Inflation and Constructions | Griffiths & Armour

In the early hours of 14 June 2017, an electrical fault in an appliance, most likely a fridge in a flat on the eastern side of the fourth floor of Grenfell Tower, caused it to overheat. Shortly before 1am it caught fire. Within the space of 35 minutes the flames had reached the top floor and within two hours all four sides of the building were on fire.

As we now know, by the end of the night, 71 women, children and men had lost their lives and a further individual died in hospital the following January. It was the worst fire-related loss of life since the Piper Alpha disaster almost 30 years earlier and the worst in a domestic setting since the second world war.

Far from being a distant memory at its fifth anniversary, the Grenfell Tower disaster continues to haunt the lives of the surviving victims and the families of all those affected by the terrible events of that night. This will continue for many years to come and the sad reality is that some will never fully recover from the experience.

This is not a piece about those lost because of the fire, nor of the fortitude of those who continue to live with the tragic consequences of that night, but it is right to start what will be a series of publications on recent industry developments with a reminder of why we are here. It is all too easy when considering the implications for the construction and insurance markets to lose sight of the individual human faces of this tragedy.

And those affected will now be preparing themselves for the outcome of the final module of the Grenfell inquiry. There is a huge amount of interest in the outcome of the inquiry and the only consolation to the delay in its conclusion is the hope that this is a direct reflection of the depth and thoroughness of the investigation. Whilst the final report of this second and final phase of the inquiry may yet be several months away, the eventual completion of the inquiry’s painstaking search for truth over some 85 weeks of evidence feels like a further moment of reflection and a timely reminder that this is more than about the use of combustible materials, shoddy procurement practices and insurance considerations.

But there are clear links between all these issues and the tragic events that unfolded 5-years ago. It is because of that tragedy that we now have what promises to be the biggest revolution of building safety in a generation and a sense within the industry that real cultural change is possible. With all change there are difficulties and unforeseen consequences and we will begin to report on some of these, such as those implemented by Building Safety Act, over the Summer.

Independent of the inquiry and, setting aside any disputes relating to Grenfell Tower itself, wider events have unfolded since June 2017 which we predict will affect the financial outcome of claims against construction professionals, whether fire safety related or not. In the following discussion we take the opportunity to remind ourselves of some factors that are at play in driving the cost of building and then we consider what this will likely mean specifically for fire safety claims.

Inflation and Construction Costs | Griffiths & Armour

Inflation

Inflation is a phenomenon in the financial environment that affects all of us both in our commercial activities and in our personal lives. In the UK inflation is currently running at a 40 year high just above 9%, with Ireland not too far behind at nearly 8%. The current consensus amongst economists seems to be that the increase is set to continue until 2024 although, somewhat inevitably, there seems to be plenty of scope for debate about the likely rate at which inflation will eventually fall from such a high level.

The media have been awash for some time now with commentaries on what is driving the rate of inflation and what (if anything) our governments might do in order to alleviate the effects of inflation on the general cost of living, particularly among those sectors of the population who are hit hardest. Rather than repeating those narratives here we take a look instead at what the likely effects of current economic conditions might be on the Professional Indemnity insurance market and its stakeholders, most importantly our clients.

Inflation and Disputes

The final cost of any PI claim that is pursued and runs its course is determined by a combination of factors, many of which have nothing at all to do with inflation. Examples of the latter include the number of defendant parties involved in the dispute, and their respective financial standing and/or insurance arrangements; the merits of appropriate defence arguments and the availability of robust evidence to support them; and the effectiveness of our team in pursuing the best strategy for concluding any such dispute on the best available terms without incurring disproportionate costs in doing so.

However, and as a broad generalisation to which there are all sorts of exceptions, what ultimately lies at the core of a typical construction PI claim is the direct cost of physically remediating the alleged defect. Any other costs are, by and large, only ever incidental to that. The remedial scheme might be undertaken many years after the original works were completed. This is particularly the case where a latent defect comes to light long after project completion, but it also now extends to schemes that have been delayed due to the pandemic and other disruptive factors which we go on to mention below. Either way, the claimant generally has little option but to proceed with a remedial scheme at today’s prices and is then entitled to be compensated for that cost.

