Indemnity Insurance - In the Eye of a 'Credit Crunch' Storm?
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In contrast to the difficulties experienced by many consultants earlier this decade, conditions in the professional indemnity market have been relatively benign over recent years. By and large, Architects have had little difficulty obtaining cover or securing higher indemnity limits and premium rates have shown signs of declining to levels last seen in the late 1990’s. All this seems like good news - certainly in terms of current overheads. At this point in the insurance cycle, the following article questions, should we begin to question whether the current position is sustainable or are we just experiencing a temporary relief brought on by developments in the wider insurance market
In the eye of the storm? In assessing the situation we need to consider both the cyclical nature of the insurance market, and the factors that influence the market cycle, including the risk profile of the construction professions generally. The insurance market essentially revolves around the availability of capital. In 2001 capital was in short supply in response to a crippling combination of inadequate levels of premium, deteriorating claims experience and diminishing investment returns. As a result, insurers became extremely selective in the business they chose to underwrite and, as was the case in previous ‘hard’ insurance markets, construction PI was a major casualty given the volatile nature and potential severity of claims flowing from the risks involved. This reduction in supply led to an increase in premium levels over the period 2001 to 2003, which eventually reached a point where the balance of premium to risk exposure began to look more attractive; at that point, capital moved back in and competition increased, leading to the premium rate reductions that Architects have witnessed over recent years. The important question is where are we now? In less than 24 months, we saw the demise of over 60 insurance companies worldwide during 2001 and 2002. Competition had become unsustainable and insurers were little more than "price takers" focussed on growth in (or retention of) market share rather than long term viability and profitability. When the market turned it was the unsuspecting or uninformed insureds that suffered and nowhere was this more evident than in the construction sector. Major studies into insurance company failure have identified the prime candidates as those which are expanding rapidly, entering new areas without the necessary underwriting knowledge and ceding extreme (very little or large) amounts of risk to reinsurers. Unfortunately, there are now a number of insurers who seem to fit this description and, with profit margins tight, there is little room for error. It has become clear recently that certain insurers are operating at an underwriting loss, with reserves from past years masking current year losses. Reserves only last for so long and there is evidence appearing that some insurers are now looking to protect their position by questioning whether individual claims are covered, which raises real concerns. We also have the spectre of the ‘credit crunch’ which is potentially very significant. There has been an understandable focus on the wider economic uncertainty the crunch causes. What has received little coverage thus far is the impact that could flow from the extent of financial exposures it creates to insurers and reinsurers through a combination of increased claims, an erosion of balance sheet strength and reduced investment income. Unfortunately, it is also difficult to argue that any sizeable element of the premium reductions seen over recent years has been due to a significant improvement in the risk profile of construction professionals. Consultants are involved in increasingly complex projects in an industry that has looked to build bigger, higher and faster than ever before. A number of high-value, high profile claims that are being pursued have been widely reported in the construction press. At the same time, there has been heightened fee competition in certain quarters and pressure for increasingly onerous contract conditions that only serve to reinforce the adversarial relationships that have traditionally been so damaging to consultants and the construction industry as a whole. As a result of such factors, it is difficult to see why construction consultants will be viewed any differently by insurers in the next hard market. There is therefore a strong incentive for individual consultants to commit to a risk management culture and it is here where informed professional indemnity insurance brokers can offer assistance. In considering professional liability exposure there are three important steps; acknowledging the risks that exist, managing them effectively and funding them appropriately. Risk funding is most likely to be established through premium contributions but in an uncertain economic climate it is perhaps understandable that premiums may simply be regarded as yet another cost that needs to be controlled. The truth however is that any significant saving in cost at this point is likely to come at a price - the potential for difficulties after claims are notified leaving a practice potentially exposed to uninsured liabilities. The implications of this are potentially more acute should we face a reduction in activity in the construction sector. Historically, this has been the point in the economic cycle when claims numbers have increased; we need only look to the UK in the early 1990’s or Hong Kong in the latter part of that decade. Despite all of this many within both the consultancy sector and the insurance industry are seemingly unaware, unconcerned or in denial of the longer term implications and the need for effective risk management. As a result, consultants need to carefully consider what they ultimately want from their indemnity insurance. If security and sustainability are key factors then they need to start asking more questions of those responsible for their arrangements: • What is their broker doing now that will ensure a different outcome to that in 2001? • Does the broker have a thorough understanding of their business and what time has been devoted to risk management? • What is being said about current market conditions, the durability of insurers and the sustainability of the arrangements? • What do they know about your current insurer, their background, and their attitude to claims handling? • How does the policy wording compare to the liabilities consultants are being required to accept under contract? The unfortunate truth however is that the market will change, there will be uninsured claims and premiums increases, there may even be insurer failures; the only uncertainty is when and with the full impact of the current ‘credit crunch’ still to unfold the time to prepare is now. Griffiths & Armour Professional Risks Ltd is an appointed representative of Griffiths & Armour which is authorised and regulated by the Financial Services Authority.
Paul Berg Griffiths & Armour marketing@griffithsandarmour.com Professional Indemnity Insurance Construction Insurance http://www.griffithsandarmour.com
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