The state of wrap-ups 2009: It will be a very challenging year, but opportunities still exist

A little less then one year ago I presented my wrap-up "state of the union" article. In the spirit of our recent Presidential Inauguration I think this is an appropriate time for The State of Wrap-Ups 2009. What a difference a few months make. Starting in mid September we saw an already difficult economic picture turn even worse. But if you were to revisit the 2008 State of Wrap-Ups, you might say, "The more things change the more they seem to stay the same." We began 2008 with a sub-prime crisis that quite certainly had an impact on the construction forecast and in turn the wrap-up forecast. We ended 2008 in the midst of one of the most severe economic downturns since the "Great Depression." The seeds for this were growing throughout 2008. Led originally by the sub-prime crisis it eventually led to every corner of our economic system; banking, retail, automotive and insurance. While one might think that the recent financial challenges of a major insurance company, active in the construction industry, would have had a devastating impact, we are happy to report this has not occurred. As we move into 2009 let us review what this latest economic crisis will mean to those of us who dedicate our time and resources to the construction industry and wrap-ups more specifically. Availability of Projects 2009 will definitely be a very challenging year to keep the "pipeline" of projects full. The credit crisis has caused major developers to re-think their plans. Where at one time developers were able to finance 65-75% of a projects value, now they have seen these same banks agreeable to financing only 25-35% of the project. This obviously has had a dramatic impact on development portfolios for residential and retail construction (to name a few). With still higher unemployment rates expected, the impact on home buying, retail purchasing and therefore construction within those venues will be greatly impacted. The residential crisis which began to impact wrap-ups early in 2008 has now grown into a major phenomenon whereby housing starts are down dramatically as foreclosures appear in the headlines more often than new construction. Events on Wall Street have contributed to the current wrap-up dynamics as well. Bonuses that quite often went to fund new condominium units have been eliminated or reduced and now may need to go to other more pressing priorities. With less demand for high rise residential buildings comes less opportunities for wrap-ups. As the economy heads into 2009 with the expectation that we may not see improvements till 2010 are there any "silver linings" we can look forward to? If the proposed stimulus package does "kick start" our economy then we could see more infrastructure projects and a renewed emphasis on upgrading our educational facilities and hospitals. The Marketplace It is encouraging to note that the marketplace has actually expanded beyond last year. These few new players entered the marketplace prior to the September headlines but they, as all the other players, still remain committed to wrap-ups as an underwriting platform. Similar to what was expressed in 2008, these potential carriers all have different project appetites. We have our traditional group that will write just about all types, be them owner controlled or contractor controlled. Others prefer to concentrate on contractor controlled. One new player (we are very happy to say) is actually re-entering the marketplace after a several year absence and will initially be selective as to which jurisdiction they write in. Another newer player has a specialty in "collective bargained" workers compensation. This underwriter (who also writes general liability) can become a critical player when projects fall under "Project Labor Agreements." While the number of carriers has dramatically been reduced over the past ten years we can be thankful that we have had some consistency in the marketplace for a few years now. In addition, capacity for the higher limits usually required in wrap-up programs is available. The simple issue is that we will most probably have more insurance companies chasing far fewer wrap-ups. As noted in my article last year (which still holds true), "the past five years has seen a substantial growth of controlled insurance programs. This had a lot to do with an expanding economy, the demand for residential housing, troubling coverage limitations in the contractor marketplace, escalating contractor rates and a tightening marketplace for "owner's interest policies." All these paradoxes made for very compelling "pro" wrap-up arguments." So as we enter 2009, the compelling reasons to do a wrap-up still remain the same. However we will certainly see a drop off in the number of wrap-ups. Simultaneously we need to be aware of several underwriting forces working against us. Some key issues will take precedence as to how insurance companies perceive the wrap-up risks they are underwriting. As a result of the tenuous economic conditions underwriters may not be as willing to provide such favorable cash flow terms. More sensitive will be the critical issue of collateral. Underwriters will apply much stricter guidelines to their financial due diligence. Where as in the past some insurance companies would be more flexible as respect securing the wrap-up's potential losses we may now see a tightening of requirements resulting in higher collateral amounts. Additionally continued adherence to rigid guidelines as respects safety will be critical to the underwriting process. Developers will need to demonstrate an "engaged" culture towards safety. To simply contractually obligate the General Contractor may not be enough. The underwriting submission must include a detailed section on the proposed project safety plan. Providing a "safety comfort" to the insurer will result in a more favorable underwriting response. Challenges As underwriters have become more comfortable with their pricing models and wrap-up rates have stabilized, we are also beginning to feel the impact of contractor rates reducing at a somewhat quicker pace. This means that the reduced contract pricing we expect from the subcontractors may not be as attractive as previously seen. Those "bid credits" that fund our wrap-ups will be below our expectations. This will put more pressure on safety and obtaining wrap-up savings from good loss experience. From California to New York we have been witness to a dramatic reduction in workers compensation rates for contractors. While we have seen pressure by workers compensation state rating agencies to recommend rate increases these increases will not nearly be enough to bring those rates to an adequate level. An additional burden we are facing in estimating contractor workers compensation insurance costs is a recent phenomenon known as "loss cost rates." In the past our ability to estimate rates was a fairly simple process. Assuming we had a trade breakdown budget to work with, we simply went to the manual and applied the proper manual rate to our work sheet. With the advent of loss rating being approved in many more states, the new rate as shown in the manual will now be expressed as a pure loss rate only. You will need to estimate the expense factors to promulgate what we knew as the actual "manual rate." In 2008 we said that the "state of wrap-ups" was very good. I wish in 2009 we could be as optimistic. It will be a very challenging year but opportunities still exist. We started off by saying "the more things change they stay the same." My summation from 2008 is a good case in point. In summary what are the challenges? * Underwriters need to be cognizant of the rating environment of the contracting community while still adhering to sound underwriting guidelines. * Brokers need to be realistic in their assessment of wrap-up opportunities * Sponsors need to understand their motivation in procuring wrap-ups. It is not all about savings." Happy New Year. Richard Resnick, ARM, MBA, is regional director, wrap-ups, for Aon Risk Services, New York, N.Y.