RICS Report on Professional Indemnity Insurance (PII) for Valuations in the UK. rics.org

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1 RICS Report on Professional Indemnity Insurance (PII) for Valuations in the UK rics.org

2 RICS Report on Professional Indemnity Insurance (PII) for Valuations in the UK 02Contents Executive Summary Introduction Background On Professional Indemnity Insurance Key Issues...08 A Structural issues around risk and reward in valuation...08 B Scale, type and cost of claims...10 C Terms and Conditions in valuation contracts...12 D Quality assurance...13 E Mortgage fraud...14 F Assessment of negligence PII and the Professions Conclusions...16 Appendix: Working Group Remit And Membership...17

3 rics.org Executive Summary The most serious financial crisis for decades is still causing significant instability in many markets. In response to the crisis, RICS set up a Working Group to undertake a review of the impact on the property sector because of concerns that have arisen in the UK valuation sector about current risk and pricing in the market, and that these issues may have a long-term structural impact on that sector once the current crisis is over. The report of the Working Group summarises the implications of the issues surrounding valuations for secured lending purposes in the UK for all stakeholders and set out recommendations for further work. Valuation as a service is only viable if valuers are able to obtain professional indemnity insurance (PII) at a commercially acceptable cost. The current quantity and real cost of handling alleged negligence claims in the market is sufficiently large that this is having a very significant impact on the cost of PII, not just for firms who have received claims, but for the market as a whole. There is a growing view that the current position is unsustainable with a dysfunctional relationship between current valuation fees, and current PII costs which are designed to cover potential unproven past negligence. There is a second dysfunctional relationship based on client requirements over levels and assignment of liability and the liabilities of valuers and their firms. If no action is taken, valuation for secured lending could potentially become an uninsurable activity effectively reducing the provision of this service to a limited few, or making this an area of expertise unsupported by insurance. This would lead to a reduction in public protection and an increase in individual risk to professionals. An additional layer of risk has been created by changes in the provision of legal services and the way that these can be charged, particularly the recent increase in confetti letters. This activity has also not been incorporated into the valuation fee structure that existed before this practice became common. It is clear though that unsubstantiated and unverified claims are feeding through to current PI premiums There is clearly a market problem here which could reduce client protection and lead to market failure. The structural defects in the market may create a situation where competition becomes very limited and customer choice reduced. Assuming that paying more premium is not a feasible option for members, then realistically, competition levels can only be maintained by reducing risk. Therefore, there must be a focus on raising the competence and quality assurance processes within the profession, and also focusing on the terms on which insurance is offered. There are two options available for discussion: either the true costs of PII are passed on to clients via higher fees, or risk is reduced in the contract. The terms of engagement are the first place to start. RICS should work to ensure that the terms of engagement are fair and reasonable for all parties involved. Many issues raised in this report require further research and consultation with stakeholders including members, lenders, insurers and clients in order to develop a position that will provide the desired policy outcome of both client and professional protection, and lender confidence. It is also recommended that, as a global standards body, RICS should explore issues around PII for valuations in markets outside the UK as these have global relevance. 03

4 RICS Report on Professional Indemnity Insurance (PII) for Valuations in the UK A full list of recommendations are summarised below. Recommendation 1 RICS should conduct further research and consultation with members and key stakeholders, including insurers to explore what alternatives, if any, there are to a claims made approach to insurance, and the potential impact of these alternatives on the market, for valuers and for public protection. Recommendation 2 To fully understand and engage with potential areas of market failure, RICS should make use of forum(s) for regular dialogue with lenders and other stakeholders. Recommendation 3 RICS must ensure that the implications of market practice are fully understood and accepted by other stakeholders including government, financial and professional regulators and consumers possibly through representatives. Recommendation 4 RICS should investigate with the SRA, the ethics of certain legal practices in claims. Recommendation 5 RICS should explore the option of alternative dispute resolution for dealing with valuation claims up to a certain level with all interested parties, by means of further research and a stakeholder consultation exercise. Recommendation 6 RICS provides guidance to its regulated firms and members so that they can review current contract terms with insurers and clients in an environment where all parties understand the levels of risk and reward inherent in the current model. Recommendation 7 RICS should consult regulators and Government agencies with an interest in competition issues to ascertain whether current market practice involves an imbalance which may, in the long term, affect the public interest through a reduction of competition in an already limited market. Recommendation 8 Further research is required into the full implications of valuers liability to third parties in the event that lenders sell on or securitise their loans. Recommendation 9 RICS should provide its members with some non-prescriptive guidance on how to approach quality assurance in the area of valuations. Recommendation 10 RICS should discuss and agree with lenders different ways in which valuation quality assurance can be enhanced, for example, valuations over agreed value thresholds or high risk categories being subject to a review by a second firm. RICS should also monitor the approach currently being investigated in Australia to determine whether there are any lessons to be learned that could be applicable in the UK. Recommendation 11 RICS should highlight the information provided in the new edition of the RICS Valuation Standards to members and look into providing additional guidance to valuers and to clients of valuation services additional advice and guidance on uncertainty in valuations. Recommendation 12 RICS should conduct further research into the evidence base for the use of the bracket in negligence cases and whether this is providing an outcome that adequately protects both firms and clients. 04

