Recent changes in the UK professional indemnity insurance market have had a significant knock-on impact in the Irish professional indemnity market. This ripple effect has already affected premia and overall availability of insurance for designers, specialists and contractors. This article unravels the implications of these changes and the potential impact on developers, purchasers and funders when identifying risks in current and historic projects.
UK Professional Indemnity Insurance Market
According to the 31 March 2021 Construction Leadership Council ("CLC") survey in the UK, significant premium increases, greater restrictions on extent of coverage and exclusion in some cases have unsurprisingly presented a real challenge. The report suggests that 60% of the survey respondents (including contractors and designers) tended to have restrictions on cover relating to cladding or fire safety. In fact, one in three of the total survey respondents had a complete exclusion in place for cladding claims, whilst 20% had exclusion for fire claims. There is an appreciation that this is part of the on-going impact of the Grenfell Tower tragedy, however, it demonstrates an overall tightening of the market, which will invariably have significant consequences for insureds.
The CLC survey was conducted between February and March 2021, and involved 1,066 respondents from a mixture of consultants, contractors and specialists. By way of market share and range of the respondents; half had a turnover of less than £2,000,000 and 10% had turnover of over £50,000,000. This is therefore generally reflective of the industry. Of perhaps greatest concern is that almost half of the respondents had recently been declined insurance by three or more insurers, and two-thirds have had to carry an excess imposed on them by their insurers. Anecdotally, premia have increased up to fourfold since last renewal and the average rate of the premium to turnover is now at 4%. (1)
How Does This Relate to the Irish PI Insurance Market?
The Irish Construction Industry Council ("CIC") letter of 26 February 2020 indicates that a number of insurers have withdrawn from the Irish market and that several Lloyd's syndicates in specialist insurance have exited the UK professional indemnity insurance market, leaving a much smaller number of brokers available to Irish industry players. Brokers servicing the Irish construction market are finding it challenging to retain the support of insurers in the local market.
Although the CLC survey provides a good insight to the market generally, the Irish market presents a number of issues that are different to the UK PII market. One of those is the operation of the Civil Liability Act 1961 which, in summary, provides that every concurrent wrongdoer can be pursued directly by the plaintiff for 100% of the losses, even if it has only caused only a portion of the losses. In light of this, the CIC and the Construction Industry Federation ("CIF"), urge the use of a net contribution clause to limit the burden on insureds and insurers. For those unfamiliar, a net contribution clause says, in effect, "if I am held 30% responsible for the damage, I will pay 30% of that damage and no more". (2)
In the writer's personal experience, large companies who have an international/global presence, will generally have more robust insurance coverage and are concerned about paying 100% of judgments in a multiple wrongdoer situation just because they are "the last one standing".
The CIF submission to the Government Construction Contracts Committee ("GCCC") also suggested that subcontractors would get some relief by supplying collateral warranties which were not insurance-backed. It goes on to say that the limit of liability should in those cases be limited to the reasonable cost of repair, replacement and re-instatement, which together, with a net contribution clause shares the proverbial load. This would close off recovery for loss of rent, revenue, interest and the like.
The writer has observed that, particularly for fire consultants, but other consultants as well, the insurance coverage has moved from the industry "norm" of €6.5 million on an each and every claim basis for coverage to an annual aggregate basis, sometimes for a lower top-line level of coverage.
Difficulty for Developers, Funders and Purchasers
Most funders look beyond the borrower's covenants and revenue streams to get comfort from the construction industry participants in creating the particular asset by getting an insurance-backed collateral warranty from design consultants, specialist subcontractors, and design and build contractors. In this context, the comfort of an aggregate basis is far less than an each and every claim basis of professional indemnity insurance. I say this because the consultant is covered by its professional indemnity insurance on a "claims made" basis, rather than occurrence based. Theoretically, some appointments and collateral warranties the consultant has provided within the previous 12 years may give rise to a claim at the same time as a more current project or set of projects might bring forth claims. In this regard, the coverage provided by the consultant's professional indemnity insurance is a sum total of say an aggregate of €6,500,000 for its entire portfolio of risk; whereas the previous each and every claim style of coverage provides that each claim could have up to €6,500,000 in insurance. All potential claimants are now competing for a single pot of €6,500,000. This is a seismic shift in coverage.
In a similar vein, the developer who is monetising its asset through leasehold agreements or the forward contract purchaser of an apartment complex, for example, will similarly face decreased coverage in the event of defects discovered after practical completion. Once the construction contract is completed, the providers in the construction industry will only have their professional indemnity insurance and their residual capital as the means to pay any significant judgments.
It is important for landlords, purchasers and funders to understand that regardless of the insurance at the point of closing of the property sales contract or lease, there is the reality of more limited insurance cover available in the market at present and perhaps for the foreseeable future. Whilst some comfort may be taken from the fact that the building has stood safely and functionally for a number of years, and therefore the risk of a detrimental defect being discovered may decrease over time, there is a different level of coverage available in the whole portfolio of current and previous projects designed by any particular consultant or contractor.
Another issue for developers, purchasers and funders is that absent a discovered and notified defect, there is less security if the asset is to be sold in the open market. In theory each of those consultants or contractors or specialist sub-contractors who have given a collateral warranty may be in technical breach of their contract. It is for another day to argue whether there is any loss arising from that breach at the present time absent the discovery of any design error or omission.
Certainly, the purchaser would argue that the asset has a lower sale value and will achieve a sale with more delay if the fully contracted level of insurance to support the collateral warranty is not available. Clearly, consultants who are in this situation do not wish to find themselves in a positon of potential breach of their collateral agreement commitments through no fault of their own.
The trite retort to the above heading is that there is not a solution other than the construction industry leaders broadly defined (including purchasers, developers and funders) will have to redistribute or bear more of that that risk at the owner/occupier/funder level for at least the time being. It is unclear when, if at all, there would be a return to the pre-Grenfell levels and degree of insurance coverage.
No doubt strategic planners in the industry are looking at project and decennial insurance as a means of supporting the risk reduction agenda. Such developments will be watched very closely. There will be a greater attraction to procure developments through design and build contracts thereby creating perhaps two pots of PI insurance for the same loss. This will shift more burden on to contractors' insurance programmes and no doubt will have a knock-on effect to their insurances at renewal.
So therefore, the problem escalates. When the construction industry leaders can no longer sustain the higher cost, it will may lead to a downturn in investment and development in Ireland.
If you are facing these challenges on your project, please get in touch to discuss the range of solutions with Chris Wheeler or a member of the UK & Ireland Construction team.
References:(1) Link to survey results
(2) Construction Industry Council letter dated 26 February 2020 from Micheál Mahon and CIF Statement for GCCC Joint Industry Meeting dated 3 November 2020.