Professional Indemnity Insurance for Residential Valuation Surveyors. Reflecting on a broken model

Professional Indemnity Insurance for Residential Valuation Surveyors Reflecting on a broken model

Professional Indemnity Insurance (PII) Report Valuation Surveyors Many column inches, committees and discussion sessions have been dedicated to the thorny issue of PII for valuation surveyors over the past three years. Here, Howden Windsor, the RICS preferred PII Broker provide an analysis of why the situation has arisen and what might be done to prevent re-occurrence. Contents 1. What is the problem?.................................. 04 2. How big is the problem?.............................. 05 07 3. The main antagonists............................... 08 09 4. Why has it occurred?............................... 10 13 5. Why is there a disparity between the professions?.................. 14 15 6. Preventing re-occurrence............................. 16 17 7. Howden Windsor.................................... 18 8. Contact us....................................... 19 3

1. What is the problem? a) A rise in repossessions since 2007, usually a result of the prevailing economic conditions, has led to Lenders incurring losses when properties are sold on. b) This resulted in a significant increase in allegations of negligence against surveying firms involved in the provision of valuations for lending. c) Valuation Surveyors Insurers have made significant pay-outs in terms of both settlements and legal costs. 80,000 70,000 60,000 50,000 d) Consequentially there has been a reduction in the number of Insurers who are willing to provide the primary 1m of PII to valuation surveying firms. e) This constriction in capacity has led to a steep rise in PII premiums. Some firms have been unable to afford PII and have subsequently either entered the RICS Assigned Risk Pool or ceased to trade with no run-off cover. f) It has recently been suggested that there is now a shortage of Valuation Surveyors. It is undoubtedly the case that the rising cost of PII combined with a significant decline in new entrants to an ageing profession has had an impact on the number of practitioners operating in this specialised area. 2. how big is the problem? Key figures Residential repossessions peaked in 2009 at 52,000 87% of properties sold, out of repossession, since the start of the financial crisis, sold at a loss Average loss to Lenders estimated to be 53,000 per property Insurance industry speculation suggests average settlement in relation to a residential valuation claim of 40,000 Notifications against Surveyors alleged to exceed 500m GWP generated per annum by all RICS regulated firms circa 70m and falling PII rates for valuations for lending averaging 10% but may be as high as 25% Surveying firms going out of business a threat to the future of the profession a) Residential repossessions peaked in 2009 at circa 52,000 per annum but they have now reduced to 33,900 1. b) Almost 87% of properties that have been sold since the start of the financial crisis have sold at a loss. This compares with 34% of properties sold prior to the financial crisis. 2 c) Where a property is sold out of repossession, the average size of the loss incurred is 28.6%. Based on an average house price of 184,131 in Q3 2007 3 this would result in an average loss to Lenders of approximately 44,700 per property (assuming 90% LTV). e) In relation to residential valuations, anecdotal evidence suggests that the average settlement amount is 40,000 (excluding legal costs). Given the figure stated above and allowing for negotiation on settlement amount, our experience suggests this figure is reasonable. f) It is not uncommon for legal costs to exceed the settlement amount. Even where the claimant does not receive a settlement, both the Insurer and, to a lesser extent, the Insurance Broker will still incur legal and administrative costs which must be taken into account when calculating premiums and brokerage or fees. 40,000 30,000 20,000 10,000 d) It is not possible to calculate how many notifications have been made against Surveyors in relation to valuations for lending, however, it is not uncommon to see proposal forms for firms that generate a few hundred thousand pounds of income with 10+ open notifications on their claims history. g) Insurers concerns regarding the legal costs involved in defending an allegation against an insured can lead to situations where it is considered financially prudent to settle a claim rather than defend it, even where the valuation is found to be within the correct range. This position is more likely to be followed where there is a lack of evidence to support the valuation. 0 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 1 Source: Fitch Ratings; Peak Vintage Originations Drives Higher UK Loss Severities 28/3/13 2 Source: Fitch Ratings; Peak Vintage Originations Drives Higher UK Loss Severities 28/3/13 Chart 1: Number of properties taken into possession each year Source: CML research 3 Source: Housepricecrash.co.uk; Nationwide average house prices adjusted for inflation 4 5

