One of the most significant expenses for any professional business is professional indemnity insurance (PII) and premiums for this essential cover have been increasing significantly in recent times, making an already difficult economic outlook even harder for many firms. This article looks at some of the most prominent factors which will have contributed to this trend.
The insurance market, like any other, is influenced by fundamental economic principles, including that of supply and demand, and this simple equation lies at the heart of the matter.
For decades there has been an ample supply of insurers keen to provide cover to UK professionals, leading to greater competition and reduced premiums. However, these 'soft market' conditions have been firmly supplanted recently by an increasingly 'hard market', driven by a reduction in the supply of PII cover caused by the withdrawal of numerous insurance providers from the sector and a reduction in capacity for many of those which remain.
This is a highly complex and dynamic industry and any one insurer might lose its appetite to underwrite a particular class of business for a variety of reasons. There are however some key difficulties which the sector has faced in recent years and which have undoubtedly contributed to varying degrees to the hardening of the market.
1. Low rates of return
For a number of years, the soft market's competition has reduced the return to insurers from professional indemnity policies to a small margin even in good years.
The nature of professional indemnity claims can lead a relatively small piece of work to create a huge loss. This means that with low margins in good years, a bad year or even a small number of large claims can wipe out several years' profit.
Over the last two decades this has led to some insurers exiting the field, specific professions or types of work, with potential policyholders finding it hard or expensive to obtain cover. For example, reports suggest average renewal increases of 30% for solicitors in England & Wales this year.
While in the recent past there was usually another insurer interested in taking over, this is often no longer the case.
2. Construction Woes
The construction sector has been a source of ever-increasing liabilities for insurers, both in terms of the number and value of claims.
Perhaps most significantly, the industry is still reeling from the Grenfell Tower tragedy and the continuing uncertainty about the use of combustible cladding in past projects.
The Public Inquiry's first stage report finding that the design utilised on Grenfell Tower did not comply with relevant Building Regulations in England has certainly encouraged the possibility of claims against the designers of similar buildings.
The potential need for costly remedial work to hundreds of such buildings has led to a wave of notifications to professional indemnity insurers concerning possible seven-figure liabilities for a single case. This is starting to manifest in a series of high value claims working their way through the UK's court systems.
Increasing volatility in supply chains and financial uncertainty in the sector, epitomised by the high-profile collapse of Carillion, is also often cited as a contributing cause of increased liabilities for insurers writing cover for construction professionals.
3. The Lloyd's Review
At the end of 2018 Lloyd's of London conducted a review of its worst performing lines of business. Non-US PII was identified as one of the worst, with claims payouts substantially exceeding premium income. It was reported that in 2017, Lloyd’s syndicates incurred over £100m more in claims liabilities than they received in premiums for non-US architects, engineers and construction risks.
Lloyds reacted with several measures designed to compel improvements in performance, including requiring its syndicates to submit plans to ensure a swift return towards greater margins on pure underwriting and so also profitability. For many syndicates this meant the end of their presence in the market or substantially reduced capacity.
Other non-Lloyds insurers have also been exiting the PII market in increasing numbers or restricting the amount of business they will write and the types of professionals or size of business they will insure. The reality of the cost of PII claims now seems to have hit home across the insurance industry.
4. Financial Services Compensation
From 1 April 2019 the amount of compensation which the Financial Ombudsman Service (FOS) can award increased from £150,000 to £350,000, massively increasing the potential consequences of complaints in the financial advice sector overnight.
In addition, the field of potential complainers was dramatically widened in 2019 to include not just consumers and micro-businesses, but also any business with fewer than 50 employees, a turnover of less than £6.5million and a balance sheet showing less than £5million of assets.
Meanwhile the sector continues to grapple with a series of high-profile mis-selling scandals. The FSCS (which pays compensation on behalf of failed financial adviser sector firms) reported that compensation awards for people wrongly advised to leave their defined benefit pension schemes doubled between 2016 and 2018, to £40m.
This increase in pensions mis-selling claims shows no signs of abating, with the FSCS warning financial advisers in December 2019 that an additional industry levy of £46m will likely have to be raised to fund the increase in complex and high value claims and the failure of a series of high profile investment schemes.
This has contributed to the exit of many insurers from the market and it has been reported in industry press that the number of insurers still offering PI cover to IFAs might be as low as six.
5. A Hardening Reinsurance Market
The reinsurance market is often referred to as the 'hidden' part of insurance. It is where insurers buy their own insurance and allows them to spread their risk around the world by taking out cover against large losses they may face. For instance, the US and UK markets have had to pay out on global hurricane, flood and aviation losses.
The reinsurance market tends to follow changes in the wider insurance market, so it follows that the hardening that was already being seen in the insurance market would also emerge in the reinsurance market. However, the global reach of COVID-19 could have a more significant impact on the reinsurance market as countries around the world face similar accumulations of risk and impacts upon their economies, making it harder to find opportunities to spread localised risks.
What does the future hold?
In late 2019 the classic signs of reduced capacity, less competition and increasing premiums had signalled the transition to a toughening, or perhaps already hard, PII market. COVID-19 can only have accelerated that process, with exclusionary language leading to yet further reductions in capacity.
Insurers are understandably adopting a robust approach to assessing risks, which takes more time, particularly with face to face negotiations taking place less frequently or not at all.
With profits expected to be lower and risks greater, regulators and ratings agencies may also require insurers to increase their capital to ensure stability of the market.
We are also already a record thirteen named storms into a reportedly above-average hurricane season and the full impact of all these factors in the reinsurance market cannot yet be known.
What can businesses do?
• Seek early advice from your insurance broker and provide detailed information
• Ensure that robust risk management processes are in place, particularly to address the causes of any earlier claims, and that you can demonstrate to an insurer that they are being followed.
For more information, please get in touch with your usual contact at Brodies LLP or the Insurance & Risk team who advise businesses on risk management and claims defence.