Current cost estimates key to manage lumber’s ‘demand surge’

August 30, 2021 / 5 min read

When will the price of lumber return to stability after more than a year of record volatility? That’s the question on the minds of property insurance underwriters, who rely on current costs to write policies.

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The historic spike in lumber brought on by the COVID-19 pandemic echoes other “demand surge” increases for commodities that typically follow catastrophic events, such as hurricanes, earthquakes, tsunamis, and wildfire.

Lumber has been the driver behind recent jumps in overall reconstruction costs—with prices for the commodity rising by 30 percent to 40 percent per quarter starting in fall 2020, with a peak spike of 162.7 percent between July 2020 and July 2021. Even as lumber futures have fallen since this past spring, the prices paid by contractors, builders, and homeowners remained at record highs in the first half of 2021. Recent price moderation shows that lumber supply may at last be starting to meet continued strong demand.

Underwriters coping with the pandemic’s disruptions have a quandary as they factor in lumber prices. Should they write policies based on today’s shifting yet still comparatively hefty lumber prices to support appropriate premiums and provide adequate coverage? Or, should they hold the line on rate increases, but risk paying more than expected on claims if prices fail to fall as rapidly as they rose?

The historic nature of ‘demand surge’

Past surges that followed catastrophes may provide some lessons for the future of lumber. The lengthy and countrywide spike in lumber prices that has occurred since the pandemic began differs from the shorter term, regional effects on commodity prices that typically accompany natural disasters. Still, we can gain insights from prior demand-surge events.

When we sought to compare the current demand surge for lumber to past post-catastrophe spikes, an event that produced somewhat similar effects was Hurricane Ike. Ike caused widespread damage and destruction along the upper Texas and southwest Louisiana coasts after it made landfall in Galveston, Texas, on September 13, 2008.¹ In the wake of Ike, fuel costs soared in a classic demand-surge pattern that shows a bump followed by a fall—but not before the ramifications spread to the building industry because fuel is a major component of composite shingles. The price of shingles spiked at the same time as fuel—rising 24 percent between July and October 2008—but even as fuel fell, the price of composite shingles remained steady. The persistent elevation of lumber prices over the past year recalls this prior scenario, and it remains to be seen whether the long-awaited moderating pattern will continue or stall.

Pandemic hits lumber industry hard

The COVID-19 pandemic affected most building materials and related labor but hit lumber particularly hard, beginning with a 60 percent jump in costs between October 2019 and October 2020. Lumber was uniquely vulnerable to price swings due to a series of blows to the industry over recent years.

For example, when the pandemic hit, the lumber industry still had not fully recovered from the Great Recession of 2008-2009, when the bust in the housing market shuttered numerous sawmills for good. Moreover, tariffs on Canadian lumber that began in 2017 still had not yet been lowered, reducing availability of the commodity in the United States. Additionally, in the first months of the economic downturn that swiftly followed stay-at-home orders in spring 2020, lumber mills reduced their output, assuming that demand would fall with the economy stalling.² However, demand for lumber surged thanks to a combination of low interest rates, a resurgent homebuying market, and a renewed zeal for renovations triggered by millions of former office denizens working remotely.

Lumber prices rose 110 percent year-over-year through August 2021. Earlier this year, prices rose more than 80 percent from April 2020 to April 2021. Lumber prices are largely behind the swell in replacement costs overall, which have risen about 14 percent over the past year. By comparison, Hurricane Ike, another demand-surge trigger event, boosted reconstruction costs by 5.3 percent between July and October 2008.

Demand_Surge_Chart_1

The rising price of lumber has added nearly $30,000 to the average price of a new single-family home.³ In general, for the typical home, Verisk research shows that lumber costs could total between 15 percent to 25 percent of reconstruction costs.

In 2021, sawmills have slowly been ramping back up to pre-pandemic levels. Prices in the first half of the year at the retail level remained at historic highs even as futures of the commodity showed significant easing because a lot of the inventory in the pipeline was purchased at record-high prices.

Understanding lumber’s outsized impact

Examining the factors driving the volatility of lumber is critical to understanding how reconstruction cost estimates are derived, as the commodity has played a substantial role in pushing overall costs higher over the past year. Calculating an accurate replacement cost estimate starts with on-the-ground data about prices paid in real-world claims. 360Value reconstruction cost estimates are compiled through extensive research, direct data feeds, claims analyses, and communication with 92,000 claims and building contractors.

When we examined claims data, we saw an increase in spending and use of the top 100 items, though lumber was an outlier that pushed overall costs upward. The most frequently used items in claims for labor and materials included hauling debris, roofing, paint, and cleaning. Costs were dominated by roofing, gutters, siding, and paint.

Demand_Surge_Chart_2

Insurers need current data to help assess exposure

Amid the ongoing demand surge, insurers need detailed and current information to help accurately price policies to support insurance-to-value and protect policyholders. Calculating replacement cost estimates in a volatile market requires the most up-to-date costs for labor and materials, down to the itemized components, including lumber.

Verisk updates reconstruction costs, which are based on claims, on a monthly basis, to support providing reliable and timely pricing information. With frequently updated component-level pricing, insurers can obtain granular, address-specific replacement cost estimates, enabling them determine premiums appropriate to the risk and protect policyholders in the event of a total loss.

Stay up-to-date on the latest reconstruction cost trends by signing up for 360Value Quarterly Cost Updates.

National Hurricane Center, “Tropical Cyclone Report: Hurricane Ike,” January 2009, https://www.nhc.noaa.gov/data/tcr/AL092008_Ike.pdf
NBC News, “How the lumber industry misread Covid and ended up with a global shortage and sky-high prices,” June 28, 2021, https://www.nbcnews.com/business/economy/how-lumber-industry-misread-covid-ended-global-shortage-sky-high-n1272542
National Association of Home Builders, “Led by OSB, Lumber Products Now Add Nearly $30K to the Price of a New Home, $92 to Rent,” July 19, 2021, https://nahbnow.com/2021/07/led-by-osb-lumber-products-now-add-nearly-30k-to-the-price-of-a-new-home-92-to-rent