5 rics.org 1.0 Introduction 1.1 RICS has a significant number of members and regulated firms involved in both commercial and residential valuations. Like most other major professional bodies, RICS requires RICS regulated firms in the UK to hold PII which meets the minimum terms required by RICS. This has long been viewed as a necessary protection to ensure that clients do not suffer losses as a result of professional advice which is subsequently found to have been incorrect. PII is something that business clients would expect their professional advisers to have in place, and also provides a layer of protection to consumer clients where there is asymmetric knowledge as to the way that professionals work. Finally, of course, it also provides residual financial protection to individual firms and professionals in the event that they are sued. 1.2 Any restriction in the availability of PII may limit public protection and is of concern to the entire valuation chain, and the economy as a whole. The chain includes chartered surveyors, businesses and clients (business and consumer) of professional services, and of course RICS as a professional body with a regulatory function. A restriction in the availability of PII could indicate some sort of market failure, caused directly by the financial crisis, and/or by a new or unexpected change in market practice. 1.3 The current approach to PII involves a traditional solution to the provision of financial protection wrapped around professional services in property. The question explored in this paper is: does it still work for all parts of the sector and continue to provide a satisfactory outcome for professionals, their clients, and the wider public? 1.4 The property market, like the wider economy, tends to operate in cycles. The last major economic downturn was in the early 1990s, when the inability of large numbers of borrowers to service the debt that they had taken out in earlier years, together with a widespread collapse in property values resulted in many banks suffering large losses. A similar pattern of loss related issues has arisen this time around. 1.5 However the response of the financial sector during the recent recession has been different. Changes in approach have helped create a much more stressed situation, with lenders seeking to recover losses in a far more aggressive manner. There is a risk that the outcome of this new approach will lead to unintended consequences and, ultimately, a reduction in both competition and public protection in the market place. 1.6 This report has been prepared by an RICS Working Group comprising both members, independent representatives and insurance experts, to explore key issues around this approach, including: describes the historical approach to PII and the landscape within which PII in valuation has tended to operate; sets out any changes in market practice that may have arisen in recent years and discusses the impact of changes in market practice; examines whether there is any linkage between changing market practice and restrictions on PII which should be taken into account in any regulatory requirements; explores whether the concerns of professionals about the increasing unavailability of PII at reasonable cost are justified. 1.7 It will also seek to make recommendations as to what action RICS should take to best resolve the desired outcomes of client and professional protection in the future. The Terms of Reference for, and composition of, the group are attached at Appendix A. RICS will use this report and its recommendations as the baseline for a full public consultation. 05

6 RICS Report on Professional Indemnity Insurance (PII) for Valuations in the UK Background on Professional Indemnity Insurance 2.1 Indemnity insurance is about risk. Insurers rate the risks that they are taking on in relation to their perception of the likelihood of those risks materialising. This means, in effect, that insurers are concerned about professional negligence claims. In addition, and like virtually all other professions, there is a general regulatory requirement for firms of chartered surveyors to have PII cover. The result is that demand for PII is relatively fixed (at around 10,000 UK firms at any one time), and the cost of PII is predominantly supply led but in a relatively competitive market. Historically, insurers have entered and left this market according to its absolute profitability as well as the opportunities for writing more profitable business in other markets. In addition, insurers have always viewed their own presence in the market as something to be reviewed in the context of their own claims experience within the valuation market. Current Arrangements for PII 2.2 The current system for PII is that each member firm is required to purchase a policy, usually on an annual basis, in accordance with the approved minimum RICS wording (see This policy provides broad civil liability cover, is written on a claims made basis (see below for detail), and is required to cover, retrospectively, all the work of the firm. In the event the firm ceases to trade, RICS Regulation advises that run off cover is maintained for at least 6 years. 2.3 PII must be provided by an RICS listed insurer. A listed insurer is one who has agreed to provide cover in accordance with the minimum RICS wording, has a minimum security rating and who subscribes to the Assigned Risks Pool (ARP), the scheme of last resort for members who cannot get PII in the open market. Relationship with RICS Listed Insurers 2.4 The RICS has a round table dialogue with the top 10 listed Insurers via the Market Liaison Group three times a year. The RICS also has the ability to meet any of the senior underwriters from any of the insurers on a regular basis to discuss topics of interest. 2.5 It is generally considered by the market that the RICS relationship with its insurers is the most proactive and positive of all the UK-based professional bodies that have a similar open market facility. Basis of cover 2.6 The basis of RICS approved cover is claims made, meaning that the cover held by firms in the current year applies to all claims arising in that year, irrespective of when the service which is the subject of the claim was carried out. One of the main advantages of this approach is its simplicity both from a firm s perspective and from the point of view of the insurers. Provided a firm renews their PII annually and maintains adequate cover, both clients and the firm are protected from claims which may arise during the current year. 2.7 There are, however, disadvantages to this approach. First, this approach results in a disconnect between the undertaking of work classed as an insurable risk and the insurance cover and associated premium for any subsequent notification of a claim. Put in simple terms, claims on old work are reflected in current premiums and while, for example, valuation is not suddenly more risky than it was five years ago in fact, it is probably less risky given the lessons that have been learnt about value to loan ratios the claims arising from previous years are creating very significant financial stresses for pricing insurance today. 2.8 In addition, the pricing of risk within any valuation fee is problematic given that that risk may never appear or emerge at an undetermined time in the future. All in all, this means that there is no direct relationship between the price of insurance cover in a year and the work done in that year. There is, of course, a historical relationship based on previous experience. 2.9 Due to the timing disconnect arising from the claims made basis of insurance, the profitability of valuation services to firms and the profitability to insurers of providing PII is proving very difficult to measure, except over a very long time span (perhaps 5-10 years).

