The Big Question: Inherent Defects Insurance – A win-win for insurers, governments and society?

From the UK government’s pledge to build 1.5 million houses to a global drive for more urbanisation construction is undergoing huge growth.

However, it comes with risks. Geopolitical events have created a severe shortage of building materials, leading to a spike in costs and there is a significant shortage of skilled labour. If the UK is used as an example the scale of the requirements for skilled labour is at crisis point.

The Construction Industry Training Board (CITB) released the results of its own research last year which found the UK’s construction output rose by 2% in 2023, the third consecutive year of growth, and will grow by an average 2.4% a year between now and 2028.

The report was released before the Labour Government’s housing pledge and based on the CITB’s figures to meet this growth, an equivalent of more than 251,500 extra construction workers are needed over the next five years, with construction employment rising to 2.75 million by 2028.

The property market is facing a demand for new building which will test the market’s ability to meet those demands. Lessons from the past have highlighted that a surge in construction can come with the potential for quality issues around design and build. However, all too often these only become apparent some years after the building has been completed creating a coverage challenge.

Ian Summers, Global Business Leader, AdvantageGo.

Jimmy Keime, head engineering and nuclear, P&C Re, Swiss Re explains: “Inherent Defects Insurance, also known as decennial insurance or simply IDI, is a specialised product that exists to solve the challenge of inherent defects in building structures that may emerge years or decades after construction is completed, where current insurance provisions may leave a gap.

“The framework for IDI we know today emerged in the aftermath of the Second World War. Nations faced the daunting task of swiftly rebuilding war-torn cities, but the urgency of reconstruction often came at the expense of quality.

“With governments seeking ways to solve this problem and increase the quality of construction, the IDI framework has become an increasingly important part of the construction insurance toolset.”

Keime adds that the product has the capability to bridge fundamental gaps in building construction.

“During the construction of a building – whether that is a house, apartment or commercial property – losses or damages are typically covered under a contract works policy that insures all risks and provides funds for any repairs or damages. Once construction is complete, a separate all risks policy will then typically take over,” he continues. “However, there is a fundamental gap in these policies: critically, they do not cover damages arising from inherent defects in the building’s structure, leaving property owners at risk should defects be discovered post construction. As an example, in 2004, part of Terminal 2E at Paris Charles de Gaulle Airport collapsed, resulting in four deaths and three serious injuries due to factors like insufficient supports and poorly spaced reinforced steel. It reopened four years later, after a EUR 150 million rebuilding project.

“That’s the gap that IDI products bridge. It provides coverage for the cost of repairing structural defects that arise within a 10-to-12-year period following the completion of construction. Though not so frequent, IDI can also be used to cover big infrastructure projects.”

IDI can also create global opportunities for the construction value chain.

“Today, we see IDI continuing to gain traction in new markets given the rapid evolution of the construction landscape,” says Keime. “With a surging global population, continuous urbanisation, rising living standards, and increasing demand for housing and infrastructure, global awareness of the risks associated with construction defects is growing. So much so, that several countries including Colombia, Mauritius, and the Kingdom of Saudi Arabia are now legislating compulsory IDI coverage.

“IDI – when adopted at the legislative level – can be a multifaceted tool that benefits society, governments, developers, lenders, investors and insurers alike, promoting security, confidence, and resilience in the construction industry.

“In rapidly developing nations like India and Indonesia, that anticipate having huge demand for buildings and infrastructure in the coming years, implementing IDI at the policy level would be a logical step. For such countries, the merits of promoting more sustainable, resilient and better-quality construction would be significant.”

He contends IDI provides a unique opportunity for insurers to open up new markets, access reliable growth and support portfolio diversification. With the right partners on board, they are able to effectively tap into a big pool of premium, increase local market share, and get closer to the construction and inspections to ensure good quality construction.

“Beyond insurance, the entire value chain benefits from IDI,” Keime continues. “At the heart, consumers gain peace of mind for the biggest purchase of their life – their homes. Developers can offer more quality assurance, lenders gain financial security, and governments can build societal resilience with better quality construction. IDI does not only promote construction quality, but also safety. The use of technical inspection services ensures building codes are respected and buildings are harmonising with the environment they are built in, e.g. taking into account soil condition or wind codes, ultimately increasing resilience to natural hazards.

However, there is much for insurers to consider.

“While an exciting product that a growing number of countries are beginning to embrace, IDI is long tail and requires careful technical knowledge and portfolio planning,” explains Keime. “With this in mind, there are a few questions insurers looking to enter the market must ask themselves.

“Firstly, whether they have the right long-term partners on board. Above all else, insurers need specialist partners who offer industry-leading solutions and expertise in this area, as well as advice that will be ready and available to access at any time. This is vital to ensuring quality and security in every project.

“In addition, while IDI is compulsory in a handful of markets, owners lack this protection in others. If insurers are to help close the protection gap in key regions where regulation is being developed such as China, India, Algeria or Colombia, they must also ensure they have access to on-the-ground expertise within these markets. There will be considerations around topics like claims management, reserving and tapping into the right network of claims adjusters and technical inspection companies – all of which require solid local knowledge.”

He concludes: “Finally, and given the complexities in this area, insurers should give consideration to the digital tools that could help them simplify and streamline the introduction of IDI to the market. In our experience, when agents and distribution partners have the right tools, they are able to price and issue policies far more quicky, while insurers can more easily place facultative risks.”