No 2 /2018

Constructing the future: 01 Executive summary

02 Introduction
recent developments in 06 Structure of
engineering insurance
engineering insurance markets
13 Underwriting
performance &
practices
20 Technology-led
innovation in
construction
28 Market outlook
36 Conclusion
Foreword

This year we celebrate the 50th anniversary of sigma, the flagship publication of the Swiss Re
Institute’s research portfolio. Over the last half century, sigma has provided thought leadership
spanning the ever-evolving risk landscape facing society, the macro and regulatory environments
and their impact on insurance markets, and industry-specific topics such as underwriting
cycles and distribution channels. As the industry’s leading research publication, sigma continues
to support Swiss Re’s vision to make the world more resilient.

For the second edition of sigma in this anniversary year, the topic of interest is engineering
insurance, a specialist area of the sector focussing on providing protection against engineering
and construction risks. Although not mainstream, such specialty insurance lines involving
difficult or unusual risks have often been covered by sigma. In fact, the focus of the second sigma
ever published, back in 1968, was marine insurance, the ‘mother of all insurance’ classes.
Marine insurance would later be featured again in sigma in the early 1970s, the 1980s, and most
recently in 2013.

Other specialty lines that have been featured in sigma include aviation and credit & surety.
Aviation insurance was covered by sigma twice in the 1970s, twice in the 1980s, once in the
1990s, and most recently in tandem with marine in 2013. Meanwhile, credit & surety has
been featured just once, back in 1971. At that time, sigma published a comprehensive market
overview of this specialty line, which also touched on the limits of insurability of credit risks
and the impact of an economic downturn on loss experience.

While this year marks the first time that a sigma on engineering insurance has been written,
Swiss Re released a study in 2006 titled “Construction as a driver of project engineering
insurance”. Over the past decade, much has happened (eg the fallout from the 2008 financial
crisis, the development in emerging economies including in their insurance sectors, new
technology etc), therefore it is useful to take stock of what the changing economic, technological
and competitive environment means for engineering insurance.

Please visit the sigma 50 years section on the Swiss Re Institute website
(institute.swissre.com/sigma50years) to find out more about the evolution of sigma,
and the breadth and depth of our overall research offering.

Mike Mitchell Jeffrey Bohn

Head Property & Specialty Underwriting Director of Swiss Re Institute
Member of Reinsurance Executive Committee Managing Director
Swiss Re Swiss Re Institute
Executive summary

Engineering insurance accounts Engineering insurance is a specialty line of business that provides protection against
for around 3% of global commercial losses from unforeseen circumstances during the construction and operation of
premiums, but plays a crucial role plant, buildings, and infrastructure. With annual premiums of around USD 21 billion,
in facilitating investment. it represents only a small part (around 3%) of the overall commercial insurance
market. However, without such cover many construction projects and the operation
of vital machinery would prove prohibitively risky to undertake.

Premiums have been broadly flat in Global engineering premiums have stagnated in recent years due to the limited
recent years. growth in exposures and persistent weakness in insurance pricing. In advanced
markets, construction spending as a percent of GDP remains considerably below its
pre-2008 financial crisis peak, while some key emerging markets have recently
experienced sharp recessions. Similar to other insurance lines, abundant insurance
risk capital has also contributed to significant declines in premium rates.

Some engineering underwriting Given the scale and complexity of some potential exposures, risk-absorbing capacity
capacity is distributed across for large engineering covers is distributed across international wholesale insurance
international hubs, such as London, markets, typically via brokers. The London Market – comprised of Lloyd’s of London
Singapore and Dubai, typically and international specialist insurers based there – continues to play an important
via brokers. role, although alternative insurance hubs such as Singapore and Dubai have
emerged. This decentralisation of capacity as well as consolidation among
incumbent brokers has enabled intermediaries to reinforce their influence in
wholesale insurance markets.

Engineering insurance remains a Engineering insurance has been relatively profitable compared with other specialty
relatively profitable line, but there are lines. However, underwriting performance has deteriorated recently, with loss ratios
signs that underwriting performance edging higher and claims rising in some construction sectors due to poor quality
has deteriorated recently. control. The increasingly complex, multi-stage, multi-party and sometimes multi-
national nature of ‘mega’ construction and infrastructure projects further complicates
the task of evaluating risks. Given declining premium rates, the profit margins of
some engineering insurers may already have been squeezed close to or below their
long-run sustainable levels.

New technologies could foster Technology is constantly evolving in engineering. Insurers must continually evaluate
efficiency and safety gains in how technology could alter the risk landscape and influence their underwriting
construction, but this will happen approach. Construction has typically been slow to innovate, but there are signs of
slowly and brings with it new risks. rising digitalisation in the sector. Digital technologies could lead to significant
improvements in efficiency including enhanced monitoring, mitigation and
management of engineering-related risks. In turn, this could underpin further
improvements in claims experience. However, such a digital transformation in
construction is most likely to happen only gradually. New technologies also affect
the nature of existing risks and bring new risks, such as cyber, which means that
the severity of claims could increase even if the frequency of incidents falls.

In a digitally-connected world, Product and process innovation will help insurers respond to the evolving risk and
engineering insurers may ultimately competitive landscape, provided they do not overstep the boundaries of insurability.
assume more of a risk avoidance/ This includes deploying new technology to bolster efficiency and improve
mitigation role. underwriting accuracy. In a digitally-connected world, insurance may come to play
more of a risk avoidance/mitigation role, rather than solely indemnifying losses. This
may ultimately require a more radical reconfiguration of engineering insurers’
business models.

The cyclical macroeconomic upswing Beyond technological innovation, the outlook for engineering insurance is heavily
together with structural shifts such as influenced by prospective growth in the world economy and, in particular, the level
urbanisation should translate into and nature of construction activity. The strengthening and synchronised global
stronger demand for engineering recovery, together with structural adjustments such as urbanisation, replacement of
insurance. ageing infrastructure and development of renewable energy sources, should
promote construction spending and stimulate insurance demand. There is still
however uncertainty about how far some of these factors will translate into a
material pick-up in premium growth.

Swiss Re sigma No 2/2018 1

Introduction

What is engineering insurance?

Engineering insurance helps absorb Engineering insurance originated in the 19th century to provide protection against
unforeseen losses during the property damage resulting from boiler explosion/implosion.1 Over time, the scope of
construction and operation of plant, coverage has expanded considerably. Today, there are broadly three main streams:
buildings or infrastructure.
̤̤ Project insurance: protects against risks incurred during construction or
installation of plant, buildings and infrastructure. Polices are usually taken out by
the project owner or contractor – eg, Contractors’ All Risks (CAR)/Erection All
Risks (EAR).

̤̤ Inherent (or latent) Defects Insurance (IDI): covers physical damage to the
property caused by defective design, materials or workmanship, which remain
undiscovered upon completion of the project. In some countries such as France,
building contractors are required to have IDI insurance before embarking on a
construction project. IDI policies typically last for ten years, and hence are often
referred to as decennial liability insurance. Unlike a professional indemnity policy,
an IDI or decennial policy typically does not require any proof of liability: evidence
of damage is in itself sufficient to trigger a claim.2

̤̤ Operational insurance: is renewable and protects against unforeseen losses

arising once the equipment or structure is operational. Popular annual policies
include protection against losses associated with Machine Breakdown (MB),
Electronic Equipment (EE) failure and Contractors’ Plant, Equipment and
Machinery Insurance (CPE/CPM).

Engineering covers can provide Typical engineering covers offer protection against possible unforeseen and sudden
protection against physical damage to physical loss or damage to property during the construction phase and once the
machinery and infrastructure as well building, plant or machinery is operational. Construction project insurance typically
as financial losses. covers liability for third-party bodily injury. These types of policies usually cover
“all-risks” associated with a particular project and may include financial losses
associated with delay or business interruption.3 Advance Loss of Profits (ALoP)/
Delay in Start-up (DSU) policy enhancements cover costs resulting from project
interruptions, although any delay must be caused by a material damage covered
under the project policy ie, a CAR/EAR policy. Operational policies usually refer to
named perils that cause losses, including associated financial losses, but exclude
third-party liability.

1 For a more in-depth discussion of the history and development of engineering insurance, see
Engineering insurance and reinsurance: an introduction, Swiss Re, 1997.
2 See http://media.swissre.com/documents/Swiss_Re_inherent_defects_insurance.pdf
3 Relatively small damages can have massive cash flow consequences. If a crucial part breaks on a drilling
machine, for example, this could heavily disrupt building schedules.

2 Swiss Re sigma No 2/2018

 Figure 1
Stylised timeline of engineering Start of Certificate of
construction/ completion/ Operational policy
insurance project policy project policy ends expiry/renewal

Project value Engineering

Pre-project Construction phase Operational phase
phase insurance

Typical non- Typical project policies: Typical operational policies:

engineering CAR, EAR, DSU/ALoP MB, EEI, DoS, MLoP, CPE/CPM
policies:
Marine (cargo) IDI/decennial insurance

Typical non-engineering policies:

Final contract Property, BI, TPL, etc
value/sum
assured

Maintenance period
Work-in-progress Ongoing production/operation

Time

Note: Abbreviations refer to types of insurance policies. BI = Business Interruption,

TPL = Third-party Liability, CAR = Contractors‘ All Risks, EAR = Erection All Risks,
ALoP = Advance Loss or Profits, DSU = Delay in Start-up, MB=Machine Breakdown,
MLoP = Machinery Loss of Profits and DoS = Deterioration of Stock, CPE/CPM = Contractors‘
Plant, Equipment and Machinery, IDI = Inherent Defects Insurance. The maintenance period
refers to the period after practical completion of a contract during which a contractor is
obligated to repair any defects in workmanship and materials.
Source: Swiss Re

Such covers often sit alongside other Prior to a particular project starting, other (non-engineering) insurance may be
policies depending on the nature of applicable – lost or damaged equipment or materials during transport/transit to the
the insured peril. construction site might for example be covered under marine policies. Similarly once
the project is completed, depending on the particular peril, policyholders might be
insured under different policies (see Figure 1). For instance, damage due to external
causes like fire or natural perils would typically not be covered by IDI but instead by
regular property or business interruption insurance.

Role of engineering insurance in supporting growth

Insurance can play an important role Some risks may be too large or too complex for some firms or governments to absorb
in fostering capital investment. alone. By providing a mechanism for firms to share risks and mitigate fluctuations in
their income and expenditures, insurance facilitates efficient investment in areas that
might otherwise not be made. In this way, insurers can promote the allocation of
financial resources to their most productive use, enable policyholders to recover
quickly following an insured incident and promote private and public enterprise.4
Insurers also work with developers and contractors to ensure that appropriate risk
management and construction standards are in place, which can help reduce the
risk of future failures.5

4 For a general discussion of the role of insurance in societies, see sigma No 4/2017.
5 Insurers usually employ independent engineering experts to consult on loss control and risk
management, conduct audits, assess quality assurance documentation and advise on contingency
planning to mitigate future losses.

Swiss Re sigma No 2/2018 3

Introduction

Size and composition of the market

Engineering insurance premiums Global engineering insurance premiums for 2017 were estimated at around
account for roughly 3% of global USD 21 billion, and accounted for roughly 3% of total commercial insurance
commercial insurance premiums. premiums (around USD 730 billion in 2017).6 The EMEA region generated the
largest share of global engineering premiums, mostly due to the popularity of
operational covers such as machine breakdown as well as construction project
insurance (Figure 2 – LHS). Among emerging economies, Brazil, Mexico and
Colombia account for 70% of engineering premiums in Latin America while China
currently contributes around a third of Asia Pacific (APAC) premiums.

