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Risky business: Construction risks in an era of evolving delivery methods, tight margins and alternative Risk capital20th Willis Construction Risk ConferencePaul Becker, CPCU, ARM Willis North America

September 16, 201420TH ANNUAL CONSTRUCTION RISK CONFERENCETodays ThoughtsProjects continue to move to more complexity not lessDifferent stakeholders are involved and driving discussions around riskRisks are being highlighted and contractors will either need to proactively embrace them or be faced with reactively trying to manage themWith the current margin environment construction firms will need to be totally focused on risk and look for ways to deliver more value to its customersNew risks are emerging with technology The insurance industry is also changing with new players and new types of financing evolving

20TH ANNUAL CONSTRUCTION RISK CONFERENCEWhat is Risk?RISK:

INSURANCE: Possibility of loss or injury

BROADER DEFINITION: Risk is the potential of losing something of value. Value (such as physical health, social status, emotional well being or financial wealth) can be gained or lost when taking risk.

20TH ANNUAL CONSTRUCTION RISK CONFERENCEOF COURSE THERE IS A POPULAR VIEW20TH ANNUAL CONSTRUCTION RISK CONFERENCEOF COURSE THERE IS A POPULAR VIEW

20TH ANNUAL CONSTRUCTION RISK CONFERENCEAre projects getting more complex and what new stakeholders are involved in risk?Section one20TH ANNUAL CONSTRUCTION RISK CONFERENCEWHAT ARE WE SEEING ON PROJECTS?Design Build: Now about 40% of the non residential commercial marketplaceWith new emphasis on Integrated Project Delivery esp. Health CareConstruction firms taking investment/equity positions in projects (including P3)Broader Performance and warranty risks in contracts Contracts starting to call for different performance security including demand instrumentsGenerally bigger jobs with significant increases in size of sub packages

20TH ANNUAL CONSTRUCTION RISK CONFERENCEOTHER STAKEHOLDERS ARE GETTING INVOLVEDOwners more prescriptive on risk and insuranceNot just requiring insurance but verifying and challenging contractors to prove itLenders taking an active role, and not reasonable in insurance and contract requirements

20TH ANNUAL CONSTRUCTION RISK CONFERENCEP3 PROJECTS ARE THE EMBODIMENT OF COUNTERPARTY COMPLEXITY

P3 creates four or more contract players (governmental body, concessionaire, financing, CJV, design and O&M) 20TH ANNUAL CONSTRUCTION RISK CONFERENCEIMPACTS ON RISK Are risks increasing? Maybe.We are spending a lot more time on the front end of jobs with youRisk analysis both insurance related or not a huge focusWe are seeing you look at new types of work and in some cases in new territories- in the past red flags for riskYou are asking us to deliver broader risk discussions and more tailored solutions-this is testing us and the insurance industry

20TH ANNUAL CONSTRUCTION RISK CONFERENCEIMPACTS ON RISK Are risks increasing? Are risks increasing or are they just being pushed around inside the contract to the contractor?In many cases risks are being shifted as the upstream parties try to attain as much certainty as possibleWe generally feel that risks are actually increasing based on several factorsTypes of financing Margin pressureSchedulesMost of these have only partial risk financing solutions

Sub contractor healthSupply chain challengesTechnology20TH ANNUAL CONSTRUCTION RISK CONFERENCEONE EXAMPLE, SUPPLY CHAIN-LARGEST STEEL COMPANIES GLOBALLYRanking(2013)2013(tons)CompanyHeadquarters196.1ARCELOT MITAI Luxembourg250.1NIPPON AND SUMITOMO STEELJapan345.8HEBEI IRON AND STEELChina443.9BAOSTEEL GROUPChina539.3WUHAN IRON AND STEELChina638.4POSCOSouth Korea735.1JIANGSU SHANANGChina833.7ANSTEELChina931.5SHOUGANGChina1031.2JFEJapan20TH ANNUAL CONSTRUCTION RISK CONFERENCEEXAMPLE 2: TECHNOLOGY RISKBoth a direct and indirect riskDirect:Housing data for all parties (BIM, IPD, Leed)Loss of data due to construction activitiesDrones-significant increase in use of drones with lack of standards for privacy, air traffic, insurance coverageIndirect:Counterparty risk-doing business via owner platforms or via third party interfacesTarget!Insurance is and must continue to evolve to provide complete financing solutions to e-commerce and cyber risk

