Easy as PI

The International Monetary Fund has warned that the losses from the credit crunch may reach almost $1 trillion (£500bn). This served notice on the financial sector that its pain is not over yet – and that it will get worse before it gets better. In fact, the view that the world is facing its most serious financial crisis since the Great Depression is growing louder all the time.

While a sense of doom pervades, there is no certainty that the UK will follow the US into recession. However, there is equally no doubt that the shockwaves of the credit crunch are rippling through many industry sectors and could well grow in strength.

The construction industry is traditionally one of the first to suffer in a period of recession, and there has been much speculation as to the possible effects of the credit crunch. Although large projects such as the London Olympics provide a degree of security for certain areas of the industry, others – particularly those in the commercial property sector – are less secure. Anecdotal evidence suggests that the increased cost of borrowing combined with a pessimistic business outlook is leading to a slowdown in overall activity. British Land was recently forced to cut £1.4bn from the value of its offices and out-of town retail parks and stated that a “pause” in building was likely until investor confidence returned.

Past experience shows that when the economy begins to waver, claims against professional indemnity insurance (PI) policies start to go up. As developers or contractors begin to see their profit margins squeezed and their overheads increase, they naturally look to any means possible to hang on to their cash. If there is even the remotest possibility of making a claim against an architect’s PI policy and recouping some of the costs of a project, then they will.

So how will this start to affect premiums? From the dizzy heights reached in 2003, rates have tumbled to their lowest level for years. So far, we are yet to see any rise in rates and there are still excellent deals to be had in the market place. However, the insurance industry has not been immune to the impact of the credit crunch and there are a few warning bells starting to ring. The likelihood is that the current spate of competitive deals could be starting to bottom out.

A firm looking to renew over the next few months should be able to secure a competitive offer – but it might be sensible to secure a fixed deal for two years.

 

Insurance companies, by the very nature of their business, have significant investments, some of them are in the sub-prime mortgage market. Although the actual holding is unknown and this investment strategy was not pursued by all, some insurance companies are going to be affected.

However, direct investment is not the only exposure the industry faces. In the US, shareholders have begun to turn on fund managers and directors in order to recoup some of the money they lost in the collapse of the sub-prime mortgage market. Some carriers of directors’ and officers’ insurance have been caught up in this wave of activity, and some have reported premium growth of 30-40% in the first quarter of 2008. Although this is yet to affect the UK, insurers are closely monitoring the situation and those with direct exposure will seek to mitigate their potential losses.

As insurers look to manage their potential losses elsewhere, it is likely that the number of those with the appetite for certain classes of PI business will diminish. We have already seen one or two start to move away from surveyors, for example. As supply dries up and there is less available capacity, then rates will start to go up.

There is, however, no need to panic: rates have not started to move yet. A firm looking to renew over the next few months should be able to secure a competitive offer – but it might be sensible to secure a fixed deal for two years to cushion any rise over the next 12 to 24 months. We would also advise firms not to be shy in coming forward if they do identify any potential action by a client. Notifying your insurance provider of the possibility of a claim should not affect premium levels - there is generally only a rise if a firm’s insurer is holding a significant reserve or has actually paid out on a claim.