Figure 2
Share of global engineering premiums, by region (USD billion) and major policy type (%)

25 100

20 80

15 60

10 40

5 20

0 0
1990 1993 1996 1999 2002 2005 2008 2011 2014 2017E 1990 1993 1996 1999 2002 2005 2008 2011 2014
North America EMEA Asia Pacific Latin America Project Operational IDI/decennial

Note: Left-hand chart is based on a sample of around 60 countries for which engineering premiums are separately reported plus estimates
for countries where separate statistics are unavailable. The latter are constructed using the corresponding regional share of engineering
premiums in non-life insurance. Right-hand chart is based only on a subset of the 60 countries where detailed engineering premiums by line
of business are disclosed.
EMEA = Europe, the Middle East and Africa
Source: Various national sources, IMIA and Swiss Re Institute calculations

Around half of the global engineering Project-related policies account for approximately half of all engineering insurance,
insurance premiums are project- a share that has been broadly stable over time (see Figure 2 – RHS). According to
related. market intelligence from IMIA, the vast majority of premiums are generated from
small-to-medium-sized infrastructure projects.7 Dedicated decennial liability policies
are popular in only a few, mainly European countries, with France generating over
90% of IDI premiums.8

Global engineering premiums have After rising rapidly through most of the 2000s as construction activity in a number of
stagnated in recent years. developing countries soared, global engineering premiums have stagnated in recent
years. The global market declined in 2015 and 2016 before bouncing back in 2017.

6 Estimates for insurance premiums are based on a synthesis of data from Axco, local regulators/insurance
associations and IMIA.
7 Interview with Oscar Treceno to Insurance Day in November 2016. http://www.docosoft.com/docs/
default-document-library/insuranceday02november2016docosoft.pdf
8 Following the enactment of Law 1796 in 2016 (also known as the safe housing law), a nascent market in
decennial liability insurance is developing in Colombia. A few Colombian insurers now offer ten-year
policies that protect property damage to property owners affected by collapses, threats of ruin or other
special coverage for the country’s construction companies.

4 Swiss Re sigma No 2/2018

 Part of the volatility was due to fluctuations of the US dollar, especially against
emerging market currencies, and the conversion of insurers’ revenues into a
common currency. In local currency terms and after adjusting for inflation, global real
premiums have been mostly flat since at least 2012 (see Figure 3 – top panel). The
lack of growth largely reflects a slowdown in project insurance in both advanced
and developing markets (see Figure 3 – bottom panel). Construction spending as a
percentage of GDP in many advanced markets remains below its pre-2008 financial
crisis peak, while some key emerging markets are only slowly emerging from
recent recessions.

Figure 3
Global engineering premium 20
growth (nominal and real) by
market and major line (%) 15

10

–5

–10

2000 2002 2004 2006 2008 2010 2012 2014 2016

Nominal (USD) Real (local currency)

Note: Dashed lines represent 5-year moving averages.

Real premium growth

(local currency, %) Major line 2011‒2013 2014‒2016
Advanced markets Project 3.0 2.6
Operational 3.6 1.8
Developing markets Project 5.4 ‒4.6
Operational 2.9 5.6

Note: The chart is based solely on the sample of around 60 countries for which engineering
premiums are separately reported (accounting for around 90% of global premiums).
The figures in the table are based on a subset of the 60 countries where detailed engineering
premiums by line of business are disclosed.
Source: Various national sources, IMIA and Swiss Re Institute calculations

Outline for the sigma The rest of the sigma explores the institutional composition of engineering insurance
markets, including the interaction between domestic and international wholesale
insurance markets and the role of intermediaries. This is followed by a discussion of
underwriting performance and the impact that new technologies could have on the
construction risk landscape and underwriting practices. Finally, this sigma will
provide an overview of the factors that are likely to shape the short-to-medium-term
market outlook.

Swiss Re sigma No 2/2018 5

Structure of engineering insurance
markets
Wholesale and retail markets
The engineering insurance market is The global engineering insurance market is typically structured with different layers
complex and involves multiple parties. straddling different actors, depending on who “owns” the risks and the nature and
scope of the cover provided. Construction projects often involve multiple parties and
extend over multiple stages of development that influence how project insurance is
organised. In contrast, operational insurance is more akin to property insurance,
where owners of the asset usually buy insurance. In both cases though,
intermediaries play an important role in insurance placement (see Figure 4).

Risk diversification is achieved via a Diversification for large, complex engineering risks is achieved via a combination of
combination of national and wholesale national (eg, retail) insurance and wholesale co-re/insurance subscription markets.
insurance markets. In a wholesale subscription market, the customer (usually acting through a broker)
negotiates insurance terms with a re/insurer that agrees to cover a certain share
of the risk and becomes the ‘lead’ co-re/insurer. If the leader is not interested in
underwriting 100% of the risk, or if the broker and client want to spread the risk
across insurers, the insurance programme may be syndicated with multiple
re/insurers that then share the risk.

Figure 4
Schematic showing the stakeholder
Reinsurance Reinsurer(s)
map in engineering insurance

Brokers

Wholesale insurance market

London Singapore Dubai Others

Direct insurance Brokers

market

National insurance market

Stock Cos. Mutuals Pools

Intermediaries Brokers MGAs Agents

Risk origination Lenders Contractors Owners Captives

Direct placement Intermediated placement

Source: Swiss Re Institute

6 Swiss Re sigma No 2/2018

 Factors shaping insurance demand
Insureds vary across contract types
Contracts govern the risk allocation Construction contracts allocate project responsibilities and determine whether
between parties and as a result one or several parties are responsible for purchasing insurance. Under controlled
insurance purchasing. insurance programmes (CIPs), also known as “wrap-ups”, one party arranges
insurance on behalf of all (or most) parties or wraps up all parties working on a
project. Depending on the contract, CIPs can be purchased by the owner (OCIP) or
contractor (CCIP) or a combination of the two (ie, a partner controlled insurance
programme (PCIP)). In a CIP, all key parties involved in construction are included as
named insureds, which helps avoid coverage conflicts.9

Policies typically relate to specific Policies are usually arranged on a single contract basis, (ie, a separate policy for each
construction projects. individual construction project). Open cover – where a general description of
contract works to be undertaken will be given and any construction contract falling
within the description is automatically covered – is available. But such policies
typically involve relatively low-to-medium insured limits and are issued selectively to
trusted contractors who demonstrate a regular flow of homogenous risks.10

Contractors sometimes assume Sometimes large, sophisticated contractors may choose to assume more exposure
significant project responsibilities, and responsibilities themselves.11 This is the case for Engineering, Procurement
including arranging insurance. and Construction (EPC) contracts, where contractors take responsibility for project
design and procuring materials and services.12 Under such arrangements, the
contractor arranges insurance (typically via CCIPs), and will include sub-contractors
and owners as named insureds.13 Contractors occasionally use captives and funded
retentions (whereby they set aside provisions to finance potential losses) especially
for casualty-related risks, although this practice is not widespread.14

Large contractors with operations in The international reach of construction firms can influence the insurance buying
multiple countries may utilise global process. In 2016, the top 20 international contractors generated 46% of their
insurance programmes. revenues from projects in countries outside their home market.15 Such projects
are typically covered by local insurance policies, although they can also be
complemented by global master policies that bridge differences in conditions and
policy limits in different jurisdictions. As a result, country-level premiums may not
necessarily reflect risks within that country alone, but also include risks assumed
by large contractors abroad, which are partially underwritten in the contractor’s
home country.

9 At times it is not possible to include all interested parties as named insureds, as large projects may have
hundreds of sub-contractors. In such cases, broad terms like “contractors” or “sub-contractors” often
apply.
10 Open cover is rare in developing markets, as smaller and homogenous risks are usually self-insured by
contractors. Exceptions include China and Saudi Arabia where open cover is sometimes issued for
government projects.
11 M. Sobolewski, A. Kent, and J. Van den Berg, “2017 Engineering and Construction Trends”, Strategyand.
pwc.com, https://www.strategyand.pwc.com/trend/2017-engineering-and-construction-trends
12 Other variations of EPC contract are EPCC (Engineering, Procurement, Construction & Commissioning),
EPCM (Engineering, Procurement, Construction & Management) and EPIC (Engineering, Procurement,
Installation & Commissioning). An extension of the EPC contract is a lump sum turnkey contract, where
contractors also guarantee operational readiness of projects.
13 Under OCIP, owners arrange the insurance and contractors/sub-contractors can exclude the insurance
budget from their bids. In CCIP, contractors arrange the insurance and the cost of insurance is factored
into the bids.
14 Based on data related to captives managed by Marsh, construction captives account for no more than
5% of the total number of captives; their share in terms of premiums is smaller still (less than 1%). See
Captive Benchmarking Report, Marsh, 2016, https://www.marsh.com/content/dam/marsh/
Documents/PDF/US-en/Captive%20Solutions%20Benchmarking-05-2016.pdf
15 “The Top 250”, Enr.com, 21 August 2017. https://www.enr.com/ext/resources/Issues/National_
Issues/2017/08-Aug/21-Aug/08212017_Top250_full.pdf

Swiss Re sigma No 2/2018 7

Structure of engineering insurance markets

Lenders often influence the scope of insurance purchased

To mitigate credit risk, lenders often The interests of financiers also play a role in insurance decisions. Lenders usually
insist on adequate insurance cover. extend finance on a non-recourse basis (ie, if borrowers default, lenders can seize
collateral yet cannot seek out borrowers for further compensation, even if the value
of the collateral is insufficient). As a result, lenders often demand adequate insurance
to protect their interests, especially because markets for the sale of project assets are
typically illiquid.16 Delays may cause extra expenses and lost revenue, which can be
partially covered by ALoP/DSU insurance.

Sources of risk-absorbing capacity

Insurers with an international presence write the majority
of premiums
International insurers’ local entities International insurers with local footprints have a strong presence in engineering
often play a significant role in placing insurance. With operations in multiple countries and sizable balance sheets, these
engineering risks. insurers have the ability to diversify risks geographically and better manage the
losses. They often lead co-insurance arrangements, especially for projects involving
international parties. The supply landscape is highly concentrated with the five
largest insurers in each country usually commanding a significant proportion of
domestic premiums (see Figure 5).

Figure 5
Share of top five engineering players in premiums (selected countries)

5%

24%
22%
11%
3% 9% 12%
5%
6% 10%
25% 14% 4%
23% 19%
13% 7% 6% 9% 7%
4% 12% 7%
5% 7% 8% 8% 12% 7%
17% 10% 10% 8%
6% 20% 8%
19% 10% 7% 7%
31% 17% 25%
17% 14% 9% 15% 34% 13%
12%
9% 8% 33% 10% 30% 7%
2% 9%
26% 24%
18% 19% 14% 17% 14%
13% 12% 11% 11% 10%

Japan United China Colombia India Malaysia Mexico South Turkey Canada Japan United Colombia Turkey
States Africa States
Construction project policies Operational policies
Domestic 1 Domestic 2 Domestic 3 Domestic 4 Domestic 5
Global 1 Global 2 Global 3 Global 4

Note: United States’ construction project insurance premiums are taken from Inland Marine line of business. The data relate to the most
recent year for which data are available.
Source: AXCO, National Regulatory Authorities and Swiss Re Institute

16 Lenders insist on including lenders’ clauses in policies, as these clauses may reduce lenders’ need for the
insured’s assistance/compliance in enforcing claims under the policy. However, insurers are often
cautious of giving wider policy rights to lenders since they are not the named insured.

8 Swiss Re sigma No 2/2018

Specialist insurers are rare; a few Leading insurers are usually active across multiple lines of business and also
exist for niche segments. dominate in engineering. The major property risk insurers often write operational
engineering covers. Stand-alone mono-line engineering insurers are rare as clients
may find it unattractive to transfer only a portion of their portfolios to specialists.17
However, specialised insurers do exist in niche areas – mainly as mutuals or captives
– providing cover to members, which is either unavailable or very expensive in
traditional insurance markets.18

National regulations related to While engineering re/insurance is international in terms of market structure,
domestic retentions influence how risk institutional arrangements sometimes work to restrict cross-border business. To
is transferred to wholesale insurance meet regulatory requirements in countries that limit participation of foreign insurers,
markets. a local insurer is often engaged to issue the policy. The so-called fronting insurer
typically retains a small proportion of the risk, earns a fee and cedes the rest via
reinsurance to wholesale insurance market participants.

