Professional indemnity insurance basics

Some professionals may be unaware of the traps which can exist even where PI insurance is in place, leaving themselves exposed to new, uncovered risks or prolonging the agony and expense when claims do arise.

Avoiding these traps lies not only in obtaining the most appropriate PI insurance policy for your circumstances, but also by disclosing past claims and notifications, understanding the policy’s cover, its limits and its requirements for managing notifications and claims.

Under a PI insurance policy, the practice is indemnified against claims for legal liability arising from a breach of professional duty in the course of the profession covered by the policy – most importantly, professional negligence claims and if included in the policy, liability arising from statute, such as the Competition and Consumer Act (formerly the 'Trade Practices Act'). Many policies also provide limited cover for claims for breach of contract. Legal defence costs incurred with the consent of the insurer are also covered – sometimes as part of the policy limit, otherwise in addition to it.

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Cover as an ‘architect’

While the standard wording of a PI policy may not differ very much between one profession and another, the profession or 'insured business' stated in the policy documents (the Schedule) is critical to what is covered by the policy.

When your practice is described as ‘architect(s)’ the insurer takes that to mean you carry out the activities and usual business of an architect (according to how the insurer understands that business). If the policy is for the profession of 'architect' it will not, unless the policy is endorsed specifically, cover your practice for, say, design construct activity you decide to undertake at the request of a client. If you wish your cover to extend to what would ordinarily be the usual business of another profession or occupation, the insurer would understandably want to gauge your competence in that field to assess its risk, and may well decline to insure that activity, or, insure it only at high cost or with policy exclusions.

The reason for the exhaustive annual questions on a policy proposal form is so the insurer can assess the risk of covering your practice’s business. Conversely, non-disclosure by you may enable the insurer to avoid liability for a claim involving that business activity.

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The standard of competence

Another aspect of the particular insured profession of ‘architect’ is the anticipated standard of competence required of the named business. The insurer ordinarily assesses the risk it must cover under the policy according to the standard of care of the architect of ordinary skill and competence. Because a PI policy is primarily covering the insured architect against being found negligent, and therefore liable to the person taking action against the insured, it makes sense that the insurer anticipates the same level of skill and competence as the law would expect from the architect in determining whether the architect has been negligent.

In other words, if the architect is found negligent in having failed to apply the standard of care the law expects, the insurer will have to pay out under the policy – if the architect is not found to be negligent, even though the architect’s work may be lacking perfection, (all other things being equal) the architect is not liable and the insurer does not have to pay out although legal costs may be incurred in this process.

Representing a higher skill and competence than you possess can prejudice your insurance cover. Depending on the accuracy of your representation, it is likely that the law would hold under the Competition and Consumer Act and/or the common law, that your client is entitled to rely on the skill and competence that you have represented. The law will then hold you to that representation, imposing a higher expectation on your skill and competence (compared to what is normally expected of an architect) in assessing your actions and conduct. If there is then a claim against you and your actions and conduct fail to meet the standard of the more highly skilled and competent architect you had represented, it is likely you will be found to be negligent (prima facie) (and/or not to have delivered according to your representation).

From the point of view of the insurer who did not endorse you as insured for the higher standard of skill and competence – if you had not made the representation, you would not have been found negligent or to have failed to deliver on your representation and the insurer would not have had to pay the claim. Because you were held to the higher standard you represented, the insurer is now (prima facie) required to pay out. Because the insurer would not be required to pay out if you had not made the representation, the insurer is entitled to pay out only that which it would be required if the representation had not been made – which may even be nothing at all. You are still liable for the damages the court imposes on you for not meeting the standard of skill and competence the law holds you to.

It is important then, to be cautious about making such representations.

Common ways such representations can be made are:

• agreeing to sign a client architect agreement describing what is required of you at a higher standard than the architect of ordinary skill and competence
• making representations of similar effect in your marketing material
• conversations with your client
• letters between you and your client prior to firming up the commission
• your website (even though you have not directed your client to look at it)
• other documents available to your client.

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What is different about 'claims made' insurance?

It is essential you understand that PI insurance is a ‘claims made’ policy. In contrast with most other insurance, PI insurance covers claims actually made or 'intimated' during the term of the current policy, even though the events leading to the claims may have occurred long ago. Each professional indemnity policy lasts for a fixed period, usually a year, after which it needs to be renewed. In the context of insurance claims, 'intimated' means foreshadowed (or hinted at) or circumstances or events have become apparent to the insured that indicate a vulnerability to a claim.

