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UK Construction Professional Indemnity (PI) Market update

Claims|Insurance Consulting and Technology
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March 7, 2019

The UK construction PI market has deteriorated significantly over the last 12 months, and it continues to do so at pace. Underwriting construction PI, especially in relation to ‘design & construct’ contractors, has proved far from profitable for many insurers.

Abundant capacity and the resultant competition led to a sustained period of benign market conditions in recent years. That capacity is now rapidly diminishing. The last two years have seen various insurers pull out of the UK PI market entirely, and several others have ceased underwriting construction PI. A recent Lloyd’s crackdown targeted loss-making syndicates, culminating in Lloyd’s restricting how much PI business syndicates are permitted to underwrite (no syndicate has been allowed to increase the amount of PI premium they underwrite in 2019).

As a result, those insurers still active in the construction sector are typically looking to limit their exposures by reducing capacity, increasing premium rates, challenging low excess levels, and enforcing coverage restrictions. 

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What has caused the deteriorating construction PI market?

Claims Activity: There has been a noticeable increase in construction PI claims activity in the UK and globally over recent years, particularly relating to large infrastructure projects and renewable technologies (especially in the ‘Waste to Energy’ sector).  The scope for costly disputes continues to g as major construction projects become ever more expensive and complex, and an increasingly globalised landscape often adds further complexity to projects and any ensuing claims. Lengthy disputes (synonymous with PI) and loss cost inflation exacerbate insurer’s pain (the value of claim settlements and associated defence costs incurred has certainly trended upwards).  Just ‘being at the scene’ is frequently enough for construction insureds to get drawn into project disputes.

Financial viability and supply chain resilience: Carillion’s demise fuelled pre-existing concerns amongst insurers about financial viability and supply chain resilience. PI insurers are wary of an economic climate where margins are so thin, and the political climate which remains so uncertain. Vicarious liability is a growing concern, as insurers’ ability to make recoveries from the parties at fault seems ever more challenging.  Vicarious exposures are increasingly significant given the popularity of ‘design and build’ procurement, and supply chains are frequently long and complex.  In a landscape ripe for insolvencies, insurers can end up effectively insuring un-known entities over whom they have no control.

Tough contracting environment:  Hugely competitive procurement processes have resulted in a race to the bottom in terms of margins, and the prevalence of fixed cost contracts drives relentless ‘value engineering’.  Onerous contractual obligations are often forced all the way down supply chains, transferring more risk away from employers than is perhaps reasonable.  PI insurers could be forgiven for being nervous about the potential consequences.

Concerns about ‘cladding’/fire safety: The Grenfell Tower tragedy highlighted issues surrounding cladding and fire safety in general, and numerous claims notifications have already been made. In spite of recent legislative changes, PI insurers are understandably nervous about such claims, and the perceived inadequacy of building regulations, given the legacy exposures still faced. 

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How has the PI market reacted?

PI insurers are becoming increasingly selective about the risks they underwrite in the construction sector. Stricter underwriting discipline and resolve is evident, and insurers are no longer chasing premium income, content to turn down risks they might previously have underwritten. 

More information required: insurers are demanding more in-depth information in the run-up to renewals, adding to the time it takes to provide formal terms and place a policy. 

Capacity restrictions: insurers are restricting the capacity they deploy on many construction PI placements.  Subscription placements (common-place in the Lloyd’s market) are increasingly necessary, even for smaller risks, and ‘differential placement’ is being more widely used to get difficult risks over the line.  Capacity reductions mean that placing high limits of indemnity can be extremely challenging, and if capacity is available, it now tends to come at a greater cost.  Some insurers have stopped underwriting ‘excess layer’ PI, deeming it unsustainably cheap. Claims experience suggests that excess layers, especially at low attachment points, are ‘working’ layers, far from immune to claims. 

Limit of indemnity restrictions: It is important to bear in mind that the extent of policy coverage does tend to differ markedly between contractors and professional consultants.  Generally speaking, insurers are still providing ‘Any One Claim’ cover for consultants, especially when they are required to carry such cover by their respective associations.  The same is not the case for contractors, where aggregate limits of indemnity are increasingly becoming the norm. Insurer’s appetite to provide reinstatements of aggregate limits is generally diminishing, especially for unlimited reinstatements. When insurers are prepared to provide reinstatements, particularly multiple reinstatements, they are increasingly likely to insist that an insured buys a higher ‘tower’ of cover (so that there is more cover above to be eroded before any reinstatement is triggered). 

