Professional indemnity insurance, designed to protect businesses from harm, is now threatening the profitability of engineering companies and consultancies. What’s being done?
At structural, facade and civil engineering consultancy Xavier Knight, growth has been impressive. Over the last five years the business has expanded from a small team of eight to more than 40 staff. It’s an engineering success story.
Unfortunately, the growth of one particular cost has far outstripped growth in profitability: the cost of professional indemnity insurance (PII).
Last financial year, the consultancy’s revenue increased by 11 per cent. In the same period, the company’s PII, having already been on a steep upwards trajectory over several years, blew out by another 42 per cent.
“We have seen a steady and significant increase in our premiums and when it came to renewing in March this year, the same thing happened,” Jyana Mareko, General Manager of Xavier Knight Consulting Engineers told create.
“I was blown away by the increase. If you have made a claim or if there’s higher risk around what you’re doing, you would expect premiums to rise. But when there are no risk changes, seeing a premium increase like this seems unreasonable.”
In a statement provided to create, the Insurance Council of Australia outlined the insurance industry’s reasoning behind the dramatic rises in PII premiums.
It said there would only be a change “when risk is better understood and when those risks are effectively managed”.
“Insurance premiums represent the cost of risk. Where claims expense is high and growing or where risk is not mitigated, the premium attributable will be higher. The quality of output across the Australian building industry has seen increased claims exposure particularly in recent years,” according to the statement.
“In the professional services sector of the building industry, PII has experienced premium increases and cover limitations have been applied in some segments. A key driver of increases and/or limitations is the recent claims experience. PII has reported a loss ratio of 95 per cent or worse for the past three years.
“More than that, in the period 2017-2021, PII claims increased by 125 per cent while premiums grew by 63 per cent. This highlights that premiums have risen, however, those rises are not matching the cost of risk of the performance of services produced in that industry segment.”
What is Engineers Australia doing?
Engineers Australia recognises this as a major issue affecting engineering companies large and small, and has been working on a multi-stage solution, said Chartered engineer Baoying Tong CPEng, Engineers Australia’s Senior Manager – Building Reform and Projects.
“In attracting the insurers back, it’s important for us to improve the risk profile of engineering and engineering-based industries,” Tong said.
Similar challenges to those in the building and construction industries are being faced in the mining and amusement park sectors, Tong said. As in the construction industry, both these sectors have experienced high profile and controversial failures over the last several years.
“It may seem that the insurance industry is being too reactive, with some insurers who will not underwrite engineering until the risk is dramatically reduced,” he said.
“But there are also innovative and proactive insurers who are interested in the work Engineers Australia is doing. They’ll recognise early that the risk profile has changed, and they will come back and win market share before the others realise.
“Engineers Australia has been running a consultation process with members, with insurance companies and with the Insurance Council of Australia and other stakeholders. As part of this process, Engineers Australia has started with a three-stage action plan designed to help restore balance in the insurance market.”
The action plan, as outlined on the dedicated Engineers Australia web portal, was developed to provide engineers with resources to address the issue. It includes:
- Stage one: short-term goals, including forming partnerships with key stakeholders, organising industry discussions to focus on the most affected engineering sectors and helping members to gain a better understanding of the insurance market
- Stage two: set for the medium term, this includes working with insurers to identify key risk areas, developing risk management protocols and encouraging insurers to determine fair risk allocation linked to Engineers Australia’s Chartered membership grade
- Stage three: the long-term plan is to promote a culture shift around risk allocation and accountability in targeted engineering sectors
The government’s view
Taking the building industry as an example, what we’ve seen for too long is lax standards of work by certain practitioners, said Angus Abadee, Director of Building Construction Policy in the NSW Government’s Better Regulation Division.
“This has led to higher rates of defects,” Abadee said. “Our department has commissioned universities to conduct research programs and they indicate that around 30 per cent of Class 2 buildings [multi-unit residential developments] contain defects.”
The effect is that such buildings, and the people and businesses involved in designing and constructing them, become a very difficult risk proposition for insurers.
“Most insurers have suffered pretty heavy losses on their construction PII portfolios,” said Nick Beswick, former Product Leader Professional Indemnity APAC at AXA XL. “The main areas that are problematic are structural engineering and geotech work.”
The real problems for insurers, Beswick said, come out of complex structures such as high-rises or complex bridge or tunnel projects.
“PI insurers have, for a long time, grappled to deal with those things, partly because of market dynamics and over 15 years of a soft market, where rates were really low and competition was high,” he said.
“In the last three to four years, rates have been increasing significantly. People describe it as a ‘PI crisis’, but it isn’t. The PI crisis was 10 years ago when no one was charging enough money and people were losing their shirts. That set up the conditions for what’s happening now.”
Another historical cause of the PII affordability problem, Abadee said, is the broad, hands-off approach the construction sector has taken to responsibility and accountability over a number of years.
