Pricing Accountants’ Professional Indemnity Insurance – The Broker’s Perspective

Accountants’ professional indemnity (PI) insurance seeks to cover the financial harm that can arise from errors and omissions in the delivery of professional services. What factors are involved in the pricing of this coverage?

Broadly speaking, the “pure” actuarial pricing of an accountant’s professional indemnity insurance policy is driven by the firm’s revenues, claims history, headcount, service mix and location, evaluated within an actuarial model containing the insurer’s book of similar and related risks. The amount of coverage and attachment point are also key factors in price determination.

During underwriting the resulting “technical price” is then modified based on multiple factors including the quality and depth of a firm’s risk controls, coverage extensions and withdrawals and market competition.

Revenues

Accountants’ PII is usually rated in relation to revenue, based on the assumption that higher revenues mean higher risk. A firm with $10M in revenue is a very different entity than a firm with $10B and has significantly less exposure, if only due to the size, number and complexity of its client engagements.

The type of revenue an accounting firm earns is also important. Firms that concentrate on, for example, tax work are viewed differently than a firm that is involved in the audit of public companies. The nature of the firm’s clients is a factor as well. Firms that specialize in industries with higher inherent risks, such as financial services or healthcare, may face higher premiums due to the potential for significant claims.

Headcount and Location

While revenue is used when calculating the PII premium rate for accountants, the size of the firm’s headcount does play a role in the pricing.

Larger headcounts, like revenues, are an indicator of higher risk. Often firms will be asked to provide granular details about their headcount, including the breakdown by type of employee and the number of partners. Similar to revenue information, insurers review historic headcount for any significant spikes that may potentially be of concern.

The location of the firm is also important. For example, U.S. national accounting firms operating in more litigious states or in jurisdictions where courts have historically been less favorable towards large companies face increased risk in the event of a suit.

Claims

Insurers pay very close attention to a firm’s claims history and may ask for 10-15 years of claims experience to help understand the historical perspective. Accounting firms that have frequent and/or severe losses would likely see higher premiums.

From an actuarial perspective, older claims may be adjusted for inflation to reflect what an equivalent claim might cost today. At the same time, older claims may be weighed less heavily than more recent claims. Less mature claims may also be adjusted to reflect their potential ultimate values, since professional indemnity claims can take years to resolve.

Insurers will typically analyze industry claims trends to bolster the claims data provided by a single firm. This approach is helpful for firms that have a limited claims history as, in isolation, there would be few data points with which to confidently gauge risk.

Market Dynamics

When the accountant’s PII market, or the broader insurance market, sees an uptick in claims it can result in reductions in available insurance capacity as insurers pull back capital or exit the market all together. All firms may experience price increases as a result.

In periods where losses are modest and underwriting profits are strong, established insurers may be willing to write more business and the market may see new entrants, increasing competition and driving prices down.

Program Structure

The structure of an insurance program greatly influences the premiums charged. Risk retention has a significant impact, with larger retentions often resulting in meaningful premium credits. Insurers may not be willing to provide quotes at retention levels below a certain threshold or will charge significantly higher premiums for coverage at this level. Depending on the risk profile of the firm, insurers may require specific coverage limitations and/or a minimum retention or a specific retention structure to quote coverage.

Firms may need more insurance than one insurer is willing to provide. When this happens, layers of additional coverage are built above the anchoring or “primary” layer. Based on client needs and insurer appetite, layers can have multiple participating insurers. The pricing of the primary layer then influences the cost of the higher layers.

Higher layers are typically priced lower than the primary layer, which sits immediately above the retention and responds first in the event of a loss. The difference in pricing is called an Increased Limit Factor (ILF) and represents the decreased risk of a claim reaching higher layers.

The ILF, expressed as a percentage, provides the relative decrease in the expected cost of the risk by layer. While pricing for subsequent “excess” layers tends to be less expensive than underlying layers, premiums will not fall below the minimum price required by the insurance company to underwrite the risk.

Other Underwriting Considerations

Besides the factors discussed above, pricing can be impacted by other qualitative factors.

Risk management practices are of particular interest to underwriters. Demonstrating strong risk mitigation policies and procedures throughout the firm can provide assurances to insurers to adjust and improve actuarial pricing.

Other factors could influence an underwriter positively or negatively, such as:

• Client contract considerations, such as limitations of liability, liability waivers and arbitration clauses;
  
  
• Client acceptance and separation practices – insurers value firms who review client riskiness before accepting an engagement and who separate from existing clients when they become unacceptably risky;
  
  
• Risk management and culture – simply put, firms that invest in risk controls and then use the experience of past claims to improve these controls will be viewed more favorably than firms that do not.

The overall quality of the underwriting submission and any accompanying presentation will also affect the underwriter’s view of the risk. A polished, detailed and compelling presentation will be viewed favorably and mitigate the risk of ambiguity or a misunderstanding of the firm’s risk profile.

Final Adjustments

Final premium also includes charges for administration, costs of capital and profit margin. An adjustment may also be made to ensure that the premium meets the minimum rate required by insurers at higher attachment points, where claims data is sparse and losses may be underestimated.

Based on the firm’s risk tolerance and appetite, the broker’s goal is to obtain the optimal coverage at a viable price for the client firm. The insurers’ goal is to offer a competitive quote while maintaining profitability and remaining within their own risk tolerance parameters.

Conclusion

The pricing of accountant’s PII combines the expertise and professional judgement of the underwriters with a data driven analysis. While revenues, claims and firm size guide modelling, the pricing can be impacted by the firm’s risk controls, business type, the selection of coverage and retention, as well as the state of the insurance market.

Given the importance and complexity of accountant’s PII, firms are recommended to work with experienced and capable brokers to achieve results and pricing in line with their business and financial needs.

Contact

The Professional Services Practice at Aon values your feedback. To discuss any of the topics raised in this article, please contact Huxley Anjilvel or Ivy Pei Wei Zhou.


Huxley Anjilvel
Vice President and Director
Montreal







Ivy Zhou
Vice President and Director
Montreal

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