Professional Indemnity Insurance – What Limit Should I Purchase?

December 2010

Determining the appropriate professional indemnity insurance (PI) limit to purchase is not a straight forward calculation. There are several key factors that should be considered when deciding the limit that is right for your business. Identifying these factors may also assist in negotiating more reasonable (insurance related) contract terms and conditions with your clients.

The selection of the most appropriate limit should be driven by your desire to protect your business and personal assets. Many firms simply purchase the minimum (PI) limit possible in order to satisfy their statutory or contractual obligations. Utilising this approach may leave you dangerously underinsured and, if this is the case you may not find out about until it is too late! With the recent unsettled economic environment we are seeing an increase in both the frequency and magnitude of professional indemnity claims, particularly against those in the building industry.

Some of the key issues to be considered when reviewing or deciding your policy limit are:

Statutory requirements

Usually prescribed by Regulation or Ministerial Order, compulsory insurance is often required to support a statutory registration or accreditation.
For example Building Practitioners in Victoria under the Building Act (Vic) 1993 require a minimum limit of $1,000,000 or $1,500,000 depending upon how cover for legal costs are provided under the policy. Interestingly this minimum $1,000,000 limit has not increased since it was first introduced in Victoria almost 15 years ago.
New South Wales prescribes a minimum limit of $1,000,000 for private certifiers, this was introduced with private certification in 1998.

Considering inflation, the increase in costs of building over this period and the potential for personal injury claims raises the question of whether these sums insured are adequate.
Northern Territory requires a minimum limit of $1,000,000 for certifying structural engineers but only requires $100,000 for certifying mechanical and hydraulic engineers!
Contractual obligations: These are obligations assumed by you under professional service agreements with your principal. In recent years with reductions in the cost and increased availability of higher PI limits there has been an increase in the limits that principals have been requesting of their consultants. Often these requirements are considered unreasonably high by the consultant because of the significant cost implications.

We have outlined in the following comments some negotiating points to assist you in negotiating reduced demands of principals where you are of the view that the insurance levels requested are unreasonably high.

Project values and types

One of the most commonly used measures assumes there is a strong correlation between both the value and nature of project you are involved with and your professional negligence exposure. Whilst we support this view, this one measure should not overshadow the following important factors to be considered. A relatively low value project can still give rise to a significant professional indemnity claim.

Perceived Exposures

This involves an assessment of the possible causes of loss, injury or damage that may give rise to a professional negligence claim against you. This can be considered from three perspectives:
Property damage – The resultant damage to property as a consequence of an actual or alleged breach of professional duty, example: Structural failure in a building as a result of a design engineer under specifying a supporting beam.

Personal Injury (including death)

Injury (or death) as a result of an actual or alleged breach of professional duty of care. A common misconception is that such risk is insured under a public liability policy. Public liability policies usually contain a specific exclusion in relation to claims arising from the provision of professional services therefore personal injury claims are a core professional indemnity exposure for many engineers. For example, an engineer providing certification services in relation to amusement rides would have an appreciably greater personal injury (professional) risk exposure than an engineer providing strategic management advice.

Financial Loss

Monetary loss suffered by a third party as a result of an actual or alleged breach of professional duty. For example: Costs incurred or income lost due to delayed delivery of a project arising from the actual or alleged breach of professional duty by the project manager responsible for timely delivery.

It is important to also remember that a cause of action and resultant claim may contain elements of one, two or all the above.
Nature of services provided: The risks associated with engineering varies across the spectrum of services provided by engineering consultancies, in our experience the generality of a role also has a strong correlation to claims exposure. Examples: Structural engineers are generally in a higher risk category than draftspersons. Also design or certifying engineers are generally in a higher risk category than a strategic management consultant.

Your willingness and ability to carry financial risk

This requires an assessment of the extent to which you are prepared to expose your assets by either carrying a higher excess or lower policy limit and your ability to control the risk or transfer liability to other parties involved.

Affordability

With PI being a significant overhead for many consultancies you will need to weigh up the above factors against what is economically viable for you. In this regard increasing the limit for a particular client or project may not be feasible however if carrying a higher limit opens up the possibility for additional clients or projects the business case may be justified. However it is important to appreciate that due to the claims made nature of PI, once you have selected a higher limit you will need to continuously purchase at least that limit in the future to maintain that level of cover for your past work.

A common misconception is that there is a strong correlation between fee income of the professional for a particular project and professional negligence exposure of that engagement. This is not the case with significant PI claims arising from projects that generated minimal fee income.

A useful tool is the Professional Indemnity Insurance Guidelines issued by the Australian Procurement and Construction Council (APCC) which involves a detailed risk assessment from the client’s perspective considering a range of issues including the consultant’s skills, experience, resources and method of project delivery. Whilst these guidelines were drafted for the public sector in 2005 when the insurance market was a lot "harder" they remain a useful public document likely to carry some weight and assist in negotiating down what are considered unreasonable client impositions.

These guidelines are available from the APCC website: www.apcc.gov.au

If the limit of indemnity provided by your policy is insufficient to settle a claim the insurer is likely to pay up to the policy limit with your own assets being exposed above this amount. For policies that operate on the "costs exclusive" limit basis (subject to the particular policy wording), if you are underinsured the insurer may also reduce their liability for legal costs in proportion to your underinsurance.

Increasing the limit of indemnity from the general industry minimum of $1,000,000 up to $2,000,000 for example may only add 20-30% to the total cost of your policy; this relatively small cost increase effectively doubles the level of protection.

Ultimately the limit you purchase is an extremely important decision to make because your professional Indemnity Insurance is likely to be your last line of defence in the event of a claim. This is a decision that demands serious consideration by senior management.

To the extent that any of the above content constitutes advice, it is general advice without reference to your needs or objectives and therefore cannot be relied upon. Before acting on the above information you should obtain advice specific to your needs.

 
 

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