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CASE STUDY

Spare a thought for builders

Introduction

Covid-19 and Brexit coincided to make 2020 one of the most difficult years that many of us have known. Covid-19 has made many of us work from home, parents have had to support home-schooling for their children and many business owners have had sleepless nights wondering whether they will survive. At the same time Brexit and the long-running negotiations made us all exasperated and uncertain about the future.

But as we get further into 2021 many of us are starting to see a light at the end of the tunnel. Covid-19 is on the run as the UK rolls out one of the most impressive vaccination programmes ever seen and we are daring to think about a summer of socialising. Brexit may have added a bit extra to our shopping bills, but many of us haven’t really seen any dramatic direct impact on our lives, and frankly we are all pleased we weren’t part of the EU wide vaccination programme.

But there are people and businesses that are not yet seeing the light. Imagine that you own a business that:

Then imagine that you have managed to adapt to all of this and then the UK government throws new tax legislation at you that hits your cashflow just as it starts to withdraw the Covid-19 financial support schemes that you have relied on since spring last year. Welcome to the construction industry, and the property claims reinstatement industry in particular.

In this opinion piece we explain the challenges facing the construction industry and why insurers need to spare a thought for building contractors. We explain the impact these issues are having on insurers and their customers and how insurers can work with MA Group to help keep the wheels of property claims management turning.

The construction industry

According to the Chartered Institute of Building, CIOBthe  UK construction industry employs 2.3 million people, about 7.1% of the UK total, with hundreds of thousands more employed within other related businesses. It is characterised by large turnover and small profit margins across all sizes of projects, leaving little room for rising costs or sudden shocks.

The industry is highly vulnerable to change due to its low margins and the variety of professionals, specialists and suppliers who work within the industry, all reliant on each other to deliver projects on time and to budget. A successful construction company knows how to balance risk and reward through careful project management and sound commercial thinking.

The recent challenges that Brexit and Covid-19 have brought to us all are having a significant and negative impact on building contractors. When the new Reverse Charge VAT rules come into force on 1st March 2021, building contractors are going to be hit hard (see below).

The construction industry accounts for approximately 6% of UK GDP (about £120 billion) but a disproportionate 20% share of the UK’s insolvencies (in normal times). These figures are likely to change for the worst with the pressures felt by the construction industry in 2020 continuing into 2021. The level of business failures will only increase once government support schemes are removed and the full impact of the Reverse Charge VAT kicks in.

Such a high level of business failures means that the role of MA Group in managing supply chains on behalf of insurers is key for protecting insurers and their customers. Insurers and their intermediaries need to be mindful of the challenges that builders face and need to work closely with the builders and MA Group to ensure that viable construction businesses stay afloat.

We summarise the issues facing building contractors below.

Brexit

We have now completed the Brexit transition and have officially left the EU. The UK government and the EU managed to reach a last-minute deal, giving companies across all industries little time to adjust to the new rules. We have avoided tariffs or quotas on goods moving between the EU and UK, however customs declarations need to be made when importing or exporting goods which is creating delays and bureaucracy through the supply chains. And we no longer have the free movement of labour between the UK and the EU which creates staffing challenges.

Materials

According to the Builders Merchants Federation (BMF) 75% of building materials are made in the UK. For the remaining 25% of building materials that are imported, around £10 billion of construction imports come from the EU, such as electrical wiring and heating systems.

In the run up to Christmas Felixstowe, the UK’s largest container port, was handling 30% more goods than usual largely as a result of stockpiling prior to Brexit. This stockpiling, and the uncertainty around Brexit rules and regulations, resulted in a drop in volumes of imports in the first couple of weeks of 2021, so initially there were few delays at the UK ports. But there are now signs that as imports start to increase again companies are struggling with the paperwork and border checks are starting to cause delays.

