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Professional indemnity market update — part two: Four key risk issues

Building on the first part of our professional indemnity (PI) market update, the second part focuses in more detail on some of the factors that have impacted the PI market.

Building on the first part of our professional indemnity (PI) market update, the second part focuses in more detail on some of the factors that have impacted the PI market, including:

Environmental, social, and governance (ESG)
Technological risks presented by artificial intelligence (AI)
Legal precedent from the last few years relating to professional duty in law
Various trends in the accountancy and tech sectors

ESG

The ESG acronym is broken down into the following topics to assess an organisation’s approach to:

“E”: How it manages its environmental impact

“S”: How it treats its internal and external stakeholders

“G”: How it is led and if it governs with accountability and transparency

The last 10 years has seen a raft of international treaties and state-level laws passed that make private sector businesses accountable for their ESG impacts. This includes the Paris Agreement (2016), the European Commission’s Corporate Sustainability Reporting Directive (2022), and the US Securities and Exchange Commission’s Climate-related Disclosure Rules (2024), to name a few. It has already led to more watchdog crackdowns, as well as, claim actions by social inequality and human rights groups and climate groups, against a variety of firms. We could also see a rise in shareholder claims (derivative actions) for misleading ESG information. Businesses partnering in a supply chain could also potentially bring claims against each other for ESG breaches.

While this issue may be more relevant to directors and officers’ liability insurance policies, it could also affect the PI market too. For example, there could be possible professional negligence claims against financial advisors or accountants for incorrect advice given about a company’s or fund’s ESG credentials, prior to investing. Additionally, from a broader PI underwriting perspective, a lack of confidence in a business’ ESG strategy could introduce risk. Some underwriters would not want to take a business onto their underwriting book that is in clear breach of ESG duties. In construction, a PI buying developer or contractor — if exposed to breaches of ESG-related statutes and regulations — could open up a civil professional negligence allegation with respect to site pollution, sustainability, or project materials supply.

Solicitors Clyde & Co reported in their PI market update, that 72% of PI underwriters responding to its survey agreed that ESG is impacting their underwriting decisions to some extent. The report comments:

“While claims related to Environmental, Social & Governance (ESG) requirements have not yet trickled through to the PI market - and are expected to hit the Directors & Officers market first, should they materialise at all - there’s a growing sense among experts that claims could begin to make their way into the PI segment in the medium term. This is something for claims teams, as well as their colleagues in underwriting and wording, to have on their radar, market experts noted.”

Source – Clyde & Co UK Professional Indemnity market report 2023.

AI

Over the last 20 years, AI has developed into a true ‘deep learning’ algorithm that is used by many professional sectors as a fundamental source for their professional services and advice. While this creates cost and time savings — allowing professions to achieve faster growth — it does present various risks from an insurance perspective, for example, in discrimination, safety, privacy, ethics, and accountability for undesired outcomes.

For PI underwriters in particular, AI becomes a concern with regards to responsibility for error or liability being taken away from humans. With AI potentially making holistic decisions on service delivery on each professional engagement, the service delivery staff in a professional firm can become more distanced from the fundamental logic or reasoning for the advice or design. Furthermore, the complex algorithms behind AI are often only understood by a small pool of tech experts, who may be unfamiliar with the profession that is using the AI tool. Therefore, there is a fear that systemic errors are not picked up or corrected. A fundamental legal mechanics issue could also arise — is it possible to apportion even contributory ‘negligence’ (which is a human concept) to a machine learning tool? This is something we could see come to the fore in future litigation.

Cyber liability policies have become more important, alongside a PI policy, after the market reaction to exclude ‘silent cyber’ risk on PI coverage. AI may impose yet unknown loss potential to cyber liability claims, with AI-driven malware outpacing security development. However, we do see the cyber liability insurance market at the forefront of AI future proofing by actively working on developing standardised terminologies and policies for data breaches, hacking, and identity theft. While businesses with exposure to crypto-assets may find it difficult to secure cyber liability coverage, some appetite is opening in the market to write wider blockchain and AI risk.

Audit errors have increased in the accountancy sector. This could be in part due to complex audit work being moved to AI systems and managed by junior staff. Therefore, as junior staff do not receive exposure to fundamental auditing concepts, knowledge gaps may be created that lead to PI claims when they start working on larger projects without AI.

In the architecture space, many design tools are increasingly replacing the human need for actual design creation, which we discuss more in the third part of this article series.

