Architects and engineers: Blueprint for recovery

Schinnerer executive says A&E business is retooling for a new reality

By Elisabeth Boone, CPCU

In the wake of the 2008 financial meltdown, the collapse of the construction market, and the persistently high unemployment rate, it's hard to find anyone who hasn't felt the sting of the nation's ongoing economic woes.

The tidal wave of residential housing foreclosures, tighter lending standards, and lack of funding for public works projects all are contributing to a frustratingly slow recovery in the construction market. Competition for available projects is intense, and every sector of the industry faces a host of critical challenges.

For architects, engineers, and consultants, the troubled economy has spurred a wave of consolidation, and the remaining firms often find themselves bidding on projects of a size or type they previously would not have considered. As a result, many design professionals may unknowingly be assuming risks and exposures for which they are not prepared.

Since 1957, underwriting manager Victor O. Schinnerer & Co., Inc., has partnered with CNA Insurance to develop coverages and risk management strategies for architects, engineers, and consultants. (See "Schinnerer's A&E Program Hits the Big 5-0" in the October 2007 issue of Rough Notes.)

The Schinnerer program is highly regarded by design professionals and is commended by the National Society of Professional Engineers. Over the 55 years of the program's existence, Schinnerer has refined and expanded it to address emerging exposures in the design/build arena.

For 22 of those 55 years, Kevin Collins, senior vice president in Schinnerer's A&E division, has had his finger firmly on the pulse of this complex and demanding market. Collins worked for Schinnerer part time while he was in college, and after graduating in 1990 he joined the company full time. Currently he is a senior manager with responsibility for the mid-sized and large firm A&E programs.

The challenges that confront design professionals today, Collins believes, are creating opportunities for firms that can adapt to the new realities of the marketplace.

Changes and challenges

Among the many changes he has witnessed over the two decades of his involvement in the insurance market for design professionals, Collins says, one event stands out from all the rest.

"I think everything we're seeing right now is in the context of what happened to the financial industry in 2008," he says. "Many of the changes that have taken place over the last three to four years have been magnified by the depth of the financial crisis as architects and engineers try to recover what they've lost."

In more general terms, Collins remarks, "Over the last couple of decades we've seen changes in the traditional relationships firms have had with their clients. Historically, most firms have had a significant percentage of repeat clients and worked primarily in their own town, region, or state. Firms also operated mainly within their established niches: public or private, commercial or residential, and so on.

"On the owner side, decisions commonly were made by just one or a few people, which allowed for the development of a strong comfort level between the owner and the principals of the architecture or engineering firm," Collins explains. "Today, A&E firms face a greatly changed world with increased public oversight and more people on the owner side involved in the decision-making process. As a result, firms now find they must prove themselves to the owner on a project-by-project basis, and it's much more challenging to manage the relationship effectively."

Pointing to another change in the owner-design professional relationship, Collins says, "Owners are becoming more nimble and acting more quickly, and that puts pressure on architects and engineers to quicken their own pace. The timetables are becoming much shorter, not only for owners and design firms but also with respect to insurance and risk management. New exposures are constantly arising, so insurers and program managers like Schinnerer have to respond quickly."

Does size matter?

The Schinnerer program for architects, engineers, and consultants is available to firms in three size categories: small firms (annual billings of $500,000 or less); medium-sized firms (annual billings between $500,000 and $5 million); and large firms (annual billings of more than $5 million). We asked Collins how the size of a firm might have affected its ability to survive the 2008 financial meltdown and ensuing recession.

"Many of the changes outlined above became more evident in the first three months of this year than they had been over the previous 12 months," Collins says. The ranks of survivors, he notes, are dominated by large firms, and these firms are experiencing the most robust recovery. "The larger firms—say the top 500 design firms as ranked by ENR (Engineering News-Record)—are starting to see year-over-year increases in their revenue base that average about 5% to 10%.