7 rics.org The Current PII Market 2.10 Overall the number of RICS listed insurers (who are able to offer PII to RICS Regulated firms) has remained fairly constant at around insurers over the last decade. However, only a small number of these will write insurance for firms with more than an incidental exposure to valuation. Of these, the largest insurers have remained constant in the UK market but there is some churn among smaller insurers The total primary layer of PII premium to ensure compliance with RICS Rules in the UK is currently around 45m per annum. Some firms will carry additional premium depending on scale and scope but this sits outside the RICS minimum requirement. The table below shows the total primary layer premium income for all RICS member firms over the last decade. The proportion of even this baseline cover that relates to valuation services is difficult to ascertain, as the figures recorded relate to premium income for all services provided, not solely valuation It seems clear from information received, although difficult to quantify precisely, that notified claims in the UK marketplace far exceed total PII premiums; and that the majority of these claims relate to valuation. In addition, annual premium income to insurers is declining in response to lower levels of activity but the number of claims made against old valuations is increasing. To put it another way, the current market is seeing fewer valuations which should make insurance cheaper, but more claims which makes it more expensive. For professionals, thus there is less income to pay higher fees to cover past work. Table 1 RICS members net PII premium income at regulated level Income (million) Source: RIMAS 2.13 The level of claims on past valuations has resulted in insurers increasing the risk rating for valuation across the market. Premiums are particularly high for firms with a poor claims record although claims made is no clear predictor of negligence or claims lost. In a very small number of cases, cover has been refused altogether. Firms have responded to rising premiums in a number of ways, including seeking to increase the level of their excess or in some cases voluntarily withdrawing from the provision of valuation services. The number of firms in the RICS Assigned Risks Pool, (i.e. firms which are unable to obtain insurance cover in the market), has decreased between 2010 and As of 1 July 2011, there are 8 firms in the pool out of a total of almost 10,000 firms. 07

8 RICS Report on Professional Indemnity Insurance (PII) for Valuations in the UK Key Issues The Working Group has looked at issues relating to: A Structural issues around risk and reward in valuation; B Scale, type and cost of claims; C Terms and Conditions in valuation contracts; D Quality assurance; E Mortgage fraud; and F Assessment of negligence. In this section, the issues will be summarised and recommendations for further work provided for RICS, chartered surveyors and other stakeholders. A Structural issues around Risk and Reward in Valuation Issue 3.2 The Working Group considered that the current insurance model may no longer be appropriate to best support the market and protect clients, the public, and firms. This is an issue that affects both the commercial and residential sectors. Summary 3.3 While there is risk in most areas of the professional services provided by RICS regulated firms and members, the risk in valuation is unusual since the potential risk may run to hundreds and in some cases more than a thousand times the fee. 3.4 There also tends to be a perception amongst some lenders that a valuation in itself provides a type of insurance, which will give them recourse to recover future losses if they arise. In fact, a valuation is a professional opinion at a single point in time. There is a level of uncertainty surrounding it which cannot be communicated through reporting a single spot figure and there has long been an acceptance that there is a bracket within which differing professional opinions may co-exist, without being considered to be negligent. In addition valuations are often undertaken under tight time constraints, particularly in the residential sector, which may mean that the opportunity to undertake unlimited and costly research is not possible. 3.5 Valuation uncertainty and the risk of valuer error are implicit within all valuations. They are not though, the same thing. In fact, a valuation should be part of a wider process of assessing the lending risk and the decision to lend. If valuers were expected to warrant their valuations for all circumstances, then the calculation of the cost of valuation would look very different. 3.6 Finally, over recent years, there has also been a gradual extension and transfer of risk from lenders onto valuers by imposition of more onerous terms. These are discussed in more detail in section C below. 3.7 Valuation has always attracted a significant level of risk but this may not have been reflected in the price. The profession and the market need to address this issue in the longer term. In residential valuation in particular, valuation has become commoditised in the same way that some areas of conveyancing became commoditised in the legal profession. The pricing no longer reflects the long term risk that is inherent in a falling market. The current economic situation has crystallised the problems in this sector. With unprecedented levels of lending in both the commercial and residential markets during the mid-late 2000s, followed by a widespread fall in property prices following the onset of the credit crunch, lenders found themselves holding debt that was not supported by the property valuations.

