Contributed by: Eric M. Alderson, CRIS®
Risk Manager - Promark Assoc. Agencies, Inc.
There are many points of consideration when calculating your premium during the underwriting process. In this article, I'm focusing specifically on that coverage because not only is professional liability coverage a top annual expense for most firms, it's also one of the least understood. That isn’t to say that having a better understanding of the process necessarily makes writing that big check feel better, but I often find that when a client understands the factors that impact their cost, they realize some of the ways it can be controlled, it starts to make a bit more sense. Understand also, as part of this article we're not taking into consideration market conditions which play a major factor in premium calculation. Anyone who has been in business for more than 15 years can tell you first-hand what a soft market has done for their insurance costs. The rule of supply and demand matters and the insurance industry is certainly not immune. For the purposes of this article, we're assuming similar rating structures and appetites across the board for insurance carriers. As you may be aware, some insurance companies prefer to write specific types of firms over others, so if your firm fits within a particular carrier's "preferred mold", you're going to see very favorable rates. Finally, I had to distill this down to five. There are many factors contemplated that we are not discussing in this article, mainly because we touch on it so often in other forums; risk management practices, contract types and contractual provisions, your firms geographic location, insurance coverage history and general business management practices which have a significant impact on your final cost. We are focusing on the most influential. To that end, here are the top five factors that impact your professional liability insurance premium.
5. Clients & Project Owners:
During the underwriting process, the probability of claims from specific client and owner types are considered. From a risk perspective, the insurance company may prefer that your projects are with private sector Owners (statistically lower risk), but your client may be a contractor (statistically higher risk). For the purposes of this section, I’m not going to delve into the specifics of why this is the case, but simply understand that some client types are generally more prone to claims than others and higher rates are applied. This data also provides insight to the underwriter about what other information to pay attention to in the application. It may indicate how often you’re a Prime consultant rather than a Sub. There are different risk factors associated with each and that information is weighed against other factors in the application to make further determinations about your risk profile. For example, if you are typically retained directly by the project owner and also list a high percentage of fees paid to subconsultants, you’re probably a Prime. In that case, additional controls must also be in place to mitigate that heightened risk factor. As a Prime, you should be hiring only insured subconsultants and use a written agreement that coordinates appropriately with your Prime Agreement. Flow-down terms and conditions should be identified and caution taken to make sure there are no gaps. You are vicariously liable for the services of your subconsultants, so the risk profile increases.
4. Disciplines / Services / Project Types
It should come as no surprise that the higher risk your services are, the higher the rate underwriters apply. But “risky” can be somewhat subjective. In fact, what one insurance company deems high risk, another may consider moderate. It all comes down to each insurance company’s experience (claims) with specific disciplines or services. Structural engineers, for instance, are applied a much higher rate than interior designers. That isn’t to say that interior design firms will have less claims, but when they do, the payout will likely be far less severe. Similarly, within each discipline are higher and lower risk services. As an architect, a higher risk service within that discipline is façade restoration. Even riskier still is an architect who provides façade restoration services on high-rise apartment buildings in a major metropolitan area. Again, the higher probability of loss, the higher the rate. As alluded to previously, some projects are riskier than others, and just like the rest of the factors discussed here, the rates are based very heavily upon the insurance company’s actuarial data. Two civil engineering firms located in similar areas, with similar annual gross revenue, may pay very different professional liability insurance premiums based on the type of projects entered into by each. A firm who contracts to provide a site plan for a new single-family residence may pay far less than one who specializes in full scope engineering services for road and highway projects. The probability for loss and the high severity thereof, increases the rate applied during underwriting.
3. Liability Limits & Deductible
The more money the insurance company puts on the line to cover your firm, the more premium you’ll pay. It’s just that simple. Higher limits = higher premium. In the same vein, your insurance carrier is responsible for a greater portion of the limit if you carry a low deductible or self-insured retention (SIR). In fact, underwriters often have a “sweet spot” for both limits and deductible amounts. Depending on the size of your firm (and the litany of other factors outlined herein), underwriters will often give favorable rates for firms who carry certain limits and deductibles. It may seem counterintuitive, but underwriters will cap deductibles for firms of a certain size for fear they may not be able to pay that amount after a claim. For that reason, some insurance companies employ SIR’s rather than deductibles. The terms may be used interchangeably by some insurance brokers, but they’re very different. A deductible is an amount owed back to the insurance company after claim payments are made on the policy holder’s behalf. An SIR means the policy holder is responsible for that amount as soon as expenses are incurred. Often, payment of an SIR is a condition precedent to further coverage, effectively eliminating the insurance company’s exposure to unpaid deductible obligations. It doesn’t change the way claims are handled, just the timing of your contribution. To that end, for policies that are written with SIRs, you may not have additional options available to you like first dollar defense coverage. This is a more expensive deductible option offered by some insurance carriers for firms who meet certain criteria, including size limitations, favorable loss history, disciplines, services, etc. Instead, you may only have the option for a standard SIR or for a shared retention, where both you and the insurance company share the cost of claims expenses.