"As for the smaller firms—the sole practitioners or two-person firms that bill under $1 million a year—we still see them struggling to some extent, with an average decrease in year-to-year revenue of 5% to 10%," Collins observes. Small firms are beginning to recover, he notes, but they still have a long way to go.

Size does matter, but it's not the only measure of success in recovery. "In general, firms that before the recession had become more diversified with respect to project or owner class have proved to be more resilient than firms that did not expand beyond their traditional niche or region," Collins explains. "For example, architects who were heavily involved in the development of condominium projects in the Southeast or single-family communities in the Southwest fell off the cliff when the recession hit because the funding for these projects just disappeared. Among the firms that survived the recession, those that specialized in markets like this are taking much longer to come back than the firms that entertained a wider scope of projects or diversified their geographic base."

Insurance turnaround

As architectural and engineering firms move through recovery, Collins observes, the demand for insurance likewise is increasing.

"From 2008 into early 2010, we experienced declines in both new business applications and renewals because many firms left the marketplace and many of those that remained could not afford to maintain their coverage," he says. "Since the second quarter of 2010, we've been seeing an upswing in firms' interest in purchasing coverage or increasing limits as they rebuild their resources and realign their budgets."

The growing demand for insurance, Collins notes, also is being driven from the project owner side. "In both the public and private sectors, owners are becoming much more knowledgeable about the insurance requirements for projects and are focusing on the details of the coverages they want firms to have, particularly with respect to professional liability," he says. "Owners also are requiring firms to obtain higher limits. The minimum limit used to be $1 million; now many owners are requiring $2 million, $3 million, or even $5 million. This trend reflects a greater awareness among owners of the insurance implications of a project, and architects and engineers are realizing that they must obtain higher limits if they want to bid on and win a project in today's marketplace."

The Schinnerer program for architects, engineers, and consultants has capacity for limits up to $15 million, Collins says. "We can provide the limits requested by the vast majority of clients, but of course there's a cost associated with higher limits. Our sense is that a lot more negotiation is taking place between firms and owners to reach agreement on this issue. An owner may want a firm to obtain higher limits, but the owner is not necessarily willing to accommodate the additional cost in the budget for the project," Collins explains. "The owner and the firm must negotiate to establish what limits are appropriate and affordable. With owners requiring higher limits, firms are having to devote more time to discussions with their broker about insurance requirements as well as the risk management components of the contract."

In Collins's view, this new equilibrium between project owners and design professionals is a positive development that demonstrates the commitment of both parties to identify and address all the risks and costs inherent in a given project. The heightened focus on risk management, he believes, will drive an increase in the profitability of projects and will be a key force in the recovery of the construction industry.

Key growth areas

As Collins observed earlier, design professionals who focused on the development of condominiums and single-family housing were hard hit by the collapse of the residential real estate market, and many firms were forced out of business.

"The demand for these kinds of development projects is still very low, and although there's some activity in this sector, it will take a long time for these markets to recover," Collins remarks.

As millions of people have lost their houses to foreclosure or experienced a job-related decline in their income, apartment construction has been on the rise as former home owners find themselves unable to meet the stricter standards imposed on borrowers. Many people who otherwise might have moved to a new location or purchased a larger house, Collins notes, are staying in their current houses and renovating to save money.

"In terms of residential development, we're seeing more activity in cities as opposed to suburban areas," he comments. He attributes this trend to "green" factors like the growing interest in sustainable design and efforts to expand the use of mass transit.

On another bright note, Collins says, engineering firms are benefiting from the federal government's investment in shovel-ready infrastructure projects; at the state level, however, the recovery is less robust because many governments are strapped for cash and lack the funding for schools and other public works projects.

"The good news," Collins says, "is that the overall rate of decline in revenue has slowed, and in some sectors, like federally funded projects, it's even starting to grow."

As the economy and the construction market continue to emerge from their worst battering since the Great Depression, architects, engineers, and consultants are retooling to meet the demands of a new reality. The Schinnerer insurance and risk management program will be a key feature of their blueprint for recovery.