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To those outside of the insurance industry it may appear that professional liability premiums are determined somewhat randomly by people with limited knowledge of the design profession. As a former underwriter turned broker, I am here to tell you that this misconception couldn't be further from the truth. Your professional liability premiums are established through a process involving the assessment of several factors over which you have some power to influence.
Looking through the eyes of an underwriter, design professionals can gain an edge in obtaining the best possible insurance premiums with the use of a thoughtful application submission. The article below describes the factors underwriters use in developing quotes for professional liability insurance.
What your application tells underwriters
When an underwriter receives your application their immediate task is to evaluate your firm's potential loss exposure. The two basic types of loss exposure are frequency and severity. Underwriters use the information on your application to calculate the probability of your firm experiencing claims over the life of the policy and furthermore, if you have a claim, how much it will potentially cost.
However, before even considering the merits of an individual firm, insurance carriers already have defined what type of firm is a "good risk" for their company based on previous experience. They try to attract as many such firms as they can with various coverage differences and program enhancements but the primary lure is price. Their objective is to set a price that attracts good risks but still allows for an underwriting profit. This is complicated by the catastrophic nature of professional liability claims in the A/E industry. Losses tend to be quite large with a recent statistic stating that the average indemnity payment for a paid loss is upwards of $350,000. As a result, the many end up paying for the few.
Design firms need to make their business look attractive to the insurance company in order to obtain the best possible terms. The first step in this strategy is to identify the different risk factors and then present your firm in the most positive way. While numerous factors determine the risk that your firm poses to an insurance company, for the purpose of this discussion we will focus on the most critical areas.
Area of Practice
There is not much that you can do to influence an underwriter in this category. You are what you are. But it may be helpful to understand how the insurance company evaluates each discipline when it comes to their exposure to risk. The most common discipline in most insurance companies' books of business is Architects. As a result, insurance carriers tend to use their rates for architects as base from which to determine rates for other types of firms.
There are two disciplines that tend to pay a higher rate for their insurance than Architects: Structural Engineers and Geotechnical Engineers. Keeping in mind that underwriters are always thinking about exposure to loss, the question they asks themselves is " what happens if there is an error in a structural calculation or a geotechnical report?" In many cases the project is stopped or even scrapped with a worst case scenario being a collapse. Because of this, Geotechnical Engineers take the unenviable position of paying the highest average rate in the industry with some carriers charging as much as two times what Architects will pay. Structural Engineers pay a much higher rate as well but they tend to be roughly 1.5 times more than Architects.
The professional discipline seen as having the lowest exposure to loss and thus paying the lowest rate is Electrical Engineers. Going back to the basic underwriting question, if an Electrical Engineer makes an error, the damage and corresponding fix is usually far less than a foundation issue or an insufficient support beam. There are always exceptions but the claims statistics strongly support this evaluation. Positioned somewhere between Electrical Engineers and Architects sits Mechanical Engineers, Surveyors, and Civil Engineers with Civil Engineers having a rate that most closely resembles that of Architects.
Location of Projects
The location of your practice or more specifically, the location of your projects, does have bearing on the rate that is determined for your firm. Claims statistics show that the probability of a loss on a building in Miami, Florida is much different than a building in Flagstaff, Arizona. There are many theories as to why this is the case, but the statistics clearly show that a higher rate is needed in most major metropolitan areas as opposed to most rural areas. Again, there are exceptions to every rule, but the statistics on this topic are definitive.
Type of Projects
Rate factors in the area of project types, more so than any other, presents the greatest amount of differentiation amongst the various insurance carriers based on their individual statistics and beliefs. Understanding the "sweet spots" of the different carriers and matching your firm's characteristics with the best markets is the job of your insurance advisor, your broker. As a design professional, you cannot possibly know all of the different markets and specifically which markets best suit your firm.
In general, project types that are seen as the least "risky" in the eyes of the insurance company are those which tend to have less individuality in the design and have less emotional attachment than other project types. This includes projects such as office buildings, banks, retail, and most commercial projects.
Project types that tend to be more of a challenge from a risk perspective are those which are more unique to their individual locations and have a much greater bodily injury exposure than the others. They can also run quite large in scale which increases the physical damage exposure exponentially. These include schools, jails, industrial plants, bridges, parking garages, and stadiums.
Finally, the projects that are considered to be high risk are residential projects, swimming pools, harbors and docks, mines, and amusement parks and zoos. The project type with the highest perceived risk is condominiums. The industry has determined that for every premium dollar received by the carrier for a condominium project, 3.5 dollars goes out. All of these projects either carry a high emotional factor from the end user or have a high inherent catastrophic loss exposure such as a mine or amusement park. It is not the intent of this article to discourage any design firm from performing services on high risk projects but it is prudent to understand the exposures and manage the risk as well as possible.
Internal Risk Management
Your firm's internal risk management practices provide the best opportunity for you to differentiate your firm and illustrate to the underwriter why you are worthy of their absolute best rate, the rate that is given to the "best in class" type firm. Throughout the application are questions that on the surface seem benign and unimportant but they are there to paint a picture of the firm for the underwriter that goes beyond the discipline and project types.
These questions include, but are not limited to, use of written contracts, limitation of liability provisions, insured sub consultants, types of contracts, in-house education programs, attendance at risk management seminars, and professional society memberships. Individually and collectively these categories allow for the underwriter to apply debits and/or credits based on the responses given. In some cases the difference can be as much as 25%.
The unfortunate reality is that far too few firms are properly advised by their insurance representative as to the effect of these questions and thus do not enjoy the premium reductions associated with them. Again, it pays to be with an expert that knows your business and the ever changing marketplace.
Loss History
The area of risk that is perhaps most quantifiable is loss history. As was mentioned earlier, when a design firm does have a legitimate claim, they tend to be quite expensive. There also is a belief in the underwriting world that past claims are a pretty fair indicator of potential future claims activity. As a result, a firm with claims in their past generally pays a much higher rate than a similar firm with no claims. The industry standard is to look five years into a firm's past for claims activity but it is not uncommon for a carrier to look ten years back when evaluating a larger firm.
The key for any design firm with a claim is to take the time to effectively articulate the circumstances regarding the claim and the lessons learned. In some cases, given the right approach and documentation, a firm along with its broker, can convince the carrier that it is an even better risk than a firm with no claims because of the experience and knowledge gained from the unfortunate situation.
Setting the price
Underwriters' thorough review of these and other factors gives them a profile from which to develop a specific rate for your insurance. The rate is applied against your professional fees and a premium is determined. The premium is increased as the limits of liability desired increases. Conversely, the premium is decreased as the deductible that is carried increases.
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