This question is often asked by many business owners. Whether it's in a pub or on a conference this topic of conversation occurs regularly. The rising cost and new restrictions of professional indemnity (PI) are widely discussed by businesses, regulators, and insurance providers. Over the last couple of years, we have seen a significant shift in insurers' approaches, and this has affected most, if not all, firms in the construction industry and beyond.
The simple answer is each firm represents a different level of risk and no two of them are exactly alike.
Influencing factors
Underwriters would use many factors whilst rating a risk. These would include the size of a business measured by the gross fee income or turnover depending on a trade. Established businesses would be rated on income for the last completed financial year, whereas newly established firms would need to declare their estimated fees.
Activities play a significant role in the process. For example, constructing a building from a design provided by an architect appointed by the end client would represent lower risk than if the firm constructs from their own design, or one prepared on their behalf. In the first scenario the third-party architect would carry responsibility for any errors that may have been made. An underwriter would apply a discount or heavier rate depending on the potential risk represented by each activity. The base rate would depend on the insurers' own history of dealing with a particular type of claim as well as wider market experience.
Types of clients/contracts are also very relevant. Participation in a small domestic project is vastly different to participating in the construction of a multistorey apartment block abroad. The consequences of a potential error would be much more significant in the latter. We need to consider what damage could one small mistake generate, and this should include any possible consequential losses.
Involvement with basements, swimming pools and high-rise buildings do represent much higher risk and the appetite for firms with this type of exposure is currently very limited in the market. The majority of insurers would apply a wide exclusion for this type of work; however, a handful of providers may be able to offer a limited coverage at a premium which would, in their opinion, justify taking on the risk of having to deal with a claim arising out of such a project.
The underwriting approaches
In recent years it has become more common for companies to accept aggregated cover as often any one claim basis is either costly or not available. Companies have become more inclined to accept higher excesses to reduce the cost. Aggregate cover policies are of course less favourable as the maximum payable in a policy period will be equal to the limit of indemnity, regardless of the number of claims. This could lead to firms potentially having to cover the cost of claims from their own resources, should the limit be exceeded.
PI insurance is written on a claims made basis and therefore, in the event of a claim, the policy in place at the time will be providing coverage. It is worth considering what contractual obligations a firm holds. Its past exposure must be factored in during the underwriting process. Younger firms will carry less liability and therefore their premiums are quite often lower.
We know that collateral warranties tie in firms to 12 years of liability, however there could be some circumstances in which this is extended. For instance, the agreement could contain a reassignment clause where the liability starts again at a point of resale or first two resales of a property. It is also not uncommon for a judge to disregard the initial agreement and decide what the fair liability period is, based on claim merits.
This is not an exhaustive list of factors used whilst reviewing an insurance application. Businesses which appear to be similar and may, at the face of it, attract similar premiums can in fact have very different risk profiles, and carry various levels of exposure which will be reflected in the premium charged for their PI.
At Lockton we are experts in providing PI cover for a wide range of businesses, from sole traders to large enterprises and we will be happy to discuss your requirements.