9 rics.org Many suffered severe losses, which they are seeking to recover wherever possible through alleged negligence claims from valuers and other professionals. 3.8 There has been in the past an expectation both in theory and in practice, that market forces will address any issues arising in valuation through competition in the pricing of professional fees. Fees for valuations would be set at a level which reflects the costs and risks, with firms that are unable to compete in this environment driven out of the market. Lenders would only use firms which provided the required quality of service at a cost they were prepared to pay. This is a theoretical picture of a perfectly operating, long term market. However, in a market where current fees cover the provision of a current service while current costs cover the provision of past and current services, there is a risk to the service provided to clients. In addition, short term market readjustment may have unintended and unacceptable long term consequences in terms of both the cost and availability of the professional service. 3.9 The long-term risks in valuation are often not fully understood or readily quantifiable (by banks or valuers) and therefore not factored into the level of fees. For example, there is no provision in a 2006 valuation fee for the levels of post-2007 claims, nor for the costs of managing the new practice of multiple (confetti) claims letters. The long time frame usually up to 6 years between a valuation being carried out and a claim potentially arising also means that cause and effect are rarely taken into account when fees are quoted In the long term, market forces should result in the price of valuations adjusting to reflect this position. In practice, however, in the short term, the structural defects in the market may create a situation where competition becomes very limited and customer choice reduced If risk were to be fully priced into valuation fees, this would result in a reduction of the financial risk to valuer, in return for fees more in line with the current market level of valuation fees, rather than paying the substantially higher fees that would be warranted for the true level of risk Much of the evidence we have seen indicates that the traditional PII model does not work well in the new situation which has arisen post financial crisis. PII, its structure, application and price are not designed to accommodate the handling of large numbers of unresearched, potential claims and the assignment of liability (see Section B below). The cost of managing the new model needs to be accommodated in the cost of a valuation and we recommend that RICS explores further, the viability of alternative bases of PII. This can be done in a number of ways There is the potential to try to insure the current valuation rather than the valuer at an indeterminate time in the future. This would involve insurance cover whereby the policy in force at the time the valuation activity was carried out covers a claim made subsequently, as opposed to when the claim was made (as currently). Injury and damage-based liability policies are currently written on this basis. A per click basis of cover where there is insurance for each individual valuation would, essentially, work on the same basis. There are pros and cons to this model The advantages are that there is more likely to be cover in place for all claims (including after a firm has ceased trading). The disadvantages are of cost, loss of competition as the majority of insurers will not write it, and it is against market practice Alternatives to the claims made approach would be difficult to implement it could also be unaffordable for the insured, if the property in question was not? a standard one. Preliminary discussions indicate that the insurance premium for a losses occurring or per click basis of coverage could be much more expensive. Recommendations for further action Recommendation 1 RICS should conduct further research and consultation with members and key stakeholders, including insurers to explore what alternatives, if any, there are to a claims made approach to insurance, and the potential impact of these alternatives on the market, for valuers and for public protection. Recommendation 2 To fully understand and engage with potential areas of market failure, RICS should make use of forum(s) for regular dialogue with lenders and other stakeholders. Recommendation 3 RICS must ensure that the implications of market practice are fully understood and accepted by other stakeholders including government, financial and professional regulators and consumers possibly through representatives. We should initiate a comprehensive stakeholder engagement strategy. 09