Building contractors are reporting delays of four weeks on timber deliveries from the EU. They are also struggling with deliveries from UK manufacturers because increased demand for building materials from locked-down DIY homeowners and the housebuilding industry has created shortages for UK-produced materials. For example, there are reports of significant delays for roofing materials, such as pitched roof tiles, because, even with extra shifts, UK factories are struggling to keep up. There are also shortages of power tools, screws and fixings which come mainly from Asia.

The increase in time to source materials is impacting the rate of progress of construction projects, including property claims. Uncertainty around sourcing materials and the associated longer lead times makes project planning more difficult and delays in getting costs authorised.

Most of our contractors work on non-insurance projects as well as insurance claims. Delays on such projects can have a knock-on effect for insurance claims work – material delays may result in delays to staged payments on non-insurance work which impacts cashflow and a contractors’ performance on insurance claims too.

We were already seeing significant price increases for materials in 2020 – according to the BCIS Material Cost Index, 2020 saw an increase in material costs of 5.4% on average. Price rises for some materials are astronomical – contractors are starting to see timber cost increases of between 20% and 40% because of supply problems in Scandinavia, and the price of steel has risen from around £650 a tonne to £1,000 a tonne. The BMF highlights many of the issues on its website.

The BCIS is forecasting significant average price increases for materials the next few years:

Period Forecast
Q1 2020 to Q1 2021 +4.9%
Q1 2021 to Q1 2022 +4.0%
Q1 2022 to Q1 2023 +3.2%
Q1 2023 to Q1 2024 +3.1%
Q1 2024 to Q1 2025 +3.9%

 

The delays at the UK-EU border are increasing costs for importers, which will also feed into higher material costs in 2021.

The increased paperwork and checks on goods passing between the UK and EU may encourage companies, at least initially, to decide to purchase materials and parts from outside the EU to avoid the administrative burden of goods coming from the EU, which could lead to the increased use of potentially defective parts in UK properties and in turn, the increased risk of a growth in claims in the future.

Labour

The UK construction industry has been heavily reliant on EU immigrants for labour, particularly in London when demand is highest. Over half of migrant workers in construction come from the EU and such migrants tend to be employed in unskilled and semi-skilled roles.

EU citizens who are living or working in the UK prior to 1st January 2021 can remain in the UK until 30th June 2021 if they have applied to remain in the UK under the EU Settlement Scheme. They will usually get settled status if they have lived in the UK continuously for more than five years. In October 2020, the Home Office announced that there had been more than four million applications to the EU Settlement Scheme.

Anyone wishing to come to work in the UK now must comply with the new immigration “points-based” system which is designed to attract “skilled workers”. Points are awarded for speaking English, qualifications at a level equal to or higher than “A” Level, and for having a job offer from a licensed sponsor to earn at least £25,600 per year. Additional points are awarded for roles that are set out on the “shortage occupation list”.  The current shortage list includes engineers, architects and quantity surveyors, but does not include plumbers, electricians, bricklayers etc. It is clear that many roles in construction do not meet the criteria of the points-based system and the supply of new labour from the EU will dry up.

A recent study, the CITB Migration Green Paper, 2018, showed that UK construction companies stated the lack of UK applicants (55%) as the main reason for employing migrant labour followed by a better work ethic (45%). There have been far too few younger UK workers joining the construction industry as the UK government has provided insufficient incentives and focus on vocational subjects and apprenticeships over many years.  The UK construction labour force is an ageing population – UK born construction workers have an average age of over 45 and it is the most rapidly ageing workforce in the UK.

There will clearly be a shortage of labour in the UK construction industry as UK businesses have to look for home grown talent to fill vacancies. In 2020 UK construction companies were already struggling to hire skilled bricklayers, masons and welders and yet the UK government refused to put them on the “shortage occupation list”.

The government has introduced incentive payments for companies to hire apprentices, but training new people takes time and there will be reduced capacity in the industry for some time. There will be delays on property claims as contractors try to source skilled labour such as bricklayers.

