A Background to Insurance, Professional Indemnity & Risk Management for Architects

Transcription

1 A Background to Insurance, Professional Indemnity & Risk Management for Architects By Graham Strez NZACS Claims Director and Chairman of Acanthus Insurance Company (Note: Several diagrams in the original are not reproduced here) History Modern living and business activities in general involve the risk of sustaining losses of varying type and degree. If risks to life and limb, and capital weren t taken there would have been little technological, economic or social advancement; e.g. Gothic architecture, aviation, hydrodams, nuclear power generation, and medical surgery techniques. The economic loss consequences of risk taking can be substantial and sometimes ruinous. Insurance is a method of compensating for these losses. Insurance of a kind is known to have existed in Greek and Phoenician societies. Bottomly was an early form of shipping insurance wherein investors would place a deposit with a shipping owner, who agreed to refund the deposit plus a premium when the ship returned safely to port. If the ship failed to return, the deposit would be retained by the ship owner for the purpose of rebuilding another ship. Marine insurance was conducted in England in 1574; Fire insurance in As an alternative to intoxicated bars, a number of coffee houses were established in London to cater for different clientele. Edward Lloyd was a coffee house proprietor who attempted to attract marine underwriters as customers by printing a weekly shipping news sheet. It was from this background in 1696 that a group of marine underwriters formed an underwriting exchange known as Lloyds, which has continued to become the world s specialist insurance underwriter. Companies formed to transact insurance now operate globally as important commercial entities. Commercial Basis of Insurance Insurance is one of the more interesting and important transactions engaged in by individuals and business firms. It embraces two related interests - financial and legal. A financial definitions of insurance is a financial arrangement that distributes the cost of unexpected losses (losses which would have occurred irrespective of insurance). Predictability of losses in advance is basic to an insurance system s operations. Because the insurance system allows the cost of losses to be predetermined, it allows

2 the cost of losses to be financed and redistributed in advance. Insurance companies therefore rarely pay for losses; they merely provide the facility for the payment of losses from a pool of funds contributed by policyholders. Legally, insurance may be defined as a contractual arrangement wherein one party (Insurer) agrees to compensate another party (Insured) for losses. This contract (policy) specifies the particular loss and provides for the insured to pay a contribution (premium) to the insurer. The policy creates rights and corresponding obligations for both insurer and insured. The insurer cannot force the insured to pay the premium, but it can cancel the policy or deny a claim for payment. Insurance Principles When referred to in insurance, loss means an undesired, unplanned reduction in economic value. It may be direct e.g. life, fire, structural collapse - or indirect (consequential loss) e.g. accommodation costs incurred as a consequence of a house fire. Property insurance policies are very specific as to whether coverage is provided for either or both. The chance of loss (probability of loss) may or may not be known before a loss takes place, but it is the ratio of the number of losses (predicted or actual) to the number of exposure units. If there was no possibility of loss, or if loss was certain to occur, then insurance would not exist. In the first instance there would be no need to insure, and in the second the loss would be an expense. Hazards are conditions that serve to increase either the frequency or severity of losses e.g. poor street lighting may result in more burglaries or storage of petrol in a garage may result in a greater loss if the garage caught on fire. If an insured materially increases a hazard, the insurer may suspend the insurance coverage. If an individual causes a loss to collect the insurance (e.g. arson) this is know as a moral hazard - it increases the frequency of loss. Where an attitude of indifference to loss is created by the purchase of insurance this is known as morale hazard. This why should I care attitude increases the severity of loss. Risk is subject to many definitions, but a convenient expression is the variation in possible outcomes of an event based upon chance i.e. the greater the variation around an average expected loss, the greater the risk. The degree of risk is a measure of the accuracy with which the outcome of an event based on chance can be predicted - the more accurate the prediction, the lower the degree of risk. Because insurance companies keep accurate statistics on losses that have occurred, they are in a better position to predict losses that will occur.

