26/11/2021 - 15:24

Builders under insurance pressure

26/11/2021 - 15:24

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Construction companies are struggling with cost blowouts and project delays, leading to questions about their levels of cover.

Builders under insurance pressure
Michael Bartier says conditions are right for builder failure. Photo: David Henry.

A spike in indemnity insurance claims in an overheated construction market has triggered concerns builders may not have adequate cover to complete builds.

The state’s Building and Energy Division has reported a 42 per cent increase in the number of home indemnity insurance claims finalised in the previous financial year.

High demand for new homes encouraged by government stimulus has led builders to take on a large volume of projects in the past 18 months.

Rising construction costs are putting companies under increasing pressure, however, with some builders facing collapse as they cannot pay for their contracts.

The recent demise of Jaxon and Pindan has highlighted the challenges facing some in the construction sector, and industry sources say more companies are on the brink of going under.

Indemnity insurance or homeowner warranty applies to residential projects with a value of above $20,000 and allows consumers to claim up to $100,000 if a builder becomes insolvent.

Builders are each allocated an indemnity cap related to their level of financial risk, which dictates how many projects they can take on. But as construction costs rise, builders may become overexposed relative to their level of cover.

Market environment In 2020-21, 483 indemnity insurance claims were finalised, compared with 340 in 2019-20, state government figures reveal.

In 2017-18, 303 claims were finalised, compared with 216 claims processed in the previous financial year. There was a spike to 469 claims in the 2018-19 financial year.

From June 30 to October 31 this year, 229 indemnity insurance claims have been finalised in WA and $2.6 million paid out.

At the current rate, WA will hit 687 claims by the end of June 2022. Since July 2016, the state government has paid $63.3 million in indemnity insurance to consumers in Western Australia.

Executive director building and energy at WA’s Department of Mines, Industry Regulation and Safety, Saj Abdoolakhan, said indemnity claims would rise as more builders faced insolvency.

“A key function of home indemnity insurance is protecting consumers in the event of a builder’s insolvency, so there is a natural correlation between these circumstances and home indemnity insurance claims,” Mr Abdoolakhan told Business News.

“The financial position of homebuilders is monitored and, when necessary, action is taken to minimise the impacts of any solvency issues.”

Some WA builders have reported having their indemnity insurance caps, or builder facilities, slashed from as much as $100 million to $10 million in recent months.

Industry sources say this reflects the precarious position some builders are in, due to cost escalations and delays in housing projects.

New Home Building Brokers managing director Tristan Kirkham said the insurance process for builders should be more transparent.

“I understand insurers being more diligent in checking on builders, but they are reactive in how they go about it,” he said.

“This is a kneejerk reaction to builders’ caps, an arbitrary change, without builders being able to plan how to deal with it.

“This can increase builders’ chances of financial difficulty.”

BGC Housing executive general manager Michael Bartier said current conditions meant some builders may be taking on more builds than they should.

“The purpose of the indemnity cap is not to overexpose builders, so they get to a point where they might only be indemnified for 200 builds, but then go and commit to 400 jobs,” he said.

“All of a sudden, if they were to fail, in a high-risk environment as we’re in today, then that indemnity insurance can pick them up for what they can support or deliver upon rather than an overexposed position.”

Mr Bartier said he would like to see greater controls and testing around builders’ insurance, given the economic conditions.

“Now we’ve got a pandemic and stimulus, it’s probably time to turn up the stringency of what is that financial capability required for your indemnity cap insurance,” he said.

“Whatever the measure was in the past may not be sufficient for today’s environment.”

QBE, the main insurer for home indemnity in WA, assesses the level of risk of builders before determining the amount of insurance offered. Builders may request an increase to their cover, which can be refused at the discretion of the underwriter, but this refusal does not affect the original cover a builder is assigned.

Builder pressures JWH Group general manager Jay Walter said it was becoming more difficult for some builders to get indemnity cover.

“There is definitely more scrutiny, which is fair considering what the industry is going through,”

Mr Walter told Business News. JWH increased its cover last year, as it took on more builds during the stimulus period.

Mr Walter expressed concern over the impact the rapid escalation of building costs would have on the effectiveness of claims.

“When you consider on average [construction costs] have moved by about 25 per cent, so in essence you will now get less for your insurance money to complete a project,” he said.

Recent CoreLogic figures show WA recorded the second largest spike in construction costs nationally, at 4.3 per cent in the September quarter.

Anecdotal evidence shows building costs in WA have increased by at least 20 per cent since early 2020, compounding the challenge for builders to maintain a strong capital position.

ABN Group managing director Dale Alcock said current market conditions could result in many builders being caught out with less cover than they required.

“The current situation is chaotic and far from a normal market; many builders have been caught with unexpected increases and of a magnitude far exceeding their expectations,” he said.

“This must have a big impact on both their cash flow and profitability. For residential homebuilders this will potentially result in a reduction in their homeowner warranty cap.”

Mr Alcock said supply chain snags were impacting builders’ bottom lines as they added to project delays, along with labour shortages.

He said ongoing industrial action at Fremantle Port was causing massive disruption to the state’s already vulnerable supply chain.

Mr Alcock said ABN Group had ensured it carried sufficient homeowner warranty cover during the stimulus period to deliver the homes it promised.

“It is very unfortunate that some others within our industry have not put limits on the number of homes they have sold, they have not allowed for price escalation, and they do not have sufficient homeowner warranty cover,” he said.

Housing Industry Association WA executive director Cath Hart said industry was closely monitoring the impacts of pressures faced by the construction sector.

Boiling point WA’s construction industry is under significant pressure, industry experts say.

A combination of cost blowouts, project delays, labour and material shortages and high demand for new homes has forced some builders out of the industry.

Mr Bartier said the risks of failure were greater than ever. “These builds are slower, there’s less revenue recognition [and] greater cost escalation, so the chance of failure is just an inevitability for some of these players that don’t have enough cash reserves to ride the storm,” he said.

Mr Bartier added that most builders had pipelines of work of at least 12 months, and given labour shortages, there may be difficulty finding new builders to take on the projects of failed builders.

“We don’t have enough labour [and] we’re fighting for materials,” he said.

“Even if our trade base doubled tomorrow, we would still have a massive pipeline of work.

“If a builder was to fail and leave consumers high and dry and caught up in that madness, [and] even if another builder had the intent to take that work on, there simply isn’t the resources to then process those builds.”

Mr Bartier said inheriting a partially completed home was not an attractive proposition for builders, even in ideal conditions.

“And even if they could get the work, [the consumer] is going to have to pay a premium again, over and above the current market rates to convince tradespeople to go there and complete a job that another tradesperson has already started,” he said.

“It would leave things in a really precarious position.”

Apartments Homeowner warranty insurance in WA only applies to buildings of three storeys or less, prompting calls for the policy to extend to apartment developments.

Australian Apartment Advocacy founder Samantha Reece said if the government wanted to meet its infill target of 47 per cent by 2050, it should have more incentives in place for apartment living.

“At the end of the day, if the state government wants to focus on infill, it should provide some certainty to apartment owners, similar to what they do to everyone else who’s buying a house and land,” she said.

“It is an unbalanced playing field.”

WA’s housing stock is currently made up of about 7 per cent infill developments.

Ms Reece also called for an apartment repatriation fund, to allow strata companies to access state government loans to pay for any defects not covered by other warranty mechanisms.

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