Overall, AI is a big talking point in the current PI market, as summed up by solicitors Clyde & Co in its recent PI market report:

“There was a marked increase in the proportion of respondents that expressed concern about the risk that the use of Artificial Intelligence (AI) might pose to the practice of professional firms, compared with last year. Experts said that while there may be fear about the use of AI and other newer technologies, the trend towards greater use of these tools was already in motion. PI underwriters suggest there is a need to try and understand the risks and opportunities posed by new technology and find ways to feel comfortable covering firms which use it heavily in their day-to-day practice”.

Source – Clyde & Co UK Professional Indemnity market report 2023.

Legal precedent

Litigation dealing with claims sets legal precedent that can affect all professionals. In recent years, one key decision on two cases has done this:

Manchester Building Society v Grant Thornton and Khan v Meadows (2021)

Both of these cases — an accountancy audit advice case and a medical negligence case — had a joint decision handed by the Supreme Court due to their similar conceptual points. The decision took a closer look at prior legal precedents, such as the “SAAMCO principle”, to clarify what scope of losses a professional can actually be held liable for. Such losses that a professional should pay for in a claim, have always been determined by:

1) The “but for” argument
This argument examines all the knock on decisions the claimant made, and the resulting losses the claimant suffered, because of bad advice or design.

Simply using this argument could apply huge losses within the professional’s liability, so under SAAMCO it also asks:

2) What was the professional’s scope of duty of care?
Liability for losses should be “narrowed” to a “nexus of loss”. For example, including only possible losses that were within the scope — with contemplation of both parties at the time services were performed.

Over prior legal cases, decision weighting has slightly favoured either of the previous cases — with recent judgements more likely to rule closer to 1). However, the Supreme Court decision has swung the pendulum slightly back to a fairer position — which could be positive for professionals having PI actions brought against them.

The judge did stress the importance of a professional services engagement letter or contract being drafted correctly. This can help detail what services are being provided and also, importantly, the purpose and reason for the services being provided. Doing so can help mitigate the amount and size of potential losses in a claim.

Recent updates on some sector specific PI issues:

Accountancy: Research and development (R&D) tax relief schemes: From 2021 to 2022, error and fraud due to its R&D tax relief schemes are estimated to have cost the HMRC around £469 million. Accountants, often via appointment to R&D specialist advisor firms helped clients claim tax relief by allocating some income/expenditure to R&D to receive tax benefits. As a result, a large number of claims have hit the PI market. There is a view by some in the industry that there was a misunderstanding of what HMRC’s acceptance of claims entailed (essentially the HMRC agreeing to the accounting methodology, not that the income being apportioned was appropriate). Additionally, there have been cases of outright fraud — with R&D tax relief specialist firms in some cases allegedly making claims when bound to fail, just to claim a fee. Finally, issues also arose from firms failing to make claims and claiming under the wrong scheme. All this inevitably resulted in the UK PI market placing exclusions on PI policies for such work. Unsurprisingly, the HMRC has since strengthened compliance requirements for the schemes. Overall, the strengthening and clarity from the HMRC on the schemes — and many specialist R&D tax advisors shutting down — will hopefully result in a reduction in claims and, potentially, the PI market opening up to cover such areas again.
Tech PI and cyber liability: Indemnity limits for data breaches: Over the last few years, the PI market has moved to explicitly exclude any cyber liability coverage that was either implied coverage via the broad nature of a PI wording, or expressly covered. The reason for this was to create a clear distinction between a PI policy and a cyber liability policy. However, tech firms often contractually sign up to high insurance limit requirements for data breaches — historically an issue that could sometimes be covered by a PI policy. Cyber liability insurance products in the market tend to offer lower limits for this than a standard PI programme. Therefore, many tech firms are finding they are in contractual breach, and it can be difficult to meet these limit requirements by a cyber liability insurer. However, the cyber insurance market is working with us, and others, to provide a solution.

Overall, while the PI market is firmly trending towards a buoyant state, there are always activity-specific issues and macro factors that can influence the market. However, the current demand from insurers to increase their book — and thus general appetite to write business — is strong. In part three of this market update, our focus moves to the construction and property PI insurance markets.

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Professional indemnity market update — part one: How we got here

18/07/2024

After experiencing several years of hard market conditions, the UK professional indemnity (PI) insurance market has transitioned to a softer market.

Top view of forest and river in Tuchola national park

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