h) Since the downturn of the early 90 s, the professional negligence pre-action protocol has been introduced (2001). Whilst this requires law firms to comply with procedural guidelines designed to facilitate the early exchange of information, there is evidence, as seen in the recent example of Webb Resolutions v Waller Needham and Green that certain law firms are not complying with the protocol. This has recently resulted in law firms acting for defendants to apply for cases, where the protocol has not been followed, to be struck out. Furthermore, until the introduction of the Jackson Reforms, law firms did not have to adhere to any strict guidelines on costs management, thus further escalating the costs that Surveyors Insurers incur. i) RICS regulated firms currently generate 40m of premium income to Insurers each year. This figure relates to the primary 1m layer only with total premium income estimated to be circa 70m. Despite the steep rise in insurance rates for Valuation Surveyors, the premium income generated from the primary 1m has fallen by 30% since 2005, in spite 6 70 60 50 40 30 20 10 0 of the fact that the number of RICS regulated firms has increased by 15% since 2008. This fall in income is likely to be attributable to a combination of four key factors: I. A reduction in PII rates for all other surveying disciplines e.g. project management, building surveying, agency, property management etc.; II. A reduction in overall income generated by the surveying profession; III. A greater proliferation of smaller firms as larger businesses have been acquired i.e. Jones Lang LaSalle s acquisition of King Sturge and Deloitte s acquisition of Drivers Jonas; and IV. Greater competition amongst Insurers and Insurance Brokers, resulting in downward pressure on premiums as firms compete to win and retain business. 2005 2006 2007 2008 2009 2010 2011 Chart 2: RICS listed Insurer premium income in m from the primary 1m of surveyors PII, October 2012 j) It has been suggested that once all matters had been resolved, claims settlements would amount to 500m. Unfortunately, it s impossible to ascertain how accurate this estimate is, however, Howden Windsor have settled over 70m of claims on behalf of our surveying clients between 2008 and 2012. We estimate that we represent approximately 10% of the premium emanating from RICS regulated firms (with a heavy bias towards the survey and valuation professions), so that would suggest the 500m estimate may, in fact, be on the low side. k) There are currently no more than five Insurers (out of 30 on the RICS list) who would be interested in providing a new quote for the primary layer of insurance for a firm generating 1m of fee income with a 25%+ exposure to survey and valuation and a good claims history. For smaller firms, this number reduces to as little as one or even zero. Many small firms have had no choice but to remain with their existing Insurer irrespective of the premium charged and, in some instances, this will exceed 20% of fee income. l) On a positive note, we are now beginning to see new Insurers who are willing to quote firms with a plus 25% exposure to survey and valuation. Whilst their appetite is limited, we would anticipate that new capacity would be available to good quality firms at their 2013 renewal as the combined impact of the Statute of Limitation and the Jackson Reforms begins to be felt. However, any increase in capacity is likely, initially, to be offset by Aviva s decision to withdraw from underwriting PII for sub 10m fee income firms and by a further restriction of appetite amongst larger Insurers as they evaluate the likelihood of unresolved claims progressing to some form of settlement. m) The number of firms in the RICS assigned risk pool remains low at fewer than 15, despite a small spike in 2009. There are a handful of firms, some well publicised, that we know of that have closed down without run-off cover and we would anticipate that there are others who have taken this course of action but have done so unobserved by all but the Panel Managers on whose behalf they were acting. These figures suggest that the majority of firms have elected to continue trading in spite of premiums that may be as high as 25% of fee income. However, that is not to say that all of these firms continue to undertake valuations for lending. Reductions to the number of businesses on a lot of panels would suggest they don t, particularly given the fact that the majority of panels will no longer work with Sole Practitioners. Whilst this is a dismal reflection on the state of the surveying sector it should mean that as the housing market begins to recover there will be a good supply of work for firms that continue operating in this area, as is evidenced by the rumours that there is now a shortage of valuers. n) Insurers who provide PII cover to Surveyors often also underwrite other professions for example Solicitors and Financial Advisers. Valuation Surveyors are not alone in being affected by a steep rise in claims and notifications; Solicitors particularly those involved in conveyancing and more recently Financial Advisers have also been impacted as have all other professions albeit to a much lesser extent. This represents a triple hit for some Insurers and partially explains why businesses such as Travellers, Aviva and Chubb have elected to significantly reduce their PII books. 7