London is still preferred for complex risks, but regional hubs have
emerged
Regional wholesale insurance hubs Historically the London Market, which comprises Lloyd’s of London and global
have emerged in recent years to wholesale insurers operating out of the City of London, has been an important centre
compete with the London Market. for engineering and construction-related insurance, especially for high-value projects
that are technically demanding to underwrite. Local hubs in developing regions have
nonetheless matured and are now often well positioned to absorb some business
themselves. In particular:

̤̤ Singapore has consolidated its position as the APAC re/insurance hub.19 Cover for
a growing number of projects is placed in Singapore, as more international
projects are led by contractors based in Asia.20

̤̤ Dubai provides capacity for engineering risks in the Middle East and North Africa,
mainly through the Dubai International Financial Centre, which includes leading
re/insurers and intermediaries.

̤̤ Miami is a centre of placement for engineering risks in Latin America and the
Caribbean.21

The London Market remains important Complex risks are still placed in the London market for primary layers, although this
for complex and high value is increasingly due to technical expertise on specific risks rather than the required
construction projects… risk-absorbing capacity. Oil & gas, power generation, heavy industries, mining, heavy
civil engineering and underground risks often continue to find their way to the
London market for underwriting expertise.

17 A portfolio of insurance policies is often placed with an insurer for cross subsidisation among lines of
business.
18 Notable specialist insurers include: 1) SMABTP in France; a specialised mutual writing mainly decennial
liability. 2) AR-CO and Protect; specialised insurers in Belgium, providing construction related
professional indemnity covers.3) There are a handful of other specialist insurers such as Hartford Steam
Boiler (HSB) that concentrate largely on operational engineering insurance.
19 “Singapore insurance market report”, axco.co.uk, December 2017, https://www.axco.co.uk/axcoimr/
report_display_frame.asp?countryid=99&marketsectorid=1&topicid=19747&levelid=2
20 Enr.com, 21 August 2017, op. cit.
21 “Latin America, Using a Hub Strategy to Access Growth Opportunities”, Aon.com, January 2016, http://
www.aon.com/inpoint/bin/pdfs/white-papers/LatAmWhitepaper2016.pdf?utm_source=slipcase

Swiss Re sigma No 2/2018 9

Structure of engineering insurance markets

…and has managed to maintain its Compared with earlier decades, the London market’s importance in placing
market share over recent years. engineering risks has probably declined.22 However, it has broadly maintained its
share of global construction project premiums in recent years (see Figure 6), mostly
by decentralising operations and pooling expertise in regional hubs. Lloyd’s has
grown its Singapore operation to 23 syndicates since 1999, 12 of which write
construction and engineering business.23 Lloyd’s also participates in Chinese
business via 100% retrocession through its subsidiary in China.24

Figure 6
London Market’s share in global 25
construction project premiums
(range of estimates, %)
20

15

10

0
2013 2014 2015 2016

Note: The swathe in the chart represents the range of estimates for the London Market’s
share of construction project premiums based on different assumptions. The lower bound of
the range uses estimated premiums written by syndicates that are part of the Construction
Consortium at Lloyd’s plus construction premiums reported by the IUA for the London
company market. The upper bound includes premium estimates for all syndicates at Lloyd’s
as well as IUA’s construction premiums. All estimates assume the same proportion of
construction to total property business for Lloyd’s syndicates as in the London company
market.
Source: Lloyd’s of London Syndicate Data, London Company Market (IUA) Statistics Report
and Swiss Re Institute calculations.

Reinsurance support is often significant, especially in developing

markets
Engineering cession rates vary In recent years engineering cession rates have declined a little in certain developing
across countries. countries, although the share of premiums ceded varies widely across markets
(see Figure 7). For example, insurers in Saudi Arabia and Singapore cede a major
proportion of their engineering risks. This probably reflects the prevalence of large
and complex engineering risks – the majority of insured risks in these countries
relate to power, civil and transport infrastructure.

22 The London Market reportedly wrote construction project premiums of approximately USD 700 million in
mid 2000s, representing around a quarter of global construction project premiums estimated by IMIA in
2004 (See Insights, Swiss Re, September 2006).
23 Four syndicates; Beazley, CNA Hardy, Talbot and Sompo Canopius formed a construction consortium in
2013. Two other syndicates, Noave and Travellers joined in 2016. See Lloyd’s Asia, Extensive specialist
underwriting, https://www.lloyds.com/~/media/files/lloyds/offices/singapore/1794c-lloyds-asia-
matrix-web-revised.pdf?la=en
24 Annual Report, Lloyd’s of London, 2016.

10 Swiss Re sigma No 2/2018

 Figure 7
Primary insurers’ engineering 100
cession rates in selected 90
developing markets (%)
80
70
60
50
40
30
20
10
0
2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016

Saudi Arabia Singapore Turkey India Malaysia

Note: Singapore figures include Singapore Insurance Fund (SIF) business only, and cession
rates for Turkey are estimated for 2009 and 2010.
Source: National Regulatory Authorities and Swiss Re Institute

Proportional reinsurance Proportional reinsurance is often preferred for engineering and construction covers.
arrangements are often preferred This reflects the nature of the portfolios, which usually combine non-renewable and
for engineering risks. annually renewable features with long tail exposures and large sums insured.25 In
contrast, non-proportional reinsurance is better suited for portfolios of standard
operational policies. Large insurers with sizeable portfolios typically have sufficient
scale to cede risks via standalone engineering treaties, although smaller insurers
often collect engineering risks under property/multiline treaties.26

Role of intermediaries
Brokers remain dominant in distribution due to the size and complexity
of risks
Brokers control distribution across Brokers organise insurance placements for most engineering and construction risks.
markets and direct placement is In some emerging markets, such as Saudi Arabia and China, state-sponsored entities
limited. may arrange insurance directly with insurance carriers through tender processes.
Nevertheless, these transactions would still typically involve domestic brokers, who
are especially active in arranging insurance for local construction projects.
International brokers play a key role for complex projects that require specialist
expertise and/or those where foreign funding is involved.

The rise of new capacity and the Over the past decade, international brokers have coordinated risk placement across
highly customised nature of policies an increasing number of local and international re/insurers. This is due to the
increasingly require broker support. decentralisation of insurance capital and transfer of expertise to emerging regional
hubs. Accessing risk-absorbing capacity from around the world allows brokers to
optimise available insurance solutions and secure the best available rates and terms
for their clients.

25 See Swiss Re 1997, op. cit.

26 Combined property and engineering (PEN) treaties may have sub-limits and specific exclusions for
engineering risks. Delay in start-up, metro rail line, nuclear power plants, offshore risks, transmission and
distribution lines are either excluded or require special acceptance under such treaties.

Swiss Re sigma No 2/2018 11

Structure of engineering insurance markets

The broker’s role has expanded International brokers also provide risk consulting, captive management and claims
beyond placement to providing value handling services to the construction industry, even helping insureds set up in-house
added services. brokers in some markets (eg, Germany, Italy). Requests for policy period and
coverage extensions are common in engineering due to delays, and brokers play a
key role in arranging these endorsements. Moreover, the involvement of brokers in
complex and high value projects can facilitate reinsurance support.

Industry consolidation has reinforced brokers’ influence

Consolidation has enabled brokers to Significant consolidation has occurred in the insurance broker sector over the past
strengthen their position and remain few years. The big four brokers (Aon, JLT, Marsh and Willis) have invested heavily in
close to clients. acquiring knowledge and data to enhance their risk management services. Coupled
with the decentralisation of insurance capacity, they have been able to strengthen
their relationships with policyholders and influence where and at what price risks
are placed.27

Brokers are developing new and Brokers continue to innovate to expand their franchise.28 They are placing risks in
alternative approaches to placing new ways, eg, via underwriting facilities where brokers decide insurance placements
business. based on pre-committed capacity from multiple insurers. Broker facilities are often
most relevant for small and medium sized engineering risks, which may be more
homogenous. They are less appropriate for large and complex engineering projects,
which require specialised underwriting and large risk-absorbing capacity.

Traditional distribution channels dominate

Managing general agents (MGAs) Engineering insurers have begun using managing general agents (MGAs) to deploy
play a somewhat limited role in their underwriting capacity. An MGA is a specialised type of intermediary vested
placing engineering risks. with underwriting authority from an insurer. This can be a highly efficient
underwriting solution for niche-type business. The level of risks assumed through
such arrangements are typically small and/or involve limited capacity. MGAs
probably write less than 10% of global engineering premiums, mostly medium sized
risks (sums insured < USD 100 million) in some advanced markets.

Innovations in distribution have not New distribution technology has not impacted wholesale commercial insurance
been widely adopted by commercial markets as much as in retail/personal lines. Previous attempts to introduce more
insurance markets. direct wholesale distribution channels have not gained traction. Similarly, while
online quotation and delegated authority platforms have developed, traditional
manual placement processes continue to dominate. Some initiatives targeted
at simplifying parts of the value chain are nonetheless moving forward. While
not specific to engineering, Lloyd’s of London, for example, have mandated that
syndicates use electronic placements for writing no less than 30% of their risks
by the end of 2018, with the aim to increase this proportion to 80% by the end
of 2019.29

27 In November 2017, the Financial Conduct Authority (FCA) in the United Kingdom launched a market
study into the wholesale insurance broker sector. This initiative aims to understand how brokers
compete, any potential conflicts of interest, and their broader impact on contestability of the wholesale
insurance market. See “FCA launches Wholesale Insurance Brokers Market Study” fca.org.uk,
8 November 2017, https://www.fca.org.uk/news/press-releases/fca-launches-wholesale-insurance-
brokers-market-study
28 S. Sclafane, “Specialty MGAs Continue to be Popular Acquisition Targets”, insurancejournal.com,
14 September 2017, https://www.insurancejournal.com/news/national/2017/09/14/464213.htm
29 “Lloyd’s issues electronic placement mandate”, Lloyds.com, 20 March 2018, https://www.lloyds.com/
news-and-risk-insight/press-releases/2018/03/lloyds-issues-electronic-placement-mandate and
https://www.reuters.com/article/us-insurance-lloyd-s-of-london-trading/lloyds-of-london-aims-to-
ditch-most-paper-trading-by-end-2019-idUSKBN1HU250

12 Swiss Re sigma No 2/2018

Underwriting performance & practices

Recent market conditions

Enhanced safety and design underpin secular improvements in
underwriting results
Improved safety measures… Although construction typically tends to be one of the most hazardous industries,30
accident and fatality rates have trended lower in many countries (see Figure 8). For
example, in the UK accident rates have fallen by around 40% over the past decade.31
This has contributed to improved claims experience in recent years compared with
earlier decades.

Figure 8
Fatal occupational injuries per 40
100 000 workers in selected
countries’ construction sectors, 35
(2005, 2010 and 2015)
30

25

20

15

10

0
United Canada United Sweden Australia Singapore Poland Argentina
States Kingdom

2005 2010 2015

Note: US 2015 refers to 2014; Argentina 2010 refers to 2011

Source: International Labour Organisation

…as well as better design and work The adoption of enhanced building standards and new construction techniques
processes have led to lower claims. together with improved site security has also led to lower claims. Consistent with
that, the share of large claims (by value) due to faulty design or operation has
generally declined over the past thirty years. Similarly, claims linked to fires and
explosions have become less prevalent, while the rising share of losses linked
to natural hazards is consistent with the recent global trend of higher frequency
and severity of natural catastrophe losses (see Table 1).32 The increased cost
predictability of projects (ie, delivery on budget) as well as enhancements in risk
management practices may also have helped to limit potential for surprises in
claims severity.

30 Out of 4,379 worker fatalities in US private industry in calendar year 2015, 937 or 21.4% were in
construction — that is, one in five worker deaths last year were in construction. Similarly, in the UK, 3% of
workers sustained a work-related injury which contributed to 2.2 million days of that year, www.gov.uk/
government/publications/the-health-and-safety-executive-annual-report-and-accounts-2016-to-2017
31 The future for construction insurance: Working together: a cross-sector roundtable discussion,
sponsored by Constructing Excellence and Lucas Fettes & Partners, December 2016.
32 For a discussion of recent natural catastrophe losses see sigma No 1/2018.

