Proposed changes for professional indemnity insurance (PII) run-off in the UK

5 Impact assessment

Summary of impacts

5.1 If we implement this proposal, there will be additional requirements on firms, as they will be restricted to having a prescribed minimum amount of PII run-off at the point of deregistration. The prepaid nature of this policy will have a further financial impact, as all costs would be prepaid in this proposal, unlike in the past where annual premium payments would spread out the cost over the life of the policy. The one-off cost is estimated to be equal to 150-200% of the last annual PII premium. We consider this resolves the issue of non-payment of premiums during a six-year period. Market insight also suggests this would be the most cost-effective option and achieves the desired balance between affordability and assurance.

5.2 Insurers will be required to take on a greater pooled risk (though not necessarily risk overall) through the ARP. Feedback from insurers suggests that this should not significantly impact their costs. Insurers with a larger proportion of the PII market for surveyors will have proportionally more risk through the ARP, although there will be a minimum of 1% of total risk for every firm, in line with the existing ARP structure.

5.3 The current role of the ARP will be diversified and expanded. The new function will not be a tool to improve the risk exposure of firms, as it will not include the ability to consultatively manage risk towards the goal of lower premiums. This is because any firm approaching the ARP for run-off will be ceasing to trade and cannot alter their risk retroactively. Many more firms will be likely to have direct interaction with the ARP when seeking run-off. This may lead to increased demands on the administration of this structure.

5.4 There will be greater assurance for all parties that PII run-off will be both available and in place on prepaid terms, which will negate concerns surrounding annually paid premiums.

5.5 Consumer clients and smaller enterprises will be ringfenced for greater minimum protection than large commercial clients. We have considered that commercial clients are better able to manage risks and retain greater ability to influence terms than consumer clients. The stated minimums will not preclude regulated firms from requiring 'adequate and appropriate' run-off should they have a history of undertaking work for large commercial clients.

5.6 A possible consequence of the higher initial cost for firms would be an increased prevalence of firms that cannot de-register due to the cost, but that are no longer actively trading, which could increase occurrences of disorderly deregistration e.g. due to liquidation. This possibility could devalue the offering of RICS firm regulation as it could be perceived as burdensome to withdraw from.

5.7 We believe the most likely negative impact resulting from these changes is that it could motivate a portion of insurers to leave the overall PII market for surveyors. We estimate that 5% of the smallest insurers might leave the market, but we would welcome views from insurers on this estimate. We would also welcome views on how this may change in adverse market conditions.

Impacts on firms

5.8 Firms will, for the first time have broad access to their preferred form of PII run-off cover through the ARP. This will likely lead to this insurance product becoming more prevalent in the open market as insurers become more familiar with it.

5.9 Firms will need to plan for the financial impact of prepaying for their six-year policy at the point of de-registration. Market intelligence tells us that this value will be 150-200% of their annual premiums when trading. Annual payment of premiums for PII run-off will no longer be possible and this will have implications for those wishing to pay for their run-off over time.

5.10 This policy will remove the flexibility for firms, with the advice of their brokers, to opt to maintain lower levels of run-off cover or to self-insure these risks. While this will be an additional burden on some firms, we anticipate that the pricing of the premium for the run-off policy will reflect the level of risk that the firm represents, and so low risk firms will not face a heavy financial premium.

5.11 Taking the average of the projected range of premiums to be 175% of the annual premium, we have prepared the following examples:

  • Firm A are relatively small with a low turnover, low frequency of complaints and/or claims. They pay £3,000 annually for their PII cover. Thus the one-time PII run-off premium = 175%(annual premium) = 1.75 (£3,000) = £5250; and,
  • Firm B is a large firm with a high turnover and relatively high frequency of complaints and/or claims. They pay £100,000 annually for their PII cover. Thus the one-time PII run-off premium = 175%(annual premium) = 1.75 (£100,000) = £175,000.

5.12 Once they have paid the premium and the policy is in place, firms will have assurance that they will have PII run-off cover for six years after ceasing to trade, even in unforeseen circumstances, e.g. death of a surveyor that is a sole-trader. This assurance was seen to be in high demand from the profession in the responses to the previous consultation with almost unanimous preference.

5.13 The cost of PII run-off may act as a deterrent to the practice of 'phoenix firms' in some cases. The term refers to firms closing operations to escape liabilities and then quickly setting up again to continue trading.6

5.14 We would welcome comments and views from firms on the impact this may have in your ability to sustainably close.

Impacts on insurers

5.15 These changes may result in some insurers leaving the market, which may have the effect of reducing competition for those that choose to stay involved. We estimate that approximately 5% of insurers, with a relatively small exposure to RICS, will leave the market. A reduction in competition may lead to higher premiums overall. However, discussions with insurers suggest the likelihood of this occurring on a significant scale is low in the case of the proposed changes.

5.16 Insurers will be required to offer PII run-off cover via the ARP to be an RICS-approved insurer. Larger insurers will be proportionally more exposed to risk via the ARP, though there will be a minimum amount of risk that will need to be taken on by insurers (1% of total).

Impacts on consumers

5.17 Consumers will have assurance that PII run-off is in place even if a firm has closed, to the extent of at least six years after ceasing to trade.

5.18 Consumers will have further assurance that if a regulated firm is exposed to both consumer and commercial claims, successful consumer or SME claims will have access to a ringfenced compensation pool regardless of any competing claims from large firms.

Impacts on commercial clients

5.19 The proposals will give commercial clients assurance that all firms regulated by RICS will retain a minimum package of PII run-off up to six years after ceasing to trade, including up to £1.5m for commercial claims.

5.20 It is feasible that, should the policy of a regulated firm pay out £2m in consumer claims, a commercial client may not have access to compensation. That said, we consider they are likely to have the ability to require, as a contract condition, a guarantee from firms that necessary PII run-off arrangements are made to cover any possible claims. RICS would still expect all cover to be 'adequate and appropriate.'