Once a claim is made or intimated (ie the matter does not need to be in a legal form), and either of these is acknowledged by the insurer, the claim will be dealt with under the policy in place at the time of the notification to the insurer, irrespective of when in subsequent years the claim materialises or is substantiated. Because it is covered by that policy, subsequent policy renewals will usually specifically exclude that claim, or intimation of a claim, from cover under them.

If a PI policy is not renewed, it will lapse on the policy expiry date, and that means after it has lapsed without renewal the architect will have no cover for any new or intimated claims that arise from either their past or their future work. This is why it is so important for you to renew your PI policy promptly each year, well in advance of the expiry date, so as not to allow any gaps in insurance cover.

This also means that, when retiring as a sole practitioner or winding up a business, it is important to consider as part of retirement planning, maintaining PI insurance in future years, to cover any new claims arising out of past work. This is called ‘run-off cover’ and may be available to you through your current insurer. In the current insurance market it is very unlikely to be available to you as an afterthought should you allow your PI policy to lapse before retirement.

The 'claims made' nature of professional indemnity insurance means that it is often impractical to get insurance for just one project. A policy obtained just for the year in which design and construction takes place will only cover claims that arise in that year. If the architect wants cover for new claims arising out of the project in future years, then the policy needs to be renewed and maintained for future years.

Different sums insured in different policy periods can be a trap because of the ‘claims made’ nature of PI policies, requiring notification of intimations, including circumstances and events that might give rise to a claim, which deem the claim to be made at this time under that policy. For example, reducing the level of cover in subsequent years where the level was much higher in the past for substantial projects, may leave inadequate levels of cover in the year that a very significant claim for one of the substantial projects materialises.

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Retroactive date

As the policy is ‘claims made’ and covers claims made during the period of the policy arising from past events, it is crucial to the effectiveness of each policy in each year that it does not exclude work you have done for which a claim may arise. For example, where the practice has been undertaking projects since 2006, but the ‘retroactive date’ in the current policy is 2009. This would leave any claims arising in this policy year from the practice’s 2006 work up to the date in 2009 without retroactive cover.

The best position to be in is to have a retroactive date of 'none' or 'unlimited' which means that new claims arising out of all past work are covered, no matter when the work was undertaken. Changing insurers is a circumstance in which retroactive cover issues can arise, requiring caution.

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Who should be covered?

A practice may be held directly responsible for its own actions and those of its employees, agents or sub-consultants and joint venture partners.

Subject to retroactive dated issues, most PI policies also cover the activities of past directors, partners and employees. As long as the practice continues to take out PI policies on the same terms, claims arising against such persons will be covered by the practice’s current policy. However, if you have been personally involved in projects at a very senior level of responsibility, not just as a partner or director, there is personal risk where the practice does not continue, or does not continue to take out insurance.

As a partner or director, it may be advisable when leaving a practice or retiring from it, to negotiate with the assistance of your lawyer an undertaking that the practice will continue to insure for a set number of years, or will take out and maintain run-off cover for a set number of years. Note that if the practice fails to keep its promise, run-off insurance may still be very difficult for you to arrange personally, at some later time.

If engaging sub-consultants or working in joint ventures, practices should make sure the policy covers these activities (many policies do not).

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The proposal form

Before making an offer of insurance, the insurer will require the architect to fill out a proposal form. This document conveys to the insurer information about the nature of the architectural business which is vital to the insurer’s evaluation of whether to offer insurance, on what terms and at what price (the premium). The proposal form should be filled in accurately and with great care, recognising the obligation of good faith. Failing to disclose relevant information can (at best) entitle the insurer to charge additional premiums before paying any claims, or (at worst) there is a serious risk that the insurer could be entitled to refuse to pay claims altogether.

Some of the more important details usually requested in a proposal form include: the value of services undertaken over the previous year, the sort of professional work undertaken (which drills down into more detail about your particular architect business), the number of staff in the practice and/or their qualifications, and any previous professional indemnity claims or notifications.

Every year when the policy expires, the insurer will generally require the architect to update information about their practice before the insurer will offer renewal terms. You must disclose all existing claims or circumstances that may lead to a claim, and especially if you are intending to change insurers. If you do not disclose a possible claim at this point and later seek to notify insurers of the claim, your claim is likely to be denied.