A shortage of labour will inevitably put upwards pressure on wages and so increase costs for contractors. These additional labour costs will erode contractors’ small margins even further and insurers will see increasing indemnity spend as labour rates are reviewed upwards.

The BCIS is forecasting significant average increases for labour over the next few years:

Period Forecast
Q1 2020 to Q1 2021 +0.4%
Q1 2021 to Q1 2022 +3.9%
Q1 2022 to Q1 2023 +3.6%
Q1 2023 to Q1 2024 +3.0%
Q1 2024 to Q1 2025 +3.0%

 

We may see more issues around workmanship as contractors try to fill vacancies with the available labour pool. They may not be able to employ labour as skilled and experienced as they would like, and this may have an impact on the quality of workmanship.

Covid-19

Covid-19 presented us with many challenges in 2020 and these continue into 2021 and will stay with us for quite some time. Not only do the contractors have to deal with staff sickness and the needs of some staff to self-isolate, they also have to manage customer expectations and work around sickness and vulnerability issues that some customers have. Project management will be challenging until well into 2022 as we continue to manage the fall-out of a global pandemic.

Contractors have also had to put Covid-19 secure safe working practices in place. They have had to provide PPE for staff and ensure social distancing on site, all of which adds time and cost on to property claims.

The latest Covid-19 lockdown has not had as large an impact on our contractors as the first lockdown. Contractors and most customers have learned how to live with Covid-19, and as the UK government was clear about the construction industry remaining open this time, customers have been more willing to accept contractors into their homes.

However, Covid-19 has increased costs significantly. Not only have contractors had to pay for lots of PPE they are finding that their businesses are much less efficient due to the Covid-19 secure ways of working. As fewer staff are allowed on site the time to complete projects is extended. Managing staff work rotas has been difficult and sometimes there have been delays as tasks have had to be done sequentially when they could normally have been done in parallel (when social distancing was not an issue).

We have found that most customers have been understanding of the challenges that our contractors face when it comes to Covid-19 and we have not seen an increase in complaints as a result of Covid-19 induced delays. Communication with customers has been important and many have been appreciative of the efforts made to keep customers safe, as well as the contractors’ staff.

Material costs have increased significantly as a result of Covid-19 largely as a result of shipping costs. Towards the end of 2020 the disruption caused by Covid-19 meant that empty shipping containers were in the wrong places which created capacity issues in shipping that will take months to resolve. The cost of shipping goods from China to Europe has hit record highs in recent weeks, with producers unable to absorb the huge price increases they have passed the costs onto importers. Building material supplier Timco has said its shipping costs have increased by 300% which is pushing up prices to their customers by between 3% and 17% for things like screws and fixings etc.

Reverse Charge VAT

From 1st March 2021 the VAT regulations for contractors registered in the Construction Industry Scheme (CIS) are changing. In summary, main contractors (such as MA Group) will stop paying VAT to subcontractors working on projects where the CIS applies. Instead, the main contractor will pay the VAT directly to HMRC. Where a contractor is invoicing an end user, such as an insurer or homeowner, Reverse Charge VAT rules do not apply.

This new rule has a serious impact on cashflow for subcontractors in two ways:

So just as contractors are having to deal with the impact of Brexit and Covid-19, they must now also deal with the cashflow impact of Reverse Charge VAT at the same time as government financial support is withdrawn. Like most businesses, contractors have delayed paying their spring 2020 VAT bills and their July income tax bills until April 2021, which will create a significant cash outflow just as the new VAT rules come into play.

Where a contractor makes a sale to an organisation that isn’t VAT registered or is an “end user” (an organisation that does not make onward sales of activities covered by CIS) then the Reverse Charge VAT rules do not apply. As insurers are an “end user” and are not VAT registered the price they pay for construction works will not change and VAT will still be charged at 20%.

Insurers are not affected directly by these new VAT regulations, but they will be impacted indirectly by contractors struggling financially and the timely payment of construction invoices will be more important than ever.