Swiss Re sigma No 2/2018 13

Underwriting performance & practices

Table 1
Share of large claims, by 1990s 2000s 2010s
proximate cause (%) Faulty design, material & operation 54.1 44.4 39.4
o/w
Faulty operation 20.3 13.7 12.6
Faulty material and workmanship 16.2 22.6 19.2
Faulty design 17.5 8.2 7.6
Fire/explosion 20.4 13.5 16.1
Natural hazards 5.7 14.3 22.3
Other 19.8 27.8 22.2
100.0 100.0 100.0

Source: IMIA and Swiss Re Institute calculations

Recent technical results understate an underlying deterioration in

profitability
Despite the generally benign claims The secular improvement in claims, in particular the absence of catastrophic loss
environment, loss ratios have picked events, partly explains why engineering insurance has typically been relatively
up recently. profitable compared with other specialty lines. But loss ratios have picked up a little
in the most recent years – globally loss ratios have increased by around 5ppt on
average since 2011. The increase is evident across most regions, although it is
particularly evident among insurers in Europe and Asia.

Weaknesses in quality control are Poor workmanship remains a key challenge for project owners and contractors, and
reportedly on the rise in some ultimately their insurers, with claims due to lower quality control reportedly rising in
construction sectors. some construction sectors.33 This can be partially attributed to the increased number
of parties in the supply chain – ie, problems with sub-contractors, or sub-contractors
of sub-contractors.

Ultimate loss experience takes time Reported loss ratios likely understate the recent deterioration in underwriting profits.
to fully develop. Ultimate loss experience takes time to become fully developed – claim settlements
are often delayed and initial estimates of claims can be highly imprecise and subject
to substantial revisions. For example, any deterioration in building quality resulting
from difficulties encountered by construction companies during the recent financial
crisis-led recession have probably not yet been fully revealed.34

33 For example, see https://www.jltspecialty.com/our-insights/thought-leadership/construction/

water-damage-how-to-stem-the-flow-of-devastating-claims and http://www.aon.com.au/australia/
insights/insurance-market-updates/2018/files/construction-market-update-brochure.pdf
34 This is particularly important for inherent defect insurance. See for example, https://www.lemoniteur.fr/
articles/a-la-recherche-d-un-nouvel-equilibre-35303345

14 Swiss Re sigma No 2/2018

 Persistent premium rate declines imply a squeeze on insurers’
margins
Abundant insurance capacity In common with other specialty insurance lines, the abundance of risk-absorbing
continues to put downward pressure capacity has maintained downward pressure on engineering insurance pricing.
on premium rates. According to IMIA, premium rates in 2017 for all major engineering lines remained
significantly below their 2010 levels; some declined by as much as 30 to 40% (see
Figure 9). This is broadly comparable with the falling trend in global catastrophe
reinsurance prices over the same period.35 Unlike in some other insurance lines,
developments over the past seven years represent a continuation of a secular decline
in engineering premium rates.

Figure 9
Developments in premium rates 160
for major engineering insurance lines
(2010 = 100)

120

2010=100

80

40
2002 2010 2015 2017

Project: Civil/infrastructure – “building” Operational: Power Plant

Project: Erection/Power Plant Operational: Oil & Gas Industry
Project: Civil/infrastructure – “road” Operational: Heavy Industries

Note: Based on information published in https://www.imia.com/wp-content/

uploads/2017/10/IMIA-Index-2017-v01.pdf
Source: IMIA

Terms and conditions have also Alongside persistent price declines for engineering insurance, contractual terms and
continued to favour the re/insurance conditions have also weakened. An analysis of the various clauses and contract
purchaser. language suggest that reinsurance buyers have benefited from less stringent policy
wordings, including improved positions on deductibles and exclusions (see “A text-
based indicator of developments in policy terms and conditions”).

Insurance buyers have resisted strong Commercial pressures in the construction sector, especially in advanced markets,
premium rate increases. have only added to downward pressures on insurance pricing. Construction firms
have relatively thin – and volatile – profit margins, which are typically in the bottom
quartile across industries.36 In some countries, the construction industry suffered
significant financial losses on low profitability contracts in the wake of the financial
crisis.37

35 http://www.gccapitalideas.com/2018/05/16/chart-global-property-catastrophe-rol-index-3/
36 Reinventing construction: A route to higher productivity, McKinsey, February 2017.
37 Construction Sentiment Survey 2017, Causeway/Barbour ABI, https://www.barbour-abi.com/
wp-content/uploads/2017/05/Causeway-Construction-Sentiment-Survey-Report-Interactive.pdf

Swiss Re sigma No 2/2018 15

Underwriting performance & practices

A text-based indicator of developments in policy terms

and conditions
Policy wordings will change Insurance contracts often contain standard policy wordings which outline the
depending on competitive conditions. general terms and conditions of cover for a specific class of insurance. For example,
Defects Exclusion(s) (DE) clauses, and London Engineering Group (LEG) wordings
are routinely recognised and widely adopted in engineering insurance. However, the
language, structure and content of clauses in individual contracts can be flexed and
amended depending on the underlying competitive environment. In this way,
changes in policy wordings often indicate the extent to which non-price terms and
conditions have moved in favour of either the re/insurer or insured.

A count of included clauses with Analysing textual information on terms and conditions (T&Cs) contained in
different risk characteristics re/insurance contracts can provide a useful way to monitor evolving contract
can inform about the evolution standards. Figure 10 shows a simple quantitative indicator based on a sample of
of contract standards. engineering reinsurance treaties for North American risks over the years 2011 to
2016. The index is constructed from the number of times relatively high, medium
and low-risk features – as categorised by reinsurance experts – appear in a
particular set of contract clauses. For instance, if a contract is renewed on multi-year
terms this would suggest, all else equal, an increase in risk for the reinsurer.

Based on an analysis of selected Overall, the index suggests that in some segments of the market and regions at least,
engineering reinsurance treaties, T&Cs have deteriorated from the perspective of reinsurers. Correspondingly,
terms and conditions have recently policyholders have secured more favourable T&Cs.
moved in favour of policyholders.

Figure 10
Text-based terms & conditions index 200
for engineering reinsurance policies, 180
(2011=100)
160
140
120
100 Improving T&Cs
from the perspective
80
of the reinsurer
60
40
20
0
2011 2012 2013 2014 2015 2016

Note: The line shows the aggregate index of the overall standard of terms and conditions
in a sample of over 1000 engineering reinsurance treaties for North American risks in which
Swiss Re participated. The index is constructed from a count of around 30 key Swiss Re
contract clauses where the latter are weighted by their risk characteristics, as judged by
reinsurance experts.
Source: Swiss Re

16 Swiss Re sigma No 2/2018

Claims on recently written business The long-tail nature of construction risk has traditionally enabled insurers to continue
seem likely to exceed expected losses. to benefit in later years from the higher prices secured when projects were originally
rated. Many of these deals have now been completed or are reaching a conclusion
with the result that new long-term projects are being locked in for extended periods
at lower premium rates, while total claims on existing business have yet to be
realised. Taking into account further claims development on existing portfolios
implies current underwriting returns for some insurers may be below actuarially fair
costing levels (ie, expected losses when the policies were originally written).

Increasingly complex projects mean As well as setting prices to cover expected losses, insurers must ultimately reward
some insurers’ returns may not their providers of capital for the uncertainty that claims turn out much larger than
adequately reflect their cost of capital. anticipated. Some engineering insurers’ profit margins may already have been
squeezed close to or below levels that are sustainable over the long term. For
instance, a few specialist insurers of French construction business have recently had
to strengthen claims reserves significantly and take profit write-downs as concerns
have grown about their solvency position.38 The increasingly complex, multi-stage,
multi-party and sometimes multi-national nature of ‘mega’ construction and
infrastructure projects can create risks that absorb additional capital for which
insurers need to be adequately compensated.39

Improved pricing likely relies on a sustained upswing in the

underwriting cycle
In some engineering lines, premium Developments in commercial premium rates are strongly correlated across lines of
rates have started to increase, albeit business and engineering rates have been affected by the broader soft market of the
modestly. past few years. In the wake of the sharp rise in natural catastrophe property losses in
2017 H2, downward pressures on commercial insurance pricing have abated
somewhat. In the United States, the cost of insurance on construction-related risks
started to increase towards the end of 2017 (albeit very modestly – see Figure 11).
Indications are that this continued into 2018 renewals, with some carriers reportedly
managing to secure prices rises for some accounts and with less pressure to relax
wordings and terms and conditions compared with earlier years.

Figure 11
Quarterly increase in US commercial 4
insurance premium rates, by
selected major lines of business (%) 2

–2

–4

–6

–8
2014 2015 2016 2017

Construction Risks Commercial Property Casualty

Note: Casualty refers to a simple average of premium rate changes for casualty-related
insurance lines.
Source: CIAB

38 See for example: http://cblcorporation.co.nz/investors/financial-announcements/cbl-updates-the-

market-on-fy17-results-expectations/
39 The share of mega construction projects, defined as those valued at more than USD 1 billion in global
construction spending, has quadrupled over the past decade to 20%. Although engineering is a very
small part of the total commercial insurance market, engineering projects are often technically much
more complex than commercial property.

Swiss Re sigma No 2/2018 17

Underwriting performance & practices

A large, market-wide upswing in the However, the resilience of risk-absorbing capital argues against a rapid and
pricing cycle seems unlikely, at least in widespread rebound in the re/insurance pricing cycle, at least in the near term.
the near term. Furthermore, in the past engineering premium rate cycles have tended to lag general
property lines, reflecting the long-tail nature of some engineering covers. Finally, any
capacity withdrawn from property markets following worries about exposures/
losses could also be shifted to engineering lines to diversify the portfolio and gain
access to new risk pools in emerging markets.

Maintaining underwriting discipline in the face of competitive

challenges
Underwriting discipline will be needed Against the background of deteriorating profitability, insurers must intensify their
to prevent further margin focus on underwriting discipline, especially while investment returns remain
compression. constrained. This might ultimately lead to withdrawing risk-absorbing capacity if the
available terms and conditions are unfavourable. Equally, insurers must upgrade their
underwriting methods to gain a better understanding of the risks, in particular, the
changing vulnerabilities and sources of exposure as construction progresses from
initiation to completion, in order to improve accuracy in underwriting. For example,
some construction projects that initially involve coordination across many parties are
more susceptible to damage or delay when they start rather than at the end.

Investment in formal risk modelling Customarily, engineering and construction underwriting have relied heavily on
can support underwriting. judgement and expertise, not least because individual projects are often unique and
involve a diverse, dynamic set of risks. Increasingly, re/insurers and brokers have
developed reliable rating models to systematise and standardise the underwriting
process and improve their capabilities to steer engineering insurance portfolios.
In 2013 Willis Re introduced its eNGINEERTM platform to provide formal actuarial
analysis for construction projects for both per-risk and catastrophe exposures.40
Likewise, Swiss Re’s PUMA (Project Underwriting Management Application) is a
tool that supports engineering underwriters in evaluating construction and
erection risks.41

A stronger collaboration between As well as enhanced risk assessment and underwriting tools, cost efficiencies will
insureds and insurers could help also be important to stay competitive. A stronger collaboration between insured and
streamline insurance. insurer might help streamline insurance, as multiple insurers sometimes end up
underwriting the same risk, potentially leading to over-insurance.42 Project owners
and contractors might then no longer worry that information sharing could lead to
higher premiums. At the same time, closer relationships between policyholders and
their insurers might meet resistance from the broker community if this began to
reduce their own margins.

