RICS draft guidance note - Risk, liability and insurance, 3rd edition

Risk, Liability and Insurance - 3rd edition

6 Professional indemnity insurance (PII)

6.1 All regulated firms need to ensure they have adequate and appropriate professional indemnity insurance in place that complies with the requirements of the RICS Rules of Conduct and the RICS Minimum Requirements

6.2 Insurance is a key part of managing risk. That firms maintain insurance is also in the interest of members' clients and therefore the reputation and standing of the profession. This is one of the main reasons RICS takes a role in ensuring that firms are adequately insured.

6.3 All members should be aware of the following points about PII:

  • In arranging PII, members should ensure the amount of cover purchased is consistent with the nature of the firm's practice and proportionate to the risks taken by the firm.
  • Limits of indemnity may now apply on an aggregate plus unlimited 'round the clock' reinstatements basis. This term refers to the reinstatement of an aggregate limit following a loss or claim. A 'round the clock' reinstatement indemnity limit means that each layer of indemnity will step down as its underlying layer is exhausted. When each layer has been exhausted up to the full limit of indemnity, the cycle should start again and reinstate back to the primary layer. Firms need to ensure that they receive clear guidance as to how reinstatement of the limit will be applied and satisfy themselves that it complies with the terms set out under the RICS minimum terms and requirements. Firms also need to ensure that each excess layer follows the terms and conditions of the primary policy.
  • When choosing the level of insurance that is required, it is important to consider the effect of the aggregation clause in the policy. This clause will typically provide that where a number of claims arise from the same originating source or cause, such as a repeated error or omission, then all claims will be treated as one, attracting only one limit of indemnity, which may be insufficient.
  • Member firms' risk management must not begin and end with putting in place professional indemnity insurance, because insurance is a contract that contains limits, conditions, and exclusions: it is not a guarantee, and it will not cover everything. Careful attention to the terms of engagements (including the use of liability caps), and ensuring consistent quality in valuation practice and reporting, continue to be fundamental to effective risk management.
  • When signing contractual documents, firms should bear in mind the policy coverage in respect of contractual liabilities, specifically the contractual liability exclusions of the policy such as express guarantees, fitness for purpose obligations and the exclusion of liability where there has been reliance on an EWS1 form (or as revised) and the valuation report does not exclude liability to the lender or any person deriving title to the mortgage.
  • At the time of this publication, there have been a significant number of claims notified to the PII market involving cladding and fire safety, which involve a number of different professional services firms. As a result, insurers are at best, restricting cover relating to cladding and fire safety claims but in many cases imposing total exclusions. In the event insurers impose specific terms in respect of fire safety or if a complete exclusion is imposed on a firm's PII policy, it is recommended that firms consider carefully the impact this will have on their business. A firm's PII broker should be able to advice on safeguarding measures to put in place to mitigate risk in this area.
  • Claims on a firm's PII directly affect the cost and terms of insurance in the future. In practice, that means it is in the interests of the firm's partners and senior staff to maintain an active involvement in risk management, so as to minimise claims under the policy.
  • Members' PII policies typically are provided on a 'claims made' basis, almost invariably on an annual basis. This means the policy that responds to a claim is the annual policy in force when the claim is made, regardless of when the relevant work was done. This offers great simplicity, but it does entail some pitfalls; in particular, if a firm were to allow its insurance to lapse from a certain date, it would have no insurance cover for claims made after that date.
  • Member firms should ensure at all times that in the event of the firm's practice ceasing, there will be 'run-off insurance' in place to protect the firm's partners and its customers. There will remain a risk of claims against the firm and its partners for at least six years after a cessation, and those claims may not be covered if the firm does not have run-off insurance for the duration of that period. This is a subject that should be considered by all firms at all times, not only those for whom a practice cessation is an obvious or imminent threat. As can be seen from section 2.7, six years should be looked on as a minimum, because it is possible that claims may be brought more than six years after a valuation has been provided.

6.4 RICS requires firms to put in place run-off cover. In addition to the consequences detailed in the paragraph above, a failure to comply with this obligation may be a disciplinary matter. Insurers should provide a £1,000,000 aggregate limit in all policies for a period of sixyearsfor consumer claimsfrom the expiry date of the policy in force at the time of cessation, which should beincluded automatically in the RICS minimum PII wording. However, firms must continue to obtain and purchase run-off cover for longer periods than six years, or with higher cover levels, if they deem that adequate and appropriate. Firms are also required to purchase appropriate cover for commercial claims.

6.5 All insurance policies will have an uninsured excess (or deductible) that is payable by the firm, a limit on the maximum amount the insurers will pay on any single claim, and may have an overall maximum amount the insurers will pay in a single policy year. Sometimes policies are also subject to 'sub-limits' relating to certain types of claims, such as loss of documents. The policy excess may now apply to defence costs for each claim made, even where a claim is successfully defended. Therefore firms need to consider what financial impact this may have given they may now be liable to pay more excesses in one policy year.

6.6 Although larger firms sometimes have designated partners or employees who manage the firm's insurance arrangements, it is important that all partners and senior members are involved to an appropriate extent and have at least a working knowledge of the firm's professional indemnity insurance, including the cost of arranging it, and the points set out above. This is to ensure that:

  • they are able to have informed engagement with clients about allocation of risk in their firm's engagements and
  • they comply with the requirements of the policy, including giving appropriate disclosure to the insurers and giving prompt notification of claims, and circumstances that may give rise to claims
  • they more readily appreciate the importance of prudent risk management and the use of appropriate terms of engagement including liability caps.

6.7 Members should always consider consulting with an insurance broker with a demonstrable understanding of the sector in which the member operates. An insurance broker should be able to explain how to ensure the member's risk profile is presented to insurers in the best way to give an accurate representation of how the business manages risk with a view to ensuring appropriate cover and value for money.