“This is punishing the good practitioners by making the cost of business prohibitive,” he said.
The approach from a regulatory perspective is to prevent the problems before they happen. This involves picking up defects in the design phase and putting in place clear accountabilities around who carried out a piece of work and what their involvement in the project was, therefore limiting their liabilities.
Taking NSW as an example, the regulatory response is multi-faceted. It includes an entirely new insurance product that the NSW Government is designing with the insurance industry — a decennial (lasting for 10 years) liability insurance product that will be attached to a building for a decade, but paid for upfront.
“First point, we’re introducing registration schemes similar to [what is in place] in Queensland for all engineers working in the construction space,” Abadee said about the action being taken in NSW for the Class 2 multi-residential unit, and mixed use development with a Class 2 part, building sector.
“We’ve also introduced a new design and building declaration scheme. This means before building work begins on any critical building elements [in a Class 2 structure], whether that be structure, fire safety systems, waterproofing, etc., a registered design practitioner must sign off, confirming the work complies with the Building Code of Australia. Those designs are lodged on the NSW Planning portal, then the building practitioner must build in accordance with those designs.”
No substitution or alteration by the building practitioner is allowed without a qualified engineer signing off, he said.
“Previously, changes to design were being made on the fly,” Abadee said. “That’s what we want to push out of the industry.
“We want people to plan to integrate designs and to get it right from the start. The benefit of that is that it will clearly show, if there is a defect, whether it was caused by insufficient or inappropriate design, or was the builder not following the design.”
And the industry is starting to see change because of this renewed focus on accountability and trustworthy players.
“At a sector level, we understand that PI pricing in NSW is now up to 30 per cent lower than the national average. That shows the work we’re doing as a government to manage risk is starting to have an impact,” Abadee said.
Engineering requires cultural change
While it’s easy to point the finger at some insurers for not knowing enough about the ins and outs of engineering, the current insurance crisis also offers engineers a chance to figure out what they could do better, and what they could change, to help reduce the risk profile of the profession.
Engineers Australia Fellow and Chartered engineer Greg Schofield FIEAust CPEng, founding director of structural engineering consulting business Greg Schofield & Associates, said there is a long history of “givers and takers” in the engineering business, which has damaged the profession’s standing with insurers.
“Not long ago I had $10 million of PI cover for about $12,000,” Schofield, a past chair of Engineers Australia’s Management Committee of the Engineering, Science and Technology Professional Standards Society, said.
“That snuck up to $16,000, then jumped to $25,000, and this year it’s about $31,000 but only offers $5 million cover.
“A lot of the problem came from the idea that if a project stuffed up, you could just sue the design engineer.
“The givers were dills like me, designers who shouldered responsibilities under the cover of PI, so at the drop of a handkerchief you’d be sued.”
How, then, does the engineering profession collectively reduce its risk?
That begins with the development of a risk management system, Schofield said, an internal framework of checking designs and changes, with a robust feedback system that is multi-dimensional.
According to Schofield, a linear checking system is not enough.
“It has to be multi-dimensional. There has to be personal checking, organisational checking, independent third-party checking, with strong collegiality between members who all share responsibility.”
Such a system would not only address risk issues in the profession, but would also help develop a culture of commitment to mitigate risk, rather than a culture that automatically reaches for the legal lever.
One of the ways that government is looking to work with industry to progress this is by developing a whole-of-construction-sector engineering practice standard.
“A clear, consistent set of obligations will allow engineers to better manage risk,” Abadee said.
In NSW, the government is also encouraging industry bodies to create Professional Standards Schemes (PSS). Abadee noted that some associations, such as the Australian Institute of Building Surveyors and the Strata Community Association, have established a new PSS. Engineers Australia is drawing on its experience of operating a PSS in every state and territory from 2008-2016 and is currently investigating the feasibility of reintroducing a PSS in the current context.
Solutions needed at all levels
Beyond factors such as a hardened market cycle in global insurance, limited insurance competition in Australia and global monetary policy, there are solutions that Engineers Australia is facilitating.
It begins with the work practices of individuals and businesses, including developing a culture of risk mitigation and risk management, and encouraging insurers to become more familiar with the way engineers work.
“Everybody has a part to play and at Engineers Australia we’re well advanced with stage one of our action plan and have already developed some guidelines under stage two to help address and solve this issue for our members,” Tong said.
“We recently made a submission to a major consultation process being run by the Insurance Council of Australia, which we wholeheartedly supported as an important step for further collaboration. We’re now having several follow-up conversations to turn recommendations into actions.
“We know this is a very big issue for our members, so it’s a priority. The fundamental solution within engineering will be around exceptional risk management. If we don’t develop an excellent risk management approach that not only works for engineers, but also meets the needs of their insurers, history will keep repeating itself and engineers will continue to face the same old problems.”
For professional indemnity insurance designed for the engineering profession, by the engineering profession, visit EngInsure, an Engineers Australia initiative.