PI insurers are painfully aware of this because whilst inflation at its current level has been a relatively recent development, the cost of construction has been steadily but significantly rising in recent years. According to the official UK source of figures the price of construction materials in the round has increased by 52% in the five-year period ending April 2022. The last 12-month period alone within that window has witnessed a sharp increase of 27%.

What is Behind the Figures?

The above figures reflect the increased cost of various construction materials through a combination of:

  • Cost increases at source for materials from European and Asian suppliers. A number of commentators have cited the 66% increase in the cost of fabricated stainless steel during 2021 and a 70% increase in the cost of imported sawn/planed timber.
  • A general shortage of labour. According to ONS, construction job vacancies in the last 20 years or so in the UK have rarely exceeded 30,000 in number and have done so only for brief periods. Earlier this year the figure returned to an all-time high of 48,000.
  • Transportation costs which continue to be affected by Brexit (European HGV drivers have proved difficult and/or costly to replace in the UK) and by huge increases in the cost of shipping from the Far East.   Those costs are expected to continue to rise.

The Effect on Insurers’ Reserves

Insurers constantly keep their current reserves for existing claims under review. We have now started to see recommendations from our panel solicitors for increases to those reserves because the current figures are based on assessments of loss that (often due to delays related to the period of pandemic) are now simply out of date. They are advising in express terms that the reason why a specific claim is now expected to cost, say, 30% to 40% more than previously estimated is that the claimant is only now ready to start the remedial scheme that was proposed several years ago and prices have increased in the meantime.

This is a worrying development because in principle every construction claim that might be ripe for settlement in the short to medium term is likely to be affected by a rate of inflation which is soon expected to reach 10%. Where physical remediation of a defect is involved it is likely also to be affected by the increased cost of construction. There is a significant risk that at a macro level the PI insurance market is significantly under-reserved to fund these increased exposures. The knock-on effects on insurers’ loss ratios and the consequent need to reconsider rating strategy could be significant.

Inflation and Construction Costs | Griffiths & Armour

We are witnessing these financial developments at a time when the PI insurance market has been building up a bubble of claims from a different source. As touched on in the introduction, the fifth anniversary of the Grenfell Tower disaster is a significant milestone at which to take stock and review what has been notified to insurers to date and whether any trends are starting to emerge.

Since June 2017 Griffiths & Armour have processed over 400 FSNs . Within that sample there is a strong prevalence of residential projects in the broadest sense, particularly including apartment buildings, student accommodation and hotels. Overall this equates to over 10% of all notifications by our construction client base over that same period.

We don’t immediately have data to hand enabling us to compare this with FSNs notified prior to June 2017 but it is safe to say that whilst they were not in themselves unusual (construction professionals have always had fire safety related duties, and disputes have formed around alleged breaches from time to time) we have witnessed a rate of FSNs in the last five years which is disproportionate to the amount of specific fire safety related work undertaken by our clients as a percentage of their overall activity.

This comes as no surprise. In the immediate wake of the Grenfell Tower fire various commentators raised concerns about the way in which various fire safety risks appeared to have been addressed during its refurbishment and whether similar approaches might have been taken on other buildings with similar risks. With this in mind, responsible building owners commissioned asset review reports. Some contained direct criticisms of designs. Others were inconclusive and recommended further investigations. Both varieties were notifiable for PI purposes depending on the precise wording, the general context and the terms in which they were shared with the relevant parties.

The other driver to the rate of notification to insurers is the cover restrictions which the market introduced as it started to anticipate the combined potential magnitude of fire safety claims. Once potential claimants and their advisers became aware of those developments it prompted them to place the construction team on notice of claims even when investigations were at an early stage.

If there is a surprise, it is the fact that we are continuing to process new FSNs even at today’s date, albeit at a reduced rate, when one might have expected new FSNs to have tailed off more or less altogether by now. It seems that not all building owners were so quick off the mark in commissioning investigations. Where investigations have been completed they can still take many months (or even years) to filter all the way through the supply chain. Sometimes parties are placed on notice only as limitation periods are at risk of expiry.

