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Building markets: insurers see China's global construction as a litmus test for a potential professional indemnity market.

The increasingly dominant position of Chinese contractors on the global construction stage has spawned a strong potential market for project professional indemnity insurance especially offered for Chinese contractors aiming for international projects, industry watchers say.

Engineering insurance, such as PI, protects against accidents and natural disasters that occur in the course of engineering construction. In particular, project PI is designed to cover all project participants who have responsibility for professional services rendered in connection with the construction process. This includes contractors and consultants alike, whether working individually or in joint ventures or consortia. The demand for PI is growing as construction project owners often insist a project PI policy is in place, particularly for the larger, prestigious projects.

This growing market is dominated by the rising number of Chinese contractors involved in major projects around the world. China is now the largest overseas contractor in the world after surpassing the United States and France in 2009.

"Chinese contractors used to be focusing on the market in developing countries such as those countries in the Middle East and Africa mainly due to political reasons," said Patrick Zeng, head of the global corporate & specialty division of Allianz China General Insurance. "However, with Chinese contractors growing financially and technically stronger, they enter more developed and mature markets such as North America and Europe. Now Chinese contractors have developed a fairly diversified portfolio covering various countries globally."

Chinese contractors cover a variety of projects, including buildings; roads, railways, bridges, tunnels, jetties and ports; utilities like coal-fired power plants, combined-cycle power plants and hydro power plants; manufacturing facilities like cement, steel, paper and chemical plants; and mining projects like iron ore and copper mines.

Allianz recently joined other overseas insurers in offering PI cover for Chinese contractors. Zeng said their PI insurance products cover national and international professional liability exposure as well as protecting managers and professionals from losses arising out of a breach of their professional duties. He noted that project PI is still considered a new insurance product in China's market. However, its awareness has been gradually promoted in recent years with China's booming local construction industry as well as the globalization of Chinese contractors.

"I am confident that our project PI will become another major line ha financial lines' book. Especially for China, project PI will grow at the similar pace with the growth of Chinese contractors' expansion to overseas markets," Zeng said.

Jay Li, head of Swiss Re's China engineering underwriting, noted the aggressive growth pattern of China's engineering construction market, which is closely related to the engineering insurance market, both in domestic and international markets.

After the 2008 economic crisis, the combination of the Chinese government's 4 trillion yuan (US$654.3 billion) economic stimulus and local government stimulus plans drove an unprecedented scale of infrastructure construction in China. However, investment in Chinese infrastructure development gradually slowed in 2012 as the effects of a weakening global economy set in.

Fast forward to 2013: As China rolled out national and local 12th Five-Year Plans, infrastructure investment was expected to increase again.

"With a renewed focus on high-speed rail and nuclear power projects, along with a huge investment in the tail transport network, 2013 may be the year for returning to natural growth," Li said.

But in today's booming construction market, Li noted, the engineering industry faces both significant challenges and new market opportunities, which means additional and more complicated risks for insurers.

"First, China has attracted significant leading international technology companies through its 'market for technology' strategy. As this leading foreign technology takes root and localizes, there is a risk of technology non-maturity," he said. "Second, infrastructure challenges are especially apparent. As urban and suburban infrastructure has steadily improved in recent years, infrastructure projects have migrated westward into remote, mountainous regions. As they do, complex hydro-geological and terrain conditions pose serious challenges for road, bridge and tunnel engineering design and construction."

And as many Chinese contractors expand their international footprint, their unfamiliarity with local legal environments, cultures, languages, design standards, and hydro-geological conditions also creates significant risk.

"The scant historical hydrological or meteorological data available as projects migrate into outlying regions causes uncertainty in design. Difficulties in making geological surveys of mountainous regions also increase the uncertainty of geological data. These unfamiliar and uncertain elements represent a potential risk to design, leading to further risk for construction organizations," Li said.

In addition to the risks from rapid construction market growth, the engineering insurance market in China faces other challenges. As an emerging market and the world's second-largest economy, China attracts foreign capital and this influx of capital in turn brings an increasing supply of reinsurance capacity, leading to higher direct insurance capacity for insurance companies.

"At the same time, domestic capital favors insurance as a financial platform, so a large amount of capital flows into the insurance industry, resulting in higher domestic insurance capacity. With insurance companies seeking business growth, the engineering insurance market has become intensely competitive," Li noted.

Engineering insurance represents about 5% of non-auto insurance business in China. Despite its relatively low market share, Li said that it has been a market "favorite," due mainly to its association with iconic projects that boost insurance companies' image and branding. In 2011, engineering premiums amounted to 7.38 billion yuan, equivalent to 1.5% of the non-life market total. But during the years 2008 to 2010, the account showed remarkably strong growth of 81.4%, mainly as a result of the 4 trillion yuan government stimulus package that was intended to counter the effects of the global financial crisis.

Once this money had been committed, however, premium growth fell to only 0.2% in 2011. Because of a shortage of new construction work, premiums were said to be almost 20% down on a year-on-year basis in the third quarter of 2012.

And with intense competition and an abundance of treaty reinsurance capacity, Chinese rates are at only 33% to 50% of world levels. A good example of Chinese risk pricing is Shanghai Tower, which will be the second-tallest building in the world when completed later this year. This is charged at less than 50% of the rate for the Burj Khalifa Tower in Dubai, despite the fact that the Shanghai Tower is being built in the much more challenging conditions of a mudflat in a typhoon zone.

Faced with this decline in market conditions and in an effort to curb competition in the market, Chinese regulators introduced a series of guidelines to standardize market competition around the pure risk loss rate and risk unit classification. However, the trend toward aggressive market competition continues, and the market faces significant profitability challenges.

"The general observation is that terms for oversea insurance policies are relatively better for insurance companies than domestic ones," Li said. "However, overseas insurance business doesn't necessarily bring better results as compared with domestic business. This is because the contractors face significant challenges in the overseas markets. And the contractors also face political risks, as well as risks in social stability in those markets. All these challenges bring huge uncertainty to insurance. With more and more Chinese contractors going abroad, it will definitely bring insurers growth in premium but not necessarily in profit."

Key Points

* The Background: China is the largest overseas contractor in the world.

* The Situation: Insurers are offering professional liability insurance to China's construction market.

* Watch For: The Chinese contracting business to face significant challenges in the overseas markets.
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Title Annotation:Property/Casualty
Author:Calucag, Ernesto
Publication:Best's Review
Geographic Code:9CHIN
Date:Feb 1, 2014
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