SA’s construction industry “digging out” in 2018

Credit rating requirements and the evolving risk management environment are challenging factors in the construction industry. Russell Myers discusses.

Russell Myers

CEO of Mirabilis Engineering Underwriting Managers

Could this year be a turnaround year for South Africa’s construction industry? This industry is a significant contributor to employment and economic growth in the country, but has been in a slump since 2009. Since President Ramaphosa’s SONA earlier this year, there seems to be an air of optimism. In his speech he proposed a Jobs Summit during 2018 to “align the efforts of every sector and every stakeholder behind the imperative of job creation”, and indicated that infrastructure investment is the key to growing the economy. These are encouraging signs, but construction typically grows in line with a country’s GDP growth, therefore we cannot expect any strong growth coming from this industry soon.

Overall, opportunities in South Africa and Africa are more limited than in prior years given the global economic slowdown. A major driver affecting the value of gross written premiums on the continent is the future outlook in terms of economic expansion and growth. However, due to Santam’s investment strategy in Africa, India and South-East Asia, we, as Santam’s leading engineering underwriter, have more opportunities and greater presence, which are proving invaluable in a more challenging and competitive space. Backed by Santam’s financial solvency, our risk consulting, claims and underwriting teams are among the most technically accomplished and can lead the largest engineering risks and construction projects across different markets, giving us a reputation earned through years of practical experience.

Challenging rating requirements

Expanding beyond the country’s borders came with its own complications. Frequently, financiers require a specific international credit rating, such as S&P, from an insurer. However, an insurer’s international credit rating is limited to two notches above its country’s sovereign rating. This meant that South Africa’s rating downgrade from Standard & Poor, for example, made it impossible for national insurers to secure the required A rating.

Some insurers have addressed this by strategically partnering with international reinsurers. For example, Santam partners with Munich Re of Africa to provide A-rated reinsurance paper in cross-border markets. Additionally, a number of insurers are fronted in South Africa, then reinsured in London. This is problematic as it means exporting premiums instead of keeping these inside the country.

This rating requirement means that while a project could be domiciled and funded in South Africa, financiers may still see South African insurers as providing unacceptable security. For this to change, there needs to be a shift. Local risks underwritten in South Africa for South African assets shouldn’t have to comply with having a rating requirement above the local rating. I’m not sure how this would be enforced, but it must be a consideration going forward.

To date, the rating requirement has not been a problem for local insurers, given the limited number of projects to insure (due to the soft economy). However, with the government pledging R940 billion to infrastructure, it may have a more significant impact going forward. We need to ensure the premiums stay in South Africa; that’s what’s going to drive the engineering insurance sector and the insurance industry’s growth.

The lack of projects means competition has been rife, especially with new players entering the market and providing excess capacity. Capacity is not an issue in this country – insurers can easily handle projects exceeding R5 billion. This can be seen in the private sector, where a number of big projects have been completed recently – like Discovery and Sasol’s new office developments in Sandton. But even the private sector is cutting back on project insurance due to ongoing economic decline. One of the most effective means of resolving this is to engage with financiers early on in the project’s life cycle.

Clients taking on more risks

For insurers, the historic decline of the construction industry saw a downward pressure on pricing from a reinsurance perspective. This catalysed companies cutting down on expenses and consequently trimming their risk management efforts.

Effective risk management is crucial in the construction industry. The role of insurers like Santam is to educate contractors on the importance of insuring infrastructure assets against fire, floods, storms, etc. It is important that project owners incorporate appropriate insurance cover into the tender process and not regard it as an add-on once the tender has been awarded. That way, insurers can give risk management input from the beginning in order to optimise risk mitigation. It’s quite possible that a better understanding of risk exposure could ultimately impact a project’s design.

Going forward, effective risk management and challenging rating requirements will require constructive partnerships between insurers, contractors, developers and financiers.