At a fundamental level, insurance companies and design professionals have quite a bit in common. They look to attract and maintain profitable clients, they look to grow their top line (gross revenues) and their bottom line (profits) on a year over year basis and, ultimately, they are in business to make money— just like you.

A/E and environmental professional liability carriers are in an extremely tough space. Claims profiles for those within the A/E community can be described as infrequent but catastrophic losses (contrasted with the more predictable insurance cover of say, auto insurance, which is characterized by frequent claims with the occasional catastrophic loss— leading to very predictable results). It is not unusual for A/E firms to say, “We have never had a claim in five years/10 years/15 years.” However, in a general sense, there is little statistical credibility to that statement. Note, however, that I wholeheartedly feel that practice management— include financial management, HR management and client selection— is a fairly reasonable determinant of a firm’s propensity toward loss— so it’s not all “luck” that some firms have better results from an insurance perspective.

Crystal ball predictions

There remains plenty of competition among insurance carriers for the “better than average” A/E firm’s business. (By this I mean firms that have had (1) low claim frequency and severity (2) firms not engaged in “tougher” service/project types— like bridge design or condo work (3) firms with strong balance sheets (they are turning a profit; aged AR’s outperform the industry average) (4) firms with low employee turnover and excellent internal controls that can be illustrated to the insurance carriers.) I predict, however, that despite the competition, insurance carriers will be forced to raise their rates in the next 12 months due to the following more generalized market conditions:

1. Significant losses in their investment portfolios that must be “marked to market” under Financial Accounting Standard Board (FASB) rules. Underperforming investment portfolios and the inability to achieve 15% return on investment by the industry (the standard performance benchmark) will force carriers to push rates higher.

2. Increased costs in reinsurance (most reinsurance covers are negotiated on either 07/01/xx or 01/01/xx). Higher costs of reinsurance or the assumption of more net risk by the primary carriers will cause a retraction in risk appetites. For example: if they cannot lay the risk off on someone else or the cost to lay it has risen, the end purchaser will have cost increases passed on to them.

3. Continued deterioration in results in the A/E space due to an increase in claims frequency as a result of the economic downturn in the construction space. Whereas some owners/developers/ contractors may have been willing to “work” with the design team when problems arose in the past, the squeeze in the availability of financing; shrinking tax rolls for government funded projects and aggressive sureties looking to recoup losses on projects means that what were once “little squabbles” are now turning into full blown litigation. Ask your built environment counsel if they are seeing anecdotal evidence of same— I predict they will answer affirmatively.

Even beyond the costs of insurance is the underwriter’s return to a more disciplined approach to risk. (As mentioned above, firms with lower propensity toward loss will continue to be attractive.) Firms in the more litigious legal regions (metro New York/New Jersey/Florida/ California/Texas/Illinois (Cook County)/Massachusetts) will likely be hit first by a retooling of underwriter guidelines and practices. For example, you may see:

1. Reduced availability of multi-year program guarantees.

2. Reduced availability of First Dollar Defense.

3. Reduced availability of higher limits of insurance or a stockpiling of capacity by the insurance companies. This is already a reality. We now are seeing some underwriters who are particularly reluctant to expose themselves to large vertical limits losses on K-12 projects and complex infrastructure projects.

a) This is especially true on smaller/midsized firms whose request for higher limits is owner driven. However, such limit requests are disproportionately large as compared to the A/E’s fee on the project. For example: $10 million in required limits on a project with total CV’s of $15 million. The underwriters are simply saying “no” to such requests.

b) Many of these claims on higher limits would be passed on to the reinsurers who, as mentioned earlier, are charging more for their covers.

4. More requirements toward insured’s larger assumption of risk through increased deductible obligations. Don’t discount how a larger deductible can negatively impact your bottom line. Accounting rules don’t allow you to maintain a “rainy day fund” for potential claims. So, deductible obligations are pulled directly out of profits.

5. More non-renewal/cancellations on unprofitable (read, claims frequency or severity) design firms. This is juxtaposed against the historic practice by A/E insurers (and the A/E’s themselves) whereby they (and you) remained linked together long-term through thick and thin. It should be noted that we believe that there is accumulated value in the maintenance of insurance relationships over time. Unfortunately, at some tipping point— price on the consumer side or unprofitable results/losses from the carrier side— leads to a divorce of this relationship.

I hope that my predictions are completely wrong, however, as mentioned earlier, insurance companies and A/E firms have quite a bit in common. The construction business and the professional liability/commercial insurance business is marked by cyclical patterns. A “bottoming” of the construction cycle would be welcomed by the A/E community; however, a similar “bottoming” of the insurance cycle will lead to additional overhead for the A/E community.

Timothy Esler's original articles are published in The Zweig Letter.