Supply, Cost Increases and COVID-19: The Link Between the Construction Sector and Underinsurance

Prior to COVID-19, the construction industry was lulled by consistent and modest price increases in materials.

The pandemic has led to skyrocketing costs across the board, and while the industry is experiencing high activity in both the residential and commercial areas, it has exposed a new issue facing the industry.

Underinsurance is tipped to be a massive issue that will have long-term implications for the industry if left unaddressed.

As costs increase dramatically it is now time for companies across all sectors to properly assess and value their assets.

Massive price increases affecting the industry

Over the last 12 months, Australia has seen significant cost increases across almost all sectors of the economy.

Building construction has seen significant price growth across most states, due to a broad range of factors including a tight labour market, input cost increases and increased demand on the back of government incentives. Cost increases have typically started in residential construction, but we are now seeing the above factors starting to influence all forms of construction.

This is emphasised by data released by the Australian Bureau of Statistics that shows that in the year to 30 September 2021 Australia saw a record value of construction work commenced, valued at more than $141.2b, this is up more than $10b on the previous record of $131.8b set in 2018.

The table below provides an insight on construction cost increases by State and construction type for the year ended 31 December 2021.

Despite, or maybe because of these increases, recent data released by ASIC shows that construction company insolvencies rose by 40%  in the December 2021 quarter when compared to the previous quarter and were up by 30% on the same quarter in 2020.

A contributing factor might be that these insolvencies are partly as a result of the federal government’s moratorium on insolvent trading that was in force during 2020, but insolvencies are suggested by some to further increase in the near term due to the record level of construction expenditure. If this occurs it. This is likely to put further upward pressure on margins.

However, it is not just a rise in costs that has impacted the construction industry over the last year.

The industry has also seen significant time delays to complete projects due to labour shortages and also a global supply shortage in many popular construction materials, such as timber, cabinetry, cement, some electrical components, steel and paints. Building material wait times during the pandemic for the above materials have at best doubled, to at worst extended by more than 10 times over pre-pandemic times[1].

Furthermore, cost increases have not been limited to building construction. The table below indicates the variation in price growth across a selected number of categories in the Australian economy.

As with building construction, accompanying the cost increases for these and other product groups, customers have also witnessed significant delays in delivery times for many of these products – for example, it has been reported that the wait times for some models of new light and commercial vehicles are up to 15 months from order[2].

Cost increases heavily scrutinised

Given the extent and variety of these cost increases, underwriters are scrutinising declared asset values far more closely, and often demanding specific insurance valuations be undertaken to support those values.

This factor is incredibly important to consider. Declaring the right value ensures the builder won’t fall into the underinsurance trap when going to make a claim.

Taking ownership of the valuation process, through either obtaining a formal valuation or employing a risk program assessing exposure of placing risk, and not being complacent is more likely to provide a win-win situation so organisations are not caught out with inadequate cover.

What’s ahead for 2022

It is expected that price increases will continue, and while there are a range of opinions on where they may go, it is a reasonable expectation that increases will be around 5% or higher in the medium term.

It is expected we will also see more investment put into infrastructure developments in 2022, with the resulting diversion of materials and labour to this part of the sector.

Although government infrastructure spend will increase, many privately funded projects – particularly impact on retail and residential projects – will continue to see delays to start times and completions.

COVID-19 and subsequent cost increases have impacted the construction sector in Australia in a number of ways, and these issues continue to have flow-on effects to many other industries and sectors. It is now time for the industry to account for these when assessing their risks now and into the future.

References

[1] The Age ‘ ‘Builders are going bust’: Construction material shortages cause costly delays’ 18 June 2021

[2] ABC online, Is now a good time to buy a car? Delivery delays, higher prices hit the industry 22 March 2022