Policy coverage restrictions: insurers are frequently looking to limit their exposure by restricting the scope of policy coverage, and some extensions of coverage are certainly proving harder to obtain. ‘Cladding’ and fire safety restrictions have become increasingly standard, typically limiting cover to a single aggregate amount, imposing a higher self-insured excess, limiting cover to a rectification-only basis (so excluding consequential and economic losses), and weakening insuring clauses to a negligence-basis only (if that is not already the basis of cover). 

Cyber liability exclusions have also started creeping in to guard against silent cyber exposure which insurers feel should be picked up by a stand-alone cyber liability policy. 

Attention on self-insured excesses: There is heightened focus on levels of self-insured excess, with seemingly widespread concerns that excess levels have escaped appropriate increases over the years.  For contractors particularly, self-insured excesses are frequently made applicable to defence costs (if they weren’t already), and defence costs are included within the overall limit of indemnity.

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What can be done to mitigate the impact on your PI placement?

Engage and address specific concerns: Early engagement with the renewal process is critical.  Meeting your insurers can pay dividends, enhancing relationships and allowing underwriters to see beyond the paperwork and get a feel for the culture of a business. You should work with your broker to pre-empt the inevitable PI market concerns, formulating risk-focussed narratives where necessary to compliment the more standard renewal documentation. Given insurer concerns about the economic climate, highlighting comparatively healthy profit margins is appropriate. Such margins would no doubt be viewed as a positive by insurers who will be concerned about the prospect of insured’s cutting corners on projects to boost their margins.

Highlight risk management processes: Providing evidence of entrenched and effective internal processes and risk management systems is expected and vital.

Highlight supply chain management processes: Emphasising robust supply chain management should serve to mitigate insurer concerns about supply chain frailties.  Provide evidence to insurers of your positive relationships with an established supply chain. Engage on back-to-back terms with sub-contractors and aim to pass down liability evenly, ideally ensuring that their liability is not limited to a lower level than your own.  Highlighting appropriate and extensive due diligence on your supply chain will be viewed positively.  Indeed, emphasising due diligence undertaken on projects you are tendering for, and due diligence undertaken on prospective employers (to identify possible funding issues) could be useful too.

Highlight contractual risk management processes: Evidencing effective contractual risk management to insurers is crucial, and of course the benefits of appropriate contractual protections will not be limited to facilitating cheaper PI premiums. Highlighting effective use of liability caps (for example) should be looked upon favourably, and will demonstrate a good risk management ethos even if ultimately such caps don’t stand up. This might also enable your broker to derive additional value, especially on excess layers.  Being able to demonstrate use of ‘Net Contribution Clauses’ (which aim to restrict your liability to the proportion of loss for which you are responsible) could prove invaluable, though no doubt client resistance to such will be met. 

Consider how much / what basis of PI cover you need: When agreeing to maintain PI cover contractually, don’t agree to buy unnecessarily large amounts of cover, and ensure that your obligation to maintain such cover is dependent on it being available at commercially reasonable rates (and that the cover only needs to be on commercially reasonable terms). Where obtaining sufficient cover (or cover on an appropriate basis) is problematic, you need to give ammunition to your broker so that they can attempt to tailor a bespoke programme accordingly.  Innovative placement structures can sometimes provide the cover required if at first it does not seem available, or it is prohibitively expensive.  You need to engage a broker capable of thinking around problems, and delivering solutions.

This is by no means an exhaustive list of considerations, but should provide some food for thought.

Conclusion

The PI market is cyclical, so softer conditions will return. That said, sources suggest that several years of sustained premium rate increases might well be necessary to mitigate recent loss experience and restore profitability. Whilst the current climate is undeniably challenging for all parties, heightened focus on risk management processes and associated strategy should serve firms well going forward, both in hard and soft PI market conditions.

Author

Associate Director - Global FINEX

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