3 Additionally insurers, by accepting a large pool of risks, rely upon a mathematical principle known as the law of large numbers. For exampie, the greater the number of observations of an event based on chance, the more likely the actual result will approximate the expected result e.g. tossing a coin or rolling a dice. Ironically, a calculated risk is something that cannot be calculated. Insurers however will pay regard to the following to arrive at an underwriting risk average. The probability of loss The possible severity of loss Types of Insurance The possible degree of variation in actual results. Insurance is a Special Kind of Contract Contracts normally assume an equal understanding of the terms by both parties e.g. A agrees to pay B for item C. Insurance is concerned with unequal knowledge i.e. the insured has full knowledge of their risk circumstances which could disadvantage the insurer. Insurance contracts therefore require the insured to disclose all information, which is material to the risk and which might influence the insurer in accepting or declining the risk. Insurance contracts are required to be made with the utmost good faith (uberrimae fide) in which both parties deal honestly with each other. Additionally the insured is required to warrant that the information provided to the insurer is accurate. Failure to disclose accurate material information may invalidate the insurance policy. Professional Indemnity (Negligence) Insurance Professional indemnity or professional negligence, insurance is a special type of legal liability insurance, which applies to professional services. Professional negligence is failure to exercise reasonable knowledge, skill, care and diligence normally expected of a particular profession. This duty of care is owed contractually to the client, but also tortiously to the client and to other classes of person who ought reasonably be contemplated as being likely to be affected by the actions of the professional - e.g. new building owner, together with subsequent owners or tenants.

4 Professional, indemnity policies are normally written on a claims made basis i.e. the policy must be in force when the claim, is notified, notwithstanding that the negligent act or omission which gave rise to the claim occurred before the policy was written. Often it may take many years for the negligence to fully manifest itself and then for claims to be settled. Writs for professional negligence typically allege breach of contract and breach of tortious duty. Such tortious claims sue the various co-defendants jointly and severally. The net effect of this is that where any of the joint tortfeasors is found to be of little financial worth, the liability payment falls upon the remaining solvent defendants. In the case of building works, this is typically the professional and the territorial authority that issued the building consent and code compliance certificate. Professionals and territorial authorities are typically insured by PI policies, and accordingly provide a good deep pocket for litigants. Clients often erroneously believe that the professional s PI policy is for their immediate benefit, whereas it merely increases the net worth of the professional, and in doing so affords the client greater surety when liability is proven. PI insurance does not protect a firm against risk occurring, it offers restoration after the eventual loss. Types of Risk Fundamental Fundamental risks affect entire communities and are uninsurable through private insurers - e.g. war, nuclear fission, and earthquake. Government assistance is involved e.g. EQC. Pure Pure risks can only result in a loss -e.g. death, fire, theft, and liability. These risks are insurable by private insurers. Speculative Speculative risks may result in a gain, loss or no change. These are uninsurable risks: cf. casino gambling, horse racing. Society may benefit from speculative risks, but always loses from pure risk loss.

5 Important Insurance Terms Actuary A statistician who solves insurance risk problems. Agent A person who sells insurance policies as an agent for the insurer. Agents may be employed by the insurer or commissioned to them. Broker A person who arranges insurance as an agent for the insured. Consequential Loss A secondary loss resulting from an insured peril. Claims Made A type of liability policy that responds to claims made during the period covered by insurance - even through the cause of loss arose earlier e.g. PI policies. This differs from an occurrence made policy where the policy responds when the loss is sustained e.g. fire or vehicle insurance. Estoppel Conduct of insurer or agent, which suggests that a waiver applies. Excess Sometimes called deductible. This is the initial loss cost, which is borne by the insured. Group Insurance A pool of like risks with one shared policy. It generally attracts a lower premium because of its minimal administrative and marketing overheads. NZACS, CEAS, and PSBG operate Group Insurance schemes. Indemnity Putting the insured in the same financial position after a loss as before the insured event took place. It recognises depreciation, unlike replacement cost insurance. Loss Adjuster An insurance investigator as agent for insurer, who checks if loss is covered by the policy, and negotiates the settlement of any Claim. Loss Assessor A person who as agent for insurer, assesses the value of loss. Proximate Relationship

6 First peril in a chain of events which results in a loss. Primary Insurer The insurer which contracts with the insured. Reinsurer A secondary insurer which contracts with the primary insurer to accept a specified portion of risk for a share of the premium. Subrogation The substitution of one party (insurer) to another party s (insured) rights. This permits the insurer to recover from a third party who is responsible for the loss. Underwriter A person who selects and rates applications for insurance. Waiver An intentional abandonment of insurance terms.