20TH ANNUAL CONSTRUCTION RISK CONFERENCEBuilding a strategic risk focusSection two20TH ANNUAL CONSTRUCTION RISK CONFERENCEVALUE IN RISK MANAGEMENT IS ACHIEVED AS IT ENABLES THE COMPANY TO SUCCEED IN ALL AREAS OF RISK

Courtesy of Business Finance20TH ANNUAL CONSTRUCTION RISK CONFERENCECONSTRUCTION FIRMS AND THEIR PARTNERS HAVE TO DEVELOP MORE STRATEGIC VIEWS OF RISKSUPPORT FUNCTIONProtect the balance sheetContract complianceMinimum insurance to meet specsAll your competitors will sign this

PROACTIVE, DIFFERENTIATIONEngineer risk. Use insurance as a differentiator by deconstructing risk costs on the job.Build data models to measure risk costs over timeSub contractors-SDILong tail exposures and defects: CIPsBlanket builders risk programs which mold around the risks particularly delays, Advanced Loss of Profits and other soft costsA close examination of other non insurable risks and alternative methods to fund these (incl. Captives)The overarching goal is to bring the project better risk solutions and reduce long term project costsTHERE ARE VARIOUS WAYS TO LOOK AT RISK WITH THE TWO EXTREMES BEING A SUPPORT FUNCTION AND THE OTHERE BEING A PROACTIVE, INTEGREATED FOCUS WHICH STRIVES TO BRING MORE VALUE TO THE PROJECT20TH ANNUAL CONSTRUCTION RISK CONFERENCEAlternative risk capital: what is this and will it impact risk financing choices for contractors?Section three20TH ANNUAL CONSTRUCTION RISK CONFERENCEALTERNATIVE RISK CAPITALWhat is this?There is not a universal definition but think of it as investors using financial transactions to take risk positions outside of traditional insurance companies and reinsurersThe biggest example to date is Cat Bonds which act as reinsurance for catastrophic events for insurance companiesThese have eaten into traditional reinsurers businesses and the result has helped to drive lower reinsurance costs. In reaction Reinsurers are now building their own investment facilities to manage these types of risk20TH ANNUAL CONSTRUCTION RISK CONFERENCEALTERNATIVE RISK CAPITALWhat impact will this have on the ultimate insurance buyer?We think it will have impacts in several areasIt will moderate premiums particularly in property lines as insurance companies can access more creative reinsurance transactionsIt should increase capital in the insurance businessUltimately it will allow financial innovation which should increase appetites for new products20TH ANNUAL CONSTRUCTION RISK CONFERENCEINSURANCE CAPACITY AND SURPLUS ARE ALREADY AT ALL TIME HIGHSInsurance Information Institute DataInvestors really, really like the P&C business20TH ANNUAL CONSTRUCTION RISK CONFERENCEAS A RESULT RATES ARE STEADY WITH SOME IMPROVMENTS DEPENDING ON LOSS OUTCOMESBy Line of CoverageBy Size of Premium SpendBy Industry ClassBuilders Risk: -5 to +1%GL: 0 to 3%Umbrella/Excess: 0 to 3%Auto: 4%WC: 4%Professional: 2%< $1,000,000: 3-4%> $1,000,000: 1%Construction: 1-3%Market Scout and Willis Benchmark data20TH ANNUAL CONSTRUCTION RISK CONFERENCEInnovation in the insurance industry for construction. YourE kidding right?Section four20TH ANNUAL CONSTRUCTION RISK CONFERENCEINNOVATION FOR CONSTRUCTION RISKSOVER THE LAST 20 YEARS THERE HAS BEEN SIGNIFICANT INNOVATION IN THE INSURANCE INDUSTRY FOR CONSTRUCTION ACCOUNTSRISK PROFILE/NEEDINSURANCE RESPONSEUncertainty of sub contractor coverage and the emergence of defect litigation