More generally, product/process Product/process innovation by insurers themselves can also help develop insurance
innovation can help widen the set of applications and improve insurability of new projects.43 Often project owners, or
available insurance solutions. their contractors, want an integrated cover to protect against the full range of risks,
both physical and financial. Provided insurers do not overstep the boundaries of
insurability, insurance can play a bigger role going forward in risk financing (how
much risk is retained by insureds) and risk intermediation (how much risk is
transferred to parties best able to absorb it). Stronger cooperation between different
lines of insurance and different functional areas within the business can widen and
deepen the available insurance solutions, including multi-peril covers (see “Recent
product innovations in engineering insurance”). A number of specialist insurers have
sought to combine design and construct insurance with liability, contractors’ all risks
and professional indemnity, although so far few appear to incorporate any form of
funding risk.

40 Willis Re Analytics Review, Issue 4, October 2013.

41 Swiss Re’s engineering platform PUMA will be relaunched in October 2018 for CAR/EAR business.
The upgrade will form the basis for a comprehensive engineering solution suite in the future.
42 Constructing Excellence and Lucas Fettes & Partners, December 2016, op. cit.
43 For a broader discussion of how product development and innovation around data and data analytics
have expanded the scope of insurance solutions, see sigma No 5/2017.

18 Swiss Re sigma No 2/2018

 Recent product innovations in engineering insurance
Holistic covers
Traditionally, construction project and operational covers have been kept separate
Holistic covers combine protection
due to their distinct risk profiles and coverage requirements. The project phase is
across the entire life cycle of a project.
often more complex and volatile, due to the longer durations and multi-party
involvement. However, there is growing interest in holistic engineering covers that
provide comprehensive protection across the entire life cycle of a project. This may
involve combining a number of heterogeneous covers eg, CAR/EAR, Credit & Surety,
Marine, Liability, ALoP and DSU.44

Parametric triggers
Non-damage parametric products With more investments being non-recourse financed, project owners often need to
may be used to cover new risks. reduce earnings volatility to safeguard debt payment obligations to financiers,
especially for projects where revenue generation is highly dependent on say weather
conditions. Parametric insurance is available to close emerging protection gaps.
Unlike traditional insurance, parametric instruments use a model to calculate the
pay-out of the insurance policy. This enables speedier claims payment, since loss
adjusters are not required to assess damage.45 Examples of parametric products
which aim to provide protection against revenue volatility include:

̤̤ Policies that pay out in case traffic volume on a toll road falls short of projections.

̤̤ Wind portfolio hedges that pay the client a fixed amount per megawatt-hour for
power not generated due to low wind.

̤̤ Non-damage weather insurance to indemnify business interruption losses caused

by a typhoon warning, even if the typhoon warning later turns out to be a false
alarm.46

44 For example, Swiss Re Corporate Solutions is attempting such an integration via its One Construction
initiative. https://corporatesolutions.swissre.com/insights/knowledge/one_construction.html
45 Parametric insurance does not necessarily indemnify the pure loss, but triggers a payment upon the
occurrence of an event – eg, rain or snow.
46 Swiss Re Corporate Solutions has developed a non-damage product called Insur8 that indemnifies
local businesses against loss of earnings and costs stemming from a typhoon warning signal 8 or above.
See https://corporatesolutions.swissre.com/insights/knowledge/insur8.html

Swiss Re sigma No 2/2018 19

Technology-led innovation in construction

Towards an age of automation

The diffusion of digital technology in Coping with technological change is nothing new for engineering insurers and their
construction could prompt significant clients. Historically, the specialty line has often evolved in response to technological
change in engineering insurance. breakthroughs. The growing digitalisation of economies and its potential to impact
virtually all industrial processes suggests the sector could be on the cusp of what
some label the fourth industrial revolution, or “Industry 4.0”. A 2016 survey by
McKinsey reported that 70% of construction industry professionals expect to adopt
digital technologies within the coming three years.47

Such technological innovations span Table 2 provides some illustrative examples of recent technology-led innovations
the entire life project cycle from that span the entire engineering project life cycle from planning and design to
design to operation. building erection and operation. Broadly, the technologies can be classified into four
main areas:

̤̤ Design and planning software: Digital tools are applied to assess the physical/
topological characteristics of a building or materials under different environmental
and topographical conditions. These include the use of virtual and augmented
reality to simulate the properties and functionality of a structure.48

̤̤ Construction management: As well as aiding in architectural design, Building

Information Modelling (BIM) provides a standardised way to share and exchange
information about a building throughout its life cycle, including post-construction
management of the facility. Such collaborative software tools can generate
significant efficiency gains, especially for highly fragmented projects involving
multiple stakeholders.

̤̤ Data gathering and analytics: Innovations in camera technology and unmanned

aerial vehicles (UAV – ie, drones) facilitate regular, detailed surveillance of
construction work-in-progress and site security. Internet-enabled sensors on
buildings and equipment (including wearable devices) that automatically capture
and send data to a central platform can also facilitate frequent and systematic
monitoring of atmospheric conditions, concrete setting, structure load and
displacement etc.

̤̤ New production methods and materials: The development of digital fabrication

techniques – ie, computer-controlled manufacturing that either builds a product
from the bottom up or cuts away at material to create a product from the top
down49 – is re-orientating the traditional construction process. Modular
components can be pre-fabricated using automated and controlled factory
environments and delivered and erected at the project site. At the same time,
robots can be deployed at construction sites to design and engineer components
or even whole structures using additive manufacturing techniques such as 3D
printing.50 New materials are also being developed, such as self-healing concrete,
which repairs cracks without the need for maintenance, or kinetic technologies
like Lybra, which enable flooring to harness the energy associated with vehicles or
people moving on surfaces.51

47 McKinsey Global Institute, February 2017, op. cit.

48 Virtual Reality (VR) is a computer-simulated environment that allows you to interact in a realistic and/or
physical way within the environment. An example of virtual reality in construction is interactive 3D
modelling that allows the user to manipulate the model to test the effect of changes before making them
in the real world. Augmented Reality (AR) is any technology that superimposes spatially contextual
information over the user’s view of the real world, providing additional data while still permitting
interaction with the real environment. See https://connect.bim360.autodesk.com/virtual-reality-
construction-technology-saves-money
49 http://www.shieldcasework.com/pros-and-cons-of-digital-fabrication/
50 Large 3D printers specifically designed for construction use a technique known as ‘contour crafting’, with
cement as the ‘ink’.
51 See https://www.balfourbeatty.com/2050

20 Swiss Re sigma No 2/2018

 Table 2
Illustrative examples of recent technological innovations in construction

Company Key technological concept Brief description

Daqri Augmented Reality (AR) The combination of AR with a security helmet can be leveraged for communication of
instructions and alerts. This helps reduce both accidents on site as well as workmanship
errors. See https://daqri.com/
Skycatch UAV/drones Camera technology is used to monitor buildings and gauge topography and soil type
throughout the construction lifecycle. Software can pair with a Skycatch UAV, or drones
from other manufacturers. See https://www.skycatch.com/
Cazza Additive manufacturing In March 2017, Dubai construction firm Cazza said it plans to build the world’s first
3D-printed skyscraper by 2020. For more details on the underyling technology,
see https://3dprint.com/189228/cazza-3d-print-construction-robots/
Pillar Sensors Wireless sensor to monitor conditions on a construction site. Various functions from
air monitoring to flood or fire alarm with the aim to increase safety and security.
See http://pillar.tech/
PlanGrid BIM Cloud-based collaboration platform for multi-user design and integration. With strict
versioning and modification tracking, it enables all actors to work on a single model,
reducing conflicts in design. See https://www.plangrid.com/
NCCR Robotics/3D printing Robotic fabrication system that “prints” two parallel reinforcement meshes serving as a
Meshmould formwork between which concrete can be poured. This eliminates the need for traditional
formwork allowing for higher degrees of freedom and precision of construction.
See http://www.dfab.ch/portfolio/mesh-mould-2/

Source: Swiss Re Institute based on published articles and company websites

Investments in tech-led construction As in other industries, start-up companies are an important part of the emerging
start-ups have increased significantly innovation narrative. Unencumbered by legacy systems and potentially less swayed
in recent years. by existing stakeholders with a vested interest in the status quo, tech-led
construction start-ups (ie, constructech) have attracted significant capital over the
past few years. According to CB Insights, more than 400 constructech firms have
formed since 2009, raising USD 2.9 billion in funding; more than half of this activity
has occurred in the past three years (see Figure 12).

Swiss Re sigma No 2/2018 21

Technology-led innovation in construction

Figure 12
Investment in constructech start-ups and their main areas of focus
800 100 Modular construction (15)
Automation (4)
Temporary installations (4)
Mobile production New construction
600 75
management (8) methods and
materials (31)
Computer Aided
B2B platform (9) Design (CAD) (8)
Design and planning
400 50 Construction software (25)
Cloud-based Visualisation (7)
collaboration management/BIM (73)
platform (9) Building solution
Data gathering and services (7)
200 25 analytics (32)
Tools eCommerce (11)
UAVs (9)
Project management
software (12) Safety products (6)
0 0 Data management (5)
2009 2010 2011 2012 2013 2014 2015 2016 2017
Note: Segments of the concentric circle pie chart refer to share of the
Funding amount (USD million, LHS)
total number of start-up investments in that field. Figures in brackets
Number of deals (RHS) refer to the corresponding number of deals.
Source: CB Insights and Swiss Re Institute calculations

Start-ups are particularly focussed on Constructech start-ups are mainly focussed on small-scale digital opportunities in
software-based innovations such as construction. Mobile and cloud-based technologies leveraging AI, analytics, robotics
BIM. and AR/VR, as well as software-based products related to BIM/project management
are particularly prominent. A number of incumbent construction firms are also
embracing new technology, either through in-house R&D or by partnering with or
sponsoring start-ups to road test larger innovations that may be integrated into their
existing processes.

Construction could one day be When the various technologies are combined, it could one day lead to unmanned
fully-automated. construction and civil engineering sites, perhaps as soon as 2050.52 Instead, robots
will be using dynamic new materials to build structures with drones constantly
monitoring the site to inspect the work and identify or solve problems as they arise.
In May 2016, the world’s first functioning 3D-printed office building was completed
in Dubai, while Beijing-based HuaShang Tengda claimed in June 2016 to have
completed the world’s first 3D-printed house in just 45 days. These two examples
reinforce the impression that new technologies have already begun to disrupt the
construction sector.53

Such a radical disruption to the sector In all likelihood, such a radical overhaul of construction and engineering remains a
seems unlikely, at least for the distant prospect, at least for most mainstream projects. The construction sector has
foreseeable future. typically been slow to innovate, which may explain why productivity continues to lag
other sectors.54 While some innovations in construction have recently been adopted,
many have not progressed much beyond the proof-of-concept stage (see Figure 13).
For example, although powder-based additives and resin 3D printing are widely
deployed in the manufacturing industry, 3-D printed construction-ready materials
have not been widely adopted. Digitalisation alone is unlikely to have a major impact
on the construction sector. Progress is more likely to occur faster when value is
added through additional functionality or integration of processes.

52 Innovation 2050: A Digital Future for the Infrastructure Industry, Balfour Beatty, June 2017.
53 https://www.reuters.com/article/us-emirates-printing-3d/dubai-says-opens-worlds-first-functioning-
3d-printed-office-idUSKCN0YF1OB
54 McKinsey Global Institute, February 2017, op. cit.

