As brokers, we have two key aims for our clients:
• To procure the optimal commercial terms for their insurance programme
• To get their claims paid quickly and satisfactorily
The ‘optimal’ terms may or may not be via a split placement depending on our client’s assessment of what is optimal for them.
If we slightly amend those aims to say that we want to procure the cheapest insurance programme for our clients and get claims paid quickly and satisfactorily then a split placement approach on anything other than price and deductibles results in these two aims conflicting. Therefore, a split placement approach involving major coverage differences would not be our recommended approach. Given that our clients bear the responsibility for funding insurance premiums, we prioritise their preferences. Thus, we engage in collaborative split placement scenarios to develop a well-considered approach. This approach aims to strike the optimal balance between minimising premium costs and mitigating any adverse impacts on claims response.
Whatever route you decide to take, the completion process for major, complex or significantly exposed projects is never straightforward and it is important that the buyer and their broker are aligned in the aims and objectives of the completion strategy and that it is executed proficiently with these in mind.
Let's talk
Arthur J. Gallagher (UK) Limited is authorised and regulated by the Financial Conduct Authority. Registered Office: The Walbrook Building, 25 Walbrook, London EC4N 8AW. Registered in England and Wales. Company Number: 119013.