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Catastrophe Risk Management

Ghost Building: What Is It, and How Do You Insure One?

November 22, 2019

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Two buildings under construction

During the course of building construction, the future part of the building that is "yet to be completed" is a ghost building. Far too often, damages caused by natural catastrophes and secondary perils contribute to the creation of a ghost building. These yet-to-be-built structures need to be insured.

Traditional builders risk policies only cover the cost to rebuild that part of the building that was actually built and damaged. When a construction project incurs significant damage, such that the project essentially starts over, that portion of the building that was "to be built" at the time of damage (the ghost building) will now be built later and will most often be subject to increased construction labor and materials costs.

NatCat Perils and Coastal Living

Today, 35 out of the 50 largest cities in the world are situated along a coastline. More than half of the global population lives within 100 miles of a coast, and that urbanization trend is not slowing down. People like living near the ocean despite the exposure to Mother Nature's hazards.

The Global Risks Report 2019 issued by the World Economic Forum (WEF) confirms that natural catastrophe events continue to be one of the key risk drivers in the global economy. Losses from secondary perils (smaller NatCat events, such as torrential rain or surge flooding, which are often associated with the larger perils) have also been on the rise. All of these events have created the need for insurance companies to be more innovative with their products. To date, recent events—such as Hurricane Dorian and the wildfires in California—have caused billions in damages in all areas. In Dorian's case, rain and flooding caused extensive damage along the Carolinas' coast as it made landfall in the United States.

There were 304 catastrophe events in 2018, the same as in 2017.

Number of Catastrophe Events - Carpinteri - November 2019Split of Primary and Secondary Peril Insured Losses - Carpinteri - November 2019

Construction Fee Increases

Studies have shown labor shortages and increases in the cost of construction products led to significant increases to complete projects, be it ghost buildings or others. A May 2019 National Association of Home Builders' survey reported a remodeling labor shortage impacts the construction industry. It has created a challenge to keep prices competitive as labor prices increase.

The survey reported the following.

  • 78 percent higher wages/subcontractor bids
  • 72 percent higher prices for customers
  • 67 percent difficulty completing the projects on time
  • 53 percent turning down some projects

An October 2018 analysis of US Labor Department data by the Associated General Contractors of America illustrated that the cost of construction products rose 7.4 percent. It reported contractors' charges to build projects have witnessed increases.

Construction materials price increases included the following.

  • 29.3 percent for diesel fuel
  • 22.1 percent for steel pipe and tube
  • 11.7 percent for fabricated structural metal
  • 11.2 percent for asphalt paving mixtures and blocks
  • 10.7 percent for aluminum mill shapes

Traditional builders risk policies do not respond to cost increases of the ghost building. Insuring the ghost building against the increased costs of these and other risks needs unique underwriting and policy forms. Properly structured plans can respond to these increased costs due to completion at a later date at higher fees.

The Situation

For instance, a broker requests an offer traditionally not covered by builders risk policy. The coverage needed to include the increased costs for completion of the ghost building. The broker needed a policy providing balance sheet protection for a risk that previously was being silently self-insured.

On his end, the developer brought up the following pain points.

  • A lack of understanding of coverage under a builders risk policy—there was a lot of confusion specific to the escalation costs coverage.
  • There was a need for a strategic approach versus transactional (pure insurance).
  • The final product was a collaborative effort and worked for all parties involved—a true team effort.

The Solution

Client, broker, and insurer guidance were used to create a solution for risk not previously covered to deliver a final policy. It provides leverage against a risk that would typically be considered a business risk in traditional insurance transactions.

Recognizing the need to look out for the construction and real estate industries, a replicable coverage policy that can be offered on a stand-alone basis or with a traditional policy is ideal. In this case, the final policy involved a hybrid of traditional indemnity triggers found in a typical builders risk policy along with a preagreed parametric payout based on the month of the damage event. This payout typically varies in proportion to the amount of ghost building at the time of loss along with an inflation amount as the ghost building will now be constructed at a later date. Upon a significant damage event, the policy can pay up to the preagreed amount of funds to help offset the escalation cost of the ghost building faced by the owner. The amount mirrors the client's need at various time periods of the construction project.

Translating the client's objectives into actionable solutions isn't always easy. In this case, ghost escalation became an answer to a traditionally unfilled need in the construction industry.

Scott Carpinteri specializes in innovative risk solutions at Swiss Re Corporate Solutions and partners with corporate and public entity clients to develop customized insurance products. He has 25 years of experience in the insurance industry. Prior to his current role, Mr. Carpinteri spent 14 years working in treaty reinsurance at Swiss Re as a reinsurance structurer, treaty underwriter, and pricing actuary. He is a designated associate of the Casualty Actuarial Society. Originally from Connecticut, but a Californian since 2001, Mr. Carpinteri has been known to use "wicked" and "dude" in the same sentence.

Greg Melton, a broker with Aon, and Paul Boatman, a developer at Prometheus, have also contributed to this article.

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