22 Swiss Re sigma No 2/2018

 Figure 13
Impact matrix of new technologies High

Integrated BIM

Wireless
monitoring

LikeiIhood
Pre-fabricated
Augmented reality components
Drones Design
and planning
Advanced building software
materials

Additive Site automation

manufacturing

Contour crafting
Low
Potential impact
Low High

The size of the bubbles represents the technology readiness level (TRL) of the particular
innovation. The TRL scale ranges from technologies that have not advanced beyond basic
principles to those where applications have been widely tested and are fully operational. For
details see:
https://www.nasa.gov/directorates/heo/scan/engineering/technology/txt_accordion1.html
Source: WEF and Swiss Re Institute calculations

The adoption of digital techniques Nevertheless, the adoption of digital techniques is on the rise in construction and
is on the rise in construction engineering. BIM, though not yet mature, is already either in use or being tested
and engineering. by a majority of construction firms. Regulation too will help shape the digital
transformation. A number of governments, including the UK, Singapore and Finland,
now mandate the use of BIM for public infrastructure projects. Similarly, the Dubai
government launched its Dubai 3D Printing Strategy in 2016, with the aim to
ensure that 25% of buildings in Dubai are constructed using 3D printing technology
by 2030. Insurers therefore need to stay abreast of emerging industry trends to
understand how they alter the nature of underwritten risks. Likewise, they may need
to revisit their own role in managing risks and adapt the services they provide.55

55 Swiss Re recently held an expert hearing on automation in the construction industry. A write up of the
event can be found here: http://institute.swissre.com/events/Automation_in_the_Construction_
Industry.html

Swiss Re sigma No 2/2018 23

Technology-led innovation in construction

Evolving risk landscape

Risk shaping
Technological innovation affects the Choices made during the design phase with regard to principles and materials
nature of risks that engineering have a major impact on a building or structure throughout its life cycle. Engineers
insurers underwrite. determine the manner in which the building or structure will be constructed and
consider factors such as cost, energy efficiency, eco-friendliness, safety, ease of
maintainability and feasibility of alterations and retrofitting. New materials and
processes that influence the risk landscape, both positively and negatively, are
constantly developed.

The development of BIM will foster BIM can contribute in a number of ways towards mitigating construction risks
efficiency gains and can help mitigate and reducing project liability, including safety, planning and execution risks.56
physical and financial risks. These include:

̤̤ Planning for and operating safer buildings. A set of rules, based on compliance
regulations and safety-related best practices, can be formulated and coded into
BIM software.
̤̤ Helping to limit the chance of negative project events. BIM systems, integrated
with construction management software, can streamline cost and time estimation
of jobs and reduce or eliminate delays.
̤̤ Making construction projects more environmentally friendly.
̤̤ Creating a digital ‘memory’ of the building. BIM can record all aspects of history
and operation, including problems which have occurred in the past and how they
were resolved. When changes and alterations need to made later in the lifecycle,
the BIM model can guide the designers and contractors, who may not have been
involved in the initial design and construction.

Robotic applications will reduce The use of robotics in construction also presents significant potential benefits in
human error and improve safety. terms of safety, accuracy and speed. Using a robot, for example, would eliminate the
need for humans to work in dusty, noisy and difficult to reach locations. Similarly,
prefabrication, (ie taking work traditionally completed onsite into a more secure and
weather-proof environment), can lead to higher quality workmanship and safer
working conditions, as well as reduce the need for maintenance and lower the risk of
human error. Using a drone to take measurements and carry out surveys also has the
potential to reduce the risk of accidents and save considerable time, especially for
unique buildings that are becoming taller and more complex.

Sensors and data analytics promote Real-time monitoring combined with data analytics can also isolate potential
pre-emptive maintenance and lower vulnerabilities and prompt increased predictive or pre-emptive maintenance,
the risk of mechanical breakdowns. lowering the risk of mechanical breakdown and potentially reducing operational
downtime.57 In the energy industry, for instance, the Internet of Things (IoT) is being
applied to the maintenance of wind turbines to improve their repair speed and
reliability.58

56 https://www.thebalance.com/how-can-bim-mitigate-construction-risks-845317
57 With sensors that track vibrations and ultrasonic emissions from machines, predictive maintenance
(PdM) technologies can predict when parts will malfunction or fail far more accurately than periodic
maintenance. This enables companies to intervene at the right place and time to avoid catastrophe.
According to the U.S. Department of Energy, PdM can reduce energy and maintenance costs by up to
30 percent, eliminate breakdowns 35 to 45 percent, and reduce downtime by up to 75 percent. See
https://www1.eere.energy.gov/femp/pdfs/OM_5.pdf
58 Digital disruption in insurance: Cutting through the noise, McKinsey

24 Swiss Re sigma No 2/2018

While sensors work well in residential The adoption of sensors in US residential properties significantly reduced the
properties, they are not as easy to use number of accidents, which could provide a benchmark for safety improvements in
in commercial buildings or on commercial settings should sensors be widely employed. Between 2009 and 2013,
construction sites. the death rate per 100 reported home fires was more than twice as high in homes
that did not have any working smoke alarms (1.18 deaths per 100 fires), as it was in
homes with working smoke alarms (0.53 per 100 fires). However, commercial
buildings are considerably more varied than typical residences, and the associated
risks and vulnerabilities are more complex. Similarly, sensors might not work as well
on a construction site, where it might be difficult to differentiate between dust and
smoke, or between a hot weld and a fire.

However, digitalisation also gives rise At the same time, increased digitalisation brings with it new types of risk. Cyber
to new risks such as cyber. security breaches, posed not only by viruses, malware and ransomware, which can
disable and disrupt systems, but also by criminal cyber activity, are a risk. These
breaches carry significant legal, financial, reputation and business interruption (BI)
risks. Remotely accessible systems, like BIM, project management software and
autonomous vehicles can create opportunities for cyber criminals to breach defences.
Data from integrated robotics that assist in builds, drones that monitor worksites and
IoT technologies could be vulnerable without their owners’ realising it.59

Technical advances can also change Technological innovations can also change the nature of traditional perils. Getting
the nature of traditional perils. pre-fabricated building modules on site creates unique logistical challenges. Pre-
fabricated units that include interior designs should not be exposed to weather,
which makes transporting, delivering and storing them risky. New projects in new
locations also bring about new exposures that are not comparable to the loss
experience on other projects. For example, wind farms in Taiwan face more serious
natural catastrophe threats (eg, typhoons) than similar projects in Europe.

The loss severity of accidents could The adoption of high-value electronic and computer equipment in construction and
rise even as their frequency falls. engineering could affect the potential scale of damage in the event of an accident.
Likewise, the expansion in scope of insurance to include more financial-related/non-
damage risks may mean that even though the frequency of losses may be
permanently lower going forward, the severity of claims might remain significant.
This is especially the case as global industries become increasingly interconnected,
reflecting the higher potential for losses from the same incident to accumulate.60
Technological advances such as BIM may help improve coordination, but alone are
not sufficient to prevent catastrophic project failure.61

59 https://www.nbins.com/blog/cyber-risk/new-cyber-risks-construction-industry/
60 http://www.agcs.allianz.com/assets/PDFs/Reports/AllianzRiskBarometer2016.pdf
61 For example, the tunnel excavation under the main high-speed rail route between Germany and
Switzerland at Rastatt that collapsed in August 2017 was a BIM-managed project.

Swiss Re sigma No 2/2018 25

Technology-led innovation in construction

Risk shifting
The rise of automation is likely to shift The current state of law often places significant liability on engineers and
responsibility for losses from users to constructors for computer-related accidents; as professionals they must exercise
manufacturers of equipment. expert judgement and not place blind in trust in machines.62 That seems likely to
change, if only gradually, as key tasks become more automated. The increasing use
of computer software and robots shifts the associated risks from human error to pure
mechanical or computer malfunction. This means that liability for any resulting losses
could increasingly be shifted to the manufacturer/designer of the equipment rather
than the user.63

The shift from personal to product In principle, this move from personal to product liability should be straightforward,
liability may not be straightforward. with insurers designing new policies to suit the changes in the underlying risks. In
practice, the adjustment will be challenging. Specifically, the cause of an accident
becomes more complicated to determine once it is no longer operator/user error.
For example, in the case of a 3D-printed defective component or building, was the
malfunction fundamentally linked to a hardware or software problem? Who is
responsible for the properties of a bespoke printed component?

Legal disputes over culpability may Such complications could be particularly significant if tasks are not fully automated.
arise if tasks are not fully automated. In these cases, there may be disputes over whether the operator was following
manufacturer guidelines (eg, overriding the robot). When autonomous machinery
is involved in accidents, resolving the question of fault will pose novel and in some
cases very complex legal and ethical questions over liability.

Risk slicing
Robotic applications will lead to more In the absence of specific information about individual risk, insurers have traditionally
usage-based insurance. had to underwrite risks by category and usually for a particular policy period.
The use of IoT is changing that with its ability to monitor insured property or track
policyholder behaviour. If data from sensors are embedded in key operational assets
(eg, a cooler, conveyer belt, plant equipment etc), policies can be based on what
industrial facilities are actually doing and the related risks – ie, usage based
insurance. Put differently, insured risks can be broken down by configuration and
duration. In this way, protection will be based more on when, how and in what
context the machine or plant is being used rather than who produced, owns or
typically uses it.

The use of robots should result in more To the extent that robotic devices permit users to control the level of machine
accurate risk pricing, although the autonomy, this will result in different risk profiles at different times. It could also lead
limited experience with them will to different liabilities: user liability in “hands on” mode and product liability in fully
make underwriting challenging. automated or “hands off” mode. In turn, this could result in different insurance
premiums depending on the mode of operation, including when machines and
plants are at rest. When calculating risk involves continuous monitoring and
diagnostics, rather than scheduled preventative actions, the pricing of risk becomes
far more precise. Given the limited experience of robotic applications in everyday
use, accurate assessment of the underlying risks is nonetheless likely to remain a
significant hurdle.

62 http://www.hpac.com/liability-amp-litigation/computer-engineering-tool-or-time-bomb
63 The question of determining liability for decisions made by robots or artificial intelligence is a live topic for
debate among legal practitioners and policymakers, especially in relation to autonomous vehicles. See
for example: https://betanews.com/2017/03/21/artificial-intelligence-robotics-liability/

26 Swiss Re sigma No 2/2018

 Reconfiguring underwriting in a world of more
connected risks
Digitalisation will change the business As well as changing the risk landscape, digital technology is reshaping the role of
ecosystem in which insurers operate. engineering insurers and the way they will likely operate in the future. In the past,
an owner of a machine or a building contractor might have consulted an insurance
carrier once a year (or at the start of a project) to discuss risk protection, perhaps
using the services of a broker. Digitalisation could change this and, with it, lead to
radical changes in the competitive environment and transform the insurance
business model. Access to valuable data from sensors and predictive analytics
capabilities will become increasingly pivotal for insurers to support their value
proposition, creating the need for different business collaborations and partnerships
(ie, new business ecosystems).

Insurers could play more of a risk In this new connected environment, which is still some way off, new types of
avoidance/mitigation role rather than insurance covers will eventually develop that are continuously updated with
simply indemnify policyholders comprehensive real-time data on risk and tailored to manage the risk of specific
against loss. industries and organisations.64 Digital simulation models and a front-loaded design
process will provide far more clarity and quantification of the potential risks, often
at a much earlier stage than traditional underwriting techniques. Insurers will know,
for instance, whether a business owner is following required safety and maintenance
procedures. In this way, insurers of the future may come to play more of a risk
avoidance/mitigation role rather than solely lending their balance sheets to
indemnify a policyholder in the event of an accident.65

Insurers will need better ways to New technologies will challenge re/insurers to develop novel approaches to
access and analyse structured and understanding and evaluating risk. The proliferation of new data sources will require
unstructured data. insurers to adjust their systems and processes to leverage the potential insights
they offer. For both unstructured data – eg, video footage of construction sites –
and structured data – eg, sensor information recording a machine’s or building’s
performance – insurers must develop new ways to locate, organise, extract and
analyse data. This may mean creating new types of databases to store and analyse
information that currently doesn’t fit the traditional mould.66

64 http://insuranceblog.accenture.com/the-journey-to-new-iiot-insurance-models-for-insurers-and-
industrial-sector-players
65 The Hartford Steam Boiler Inspection and Insurance Company has introduced an Internet of Things
based turnkey service to help insurers manage risk. This includes installing sensors at commercial
locations insured by its client insurance companies to monitor conditions that pose potential risks.
https://www.businesswire.com/news/home/20161004006443/en/HSB-Internet-Things-Insurers-
Prevent-Losses
66 https://www.adlibsoftware.com/blog/2017/November/how-data-analytics-is-changing-up-the-
insurance-industry.aspx

Swiss Re sigma No 2/2018 27

Market outlook

The outlook for engineering insurance Beyond the impact of new technology, the outlook for engineering insurance
will be mainly shaped by growth in markets will be affected by the future development of premium rates and the
risk exposures. prospective growth in risk exposures. With few signs of pricing shifting sustainably
higher, business volume growth will instead depend heavily on prospective growth
in the world economy.

