Much has been done to bring icare’s Home Building Compensation Fund (HBCF) back to financial health and level the playing field for builders.
The HBCF protects homeowners undertaking residential building projects in NSW worth more than $20,000 if building contractors are unable to honour their commitments due to insolvency, death, disappearance or suspension of licence (for failure to comply with a money order in favour of the homeowner by a court or tribunal). The HBCF insured more than $17.4 billion in residential projects during 2016–17.
The HBCF scheme covers 17,205 builders but premiums have been insufficient to cover projected claims costs, based on the past experience of the former private insurers. The fund was $375.8 million in deficit as at 30 June 2016, up from $293.8 million the previous year, based on actuarial estimates of future claims costs but has been meeting all its claims obligations from written premiums. The balance sheet losses arise from actuarial estimates that insufficient premiums have been charged since 2010.
However, the NSW Government decided that future policyholders should not pay the debts of the past, so it is using the treasury surpluses to fund any liabilities should they arise.
Change was imperative
Nevertheless, it was imperative that the HBCF made changes. “As the sole underwriter of this insurance, we wanted to increase the financial accountability of builders,” says HBCF General Manager Jon East, who has a depth of knowledge about home warranty schemes. “This has resulted in risk-based pricing, so that premiums better reflect a builder’s level of risk.
“We start with the generally accepted principle that a business that is under financial stress will produce poor work. Guided by that, we have been assessing the financial resilience of a business to ensure it can meet its obligations for the past seven years.”
One of the most important changes was finding a way to calculate fair and reasonable premiums for builders. High-risk contractors pay more while lower-risk contractors receive a discount. This can be up to 30 per cent higher or lower than the standard premium. Not only does this give builders an incentive to reduce their risk, it will improve the quality of construction because builders have more motivation to run good businesses.
Data driven changes
“When we looked at the data of six years of claims, it became obvious that there were some characteristics of a business that lowered the frequency of claims and other characteristics that increased the frequency,” East says. “Two characteristics stood out. The first was whether the business was incorporated; that is, whether it was a sole trader or partnership with personal assets exposed, or a discretionary trust or company where the assets were somewhat protected. The second characteristic was the length of time a company had been trading.
“Being a monopoly government provider, we needed to ensure our assessment criteria were transparent, and the measures of company structure and time in business are not open to interpretation. We use these eligibility criteria for basic pricing but set higher benchmarks for bigger businesses. About one-third of the 17,205 builders in our portfolio are large enough for us to be concerned about their cash flow and profitability, so we do annual reviews on these.
“In the group of large businesses, what stood out in the data was whether they were profitable, had capital committed to the business and whether their accounts were independently audited. We added these criteria to the other two benchmarks – time in business and corporate structure – to get a review structure.
“The result is a totally transparent pricing model,” East says. “A small sole trader can now get insurance at the same price as a major corporation.”
And by July 2018, the HBCF is expected to be able to cover all projected claims from the premiums charged.
Part three of the series covers the innovative solutions that are helping both homeowners and builders.