10 RICS Report on Professional Indemnity Insurance (PII) for Valuations in the UK Changing RICS policy Minimum wording There are measures that RICS could implement via the Minimum Policy wording, in order to make valuers more insurable. The proposal here would be for the insurers to limit cover for high risk activities (secured lending valuations), allowing insurers to limit the cover, as they do for other high risk activities (pollution, asbestos, US exposures). The advantage of this approach is that it will allow insurers to limit their exposures and reduce the overall loss record of the profession. The disadvantages are that some exposures will not be covered and that these measures would, of course, not be popular with the financial lending institutions. A recent report on solicitors PII (see section 4 below) made a specific and clear distinction between the needs of private consumers and commercial ones, such as financial lending institutions and recommended that the minimum PII requirements should be less onerous for the latter. This is feasible and would certainly be attractive to insurers, as it would give them the ability to limit the cover for financial lending institutions, including by aggregating limits, applying more rigorous market fluctuation clauses, increasing excess levels or excluding cover entirely. It would not, however, be attractive to lenders. Any such change could therefore find itself implemented in a market where professionals and clients are at odds, with unpredictable results. In addition, a consequence of such measures would be to further fragment the valuation marketplace, with a potential two tier regime. This would result in small valuers only having the capability to purchase the unattractive minimum cover, whilst large valuers would have the buying power to obtain far more attractive (to lenders) cover. In summary, it is our belief that changing the insurance product is not really the answer to the risks posed by unlimited liability and claims arising out of recession-driven losses claims funded by ATE solicitors. B Scale, Type and Cost of Claims Issue 3.16 Changes in the provision of legal services and the way that these can be charged (particularly the increase in confetti letters) have created a new and additional layer of risk, which the market has failed to incorporate within its valuation fee structure. This has particularly affected the residential sector. Summary 3.17 The evidence indicates that the vast majority of claims against valuers and their PII are from lenders. Actual claims data is difficult to obtain because of commercial confidentiality; however, there is some speculation that the total of valuation PII claims in the UK had reached 500 million and was still rising by the end of If the six year limitation on bringing claims is used as a guide, we would expect that large numbers of new claims would largely disappear six years after the peak of the market, i.e. by However, any significant level of losses incurred by lenders (and therefore their ability to substantiate claims in those cases where a valuation is found to have been negligent) will to a significant degree depend upon the health of the economy and their borrower s ability to finance the debt Successful claims are a different matter and few claims have reached the courts. According to Ministry of Justice figures, the number of all professional negligence claims in the High Court rose from 147 in 2008 to 339 in Of these, the figures relating to surveyors and estate agents were 1 and 17 respectively. Thus it appears that the vast majority of claims are not reaching the courts. This may be because there is significant risk attached to lending practices before 2007 being exposed in open court, since any public airing will open up issues of contributory negligence. In the light of this the issue is as much about how claims arise and are dealt with as whether they are justified, since significant costs are incurred in both cases The current downturn has seen a significant increase of precautionary claims (which have become known as confetti letters ) These letters, which are sometimes issued in their hundreds to all valuers who have undertaken valuations for a lender over a period of time, create considerable difficulties for firms and their insurers. They are mainly but not exclusively to be found in the residential market. The administration involved in handling the volume of letters and the costs of researching cases and preparing a preliminary defence are significant. 10

11 rics.org 3.20 In addition to the widespread use of legal put on notice letters which drive up current PII premiums, the market has also seen an increase in claims using no win, no fee mechanisms, such as Conditional Fee Arrangements (CFA) and After the Event (ATE) Insurance. These allow a successful claimant to recover costs from the defendant, but not to incur costs if they lose. Whilst intended to improve access to justice for those otherwise unable to afford it, these arrangements are increasingly being used by others such as lenders Commercial organisations are using the new legal vehicles to remove or reduce the costs risks associated with bringing claims in negligence against valuers. There is a question as to whether such activity by lawyers is ethical which the SRA is looking at. Whether or not it is ethical, the fact remains that precautionary claims based on no research are having a significant impact on the provision of broad based professional service. This may simply be a fact of market life; but it is a fact that should be made clear to all. In a similar situation the Solicitors Regulation Authority are considering how to tackle the relationship between PII and unsubstantiated claims from large financial organisations (see the next section on PII and the Professions) The problem is not limited to the professional negligence field and the review by Lord Justice Jackson 1 recommends that success fees should not be recoverable. However, the issue is a political one and it remains unclear whether and when a legislative solution will emerge. In the meantime, CFAs and ATEs encourage the making of multiple claims and increase disproportionately the overall amount of any settlement, which in turn encourages [the lender] claimants to make further claims. If insurers are predisposed to settle early to avoid further cost, whether or not a claim is justified, then the only place they can recover the cost settlement is through current and future premiums 3.23 With evidence suggesting that current problems in insurance relate to the way that the insurance product is structured and how claims are made, it is also worth examining alternatives to the current claims approach. Several years ago, RICS introduced alternative dispute resolution (ADR) into consumer complaints first through arbitration and then through a mandatory Ombudsman scheme. Such schemes work well and are consistent with the overarching UK Government policy and legal system objective of reducing the costs of defending and settling claims. While it is clear that there is a place for a traditional legal approach in pursuing some claims, it is also clear that precautionary legal notifications concerning large numbers of past valuations are distorting the current PII market One option, to help reduce the value of cost, primarily in terms of defence costs, is to introduce an adjudication scheme, which members insurers and lenders all agree to, which becomes an agreed quick and inexpensive mechanism for dealing with valuation claims up to a certain level. In discussion with insurers, they have indicated that they would welcome some form of ADR. It is also accepted that ADR is in the interests of individual clients. Recommendations for further action Recommendation 4 RICS should investigate with the SRA, the ethics of certain legal practices in claims. Recommendation 5 RICS should explore the option of alternative dispute resolution for dealing with valuation claims up to a certain level (for example, 100,000) with all interested parties. 1 Review of Civil Litigation Fees: Final Report 2009, 11