3. The main antagonists Unfortunately, it s impossible to access collated Insurer statistics on claims and notifications against Surveyors. Consequently, we can t provide accurate data on which Lenders have been most active in terms of making allegations, although we can comment to some extent on the experiences of our own insured s. At the outset of the current crisis, we would have anticipated higher levels of activity from: Lenders which received bail-outs or entered Administration Sub-prime Lenders, providers of bridging loans etc. Instances where multiple valuations had been provided by the same firm in new build developments To some extent this has been borne out with Lenders such as Northern Rock, RBS, Commercial First and Bank of Scotland appearing regularly as claimants. However, smaller Sub-prime Lenders and providers of bridging finance appear less frequently, although Insurers views of what exactly sub-prime lending is vary. It is important, when assessing the level of claims originating from sub-prime that one considers that in 2007 sub-prime mortgages only accounted for 7% of the UK loans market. 4 Our own conversations with representatives of the sub-prime industry suggest their appetite for making allegations against valuers is limited. This lack of appetite may be partially accounted for by a lack of willingness on behalf of Sub-prime Lenders to open up their historical lending practices to scrutiny. It may also reflect the fact that Sub-prime Lenders are finding it harder to find valuers who will undertake instructions on their behalf (partially due to the severe lack of availability of insurance for this work). As a general rule of thumb Insurers are nervous, and are likely to remain wary about any firm that: Values for Lenders routinely lending more than 90% LTV particularly where valuations were done at the tail end of the peak of the market. Values for providers of sub-prime/ second charge/bridging finance Undertakes residential valuations at an average net fee of below 120 Operated in an area of the country where re-possessions where high e.g. the North East, North West and East Midlands. Carries out a high number of drive by valuations Values a high percentage of total properties in any one new build development As an Insurance Broker and Adviser we would counter concerns about several of these areas, for example higher property values, as our experience shows that claims are far less likely to occur on prime property where LTVs are typically lower and borrowers more financially stable, but ultimately it must be accepted that, unless an Insurance Broker insists otherwise, Insurers are likely to apply a broad brush approach when rating a risk rather than taking into account the specifics of a firm s activities. Rightly or wrongly, Insurers take a more positive view of those firms working for private client banks. Typically, the relationship between Lender and valuer is closer; the reporting format is less likely to be standardised, thus allowing greater capacity for the inclusion of caveats and warnings regarding particular aspects of the property and the fees received higher. Additionally, there is a perception that purchasers who borrow from a private client bank are far less likely to borrow at a high LTV and it is expected that the bank has an in-depth understanding of the borrower s financial stability. Where multiple distributors are involved in the instruction chain, the level of information Surveying firms can provide at renewal decreases. We now ask firms with a significant exposure to valuations for lending to provide random audits of 100 valuations done at the peak of the market showing Lender, LTV, Property Value and whether or not the property has changed hands. Those firms who have received an instruction via two or even three distributors appear to find it difficult, if not impossible to collate this information. This makes it hard for Insurers to accurately assess risk and reflects poorly on the firm s internal management systems. Most importantly, the more remote the valuer becomes from the lending institution, the lower the fee received which directly impacts the premium Insurers can generate. 4 Source: The return of the sub-prime mortgage; mortgage firms target overlooked market, The Guardian, Friday 29 October 2010 Patrick Collinson and Rupert Jones 8 9