Spare a thought

It isn’t possible to clearly differentiate between the extra time and costs caused by Brexit and Covid-19 – both challenges have arisen at the same time and have created similar problems. The Reverse Charge VAT rules will exacerbate the problems for contractors, creating a perfect storm that will push some contractors into insolvency.

We mentioned the high rates of insolvency for the construction industry above. According to the Insolvency Service’s Quarterly Company Insolvency Statistics, insolvencies were significantly down in 2020 compared to 2019. This is mainly due to the huge levels of financial support that the UK government gave to all businesses in 2020 – furlough schemes, business grants, rates relief, CBILS loans and bounce back loans will have kept many businesses alive. As these financial support schemes start to unravel in 2021 and the impact of Reverse Charge VAT is felt, construction industry insolvencies will increase dramatically.

A recent Office for National Statistics (ONS) survey of 3,568 construction firms has confirmed what we fear – increasing pressure on construction firms from price rises for materials, labour shortages and lower productivity due to social distancing. One in eight construction firms have low or no confidence that they will survive until the end of April.

Impact on insurers

The increase in time and costs means that all parties should seek to identify, allocate and (where appropriate) share the risk of uncertain adverse consequences arising from Brexit and Covid-19. MA Group and its suppliers are grateful for the support shown by clients so far, but these issues will impact time and cost for months, if not years, to come. Indemnity spend will continue to increase and claim durations will remain longer than average for the rest of 2021.

Delays will lead to increased alternative accommodation costs and complaints, and insurers will need to accept that this is inevitable in such challenging times.

There are also some specific outcomes and considerations that insurers need to understand and act on:

Keeping calm and carrying on

We are very pleased with how our building contractors have continued to work in these difficult times. They are following the government’s guidelines and are continuing to deliver for our clients and customers. They have continued to adapt, innovate and work tirelessly to keep up with the changing demands that Covid-19 and Brexit have placed on us. And we are sure that, with our support and the support of our clients, the vast majority will continue to adapt, innovate and work tirelessly through the challenges that Reverse Charge VAT will create.

Throughout 2020 we have supported our suppliers by maintaining weekly payments on time, as scheduled, and worked with our clients to maintain the levels of invoicing required to keep the cash flowing. We have also been able to track and identify customer vulnerabilities so we can respect and manage customer and client expectations, and to redirect capacity to alternative claims and projects (such as vacant properties and homes where safe working can be carried out with PPE and social distancing). We will continue to do this throughout 2021 and beyond.

We are also helping to manage customer expectations around material supplies and the capacity challenges that will continue as a result of Brexit, and we hope that our clients will understand these challenges and support MA Group and its contractors as well. And as the impact of Reverse Charge VAT is felt we hope that our clients will spare a thought for builders and all of the issues they face and will work with us to keep the cash flowing.

But credit really has to go to the building contractors who have kept going throughout all of the challenges they have faced. In November the Business Secretary, Alok Sharma, published an open letter paying tribute to the construction industry for performing a vital role for the UK during 2020. He said:

“Whether working on large or small construction sites, in peoples’ homes across the country, in builders’ merchants, designing and project managing schemes or producing construction and mineral products, you are making an invaluable contribution in supporting the economy.”

The construction industry accounts for 6% of UK GDP and over 7% of UK jobs. The property claims industry needs to recognise the contribution that building contractors make to the property insurance industry and the wider economy – help us to support them please.

Conclusion

The construction industry has dealt with many challenges over many decades and will adapt to these most recent challenges. But they will not adapt over-night and there will be a period of “creative destruction” as economists like to call it. Here at MA Group we have strong processes and management tools in place to quickly identify poor financial and operational performance issues within our supply chains, so we can provide immediate support when needed or assign new builders should the worst happen.

Please get in touch to find out how MA Group can work with you to support building contractors and deliver for your customers during this difficult time for builders.