Risk management in today's market

Construction professionals across the board have seen their professional indemnity premiums rocket on renewal this year and it seems the pattern will be repeated again next year. In "Building" on 2 May 2003, Rudy Klein (Chief Executive of the Specialist Engineering Contractors Group) commented that: "the tactics of insurance companies are the most extreme form of commercial bullying. Just days before firms are about to renew their cover, they are told of massive hikes in their premium. It makes no difference if they have traded for years without making a single claim."

While, no doubt, this will strike a familiar chord with many seeking to renew their professional indemnity cover, it is incorrect to categorise the premium increases being experienced as "commercial bullying". Quite simply, the increase in premium merely reflects the commercial realities of the current UK insurance market.

Professional indemnity insurance brokers will explain, quite rightly, the fact of rising premiums (with corresponding increases in the deductibles that insureds are forced to bear) on the "hard" market. But what does this mean and what is its cause?

The hardening of the market (traditionally cyclical in nature) over the last 18 - 24 months is due essentially to four factors:

• Underwriting performance
• Poor investment performance
• Reduction in the number of professional indemnity insurance providers
• The effect of September 11

Previously in "soft" market conditions, premiums have been under-priced. Over the last 5 years, professional indemnity underwriters have reported average loss ratios (a measure of underwriting performance) in the region of 153%. This translates into underwriting losses of millions against a backdrop of poor and unpredictable equity market performance and diminishing investment returns which had been relied on in the past to offset those losses. Consequently, the market is now focussing on making a profit by achieving underwriting profitability, reducing claim costs and ignoring potential investment profit.

The professional indemnity market has also contracted significantly over the last 2 years meaning fewer insurers are providing this type of cover. There have been three main reasons for this:

• The collapse of some of the significant professional indemnity insurers including The Independent Insurance Company, HIH and Reliance, whose very presence, it is said by some, led to artificially low premium rates.
• Mergers of providers: Norwich Union, Commercial Union and General Accident now form CGNU and Royal Insurance and Sun Alliance have merged to form Royal Sun Alliance.
• Some professional indemnity insurers have simply chosen to withdraw from the market completely having suffered disappointing returns.

September 11 had an enormous effect on global markets, particularly the insurance market that is estimated to have lost US$75 billion in one day, representing a significant chunk of the global insurance market.

So what does the future hold for the professional indemnity market and its insureds? Professional indemnity cover is being left in many instances to smaller specialist Lloyds' syndicates to write and they need to get it right. Those insurers make no apology for the increase in premiums; the fact that they are still in the market at all providing this type of cover is, in their view, sufficient justification. High premiums will be a fact of life for construction professionals at least in the short term. But can anything be done to mitigate a continuing rise in premiums? One professional indemnity underwriter recently expressed the view that an insured's long term aim must be to improve its loss record. One way to achieve this is to spend more time and money on risk management. In other words, how to avoid getting sued.

There are real opportunities to manage and thus minimise professional indemnity risk before, during and after a construction project. Proactivity in the following areas can bear dividends.

Construction professionals need to spend more time on their terms of appointment. As a guiding principle, professionals should not sign up to something that they are unable to achieve or that they know they in fact have not done. This is particularly relevant when executing appointments during the course of the project or post-completion: professionals should know by this stage whether they have, for example, issued information in accordance with an information release schedule. If not, they should avoid signing up to an obligation to comply with that schedule!

There are a number of points to bear in mind when negotiating contracts: a professional's duty of care is "reasonable skill and care" and woe betide them if they accept any contractual duty in excess of this such as "utmost skill and care", or the "level and skill and care required of an expert". Professional indemnity insurance rarely covers liabilities resulting from any higher duty than that of "reasonable skill and care". Fitness for purpose obligations should also be avoided for the same reason. If a fitness for purpose obligation is assumed, when the finished building is not suitable for its purpose, this will amount to a breach of contract. Contractual guarantees and performance warranties should be approached with similar caution.

In terms of obligations relating to maintenance of professional indemnity insurance, professionals should not commit to providing single project professional indemnity cover. This is very expensive and practically unavailable in the current market. Instead, professionals should endeavour to secure their clients' agreement to their annual policy with its existing limits and deductibles. Furthermore, an obligation to maintain cover should last only as long as such cover is available at commercial rates. Neither should one agree to maintain the same limits and type of cover for 6 or 12 years post-completion.

Other ways in which to restrict liability include excluding liability for consequential losses, avoiding liquidated and ascertained damages or limiting this type of liability to normal compensatory damages, and capping the limit of contractual liability - it is important to realise that limits of indemnity under professional indemnity cover should not be relied on as limits on contractual liabilities. Ideally, proportional liability or net contribution clauses should be incorporated.

Once you have executed a contract, and work has commenced on site, there are still a number of ways in which professionals can protect their position. One guiding rule is that it doesn't matter what a professional has done, it only matters what he can prove he has done. It is important to record in writing, for example, variations of your duties by the client; warnings as to risk which develop during the project; advice on particular points raised by the client, particularly setting out further information required for a definitive opinion to be given; circumstances where the client has requested something which is outside a professional's expertise, and the outcome of discussions at meetings and during telephone calls.

In the event of a claim, all relevant documents on a project except correspondence with lawyers or prepared with litigation in mind will be disclosable. Care in producing and maintaining records of correspondence is not the end of the story; emails, notebooks, daybooks and diaries (where often professionals are less guarded than is prudent) are disclosable.

Having ensured that one's house is in order, files should be retained for a minimum of 6 years after a project has completed or 12 years when the contract is executed as a deed.

So, once professionals are actively practising risk management, how do they communicate this to their professional indemnity insurers?

Take the time to make a convincing submission on renewal of cover. Brokers will be able to assist here. An underwriter's stock in trade is an ability to assess risk. If an activity appears high risk (notwithstanding in reality that that is not the case) prudence dictates that an underwriter will rate it as he perceives it. Only by arming one's broker with information to dispel this perception will that risk be rated realistically.

Underwriters are only human and will inflate the premium if they do not understand the risk. The name of the game is to give them comfort in areas they perceive as high risk.

For further information please contact Rachael Trist at [email protected] or on +44 (0)20 7367 2990