Survey findings offer insight to potentially mitigate claim risk. Part 3
In our previous articles, we discussed several emerging claims trends identified in the WTW A&E Professional Liability Carrier Survey Report: social inflation, cyber liability, climate change, Covid-19, and risk-shifting in contracts. In this issue, we will conclude with an analysis of the enhanced risks associated with certain project types, the most important thing you can do to preserve your professional liability coverage, and the state of the professional liability marketplace.
Project Types
Another question in our WTW A&E survey was to list the top project types that experience the most professional liability severity claims. The responses listed many project types, including residential, apartments, condos, roads, highways, infrastructure, hospitals, schools, arenas, offices, and “other,” including oil and gas.
Residential traditionally has led the field in terms of both frequency and severity. The expectations in residential construction are very high, and residential owners have certain legal protections that are not available to commercial owners. For instance, there’s the implied warranty of habitability. Residential owners tend to need to be more sophisticated about maintenance requirements.
Condominiums have shown the poorest performance of any project type. There are several reasons for this: the developer will never occupy the building, so he has incentives to do things cheaply, especially regarding mechanical systems. Condo unit owners want to spend their money on their units rather than on the maintenance of the common areas. The condo board members can be unsophisticated about maintenance requirements, and the board can be easily intimidated into making claims based on their fiduciary duties to the other unit owners. It is interesting to note that these are primarily human factors.
Right now, apartments are trending badly. This experience is driven partly by inexperienced designers dabbling in the market and partly by shoddy work done by inexperienced contractors, especially “paper” general contractors. We have seen some design firm clients successfully manage these risks by insisting on a high level of service and implementing specific risk mitigation efforts. These include organizing their firm into studios where groups have a long history of working together. They strongly recommend qualified contractors and do much planning with pre-construction teams. They bring in independent consultants to do peer reviews of accessibility and waterproofing issues. They work with experienced attorneys to review all of their contracts. They ask that a “no condo conversion” clause be written into the deed. They have people who are dedicated to the construction administration phase and who are expert at it. They have a Chief Learning Officer and hold Project Manager meetings to share lessons learned. They require sub-consultants to submit documents a week in advance of the due date to allow time for review. They require owners to hire a construction inspector to verify that the work is being done in conformance with the plans. They offload specific consultants, including the geotechnical consultant. And in addition, they are willing to say no. They have a documented history of saying no to bad deals. Together, these measures have allowed them to thrive in a challenging market.
Schools have been a leading source of claims frequency due to several factors. One is inexperienced boards with champagne tastes and beer budgets. Second is low-bid contractors. And third is the unlevel playing field, where our potential jurors know that they, as taxpayers, will have to pay if the defendant does not.
There is frequently a powerful correlation between project size and claim severity. Larger projects are understandably more complex. While $5 million change orders on a billion-dollar project might be less than 1% of construction values, it’s still a lot of money. And so we see more significant lawsuits filed on larger projects generally – which firms can address by offering a higher level of service.
One carrier that responded to our survey noted, “The loss ratio for our large firm segment is running more than two times higher than the loss ratio on the rest of our book. We know we are not the only carrier seeing these claims. I believe the large firm segment will be a tough market for the professional liability markets to manage shortly.” This begs the question: what is a large firm? It’s a subjective question, but the authors consider any firm with over $20 million in annual billings to be a large firm.
Design Build projects have also become a concern for A&E PL carriers. Contractors have been giving GMPs based on 15% to 30% design and have increasingly leaned on the designer’s E&O coverage to cover contingencies. This phenomenon has been acutely apparent in infrastructure design-build versus vertical design-build. As a result, we have seen some A&E PL carriers refuse to accept infrastructure design-build risks.
In a related trend, a couple of major players left the project-specific insurance marketplace. As a result, some of those risks that may have been covered in the past by a project-specific policy are now being picked up under the practice policies of the designers. Many large firms have ceased offering GMP pricing on schematic design documents and are leading a drive for a progressive approach to design-build, which requires at least 60% design before a GMP can be contemplated.
Staffing
Staffing is a real issue in the design community. There’s currently more work than can be completed by available engineers at the senior, mid-level, and new graduate levels. As a result, we are seeing a rise in technical claims. This is a real challenge for design professionals, the contractor community, and their clients. Successful firms are increasing their pipeline of applicants by reaching out to students with internships and engaging them before graduation, and adopting strategies that make them the preferred place to work for existing staff.
Coverage Issues
Another question we asked our carriers is, “What are the leading contractual risk design professionals assume that give rise to a reservation of rights or denial of a claim?” The coverage offered by the major providers of professional liability insurance is so broad that a design firm should be able to transfer virtually all of its professional liability risk to insurance. However, firms can jeopardize that coverage by failing to report claims timely or by assuming liability above what is required by the professional standard of care.
There was the one question all carriers in our survey agreed on: the number one reason coverage might be declined is failure to report a claim timely per the policy. We rarely see coverage declined, but when it is, it is almost always due to failure to comply with the reporting requirements of claims-made coverage. Claims need to be reported promptly during the policy year when the claim is first made or when the firm becomes aware of circumstances reasonably likely to result in a claim.
The one thing that keeps insurance brokers up at night is the possibility that our clients might fail to timely report a claim. If you don’t report the concern in accordance with policy requirements, you could void your coverage. In the case of professional liability, our advice is to report anything that qualifies as a claim (defined as a demand for money or services) – even if you think it will resolve under your deductible or if you think you can manage it and it will go away.
You also don’t want to settle a matter without the carrier’s consent. Your insurance policy is a contract, and there are two sides to that contract. Both the insured and the insurance company have specific responsibilities and obligations under the provisions of that policy. One obligation of the insured is not to admit or assume any liability without the prior consent of the carrier.
The Insurance Marketplace Response
Over the last few years, the increased cost of claims resulting from the trends we discussed has caused property-casualty carriers to increase rates and adjust their risk appetite. Due to an abundance of capacity, insurance rates have generally fallen since 2008. And while the architects’ and engineers’ marketplace has been relatively stable, we have seen some recent changes that we need to monitor.
Recently, we’ve seen an increase in some rates. We’ve seen some carriers exit the marketplace, and we’ve seen some carriers reduce their appetite, not wanting to write larger firms, for example, or show decreased interest in firms with specific exposures such as bodily injury, design-build, and residential risks. And we are seeing more professional liability carriers reduce their available limits. Where carriers might have offered $10 million policy limits in the recent past, some of these carriers are now only offering up to a $5 million limit. As a result, larger firms that need higher limits to meet contractual requirements or protect the financial core of their business will have to go to excess markets, which will come with an additional expense.
In addition, we are seeing real pressures to increase self-insured retentions and deductibles. A&E PL carriers would like to see firms retain 1% of their annual revenue as their deductible. In reality, most firms retain 0.5% or less. But we see some pressure on this marketplace for firms to raise their retentions.
There are many companies out there that might want to sell you insurance, but you need to be careful when it comes to picking your long-term insurance partners. There are a finite number of tier-one carriers in the A&E marketplace. Tier-one carriers are those carriers with a history of backing their promises, have a strong balance sheet with an AM Best Rating of A- or better, broad policy forms, as well as good people that are backing those promises with underwriters and claim representatives exclusively dedicated to the A&E marketplace. WTW A&E has direct relationships with the major providers of professional liability insurance who provided the data summarized in this survey.■