12 RICS Report on Professional Indemnity Insurance (PII) for Valuations in the UK C Terms and Conditions in Valuation Contacts Issue 3.25 There is a view amongst parts of the profession that Terms and Conditions in contracts are unfavourable to valuers as a result of the influence of lenders on what is essentially a captive market. This has an impact on contracts in both the residential and commercial sectors. Summary 3.26 Most of the major lenders (in both the commercial and residential sector) appoint valuers to panels. It is normally a requirement of being appointed to any panel that valuations are undertaken under a contract drawn up by the bank and there is limited scope for a valuer to amend the terms of the contract. Amongst other commercial lenders, (i.e. lenders other than the four largest UK banks) most valuation instructions are issued on individual contract terms. Some banks require the contract to be entirely on their terms; others will accept to an extent the valuer s firm s terms of engagement (provided that they do not conflict with their own contract terms) There is clearly an unusual relationship here, with a captive specialist profession operating to a large extent to the lenders contractual wishes. Those contracts are designed, quite reasonably, to protect the interests of the lenders and their shareholders. However, control of both contract and price in a professional service environment carries with it a responsibility to ensure that price reflects both quality and risk. Because of the nature of the way that PII is structured, and the control exercised by the financial sector, this is not the case and has not been for some time. Providers of the professional service either agree the terms or do not get the work The main areas of risk with contracts are: Limits of liability. The liability in many contracts is either unlimited, or limited to such a level that it would not in practice limit the valuer s liability in the event of a claim. Breadth of liability. Where valuers are found to be at fault, they will generally be held liable for the direct losses of the lender (subject to the SAAMCO cap 2 ). However, unless expressly excluded in the contract, it is also open to a claimant to claim for other (indirect) losses (e.g. consequential losses, loss of profit). Liability to third parties. It has become increasingly common for lenders to include clauses within contracts that allow them to assign the benefit of reliance on the valuation report to third parties to whom they may then sell on the loan. It is possible that this has arisen without the implications of this assignment being fully understood within the industry. Personal liability of the valuer. In most cases, the valuer will be an employee. In such instances, and certainly in relation to companies, the valuer should not owe any direct duty of care to the client, although this may not always be expressly stated within the contract. Dispute resolution. Most contracts are silent on the issue of how disputes over a valuation should be resolved. Often, the first a valuer will know of a client querying a valuation will be a preliminary notice of a claim from solicitors. It seems that the development of valuation services provision has not kept pace with general developments in ADR that seek to reduce both time and cost for all parties While the areas of risk listed above may not cause problems in a rising market, they can in a falling one. In the long term this is likely to reduce competition which is unlikely to serve the public interest. It is uncertain how, in a less competitive market, the financial sector would then ensure it gets the professional advice it requires. The current movement tends to suggest that the commissioning of valuations, the terms and conditions surrounding the service, and the opportunities for new entrants will all be controlled by fewer and fewer firms with the financial sector playing a dominant role. RICS has some concerns as to how this will affect long term quality and competition. Recommendations for further action Recommendation 6 RICS, provides guidance to its regulated firms and members so that can review current contract terms with insurers and clients in an environment where all parties understand the levels of risk and reward inherent in the current model. Recommendation 7 RICS should consult regulators and Government agencies with an interest in competition issues to ascertain whether current market practice involves an imbalance which may, in the long term, affect the public interest through a reduction of competition in an already limited market. Recommendation 8 Further research is required into the full implications of valuers liability to third parties in the event that lenders sell on or securitise their loans South Australian Asset Management Company (SAAMCO) v York Montague [1997] set out the concept of the cap on damages which could be recovered by a lender from a valuer, being the amount of the negligent overvaluation.

13 rics.org D Quality Assurance Issue 3.30 As claims against valuers address the competence or potential negligence of the valuation/valuer, it is essential that the profession upholds the highest standards in valuation practice. The profession has responded to the recent financial crisis by taking steps to demonstrate its commitment to standards and will need to continue to promote quality of individual valuations and processes. Summary 3.31 The profession has developed ways to provide the market with levels of additional confidence through regulatory frameworks and intervention. RICS identified some time ago that there is an important role for some level of quality assurance (QA) as part of the valuation process. At a profession-wide level, RICS has recently introduced the Valuer Registration Scheme (VRS), which is aimed at ensuring that only those RICS members who have the necessary skills and experience to undertake valuations do so. The scheme is to be backed by a regime of greater monitoring and intervention to support and review compliance with professional and technical standards. While it is clear that this new initiative will need time to demonstrate impact across the profession, it should assist in resolving some of the issues raised elsewhere in this paper through demonstrable independent verification of compliance with a published recognised standard The VRS and monitoring regime will assist with raising some of the fundamentals of valuation practice risk management. In particular, as the scheme develops, the regulatory and professional arms of RICS will provide guidance and develop new tools and elements of best practices, such as peer reviews, independent checks of reports, and reinforce messages about comparables on file with accompanying logic and orderly structured files, for example. We consider that the VRS scheme will thus help provide confidence to clients by demonstrating continuous improvement by the profession It is worth noting, however, that most bank contracts do not expressly consent to their files being monitoring by RICS. Without this, firms cannot provide RICS with access to these files. RICS will monitor the impact this may have on our monitoring process to determine any steps that may need to be proposed In addition to raising individual standards, VRS will also look at firms processes. There is a need for firms to have a focus on QA and many already do this. QA processes which are appropriately tailored to the nature of the work undertaken by the firm are a very effective method of ensuring the quality of the work being delivered to clients. This may, for example, comprise specific requirements in respect of the number and quality of comparables to be held on each file and/or a system of peer review or checking of valuations before they are sent to clients Regular internal auditing of files by the firm also has an important part to play in ensuring that standards are being maintained, as does the greater use of technologybased risk management tools such as those introduced to the residential sector by suppliers such as Quest and XiT2. That said, all of these measures, whether in place for a long time, in development or relatively new, relate to valuations as they are done and reviewed. They can be used to defend legal claims but not to prevent those claims Finally, it may also be worth exploring the concept of introducing second opinions to assure the quality of valuations. In Australia, (where the valuation market is in a very similar position, if not worse, than the UK), it is being investigated whether in some circumstances, it is feasible for two valuations to be undertaken and the lower value being the adopted valuation. Recommendations for further action Recommendation 9 RICS should provide its members with some non-prescriptive guidance on how to approach quality assurance in the area of valuations. Recommendation 10 RICS should discuss and agree with lenders different ways in which valuation quality assurance can be enhanced, such as, for example, valuations over agreed value thresholds or high risk categories being subject to a review by a second firm. RICS UK should also monitor the approach currently being investigated in Australia to determine whether there are any lessons to be learned that could be applicable in the UK. 13