Limitation periods and standstill agreements

In spite of the overall volume of FSNs referenced above it remains the case that relatively few are currently being actively pursued as claims. This is likely to change once the public inquiry is concluded. Whilst its outcome won’t set any legal precedent its findings will have a weight of authority which is likely to influence how related disputes then play out. Our suspicion is that some claimant parties will be deferring further action until the inquiry produces something which will assist their case.

In the meantime they are keeping a close eye on limitation periods since some of the projects involved are approaching twelve years old. Claimants who are not yet ready to advance their claims as the relevant expiry date looms usually ask potential defendants to enter into a standstill agreement, effectively agreeing to waive any time bars that have not already taken effect. Sometimes it is in our interests to cooperate with this suggestion, subject to the terms being acceptable. At other times it is less attractive. Each case is different and our team continue to provide bespoke advice depending on the circumstances.

However, in the round, an unusually high proportion of standstill agreements are in place in relation to FSNs, effectively meaning that professionals and their insurers are exposed in principle to claims which might otherwise have been time barred, extending the length of the ‘tail’ beyond its normal period.

Swift settlements

The other side of the coin is that where cover restrictions mean that limited insurance funds are available it can be a catalyst to resolution, especially where policy limits are costs inclusive. Where our strategy has been to negotiate settlement with the claimant we have sometimes been able to argue that our current offer is our best and that it can only reduce over time if the claimant refuses to accept it – they would be forcing us to incur further defence costs which would then only then erode the remaining available policy funds. Claimants have a further incentive to accept those offers where there is a risk of further erosion of the available funds by other claims in the same policy period.

Multi-party disputes

Wide of FSNs, and in relation to construction more generally, the way in which design decisions are often taken with some degree of input from employers and/or specialist suppliers, combined with the way in which defects are often attributable partly to workmanship as well as design, means that claimants often pursue many more than one defendant party.

It is therefore unremarkable in itself that this is a further characteristic of FSNs although here to cover restrictions have had a broader effect. The direct costs of remedial works (certainly as presented by claimants) frequently run into eight figure sums where substantial developments are concerned. Where that happens it may be that no single defendant party is sufficiently well insured to negotiate settlement acceptable to the claimant party. Claimants therefore have a further incentive to cast their nets as wide as possible. This is all the more so where some would-be defendant parties are no longer trading or have no relevant insurance cover at all; again, nothing new or unusual here, but it is proving to be particularly relevant in relation to small cladding subcontractor firms.

From a claimant’s perspective, bringing more parties (and their respective insurers) to the table certainly increases costs but their hope is that it will nonetheless mitigate their net losses. In that regard it should also be remembered that where remediation is required and the building owner is eligible for a grant under the UK government’s Building Safety Fund, the grant will only be made available subject to the owner undertaking to exercise reasonable endeavours to recover what they can from the construction team. Not only that, but the Department for Levelling Up, Housing and Communities then provides a further financial grant to assist in the cost of pursuing that recovery.

Inflation and Construction Costs | Griffiths & Armour

By its very nature, any review of FSNs merely sums up some of the main trends and recurring themes around FSNs as they currently stand, but it is nothing more than a current snapshot. The picture is likely to continue to evolve for many years to come, very much in keeping with the long-tail nature of PI construction claims generally (wide of FSNs). Only once all claims have resolved will it be possible to quantify the total financial impact for our construction clients and their insurers.

In the meantime we have seen claimants estimating their losses at up to tens of millions of pounds for remediating unsafe buildings, particularly where extensive re-cladding is required on a large high-rise structure. Those figures are subject to revision depending on the actual cost of remedials, which in turn are subject to whatever market conditions prevail at the time that the work is undertaken.

Current construction market conditions are a product of the pent-up demand created by successive lockdowns and a combination of other disruptions in supply chains, a global increase in construction costs and the general effects of inflation. All of these factors combine to push the value of Professional Indemnity claims upwards, placing further pressure on an already stretched insurance market and increasing the chances of uninsured losses where remedial costs exceed the amount of cover available.

This is particularly relevant in relation to fire safety because of the volume of claims in the market and the fact, that for many, cover for fire safety claims operates subject to restrictions, if it is covered at all. More generally, however, it prompts us to advise all consultants to think carefully about when they last reviewed their liability exposures, policy limits and claims notification policies. Our team are available to discuss any particular scenario or situation in order to advise on appropriate and available steps.