4. why has the problem occured? Lenders have incurred losses They have attempted to recoup losses and been strongly encouraged by law firms providing access to After the Event (ATE) Insurance and Conditional Fee Arrangements (CFA) Valuers have made mistakes The likelihood of a valuer making a mistake has been increased by the high volume of reports undertaken on a daily basis during the boom Even where no mistake has been made the quality of the valuation file does not assist in the defence Given escalating litigation costs prior to the introduction of the Jackson reforms it may be more financially viable for an Insurer to settle a claim rather than defend it The low fees charged by Valuation Surveyors restricts the level of premium income that Insurers can generate thus increasing the rate they have to charge a) Compared to the recession of the early 90 s, repossession levels are proportionally significantly lower during the current economic downturn (see chart 1), despite the fact that the variance between total residential property transactions in the four years preceding each downturn was just 6% (6.8m in 1987 1990 compared with 6.4m in 2004 2007). The reduction in the number of repossessions has been attributed to a combination of factors: low interest rates, low inflation, comparatively low unemployment levels and the banks reluctance to repossess properties, given the public s already tarnished view of the role they played in causing the current downturn. b) Despite the lower level of repossessions, having questioned several individuals who were involved in Surveyor s PII during the downturn of the early 90 s, the prevailing view is that there have been more notifications during the current financial crisis. c) The most significant difference between the current recession and that of the early 90 s (in relation to claims against Valuation Surveyors) is the availability of CFA and ATE insurance to claimants. These arrangements have allowed Lenders to bring claims at no direct cost to themselves (any fees owing are paid out of the final settlement amount). It is felt that many of the current notifications arose not due to a genuine belief that negligence had occurred, but because law firms have aggressively encouraged Lenders to make allegations, based on the availability of these facilities. Combine this view with the acknowledgement that Valuation Surveyors output has improved markedly in quality since the early 90 s and there is a feeling that, once the dust has settled, a lower percentage of notifications will have resulted in settlement. One of our clients has recently used the services of an external expert to retrospectively value 10 properties that are the subject of notifications from a single Lender. In each instance, the expert s view was that the valuations were within an acceptable margin. Unfortunately, these services and those provided by law firms acting for defendants all come at a cost and it is not, therefore, surprising that we would anticipate that legal fees associated with notifications and claims will be significantly higher than during the last downturn. What is After The Event insurance? After The Event (ATE) insurance covers the legal costs and expenses incurred in litigation. It can be used in any type of litigation by either a claimant or a defendant, although in practice it is mainly used by claimants. It is normally purchased by Solicitors on behalf of their clients. ATE insurance normally covers the legal costs which a claimant must pay to a defendant when a claim is unsuccessful. What is a Conditional Fee Arrangement? A Conditional Fee Agreement (CFA) is an agreement between a client and Solicitor whereby the Solicitor agrees not to be paid unless they win the case. Hence their more common name, no win, no fee. The CFA usually incorporates a success fee, which is an uplift on the amount of costs the client would have paid had they engaged their Solicitor on a usual retainer basis. 10 11

d) Whilst there has been a noticeable improvement in the quality of Valuation Surveyors output, mistakes are still being made and even where the valuation is within an appropriate margin, the documentation presented to assist in the defence of a claim is not always of sufficient quality to demonstrate that the Surveyor has met the standard of a competent professional. At the extreme end, we are still seeing instances where there is no paper file to support a valuation. e) Due to the lack of collated claims data from across the entire valuation profession, it is hard to pinpoint the most common underlying causes of claims, however, discussions with Insurers suggest that the following factors are the most common causes of claims: I. Lack of experience II. Working outside a reasonable operational area III. Failing to fully audit high risk instructions IV. Inappropriate comparables V. Measurement mistakes VI. Making incorrect assumptions f) It has been suggested that these errors arise because surveying firms were seeking to maximise income whilst minimising their cost base. Given the inability of firms to negotiate uplift in income with Panel Managers and Lenders, too much focus was placed on minimising costs resulting in Surveyors undertaking too many inspections in any one day, the appointment of inexperienced Surveyors, insufficient investment in systems and procedures and a lack of focus on risk management. g) When assessing the viability of a particular line of business, one of the key areas Insurers will analyse is the potential risk to reward ratio, as determined by the premium available from a line of business against the likely settlements and legal costs that will be incurred. As already discussed, the total premium income from the surveying profession has fallen markedly over the last six years. This has been directly affected by the fees that Valuation Surveyors generate from each instruction. As these have declined, so too has the premium available to Insurers, since it s charged as a percentage of fee income. Whilst this pressure on fee income has also been felt by Solicitors involved in conveyancing, we estimate that the lowest fee a Solicitor receives is around double that received by a surveying firm. If a surveying firm received 300 for the average residential valuation report as opposed to 150, Insurers could halve the rate they charge whilst maintaining premium income. h) Whilst other professions are experiencing similarly high levels of notifications, Valuation Surveyors have been far harder hit in terms of a rate rise than IFAs and marginally harder hit than law firms undertaking conveyancing. Even the highest risk IFA firm should be able to secure a rate of circa 2%, whilst the average rate for conveyancing is currently at approximately 8% (marginally lower than the estimated 10% for valuations for lending). 12 13