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The amount of insurance

The 'limit of indemnity' on a PI policy is the maximum amount the insurer is obliged to pay out on any single claim. The 'aggregate limit of indemnity' is the maximum amount the insurer is obliged to pay out on all claims in a single policy year.

Some considerations a practice would normally take into account when determining an appropriate limit of indemnity for their PI insurance are:

• any minimum requirements imposed by law or regulations
• the contract value of the projects they are typically undertaking
• the expertise and experience level of staff, including partners and directors
• the type of contract and the delivery strategy
• the type of client for whom work is being undertaken – commercial and government clients are often particularly insistent upon higher limits of indemnity being obtained
• the potential for third-party bodily injury claims, property-damage claims and consequential-loss claims to arise
• the effect of inflation on the cost of construction, and on damages awards, bearing in mind the long delay that occurs between the date a claim is made and its final settlement or court determination
• an architect's individual perception of risk, and their own risk-appetite.

The risk of setting the limit of indemnity too low is that, if a very large claim is successfully made against the architect or practice, the insurer will only pay the limit of indemnity (and possibly some legal costs in addition). The architect or practice will then have to pay the rest of the claim over and above the limit of indemnity out of their own pocket.

The construction contract should be used only as a guide, because rectification costs, or consequential losses, can easily exceed the physical value of the works or the value of the contract.

The sum insured is usually an aggregate limit, which gets ‘used up’ in that year of cover, as claims are made. So the volume of work done in the past history of your practice is a relevant consideration. A policy providing for automatic reinstatement of cover is a very wise option.

Architects should regularly check, and update when appropriate, the level of their professional indemnity insurance cover taking into account the factors such as those listed above.

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Client request for higher cover

There are a number of factors to be considered in the event that your client requires you to have professional indemnity cover with a limit of indemnity that exceeds the level that you currently hold.

• Ask yourself why the request is being made, and evaluate your appetite to take on an additional risk which is ongoing.
• Does the requested level reflect or overstate the risks associated with the scope of services that you will be providing on the project? Is the level of cover requested reasonable in the circumstances?
• Remember that if PI limits are increased for a particular project this will almost certainly mean higher insurance costs into the future. Does the financial reward from the particular project justify the additional expense of increasing your limit of indemnity for the project and into the future, either in case there is a major claim, or because your client insists on it under the terms of your engagement?
• Review your PI requirements with your insurance broker.
• Consider requesting your client to pay for increased premiums due to a higher level of PI and for an appropriate period of time into the future.
• Consider the corresponding PI of any sub-consultants you are to engage. If possible, have them provide identical PI cover and similarly require it to be maintained for as long as you are exposed to risk for sub-consultants’ errors (an almost indefinite period, but a minimum of 10 years).

The most important thing to remember when asked by a client to take out additional professional indemnity cover is not to automatically agree to the client's request without considering the possible consequences. It is always worthwhile to negotiate the level of cover acceptable to you. Raising the matters listed above in discussions with your client should assist you in negotiating an acceptable outcome.

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Cover for legal costs

Professional indemnity policies almost always provide some cover for the legal costs and expenses associated with defending a claim, but they differ in how much cover they provide, and whether it is part of the limit of indemnity, or in addition to it.

The 'limit of indemnity' is the maximum amount the insurer will pay on any single claim. If the limit of indemnity is $1 million and the policy says that the limit of indemnity is inclusive of costs, then the insurer is offering to pay only $1m for the combination of compensation and legal costs. If a claim costs $900,000 in damages and $300,000 in legal costs, the insurer only pays $1m and the architect has to pay the additional $200,000 out of their own pocket. On the other hand, if the policy says that the limit of indemnity is exclusive of costs then the insurer is offering to pay up to $1m for the claim and also up to $1m for legal costs. So in the example scenario, the insurer pays the full $900,000 as well as the $300,000. (Note - in both cases, the architect would still have to pay the policy excess/deductible.)

The excess/deductible on the policy will also be stated to be either ‘inclusive’ or ‘exclusive’ of costs. ‘Inclusive’ means that, as soon as any legal costs are incurred on the claim, the architect has to start paying the policy excess/deductible. If the excess is ‘exclusive’ then legal costs are wholly paid by the insurer, and the architect only pays the policy excess/deductible if the claim is successful and some compensation has to be paid to the claimant.

A cost ‘exclusive’ excess and limit of indemnity provides the greatest cover. Often, when insurers offer 'cheap' policies, it is because the policies are 'inclusive' and therefore offering less cover.

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