2. Loss History
Claims activity makes this list as the second most influential factor in determining policy cost. Firms that have significant claims activity will generally pay a higher premium. Conversely, firms with a clean loss history pay less. Once all the other underwriting factors are considered, your policy is applied a surcharge, or a credit related to your loss ratio. Loss ratio is calculated by claim (and expense) dollars paid versus premium dollars collected. When that ratio is upside down, surcharges are applied. Typically, once a firm gets to around a 30% loss ratio, additional rate is applied. That threshold varies by carrier. Depending on the size of your firm, carriers will either review a five year or a ten-year loss history. Firms with gross annual revenue greater than $5 million, will typically be subject to a 10-year history. This can be positive and negative. For larger firms, over a 10-year period, they have more premium dollars paid that can help absorb losses and keep their ratio reasonable. However, for firms with a catastrophic loss on their record, they may never pay enough premium to make up the difference. In those cases, a longer review period is detrimental. Your claims are reviewed for their duration for as long as they’re in an open status with the carrier. So, if you’re a smaller firm, subject to a five-year loss history, your seven-year-old claim that is on-going, may still be factored. However, once that claim closes, it’s removed from the loss ratio calculation altogether. Surcharges applied to a claim diminish over time. The further removed a policy period is from a claim, the less impactful it is on your premium. Once a closed claim falls outside of the review window, it’s as if it never happened.
A common misconception about claims is the idea that frequency is problematic. Unlike your personal auto policy, you’re not penalized for simply reporting a matter to your insurance carrier. In fact, when it comes to professional liability, your carrier prefers that you report as much activity as possible to allow them the opportunity to get ahead of a potential claim situation. [Hopefully], your policy includes a coverage provision called “pre-claims assistance”. If it doesn’t, call me. You need it. This provision allows you (not mandates you, very different) to report circumstances to the insurance company. Upon that report, the insurance company may elect to spend their own dollars to investigate and help you mitigate the matter in an effort to avoid a claim. It costs you nothing (except the cost of the policy). It does not erode your limits and is not subject to your deductible, AND underwriters can apply subjective premium credits to firms who they believe are proactive in the claims management process.
Additional considerations are given to firms who settle claims through non-binding mediation. This is not an article about alternative dispute resolution, but the insurance company wants so badly for you not to arbitrate that, in many cases, they’ll refund half of your deductible for claims successfully resolved through mediation instead.
- Gross Annual Revenue
Finally, your billings. What do your billings have to do with your risk? Well… a lot. The size of your firm, your firm’s gross annual income, is the basis for everything we’ve just discussed. This is the very first factor contemplated, before anything else is considered, as a means of determining the base rate for your premium. The logic is simple; the larger your firm, the more projects you undertake, the larger the scope and scale of your services, the more risk you tend to incur. This is one area, similar to some degree, to your projects and services, that just sort of are what they are. You can influence risk management practices, and even contracting practices, but if your firm provides structural engineering, that’s the rate you’re given. If your firm bills $10 million per year, you’re a $10 million firm any way you slice it. So, what can you do to make sure you’re viewed in the most favorable light by the underwriter? Appropriately allocate your billings. This is where your broker comes in. Understanding all the factors we just reviewed, your broker can help make sure the billings you report are categorized to best represent your firm to the underwriter. Keep in mind, in most cases, the only thing they know about you is your application. If important information is misclassified, or not provided, it can leave the underwriter to make certain assumptions and potentially misinterpret your profile. Adequately accounting for your low-liability services, breaking out fees paid to subconsultants, reimbursable expenses and appropriate classification of lower rated services are all areas that can be examined during the underwriting process. Smaller firms may have the ability to procure relatively inexpensive coverage and have the benefit of some nice policy features not always available to larger firms, but larger firms have the benefit of significant rate flexibility that makes examining these factors on an annual basis that much more important. Larger firms can also have unique coverage considerations included in the policy that smaller firms may not be able to negotiate. Special services not typically covered, removal of certain policy exclusions, client specific requirements, etc. are all considerations available to large firms that allow them to craft coverage very specifically to their unique needs.
In general, when insurance companies are quoting your firm, they're all looking at the same set of data. The items listed above may be more impactful for one company versus another. And again, we didn’t cover them all. The way insurance companies apply their rates, individual loss experience with certain risk factors (actuarial data), and their general comfort level (appetite) for certain types of risks, all play a role in calculating your final cost. My job as your risk manager is to help you understand these factors, identify the areas where you can control the cost, help you implement programs to better manage your risk, reduce the probability of loss and ultimately advise you on how best to represent your firm’s profile to maximize available credits and gain the most favorable rates. In the end, all of this horribly boring information that most of you probably didn’t read, or at best skimmed, is our job at Promark to know and understand. It's your job to be a design professional. Like you, we strive to be a trusted advisor and resource for our clients by staying abreast of this ever-changing market.
As the saying goes, “If you think it’s expensive to hire a professional, wait until you hire an amateur.”