5. why is there a disparity between the professions? a) One of the key differences between professions is the variation in fees previously referred to. b) Insurers of IFAs have the ability to restrict cover and cover is offered on an Aggregate rather than Any One Claim basis. However, a Solicitors PII wording (as laid down by the SRA) is broader than the RICS minimum terms. c) Solicitors have the option to insure with unrated security. Whilst this rarely makes sense in the long term, particularly given the demise of Quinn, Lemma and more recently Balva, unrated Insurers will often offer very competitive terms to enable them to rapidly establish books of business. Whilst there have been new Insurers who have been willing to aggressively quote to win Surveyors business, their appetite has often been short lived and it remains the case that Surveyors (rightly so in our opinion) do not have access to unrated security. One only needs to explore the demise of Quinn to find justification for the RICS strict approach to monitoring the financial stability of RICS listed Insurers. In 2008, the RICS removed Quinn from its Listed Insurers whilst the SRA elected not to take any action. When Quinn later entered administration, many law firms where left uninsured. d) Whilst the total premium pot for IFAs is around 40m, Solicitors generate in excess of 200m per annum (compared with a total of 70m from RICS regulated firms) even though there is only 1,000 more law firms in the UK than RICS regulated firms. e) Insurers consistently view lending valuations as the highest risk activity a surveying firm can undertake, irrespective of the fact that outside of an economic downturn they will receive a higher volume of claims from property management, Home Buyers reports and Building Surveys. Insurers take this view because: I. Higher values at risk therefore, potentially higher quantum s associated with claims. In 2009 we settled 36m of claims on behalf of surveying firms as compared with 20m for IFAs. In 2010 settlement amounts were broadly similar but our IFA book is six times the size of our surveyors book (in terms of number of accounts) II. Valuations are generally unpopular with Insurers, as it is one person s objective opinion of a value, supported by comparables, at a given time in a particular set of circumstances (i.e. willing buyer and willing seller). It is very difficult to get a valuation correct (whatever that means) in those circumstances and equally difficult for courts to ascertain correctness III. Lenders are consistently viewed as being highly litigious, although this impacts conveyancing Solicitors as much as Valuation Surveyors IV. Concerns regarding fraud although, again, this concern is equally applicable to conveyancing firms. Furthermore banks, through contributory negligence reductions, are being forced to take greater responsibility for their own actions in relation to fraud. f) There has been a suggestion that Surveyors are less sophisticated buyers than their legal and financial counterparts. There is no empirical evidence to support this view, but my personal experience suggests that surveyors are more loyal to their Broker/Insurer (occasionally irrespective of the service they receive) and less inclined to negotiate hard on price at renewal. Additionally, the profession s approach to purchasing PII is not always conducive to enabling an Insurance Broker to secure a competitive quote, or indeed any quotes at all. Firms continue to submit illegible, inaccurate proposal forms and to start the process just a few weeks ahead of renewal. This is, however, true of all professions. g) It has also been suggested that Surveyors are less sophisticated legally and commercially when negotiating contracts with their clients. The profession and its Insurers have certainly not been helped by the broad contractual obligations enforced by both Lenders and Panel Managers. 14 15

