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UK construction Professional Indemnity insurance (PI) update

Risk & Analytics|Financial, Executive and Professional Risks (FINEX)
COVID 19 Coronavirus

By Peter London | June 4, 2020

This UK construction PI market update briefly considers the cause of the tough market conditions and details our observations of the market’s reactions.

Current climate

UK PI market conditions have deteriorated rapidly since late 2018, especially in the construction sector, and the deterioration looks set to continue. Whilst the impact of market conditions has been toughest on contractors, consultants have suffered too.

It is still too early to understand the likely extent of the impact of the COVID-19 pandemic on the UK insurance market, and on the UK PI market more specifically. However, reference to what could potentially be ‘the biggest insured loss in history’ suggests that the effects will undoubtedly filter through to impact PI market conditions.

What has caused current construction UK PI market conditions?

Ultimately, underwriting UK construction PI in recent years has not proved profitable. Premium rates in the protracted soft-market conditions which preceded have been driven unsustainably low as a result of abundant insurer capacity, persistent competition and weak underwriting discipline. Profitability has been eroded further by an increase in the number and the severity of claims, adverse historic claim developments and loss cost inflation. Lloyd’s has led the way in seeking to address profitability concerns, and they continue to scrutinise the performance of syndicates.

Beyond existing claims performance, construction PI insurers have numerous concerns. These include fears about financial viability, which clearly the COVID-19 pandemic will exacerbate. Challenging financial conditions will be conducive to disputes, and wafer-thin margins in the construction sector have resulted in relentless value engineering and cost-cutting. Vicarious liabilities borne of D&B procurement and lengthy supply chains are concerning Insurers, as effecting recoveries from the parties at fault is increasingly challenging and costly. The procurement environment remains extremely tough, with onerous contractual obligations passed down throughout. Insurers also have well-documented concerns about fire safety, and the perceived inadequacy of Building Regulations and testing regimes. Economic and political uncertainty seems conducive to further claims activity, and the impact of the COVID-19 pandemic will be profound to say the least.

What has been the impact on UK construction PI?

More selective underwriting

There is greater scrutiny, and less underwriting flexibility. Many insurers are looking to cut the capacity they deploy and don’t want to increase their overall premium income or market share. The underwriting process seems to be taking considerably longer, with more frequent internal referrals, and more regular and comprehensive requests for information. Underwriters are ensuring they ask the right questions so as not to take on specific exposures, with an eye on the audit trail too. The current pandemic has seen almost all PI insurers start to demand information about insured’s contingency plans, and for comfort about their liquidity.

The market for multi-year 'single project' PI policies has contracted significantly, with many insurers having pulled out completely, and those remaining being far more selective.

Capacity reduction

An estimated USD130m potential capacity has been lost from the UK construction PI market in the last 18 months or so. In conjunction with this, insurers are frequently restricting the capacity they deploy on individual risks, by cutting ‘line’ sizes, meaning more insurers can be needed to build a programme. ‘Subscription’ placements (whereby multiple Insurers share the risk on individual policy layers) are more prevalent.

Capacity restrictions have made completing large placements increasingly challenging, and some larger insured firms are having to accept purchasing lower limits of indemnity than previously. To complicate further, end-of-year placements can prove tough, with some insurers already having deployed all their available capacity before year end. Insurers need to manage their premium income capacity carefully (especially Lloyd’s syndicates with their annually enforced income restrictions), and permitted income budgets are exhausted more quickly when renewal premium rates are increasing.

There have been concerns as to how Managing General Agents (MGA’s) manage capacity on behalf of Insurers. Several Lloyd’s syndicates have removed their backing for MGA’s, and some MGAs have struggled to replace their capacity. Many capital providers to MGAs are enforcing more restrictions on the type of business / professions that they are permitted to underwrite.

Premium rates

Insurer’s PI premium rates have continued to increase, and rates seem to be under constant revision. Increases have been especially pronounced for excess layers, which are widely deemed to have been set at unsustainable levels for many years. Excess layer premium increases regularly seem out of kilter with the primary layers, and 50% to 100% premium rate increases on excess layers have not been unusual.

Some Insurers seem to be focussed on implementing a specific rate increase across their whole books, whereas others seem more focussed on the adequacy of pricing on individual risks. We have noted a lack of consistency between insurers in the pricing of specific risks, which can have a huge bearing on final pricing. That said, regional underwriters seem to be starting to fall into line with London market guidelines.

Differential pricing (utilising different premiums quoted by participating insurers in respect of their participation, as opposed to asking all Insurers to simply agree to a premium set by the lead insurer) has become more prevalent throughout the broking community.

Coverage restrictions

We have noted significant upwards pressure on the levels of self-insured excesses, with material increases enforced on many insureds, whilst others have elected to retain more risk in an effort to mitigate premium increases. Excesses are often made inclusive of defence costs, where previously an excess would only have been payable in respect of damages.

Combustible ‘cladding’ restrictions have become standard on construction PI policies, though these restrictions have become more onerous, and will generally tend also to apply to any situation directly or indirectly connected with ‘fire safety’. Typical coverage restrictions will limit cover to an aggregate amount (including defence costs), will exclude any consequential losses, will weaken the insuring clause to a negligence basis only, and a higher self-insured excess will usually apply (sometime applicable to each and every building or site as opposed to each and every claim, and almost always being on a defence costs-inclusive basis). Full cladding / fire safety exclusions are frequently applied, especially when an Insurer is new to a risk, as they simply don’t want to expose themselves to exposure in this rapidly evolving area.

