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When similar conditions existed in the early 1980s, the results were escalating claims frequency and severity rates that exceeded any projections. Much of the claims activity during that period has been traced to the inflation in construction costs. When there is a sudden increase in inflation, insurance reserves and current pricing of coverage become inadequate if they are based on overly optimistic future cost assumptions.
Cost inflation may be affecting insurance rates again. The inflationary increase in 2004 for the kinds of construction projects for which Schinnerer and CNA policyholders provided services was more than 5.2 percent; the 8.7 percent increase in 2005 was the highest annual rise since the early 1980s.
Many in the industry are worried that conditions are ripe for another breakdown in the stability of the design and construction process. So, too, are insurers that have a long-term perspective. Although there are many factors that influence the level of damages resulting from construction claims, the remedial construction expense level is a major determinant.
Inflationary construction costs also jeopardize projects. Some planned construction may be halted, and other projects may be curtailed in scope. Rising costs make it difficult to maintain quality since fast-track construction, substitutions, and inappropriate use of value analysis often compromise plans. Contractors are squeezed because of clients and contracts that do not recognize soaring costs.
Now, external factors including global competition for construction materials and energy sources are exerting pricing pressures that have not been present in past cycles. While the worldwide demand for construction materials may moderate, demand will continue. In addition, market-driven energy costs will continue to cause long-term inflation in both construction processes and the encapsulated energy in construction materials. Although a steady inflationary rate can be accommodated in planning projects, inflationary surges disrupt the design and construction process. They also lead to a spike in claims and therefore in insurance costs.
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