14 RICS Report on Professional Indemnity Insurance (PII) for Valuations in the UK E Mortgage Fraud Issue 3.37 Mortgage fraud is identified as the second most common form of fraud, after insurance fraud, and the risk of fraud across the property sector and associated professionals/intermediaries clearly has an impact on the pricing and availability of insurance. Summary 3.38 The FSA report Mortgage fraud against lenders 3 found that many lenders identified third parties such as solicitors, brokers and valuers as the main source of mortgage fraud risk. In the past few years, there have been substantial improvements in lenders oversight of some relationships, particularly those with solicitors. However, the report determined that there remains scope for significant improvement in how lenders manage relationships RICS members commit to a code of conduct and clear rules on ethical behaviour. RICS provides guidance to members, monitors members conduct and initiates disciplinary procedures where appropriate. These measures provide assurance to clients, the public and stakeholders that chartered surveyors conduct themselves and their business legally and ethically. RICS also works with legal and regulatory authorities as part of its investigation and risk intelligence gathering operations, and will continue to do so A second review of valuations as mentioned at 3.44 would go a long way to assisting with this issue as the process would identify and highlight suspicious or wildly unrealistic valuations. Recommendation RICS will continue to monitor any pronouncements or rule changes from the FSA and work with legal and regulatory authorities. F Assessment Of Negligence Issue 3.41 There is an element of uncertainty within most valuation. However there is some evidence of a reluctance on the part of valuers to report uncertainty, and a lack of understanding on the part of the client as to how to interpret uncertainty. This affects both commercial and residential sectors, but is exacerbated in the residential sector as there is no facility to address uncertainty in the standard reporting format. Summary 3.42 It is a long-established principle of common law in the UK that a professional adviser who provides negligent advice to a client, may be liable to that client for some of the consequences of that advice being wrong. In valuation, there is an extensive body of case law to support this view. However, human error aside, there is an element of uncertainty within most valuations. In some cases the level of uncertainty will be considerable It is clearly important that valuers have the skills and the opportunity within their reports to communicate levels of uncertainty to their clients. The new edition of the RICS Valuation Standards (The Red Book) provides valuers with assistance in identifying uncertainty and reporting upon it. However valuers would benefit from more tools and guidance to articulate uncertainty in a way which is meaningful to clients. This is something RICS will explore as part of the VRS programme. Additionally where residential mortgage valuations are concerned there is a standard format for reporting and no facility to address uncertainty. Finally, there is also a lack of understanding amongst clients as to how to interpret valuation uncertainty Academic papers focusing upon commercial property valuations (notably Crosby) have highlighted a lack of empirical evidence to support the approach taken by the English courts to assessing valuation negligence through the use of the acceptable bracket within which a non-negligent valuation may lie. There could be merit in examining closer, whether this subject needs to be looked at further. Recommendations for further action Recommendation 11 RICS should highlight the information provided in the new edition of the RICS Valuation Standards to members and look into providing additional advice and guidance on uncertainty in valuations to valuers and to clients of valuation services. Recommendation 12 RICS should conduct further research into the evidence base for the application of the bracket in negligence cases and whether this is providing an outcome that adequately protects both firms and clients. 3 Mortgage fraud against lenders (June 2011) 14

