Construction PI - Bricking it

The construction industry was one of the first sectors to experience tough times and many architects, surveyors, engineers and contractors will now be reviewing their costs more carefully than ever. Yet, just as cash flow is becoming a more urgently pressing concern, professional indemnity - a business essential - looks set to become more expensive.

Clients have benefited from a soft market in which premiums have been stable for years and many now believe that the status quo is on the verge of considerable change. Andrew Fryer, director of Finex at Willis, observes: "The credit crunch has had a severe impact on the UK construction industry. Construction firms' turnovers have been hit hard and, if the insurance market hardens, the construction industry will suffer a double hit with income reducing and premiums rising."

Fryer is not alone in foreseeing turbulent times ahead. "This year is going to be very different from previous years," comments David Harries, head of PI at QBE: "It's the first time in a long time that insurers have wanted to achieve rate increases and this will cause friction when they can least afford it. Previous rate reductions have meant lower profits though and risk is now increasing, so they have to take action."

Complex

There are other serious repercussions. "The UK construction industry is facing a three-pronged problem," explains Fryer. "It is not just dealing with significantly reducing income and the potential of a hardening insurance market but also an increase in claims."

This combination of woes is not expected to be a short-term problem and Fryer does not envisage light at the end of the tunnel for some time: "Even though the government has announced a public works programme, this will have a long lead time. The UK construction industry is battening down the hatches."

In the meantime, it is still possible to grab a good insurance deal, according to Chris Allen, head of PI practice at HSBC Insurance Brokers: "For the right risk, there is plenty of appetite from insurers and so there is an opportunity for architects, engineers and contractors to obtain competitive rates if they shop around.

"This isn't the case for everyone, though. For instance, if more than 10% of a surveyor's work is surveying and valuing then the market is restricted and rates increase by between 25 and 200%."

This increase in price can make a substantial difference, especially to smaller surveying firms as Marcus Elwes, consultant at Miller Insurance, points out: "The inflated cost could put some out of business. Others will struggle to take out PI at all, especially if they have claims against them."

Fryer agrees that surveyors were the first to be hit: "The market is hardening sharply for surveyors' PI as insurers attempt to reduce their exposures to the property market by pulling out of insurance for commercial and residential valuation.

"After the last property crash, there was a high rate of negligence claims against surveyors and insurers are wary of this, despite surveyors having more risk management in place since then. Contractors with international contracts are more insulated because they are often in regions such as the Middle East and Asia that have not yet been as badly hit by the credit crunch as the UK. This may simply be a timing issue, though."

Despite initial signs, Fryer believes that full market hardening might take a little longer: "We're not quite in a hard market yet for construction PI, although it has begun to some extent. At the 1 January renewals, rates were flat with a slight upward movement. Also, new insurers have been entering the market, therefore capacity is not reducing."

Putting a timescale on it, he concludes: "We think there will be a hard market in 2010-2011."

Other industry professionals agree that it lies some way in the distance, as Simon Brookes, executive director of the professional risks practice at Heath Lambert, comments: "Twelve months or so ago it was usual to see 10% discounts but what we're seeing in the market at the moment is that most insurers are holding their rates. It is too early to tell but we expect to see some changes by the third quarter of this year. There is potentially a lot of change coming in this sector of the market."

Claims

It seems that no business within the construction industry will emerge unscathed from an increase in claims. Brady points out: "More claims will be brought as people look for others to blame for loss, even if their claims are fruitless."

It is not yet clear how serious the wave of claims could be but, as Fryer points out, they are already growing: "The PI claims environment has been benign since 2000 but this started to change in 2007 with big claims - such as the late completion of Wembley Stadium - hitting the market.

"Also, in commercial and residential valuations, the market is already seeing a growing number of fraud-related claims; insurance market capacity on valuation activities has shrunk significantly over the last 12 months."

Harries explains that, as claims increase, mistakes and shortcuts taken in the past will come to light: "The downturn will reveal previous bad practice. To quote Warren Buffet, 'Only when the tide goes out do you discover who's been swimming naked.'"

Harries also believes that construction will not be the hardest hit sector when it comes to increased PI premiums: "Some other sectors, such as law firms, will see bigger increases because of the correlation between the downturn and the claims made against them as a result, for example in conveyancing."

The increase in claims is gaining momentum and Roger Flaxman of Flaxman Partners estimates that it will escalate by the summer: "After June of this year, we will see a big increase in claims, which I believe will last for two to three years.

"In the last 10 years, claims have been comparatively fewer than those following the previous recession and there has been less imperative to increase premiums. Yet, now that there is fear of a claims tsunami, insurers are desperate to put up their prices."

Jonathan Swann, director at CFC Underwriting, agrees: "At the moment for engineers, everyone is in denial and rates are static. No one is making a big enough loss yet and if someone ups their rates now then they may lose business. However, something will happen to trigger things off and rates will go up. The fallout from events in the banking sector may be the cause in the long run. Surveyors' PI is now increasing significantly."

Together

The combination of less work, less income, greater expense and more claims affecting the construction industry could result in a shrinking market; the consequences could then have a considerable effect on insurers' and brokers' own businesses.

Despite anticipation of tougher times ahead, brokers and insurers are rising to the challenge: "Due to the changing circumstances, we are having a far more engaged debate about renewals with our clients in this sector," says Andrew Wallin, director at Oxygen.

"Now more than ever, there has to be a team approach among client, insurer and broker," he asserts."We are just as necessary as other professional advisers such as solicitors, bankers or accountants to help our clients find a solution to the needs of their businesses."

Harries agrees that a team approach can be constructive: "Our advice to brokers is to put the client in front of the underwriters so that they can talk through their risk management processes; brokers should give them the opportunity to show us how they are going to mitigate risk."

Thorough preparation also maintains its place at the top of the agenda. Gail Cook, professional and financial lines manager at Zurich, highlights: "Our advice to clients is that they should keep records of all phone calls, ensure that contracts are clear, provide robust evidence, keep well-documented records and have a strong risk management structure in place."

Attitude counts too, as Stubbs remarks: "In our experience, a hard market brings out the best in good insurance brokers."