Sub contractor default risk

Emergence of Design Build and assumption of professional liability by contractorsUse of CIPs by contractors and the emergence of General Liability Only Wraps

SDI

Development of contingent professional policies (protective)20TH ANNUAL CONSTRUCTION RISK CONFERENCEINNOVATION FOR CONSTRUCTION RISKSRISK PROFILE/NEEDINSURANCE RESPONSEGrowth into multiple geographies created uncertainty as to how General Liability policies would respond to property damage to your workIntegrated Project Delivery created a need to address professional liability with mutual indemnity waivers in the contract

General contractors began assuming risks of their subs and needed risk financing vehicles to allow them to fund for risks business risk and modifications to definition of occurrence reduced uncertainty

Professional policies were amended to address rectification and mitigation allowing these contracts to go forwardCaptive usage expands exponentially by contractors as SDI and CCIP programs grow20TH ANNUAL CONSTRUCTION RISK CONFERENCEINNOVATION FOR CONSTRUCTION RISKSRISK PROFILE/NEEDINSURANCE RESPONSEAn era of mega jobs in excess of $500 million in size created the need for higher limits of liability for contractors and Joint VenturesThese same mega jobs called for surety at levels never before contemplated

Global firms significantly increased their footprint in the US and US firms globalized in response to client needs and other opportunitiesUmbrella and excess liability capacity is at a peak now with limits up to $1 billion available globallyThe surety industry responded by expanding capacity and today single job capacity is well in excess of $1 BillionUtilization of global solutions with access to insurance carriers in all countries20TH ANNUAL CONSTRUCTION RISK CONFERENCETHATS ALL FINE AND GOOD BUT WHAT NEEDS DOES THE CONSTRUCTION INDUSTRY HAVE NOW AND WHAT SHOULD WE EXPECT IN THE FUTURE?REEVALUATING EMERGING RISK NEEDSPerformance RisksTechnology RisksEquity/operational RisksProject maintenance guarantees and broader warranteesCost overrunsInsurance which responds across multiple risks and lines of coverage while reducing frictional costs and litigation expensesWith the growth of P3, products which addressing all phases of project risk from finance, engineering, construction and operations seamlessly.20TH ANNUAL CONSTRUCTION RISK CONFERENCEI AM ACTUALLY QUITE HOPEFUL ABOUT PRODUCT INNOVATIONAs all our contractor friends in the audience knows there are several ways to compete in any industryPriceBest ValueInnovative approachesFinancial strength Long term relationshipsThe insurance industry is no different, it has a capacity and margin challenge just as the construction industry does.20TH ANNUAL CONSTRUCTION RISK CONFERENCEAS A RESULT THE INSURANCE INDUSTRY HAS TO DECIDE WHERE IT WANTS TO PLAYThere will always be a substantial portion of the market that will stick with core product portfolios

We believe however that carriers will need to create innovative approaches to bring more VALUE to construction projects with more flexible solutions20TH ANNUAL CONSTRUCTION RISK CONFERENCEINNOVATION NEEDS TO CONTINUE AND ACCELERATE.I believe we are in the beginning of a period of more innovation as insurance carriers continue to put their surplus to work and bring higher value solutions to construction projects20TH ANNUAL CONSTRUCTION RISK CONFERENCEI AM HOPEFUL ABOUT PRODUCT INNOVATIONLooking at the last two decades a lot has changed Over the last three years we have seen new carriers enter the market in all lines creating intense competition

This includes the surety industry where major financial bets are being made by new carriers-this will impact the product offerings in surety significantly as they look to differentiate themselves20TH ANNUAL CONSTRUCTION RISK CONFERENCETHE NEXT FEW YEARS WILL CREATE A NEW SET OF IDEASWe look forward to working with you on new solutions in the next few yearsWe know these will be different than today but we believe that there has never been a better time to bring you the value you need to be successful 20TH ANNUAL CONSTRUCTION RISK CONFERENCEThank YouPaul R. Becker CPCU, ARMChairman Construction PracticeWillis North America(615)872-3464Paul.becker@willis.com20TH ANNUAL CONSTRUCTION RISK CONFERENCE