15 rics.org 4.0 PII and the Professions: Alternatives to Market Solutions 4.1 Having reviewed thoroughly the issues the group took the opportunity to look at the issue of PII in a broader context and the approaches explored by other professions, specifically the legal profession. 4.2 One of the key issues is whether there are alternatives to the claims made basis of cover, as it is the very nature of claims made policies which is partly to blame for the present problems. Other ways of insuring the exposures need to be considered, including types of mutualisation, different arrangements with insurers, levies etc. 4.3 However, it should be said that the question of alternatives is rehearsed regularly when the market cycle enters a hard phase. There are, of course, alternatives, but each has possible unintended consequences and likely significant extra costs to the profession 4.4 Self insuring and a master policy are all options that have been explored previously, both by the RICS (RICSIS and SURMIA) and other professions (MAPIC, SIF, SIMIA). All have ultimately failed, often with significant costs to the profession over and above what it would have paid to the traditional insurance market. If claims outstrip premium within a mutual arrangement, then the only avenue to pursue is to seek additional contributions from the membership, whereas currently, for better or worse, the insurance market carries this burden alone. The same arguments apply to generic compensation schemes provided by a profession for a profession. 4.5 A recent report by Charles Rivers Associates, independent consultants, commissioned by the Solicitors Regulation Authority (SRA) about PII issues in the legal sector made it clear that solicitors are suffering some of the same problems as Chartered Surveyors with the notification of potential claims rather than successful claims affecting the price and availability of cover. The report s findings also support the Working Group s views on the relevance of mutual or profession-led compensation schemes in today s market place. 4.6 The report to the SRA by Charles Rivers Associates (CRA) concluded that: Regulatory intervention should only be necessary in PII matters when there has been a clear market failure. The open market insurance solution for solicitors PII has saved its member firms a significant amount of money over the years, when compared with mutual or master policy arrangements. There should be specific and clear distinction between the needs of private consumers and commercial ones, such as financial lending institutions and recommended that the minimum PII requirements should be less onerous for the latter. 4.7 As stated above, the open market option has saved considerable money for the legal profession over a mutual arrangement. In addition, mutualisation and/or a master policy arrangement also give rise to potentially unpalatable issues surrounding good risks subsidising bad risks. In regulatory terms this approach, while potentially acceptable in the mid 20th century when the market was very different, is no longer considered good regulation. 4.8 The findings of the report were considered by the SRA and the Law Society and (limited) changes to the way in which PI Insurance will be purchased by solicitors in England & Wales and the operation of their Assigned Risks Pool arrangements will begin to be made in The changes did not go as far as the PI Insurance market had hoped. 4.9 Notwithstanding this, it is recommended that the RICS continues monitor to see what happens with the SRA requirements in this area. In particular, if it is a agreed that there should in fact be a distinction between the minimum terms that apply to consumers and commercial organisations, the RICS should mirror this in their arrangements otherwise RICS members risk becoming a bigger targets for financial lending institutions seeking to recover their losses than they may be presently. 15

16 RICS Report on Professional Indemnity Insurance (PII) for Valuations in the UK 5.0 Conclusion 5.1 There is clearly a market problem here which could reduce client protection and lead to market failure. Many potential solutions are not likely to be attractive to one or other party but that there are things that can be done to make insurance more widely available. Put simply, either more premium needs to be added to the pot to pay for claims or the risks need to be reduced. 5.2 Assuming that more premium is not a feasible option for members, then realistically, this can only be achieved by reducing risk. Therefore, there must be a focus on raising the competence and quality assurance processes within the profession, and also focusing on the terms on which insurance is offered. There are two options available for discussion: either the true costs of PII are passed on to clients via higher fees, or risk is reduced in the contract. The terms of engagement are the first place to start. All stakeholders should work to ensure that the terms of engagement are fair and reasonable for all parties involved. 5.3 RICS must ensure that we take an equally co-ordinated approach to ensure that the position of our members (of all practising sizes) is suitably protected whilst ensuring public and client protection are maintained. 5.4 Many issues have been raised in this report that require further research and consultation with stakeholders including members, lenders, insurers and clients in order to develop a position that will provide the desired policy outcome of both client and professional protection, and lender confidence. 5.5 Finally, it is also recommended that, as a global standards body, RICS should explore issues around PII for valuations in markets outside the UK as these have global relevance. 16

17 rics.org Appendix A Working Group Remit and Membership Remit The Working Group was formed in September 2010 to look into mounting concerns from RICS members providing valuations for secured lending purposes in the UK, over the rapidly rising cost and shrinking availability of professional indemnity insurance (PII). The Working Group was asked to look into the causes of this and to make recommendations. The Working Group was asked to report to RICS Valuation Professional Group and Leadership Team by the end of 31 July Membership The membership of the Working Group comprised members with experience in a variety of relevant areas including, commercial and residential property valuation, professional indemnity insurance and the legal aspects of valuation professional negligence disputes. The membership of the Working Group was as follows: Peter Clarke FRICS, Jones LangLasalle (Chairman) Marcus Elwes FCII, Regulated Insurance Management and Advisory Services (RIMAS) Mark Gerold FRICS, Ernst & Young LLP Dellah Gilbert, Solicitor, Hogan Lovells LLP Andrew Gooding MRICS, Knight Frank LLP David Larkin FRICS Paul Latham FRICS, LSL Holdings Warren Wright FRICS, Connells In addition, the following were invited to sit on the Working Group as independent members: Sir Bryan Carsberg Lance Rigby The Working Group was supported by the following RICS staff: David Dalby FRICS David Rusholme FRICS Mark Southwell 17

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