Increasing risk exposures will drive premium growth

Global economic upswing will stimulate investment
Fixed investment has been weak in Investment in physical capital (buildings, infrastructure, machinery etc) has been
recent years… relatively weak in recent years, most notably after the global financial crisis. This is
most obvious in advanced economies, where total investment as a share of GDP
remains well below levels in earlier decades. Even in emerging markets, investment
has slowed noticeably since 2010 (see Figure 14).

Figure 14
Gross fixed capital formation 34
(GFCF) by World Bank income
category, % of GDP 32

30

28

26

24

22

20

18
1980 1983 1986 1989 1992 1995 1998 2001 2004 2007 2010 2013 2016

World High income Low & middle income

Note: Gross fixed capital formation (GFCF) refers to the net increase in physical assets
(acquisitions less disposals) over a specific time period, but does not account for depreciation.
Source: World Bank and Swiss Re Institute

…but is set to accelerate as the global However, this situation is forecast to reverse somewhat over the coming years as
economic recovery strengthens. the synchronised global economic recovery strengthens.67 In the G20 group of
countries, fixed capital formation rose by almost 6% in 2017 (well ahead of real GDP
growth of 4%) and is set to continue its revival especially in emerging markets.68
Within investment, real global construction output is projected to accelerate in the
near term – around 4% per annum over the next few years according to some
estimates – outpacing overall global economic activity.69

67 The Euro area-wide aggregate manufacturing utilisation rate is almost back to its pre-financial crisis
peak, despite a double dip decline both in 2008/2009 and during the Euro area debt crisis in 2012.
68 OECD, 13 March 2018, “Interim economic Outlook: Getting stronger, but tensions are rising”. Gross fixed
capital formation in Brazil is forecast to bounce back in 2018 – 2020 after contracting for four years,
while accelerating further in India to grow at the fastest in emerging economies. Morgan Stanley,
“Global Economics Playbook: Global Capex Cycle: Gaining Strength and Breadth,” February 7, 2018.
69 https://www.construction-ic.com/Insight/global-construction-outlook-2022---highlights and
http://www.lucintel.com/construction-industry-2018-2023.aspx

28 Swiss Re sigma No 2/2018

 Slow moving structural developments also underpin rising protection
needs
Structural factors also underpin future The cyclical recovery in investment is augmented by slow moving, but potentially
capital investment. high-impact structural factors, such as urbanisation, the rise in renewable energy,
and replacement/upgrades of ageing or inadequate infrastructure.

Urbanisation
Massive infrastructure investments The United Nations forecast that the global urban population will increase to 5 billion
are needed to deal with the influx of by 2030 means that by then, three-fifths of the world population will live in cities.70
people into cities. Emerging markets account for approximately 95 percent of that growth and ten new
megacities of at least 10 million inhabitants will emerge.71 Projections for global
investment in transport (ie, rail, roads, airports and ports), utilities (power generation
and water) and telecoms structures, based on current trends, are expected to
accumulate to approximately USD 79 trillion (in 2015 constant dollars) between
2016 and 2040. Asia is projected to account for roughly 60% of these investments
(see Figure 15).72 Amongst emerging markets, Asia and Africa are expected to
experience the most significant transformation.73

Figure 15
Forecast of infrastructure trends 18000
by sector in selected emerging 16000
markets, 2016–2040
(USD billion, 2015 prices and 14000
exchange rates) 12000
10000
8000
6000
4000
2000
0
China India Latin America* Turkey Other emerging
Asia**
Transport Power Water & Sanitation Telecoms

Notes:
* Sub-sample includes: Argentina, Brazil, Paraguay, Peru, Uruguay and Mexico;
** Sub-sample includes: Bangladesh, Thailand, Philippines, Indonesia, Malaysia and Vietnam.
Source: Global Infrastructure Hub and Swiss Re Institute

70 UN population projection
71 The World’s Cities in 2016 – Data Booklet (ST/ESA/ SER.A/392), United Nations, Department of
Economic and Social Affairs, Population Division (2016), and https://www.huffingtonpost.com/wendell-
cox/the-worlds-ten-largest-me_b_6684694.html
72 Global Infrastructure Hub 2017, “Global Infrastructure Outlook – Infrastructure investment needs 50
countries, 7 sectors to 2014” and Swiss Re, sigma No 5/2013, “Urbanisation in emerging markets: boon
and bane for insurers.”
73 The World’s Cities in 2016 – Data Booklet (ST/ESA/ SER.A/392), United Nations, Department of
Economic and Social Affairs, Population Division (2016).

Swiss Re sigma No 2/2018 29

Market outlook

Investments in renewable energy

Significant investment in renewable Despite a decline in 2016, investments in renewable energy are expected to
energy is needed to meet climate expand as the world continues to seek alternatives to fossil fuel power generation.74
change targets. The International Energy Agency estimates that USD 3.5 trillion in energy-sector
investments will be required on average each year between 2016 and 2050 to limit
the global mean temperature rise to below 2°C with a probability of 66%.

̤̤ In the US, total renewable energy production was roughly 12% of total energy
production in 2016, a record high, and is forecast to increase to 17% by 2050.75

̤̤ In Germany, renewable energy already accounts for 29% of gross electricity

generation, and associated investments have been an important source of
demand for engineering covers (see “Renewable energy and engineering
insurance”). Estimates suggest that until 2025, investments in renewables will
add another EUR 370 billion, on top of the EUR 150 billion already invested, to
achieve Germany’s “Energiewende”.76

̤̤ In China and other emerging markets, renewable energy production is also

expanding rapidly. Under the 13th Five-Year Plan, the Chinese government plans
to nearly double land-based wind capacity and triple solar PV by 2020.77

Renewable energy and engineering insurance

Renewable energy premiums in Investments in renewable energy have been a key source of business growth for
Germany have increased significantly. some engineering insurers. In Germany, related premiums have risen from 5% of total
engineering premiums in 2006 to almost 17% in 2016 (see Figure 16). Annual
growth has averaged over 20%, holding up even during the global financial crisis in
2008 and 2009.

Figure 16
Total and renewable energy 2500 25
premiums written in Germany, in
EUR million, and as a % of total
engineering premiums (RHS) 2000 20

1500 15

1000 10

500 5

0 0
2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016

Renewable energy Total % of total (RHS)

Source: German Insurance Association (GDV) and Swiss Re Institute

74 Executive Summary/Chapter [1/4]] of Perspectives for the energy transition – investment needs for a
low-carbon energy system OECD/IEA and IRENA 2017.
75 Based on the reference case of the U.S. Energy Information Administration. U.S. Energy Information
Administration, “Annual Energy Outlook 2017” and U.S. Energy Information Administration,
“U.S. Energy Facts”. https://www.eia.gov/energyexplained/index.cfm?page=us_energy_home
76 https://www.welt.de/wirtschaft/article158668152/Energiewende-kostet-die-Buerger-520-000-000-
000-Euro-erstmal.html
77 Next Generation Wind and Solar Power – From cost to value, OECD/IEA, 2016.

30 Swiss Re sigma No 2/2018

Increased reliance on renewable The shift towards renewables has broader implications for engineering insurance.
energy may impact the broader Increased volatility in power production resulting from intermittent energy sources
engineering risk landscape. (eg, fluctuating weather patterns that affect wind, hydro and solar power generation)
increases peak-load strains on existing electricity infrastructure. This might increase
wear and tear on machinery leading to increased chance of mechanical breakdowns.
Innovations in large-scale battery storage technologies will go some way to mitigate
that risk but also create additional complexities.78 Fire hazards arising from inherently
flammable material and the thermal properties of the battery can be serious.
Likewise, batteries often contain toxic, caustic or corrosive components that can
cause harm.79

Infrastructure upgrades
Infrastructure spending has fallen Another key underlying driver of exposure growth is the need to upgrade and close
behind the pace needed to support the global infrastructure gap. The gap represents the difference between what
future economic growth. countries are forecast to spend on infrastructure, and what is actually needed to
meet basic human needs, as well as satisfy the demands of a modern economy.
Estimates vary although all suggest the infrastructure gap is large. For example:

̤̤ The Global Infrastructure Hub, a G20 initiative, and Oxford Economics estimate
that by 2040, the world could experience an investment shortfall equal to
USD 15 trillion, or one-fifth of the forecasted global infrastructure investments.80
To close this gap, infrastructure spending would have to rise by an extra
0.5 percent of global GDP annually, from 3% to 3.5%.

̤̤ Similarly, the McKinsey Global Institute projects that the shortfall in infrastructure
spending amounts to around 0.3 percent of global GDP. In nominal USD terms,
the cumulative gap is set to expand to USD 5.5 trillion globally between 2017
and 2035.81

Emerging markets account for the Emerging economies account for close to two-thirds of global infrastructure needs,
majority of the global infrastructure with China alone accounting for 34%, followed by India with 8% (see Figure 17).
gap, although the US gap is the China, however, is expected to almost fully meet its infrastructure needs. This
largest. contrasts with the situation in some advanced countries, such as the US, where
the infrastructure gap is exceptionally large and growing, reflecting not only the
depreciating capital stock, but also a continued projected underspend on
investment.82

78 For a broader discussion of the implications of new storage technologies for the different services on the
electricity grid, see http://institute.swissre.com/research/library/Grid_Storage_Summary.html
79 A recent incident in Belgium aptly illustrates the potential dangers. A large-scale battery – part of the first
real live testing of power batteries being used to store wind power in Belgium – exploded into flames at a
power station located near Brussels. https://www.wind-watch.org/news/2017/11/12/wind-power-
backup-and-storage-batteries-explode-into-flames-and-send-a-toxic-cloud-over-the-city-of-brussels/
80 At current trends, global investments of USD 79 trillion are projected by 2040, while USD 94 trillion
would be needed, leaving a gap of USD 15 trillion. See Global Infrastructure Hub http://blogs.worldbank.
org/ppps/forecasting-infrastructure-investment-needs-50-countries-7-sectors-through-2040
81 McKinsey Global Institute, Bridging global Infrastructure gaps – Has the World made Progress, October
2017, an updated version of McKinsey Global Institute, Bridging global Infrastructure gaps, June 2016.
82 The average age of all government-owned fixed assets reached 24 years in 2015, a new record for a data
series going back to 1925. Swiss Re “Underwriting the US infrastructure gap”, http://www.swissre.com/
rethinking/financial_stability/underwriting_the_US_infrastructure_gap_new_publication.html

Swiss Re sigma No 2/2018 31

Market outlook

Figure 17
Total infrastructure spending gap per country 2016–2040, USD trillion
Europe
Current trends 12.8
investment need 14.8
Gap 2.0

Asia
Americas Current trends 46.2
Current trends 13.7 investment need 50.8
investment need 20.2 Gap 4.6
Gap 6.5

Africa
Current trends 4.3 Oceania
investment need 6.0 Current trends 1.7
Gap 1.7 investment need 1.9
Gap 0.2

Source: Global Infrastructure Hub and Oxford Economics

Governments in advanced economies Governments in advanced economies have announced policies promising to
have announced plans to address the boost public investment to address deteriorating infrastructure. The European Union
shortfall. has committed to invest in excess of EUR 315 billion under the EU Infrastructure
Investment Plan, (also called the ‘Juncker Plan’).83 Likewise, in the US, President
Trump has promised to invest USD 1.5 trillion into rebuilding the nations “crumbling
infrastructure”.84 This promise however, is as yet unfunded in the budget.