Underwriting actions to mitigate the extent of COVID-19 seem likely, and some PI insurers have sought to attach onerous COVID-19 exclusions to policies going forward.

Limits of indemnity

The basis of indemnity limit has historically differed between contractors (typically ‘aggregate’ limits, perhaps with reinstatements), and consultants (predominantly ‘Any One Claim’ (AOC) limits). However, AOC cover seems less readily available in the current climate, even for some consultants, as Insurers look to reign in their exposure and guard against multiple losses. Aggregated limits of indemnity with unlimited ‘round the clock’ reinstatements have become more widespread, for many consultants too. Where multiple or unlimited reinstatements are required, Insurers will frequently dictate the minimum ‘tower’ of cover that is purchased (the higher the overall tower purchased, the less likely their limit will be reinstated). The ‘cost’ of additional reinstatements has increased markedly, having essentially been un-costed in softer market conditions. PI Insurers are hugely cautious about offering any / multiple reinstatements for many contractors, especially D&C contractors.

We’ve also noted a tendency for Insurers to include defence costs within the indemnity limit, even on some AOC placements where defence costs were previously afforded in addition to the indemnity limit for damages.

Placement structures

Due consideration to placement structure is critical. Low level excess layers are unattractive to insurers (especially large limits sitting above a low primary limit). Such layers are increasingly seen as ‘working’ layers, given the prevalence of multi-million-pound claims, with defence cost inflation to boot. Premium intake from these still isn’t deemed commensurate with the risk.  This is even more the case on ‘aggregate plus round the clock reinstatement’ placements, where excess layers are even more exposed. Insurers are also paying far more attention to ‘ventilation’ (meaning that they will not subscribe to consecutive layers, especially lower down a placement, so that they have a gap in exposure in the event of a catastrophic claim which could erode a whole placement).

We have also noted an increasing tendency to ‘co-insurance’, whereby insureds ‘co-insure’ part of the risk. This entails taking on a percentage of the risk themselves (on specific layers or throughout the programme), but without utilising a traditional captive. This is sometimes driven by a shortage of capacity, but it can also be part of a deliberate strategy aimed at addressing an insured’s risk and premium tolerances.

Premium settlement

In the current climate, insurers are acutely aware of the potential for businesses to fail, and consequently many insurers are seeking additional comfort when underwriting about the liquidity position of their insureds. They are evidently conscious of the potential for bad debts. We have already noted increasing reluctance from insurers to extend timelines for the payment of premiums, and they are unlikely to be keen to receive payment via instalments. Early consideration should be given as to how premiums will be settled so as not to breach policy payment conditions, and firms will need to bear in mind the additional costs incurred through third party premium financing facilities.

What should Firms do?

Whilst UK construction PI market conditions are extremely challenging, it is possible to mitigate their impact. Being well prepared and well represented is paramount.

It now seems insufficient just to say that firms must engage with their brokers early in the PI renewal process. The landscape continues to change so quickly that frequent engagement with brokers throughout the policy period is a necessity. Given the continually evolving landscape, managing internal expectations will be crucial for those with PI responsibilities. Your broker needs to be your trusted advisor on this front, not afraid to deliver bad news, understanding of what battles can be won, and willing to roll up their sleeves to help you.

In the current climate, you need to ensure that your broker has the operational and technological resource to continue to work effectively, and to be able to represent your firm in the manner that market conditions now demand. Insurer meetings remain vital in the current climate (enhancing relationships and allowing underwriters to see beyond the paperwork and get a feel for the culture of a business). When face-to-face meetings aren’t possible, you need to engage a broker with the ability to chair virtual presentations to the necessary insurers and to the necessary standard.

Such presentations need to be slick, meaningful and appropriate. They must convey appropriate information to compliment the more standard renewal documentation. Addressing the concerns of the PI market is vital, and risk-focussed narratives should highlight entrenched and effective internal processes and all risk management systems (contractual risk management, supply chain management, technical risk management etc). Insurers expect their insureds to have such systems in place – they want to see how the systems work in practice and how they adapt when new risks emerge.

In such a testing climate, creative, strategic broking can really help, and due consideration to programme re-structuring and to additional means of addressing risk retention could make a real difference. Innovative placement structures can sometimes provide the cover required if at first it does not seem available, or if it is prohibitively expensive. Your broker needs to provide you with their plan ‘A’, but also their plan ‘B’ and ‘C’. You need to engage a broker capable of thinking around problems and delivering solutions.

It is beyond the scope of this article but suffice it to say that worsening PI conditions have not been isolated to the UK, and some other geographies (most notably Australia and Canada) are suffering too. Many construction firms will have international offices / projects with their own territory-specific insurance requirements. Willis Towers Watson owns an extensive network of international offices in 140 or so locations. Not all brokers have the benefit of such an extensive ‘in-house’ network of global offices, and they may have to rely on associations with third party insurance brokers (in fewer territories). Having a large ‘in-house’ network can be of significant benefit to Willis Towers Watson clients, as the interests of our overseas offices are more aligned with our own, and consequently the interests of our clients can be better-served.

Author

Associate Director - Global FINEX

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