6. Preventing re-occurrence of the problems We have tried within this section to make recommendations that are achievable rather than merely desirable and to recommend actions that are within the control of the individual surveying firm. a) Don t undertake instructions that are outside your area of expertise in terms of either geographic location or asset type. b) Ensure that your firm has a robust audit process in place and ensure that this is consistently applied even during peak periods. c) Highlight any concerns that you have regarding the property and refer owners/ Lenders to appropriate professionals where required. If you can t carry out a full inspection, e.g. walls are dry lined, refer to this in the report. d) Ensure comparables are appropriate. e) Attach photos to reports. f) Ensure that electronic copies of all reports, file notes, comparables and photos are retained for at least 15 years and that all files are regularly backed up. g) Use a specialist Professional Indemnity Broker with direct access to all RICS Listed Insurers. h) Start the renewal process at least two months ahead of renewal. i) Ensure that your proposal form and supplementary questionnaire is neatly completed, legible and accurate. j) Ensure that your reporting systems facilitate the simple collation of data on items such as Loan to Value ratios and Lenders for which you have undertaken instructions. Ask panel managers for full reports on all valuation instructions you have undertaken to support your renewal submission. k) Remain in regular contact with your Insurance Broker throughout the policy year to give you the best chance of receiving an early warning about the possibility of your existing Insurer declining to offer renewal terms. l) Know your client and be wary of accepting instructions that have been through multiple distributors. m) Think very carefully about undertaking valuations at a fee which you feel does not reflect the workload and potential liabilities involved. Remember that you will incur a premium cost for that valuation for the next seven years. n) Never allow a third-party to pressure you into arriving at a valuation figure that you are not entirely comfortable with. o) Ensure you fully understand any agreements that you sign up to. Don t just accept items such as unlimited assignment and unlimited liability. p) Consider setting aside a certain proportion of fee income to cover the cost of PII insurance and run-off cover in future years. The first year of run-off cover will generally be equal to the premium paid in the last full year of trading. Subject to claims levels and insurer appetite remaining stable, you should then budget for a 15% year-on-year reduction. q) Maintain an open and frank dialogue with other firms regarding their experiences. Which Lenders are most active in terms of allegations? Which areas/property types are throwing up the highest numbers of notifications? Above what LTV level do claims typically occur? r) Remember that claims will occur as soon as losses arise. Be wary of valuing in an overheated market. There are more all-encompassing solutions to the PII problem but the ability to deliver these rests with a collective group of Panel Managers, Surveyors, Regulators, Lenders, Insurers, Insurance Brokers and Lawyers. For this reason they have not been explored in this document. 16 17

ABOUT HOWDEN WINDSOR Howden Windsor is the only Insurance Broker to hold the Royal Institution of Chartered surveyor s preferred Professional Indemnity Broker status. We are responsible for placing over 20m premium per annum on behalf of 650 surveying firms, ranging from sole traders to some of the world s largest property consultancies. We have assisted a large number of Panel Managers and surveying firms generating in excess of 50% of income from valuations for lending in securing PII at a competitive price. We maintain strong relationships with all RICS listed primary layer Insurers and are one of the largest producers of PII premium to several key Insurers to the surveying profession. We also have strong relationships with key influencers within the surveying profession including Panel Managers, Lenders and Solicitors. This ensures we can offer innovative insurance solutions that respond proactively to changing market conditions and client demands. We have a highly experienced team, many members of which have over 20 years experience of handling PII on behalf of Surveyors, ensuring we deliver the right premium for the right level of cover, with the ability to tailor policy wordings where required. In addition to our Account Handlers and Brokers we operate one of the largest in-house PII claims team in the UK, which helps to reduce the time your directors, partners and employees spend managing claims and ensures that where coverage issues arise, you have a tough advocate on your side. We are the specialist Professional Indemnity division of Howden Insurance Brokers Limited, as a team we are responsible for placing over 134m premium per annum on behalf of over 7,500 businesses. The greatest testament to our expertise is our dominance in many of the sectors in which we operate; over 50% market share in the IFA sector, the Royal Institution of Chartered Surveyors only preferred Professional Indemnity broker and broker to 30% of the UK s largest Accountancy practices. Contact Us Matt Farman Tel: 020 7133 1565 matt.farman@howdengroup.com Dale Williams Tel: 020 7133 1575 dale.williams@howdenwindsor.com www.howdenwindsor.com/surveyors 18 19

71 Fenchurch Street London EC3M 4BS United Kingdom Tel: +44 (0) 20 7133 1400 www.howdenwindsor.com Howden Windsor is a trading name of Howden Insurance Brokers Limited, a subsidiary of Howden Broking Group Limited, part of the Hyperion Insurance Group. Howden Insurance Brokers Limited is regulated by the Financial Conduct Authority: firm reference number 312584. Registered in England and Wales under company registration number 203500. Registered office 16 Eastcheap, London, EC3M 1BD. Disclaimer: The observations, comments and suggestions made in this document by Howden Windsor or any other part, are advisory and are not intended nor should they be taken as legal, financial or insurance advice. Please contact your specialist broker, legal or financial advisor for an analysis of your specific facts and circumstances.