Emerging economies are promoting In emerging economies, modern infrastructure needs to be built, often from scratch,
infrastructure development, supported to support long-term development. China, for example, plans to invest significantly to
by China’s Belt & Road initiative. strengthen the country’s integration with countries in Asia, the Middle East, Africa
and Europe via land and maritime trade routes. The spending estimates in the Belt &
Road Initiative range from USD 4 trillion to USD 8 trillion.85 Much of the spending will
be for constructing and upgrading infrastructure, both within as well as outside
China. In markets like South East Asia, projects mainly involve the construction of
transport and power infrastructure.

Baseline premium projections

Engineering premiums tend to grow at Statistical analysis confirms a relatively strong positive correlation between
around three quarters of the pace of engineering insurance and indicators of economic activity. Based on a panel of
construction output. advanced and emerging countries, the long-run sensitivity (ie, elasticity) of total
engineering premiums with respect to gross construction output ranges from 0.7 to
0.9, depending on the regression estimation technique used.86 This suggests that,
on average, engineering premiums tend to grow at least three quarters of the pace of
gross construction output (see Table 3).

83 https://ec.europa.eu/commission/priorities/jobs-growth-and-investment/investment-plan-europe-
juncker-plan_en
84 https://www.ft.com/content/1ea12ffc-0f3e-11e8-8cb6-b9ccc4c4dbbb viewed 20 February 2018
85 “Can China Afford Its Belt and Road?”, Bloomberg.com, 17 May 2017.‎
https://www.bloomberg.com/view/articles/2017-05-17/can-china-afford-its-belt-and-road
86 Gross construction output refers to the total of all material and service inputs to construction plus the
value added by the construction industry itself, all of which may count toward the sum assured.

32 Swiss Re sigma No 2/2018

 Table 3
Actual and projected average annual growth for construction and engineering premiums (%) and corresponding
long-run elasticities

Construction Long-run elasticities* Premiums

2008–2017 2018–2027F GDP Construction 2008–2017 2018–2027F**
Global 3.5 7.3 1.1 0.7–0.9 –0.1 4.8–6.5
Advanced markets 0.1 4.2 1.0 0.7–0.9 –0.9 2.7–3.6
Developing markets 7.2 9.1 1.1 0.7–1.2 2.1 6.1–10.6

Note:
* The long-run elasticities are averages across countries based on a range of different panel regression estimators. Engineering premiums
were regressed on nominal GDP and/or gross construction output for each country plus a survey-based indicator of global premium rates
in construction. Different dynamic regression estimators were applied depending on the assumed degree of heterogeneity in parameters
across countries and restrictions on what drives premiums in the long run. For example, premium rates were assumed to have only a
short-run effect since they follow the broader commercial insurance underwriting cycle.
** Based on the range of long-run elasticities of premiums with respect to gross construction output.
Source: Various national sources, IMIA, Oxford Economics and Swiss Re Institute calculations

The co-movement is strongest for The empirical co-movement between premiums and construction activity appears
developing economies. to have been stronger in the past for developing markets compared with advanced
markets. In part, this reflects the relatively larger share of project covers in
developing countries especially on infrastructure. Demand for operational
engineering insurance seems more likely to respond to developments in the wider
economy, including industrial output, reflecting the intensity at which machines and
plants are employed. Perhaps consistent with that, the elasticity of premiums with
respect to nominal GDP are more broadly similar (and close to unity) for both
advanced and developing economies.87

Strengthening construction activity A number of market commentators anticipate an extended period of strong growth
should translate into engineering in construction. According to Oxford Economics, global gross construction output is
premium growth of around 5% per forecast to grow, on average, by over 7% per annum over the next ten years, up from
annum over the next decade. 3.5% over the previous decade. Assuming that the long-run elasticity of premiums to
construction spending is maintained in the future and that premium rates have a
broadly neutral impact over the forecast horizon, this would mean that the global
engineering market can be expected to expand by around 5 to 6% annually between
2018 and 2027. Most of that growth will likely come from activity in developing
economies.

87 The slightly larger elasticity estimates for developing markets is nevertheless confirmed by a simple
comparison of long-run growth in premiums, nominal GDP and gross construction output.

Swiss Re sigma No 2/2018 33

Market outlook

Key sources of uncertainty

As forecasts involve uncertainty, it is As with any forecast, uncertainty around these central projections remains. In order
important to consider the factors that to assess that uncertainty, it is important to consider the factors that could affect the
could affect the outlook. outlook for engineering premiums, particularly the downside risks.

Walking the talk

Many of the current plans for public Whether due to overpromising and under-delivering, technical difficulties or simply
infrastructure spending remain mismanagement, public infrastructure spending plans have often fallen short.
aspirations rather than guaranteed Current public spending plans may also prove overly optimistic. In Germany, it is
commitments. likely that the country will miss its own targets for renewable energy production by
2020.88 Meanwhile, at the EU level, Juncker’s plan for Europe does not entail
significant sums of new money and may in fact cannibalise funding for other
projects.89 Similarly in the US, President Trump promised USD 200 billion to fund
infrastructure, hoping the private sector would also contribute to reach the total
financing package of USD 1.5 trillion.90 However, concrete details have not yet been
made available.

Availability and cost of finance

The global debt overhang represents a Following the global financial crisis, many countries continue to carry high levels of
hurdle for future debt financing of debt. Some government and corporate sector balance sheets remain stretched.
infrastructure investments… Global credit extended to the non-financial corporate sector (CRE) as a percentage
of GDP has continued to climb in recent years to reach its highest level on record at
the end of 2016. The rise in debt is particularly noticeable in emerging markets
where CRE (as a percentage of GDP) is over 50% above its pre-crisis peak.91 Such
high levels of public and corporate debt present a significant challenge for the future
financing of new fixed investment.

…especially since interest rates are This debt overhang constraint could become especially severe as the extraordinarily
expected to rise. low interest rates over the past decade unwind. With global interest rates forecast to
rise, borrowing costs for new projects as well as refinancing of existing debt will only
increase.92 This may undermine financiers’ confidence that highly-indebted
borrowers have the future capacity to repay any loans and thereby limit the
availability of credit.93

Financing issues could be particularly The IMF has recently highlighted that financing issues are a particular challenge for
important for the Belt & Road Initiative. the Belt & Road Initiative.94 The initiative may encourage unsustainable increases in
borrowing in affected countries where public debt is already high. In addition, it
relies heavily on debt financing from China, at a time when China itself is looking to
deleverage and rebalance its economy away from investment towards consumption.
Together with the limited capacity of the IMF or Asian Development Bank to support
Belt & Road projects, this could ultimately lead to fewer projects and less investment
than currently envisaged. So far, less than 10% of Belt & Road projects in countries
outside of China have actually secured finance.95

88 https://www.welt.de/wirtschaft/article158668152/Energiewende-kostet-die-Buerger-520-000-000-
000-Euro-erstmal.html
89 This might go some way to explain why only EUR 4 billion of infrastructure projects had been disbursed
by the end of 2016, out of the original EUR 315 billion planned investment.
https://www.ft.com/content/90712920-138b-11e7-b0c1-37e417ee6c76
90 https://www.vox.com/policy-and-politics/2018/2/1/16959310/trumps-infrastructure-plan
91 Based on BIS statistics: Table F1.1: Total credit to the non-financial sector (core debt)
92 https://fred.stlouisfed.org/series/A091RC1Q027SBEA
93 https://www.moodys.com/research/Moodys-US-corporates-5-year-investment-grade-maturities-
exceed-1--PR_378820
94 http://www.imf.org/en/News/Articles/2018/04/11/sp041218-belt-and-road-initiative-strategies-to-
deliver-in-the-next-phase
95 “China’s Belt & Road initiative, and the impact on commercial insurance,” October 2016, Swiss Re.

34 Swiss Re sigma No 2/2018

Long-term investors could help boost Private institutional investors like insurance companies and pension funds, which
available finance, but private hitherto have not been very active investors in this space, can help boost
participants in infrastructure projects infrastructure investment. Innovative financing instruments may help alleviate
continue to face challenges. funding constraints, especially if they could be designed with some equity-like
features. Despite policy initiatives to help widen the investor base – including
reduced requirements on capital that insurers must hold against qualifying
infrastructure investments – institutional investor participation in infrastructure
financing faces significant challenges. The lack of standardised reporting together
with the inability to hedge political risks is holding back the development of tradable
markets for infrastructure-related securities, which in turn makes it difficult for
investors to benchmark and monitor returns.96

Political challenges
Construction projects face Even when financing has been secured, construction projects face a myriad of
considerable political implementation implementation challenges including political obstacles and social opposition.
risks. Frequent changes in political leadership or policy changes can disrupt infrastructure
projects that rely on long-term planning security. For example, the UK’s decision to
leave the EU could have a long-lasting impact on UK fixed investment. Cross-border
projects may also face geo-political uncertainties during their life-cycle. China’s
Belt & Road Initiative is particularly vulnerable to political instability.97 A number of
target Belt & Road countries face heightened implementation risks raising doubts
about project execution.98

Heightened protectionism has the Protectionism is on the rise globally. Newly imposed trade barriers, such as the
potential to curb investment spending recent tariffs on steel and aluminium imports into the US, have the potential to spark
and in turn insurance demand. a full-scale trade war. A slowdown in global trade would undermine economic
activity and ultimately reduce living standards. The construction and engineering
insurance sectors would not be immune to such a development if investment
spending plans were shelved.

96 Swiss Re, Infrastructure Investing. It Matters.

97 “One belt, one road”: an economic roadmap, The Economist Intelligence Unit (EIU), 2016,
https://www.eiu.com/public/topical_report.aspx?campaignid=OBORSept2016
98 “China’s Belt & Road Initiative, and the impact on commercial insurance,” October 2016, Swiss Re.

Swiss Re sigma No 2/2018 35

Conclusion

Engineering insurance plays a crucial Engineering insurance plays a key role in supporting economic activity. Although
role in supporting economic activity. aggregate engineering premiums are small relative to the size of the broader
commercial insurance market, many large construction and infrastructure projects
could not be undertaken without such policies. Likewise, the use of key plant and
industrial machinery would be severely constrained if operators were unable to
protect themselves against losses that arise from circumstances beyond their
control, such as mechanical failure or boiler explosion.

Compared with other specialty lines, Compared with other specialty insurance lines, engineering has been relatively
engineering remains relatively profitable. Underwriting performance has deteriorated recently, not least because
profitable, but there are signs that the long-tail nature of some construction and engineering insurance lines means that
underwriting performance has ultimate loss experience on existing policies has yet to be fully developed. With
deteriorated recently. engineering premium rates having declined for over a decade, alongside persistent
weakness in other contract terms, some engineering insurers’ profit margins may
already have been squeezed close to or below levels that are sustainable over the
long term. This is especially the case given the increasingly complex, multi-stage,
multi-party and sometimes multi-national nature of ‘mega’ construction and
infrastructure projects, which only add to underwriting risks.

New construction technology could Advances in technology could provide some relief if they bring continued
foster further efficiency and safety improvements in safety and accident rates in construction and other industrial
gains, but this will happen only slowly sectors. The digitalisation of manufacturing and construction offers much hope of
and brings with it new risks. significant improvements in efficiency, including enhanced monitoring, mitigation
and management of engineering-related risks. But such a digital transformation is
likely to happen only gradually. Moreover, new technology affects the nature of
existing risks and brings with it new risks, such as cyber, which means that the
severity of claims could increase even if the frequency of accidents decreases.

The outlook for engineering insurance The short-to-medium-term outlook for the engineering market is heavily tied to
is positive, although uncertainties developments in global construction markets. After a period of relative stagnation in
remain. premiums, the expected acceleration of building investment in advanced and
developing markets in the near term should underpin stronger insurance demand
and revenues. This reflects the confluence of the ongoing cyclical upswing in the
global economy and underlying structural shifts, such as urbanisation and rising
demand for renewable energy. While the market outlook is positive, engineering
insurers must remain alert as a number of macroeconomic uncertainties remain.

36 Swiss Re sigma No 2/2018

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