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Although you may not feel you鈥檝e had a great deal with your professional indemnity insurance, it鈥檚 fair to say that most construction professionals had it good last year. Rates across the board have fallen by an average of 25%, and for lower risk professions such as quantity surveyors or interior design architects, the falls have been as great as 40%. At the other end of the scale the likes of geotechnical and environmental have seen their rates remain stable or fall moderately, but they are unlikely to have seen any rate hikes. The result is that rates are at their lowest for five years.

It was a different picture a few years back. In 2003, when rates were at their height, some professions saw PI costs rocket 400%. But what goes up must come down. The insurance market is cyclical and driven by the rule of supply and demand 鈥� when more insurers have an appetite for your business, rates fall; when there鈥檚 less, they rise.

After a period of low premiums in 2005 we are approaching the bottom of the market cycle, and there鈥檚 much speculation as to when the tide will turn and rates begin to climb again, and by how much. So if you鈥檙e a construction professional don鈥檛 assume your PI costs will remain the same; you need to prepare for price rises and budget appropriately. But how much will you need to set aside for PI next year? Will we see a return to the crippling costs of 2003?

Tougher times ahead

Back in 2002, it would have been correct to say that the market for professional indemnity insurance was severely limited. Since then we鈥檝e seen a steady increase of PI insurers coming into the Lloyd鈥檚 market to chase the profitable premium. On the whole these insurers have targeted architects and surveyors, sectors that underwriters feel more comfortable with and view as less specialised, and therefore easier to understand. As a result, premiums for many professions dropped and competitive prices became readily available.

More recently, however, there鈥檚 been evidence of 鈥渃apacity shrinkage鈥� in the PI insurance market, largely for two reasons:

• The Lloyd鈥檚 insurance market has taken a decision to manage its syndicates differently in a bid to bring cyclical price swings under control; syndicates applying to enter the market now have to support their applications with tight business plans to justify their market entry, and as a result it鈥檚 becoming increasingly difficult for new insurers to enter.
• Hurricane Katrina and other natural disasters last year have had repercussions on the market. The total losses suffered still haven鈥檛 been finalised, but property premiums in North America have gone by as much as 400%. The fact is that the core of the insurance market is driven by property rates, and the liability sector, which includes PI cover, is very much a fringe area; it is quite possible that many insurers and Lloyd鈥檚 syndicates will look to reallocate their available capital away from the fringe of the market to the core. If they do shift capital we will definitely see a hardening of rates in the liability sector. What鈥檚 more, a further impact of the hurricanes will be in reinsurance rates 鈥� if these rise insurers will be likely to pass the costs on to clients.

Shrinking capacity means it will become more difficult for your broker to secure you PI cover, and certainly at this year鈥檚 rates. With more brokers chasing fewer insurers, rates will go up and stimulate the swing to higher premiums.

But it鈥檚 not all doom and gloom. Although it鈥檚 almost inevitable that your PI costs will rise over time, there鈥檚 every indication that this won鈥檛 be as dramatic as the swing in 2003. It鈥檚 far more likely to be a gradual process and there鈥檚 evidence to suggest that for some classes the cycle has some way to fall yet 鈥� we predict rates will go down a further 10% across the board before they start to rise.

There is other evidence to support the view that premiums will rise gradually:

Although it鈥檚 almost inevitable that your PI costs will rise in time, there鈥檚 every indication that this won鈥檛 be as dramatic as the swing in 2003. We predict rates will go down a further 10% across the board on average before they start to rise

• Since the introduction of fast-track alternative dispute resolution methods the number of large claims has declined and the number of smaller settlements has increased. Although it is harder to estimate PI reserves and rates because claims are generally submitted a long time after the work has been done, improvements have given insurers the confidence to set rates and estimate reserves earlier.
• Insurers now have a better understanding of the needs of the construction sector. Prior to 2002 some insurers were guilty of having underwritten risks at unprofitable levels, largely because of difficult market conditions, but partly owing to a misunderstanding of the needs of the construction sector. In 2003 rates needed to be adjusted to compensate for the shortfall. Insurers are now more aware of the issues, complexities and risks associated with the professions in construction, and the need to maintain disciplined underwriting practices.
• Changing attitudes to risk management procedures. Insurers and brokers are advising clients on good risk management, which is also being promoted by the Financial Services Authority and construction associations. The challenge is that not all can afford to invest in risk management. Firms tend to fall into two camps: those that earn more than 拢500,000 in fees and can afford it, and those who don鈥檛 and can鈥檛.

So what are insurers looking for and how can you ensure you get a favourable premium? From our experience the surest way to get the right cover at the right price is to make sure your house is in order and that you can demonstrate good internal practices, sound risk assessment and a strong overriding ethos of risk management. Risk management should be your first line of defence, and PI the safety net.

Underwriters also appreciate some loyalty and continuity, switching deals and shopping around for cover too often damages your credibility in their eyes and they鈥檙e less likely to reward you or be too understanding of past claims. Often it鈥檚 worth paying a little more in a favourable market to secure a better deal when times get tougher. Underwriters are also increasingly keen to see that you are aware of the 鈥渜uality鈥� of the policy rather than simply concerning yourself with cost; PI should be viewed as a tool to protect your balance sheet. So make yourself aware of what your policy does and doesn鈥檛 cover.

But the best advice we can offer is to seek out a specialist PI broker 鈥� the guy who sorts out your commercial insurance is unlikely to have the contacts in the marketplace to be able to hunt out those underwriters who still have an appetite for your business.

We鈥檝e seen a number of so called 鈥渟pecial deals鈥� being offered to engineers in particular over recent months including a two-year fixed rate. By the time your two-year fixed rate is up premiums are sure to have increased, so be careful when considering deals like these. If rates do fall then you could be saddling yourself with a higher PI bill than is necessary and be unable to take advantage of lower rates on offer.

The table below gives an idea of the sorts of rates you can be expecting to pay next year, and by using a specialist PI broker 鈥� especially one who specialises in your area of construction 鈥� you could secure an even better price than shown here. The table illustrates types of high, medium and low risk work and what percentage of fees each should expect to be paying for PI in 2006.