The builders’ warranty insurance (BWI) market is a confusing party that few insurers want to attend.

The last two states to have significant private insurer underwriting involvement, SA and WA, face losing their major provider, QBE, because it says BWI is no longer viable.

The failure of the private market despite significant premium increases is forcing state governments to underwrite schemes to protect consumers if their builders go broke, abscond or die.

The SA Government is underwriting QBE to keep the insurer covering the state for another year while bureaucrats investigate alternatives.

And a review of the WA scheme is under way, with the economic regulator proposing private insurers cover construction risk and building associations cover the warranty period, or long-tail risk.

QBE is the major private player in BWI, acting as an agent for governments in the NSW and Victorian schemes, while Calliden has carved out a niche covering smaller builders in NSW, SA, Victoria and WA.

CGU and Lumley left the WA market in 2009 and Vero followed a year later.

In 2010 the NSW Government became the state’s sole BWI provider after Lumley, CGU and Vero quit the market; in the same year, Victoria adopted a government scheme after four of the five insurers there left or announced their intention to do so.

Tasmania is the only state not to make BWI compulsory, and private insurers have quit the market there. In Queensland a statutory body, the Building Services Authority, operates a non-profit BWI scheme, licenses builders and handles disputes.

Builders’ groups such as branches of Master Builders Australia and The Builders Collective, which represents smaller companies, argue in favour of the Queensland system, but there seems to be no appetite for it in WA or SA.

WA’s Economic Regulation Authority (ERA) says “first resort” schemes such as the Queensland system can attract nuisance claims, because the consumer’s first step is to make a claim; they may also encourage builders to lower standards because they know customers are covered. Consumers can make a claim when the builder is still trading.

A Queensland parliamentary inquiry last year recommended the Building Services Authority “one stop shop” be disbanded, saying the insurance role should be separated from other functions to ensure there is no conflict of interest.

It says premiums should reflect the work and level of risk being undertaken.

WA’s ERA last month released a draft report on BWI and is taking submissions until May 13.

The state currently has a private-public mix, with the Government underwriting some of the risks covered by QBE. That agreement expires on June 30, and QBE is reviewing its involvement in the market.

The ERA notes the Government – which underwrites losses of more than $10 million incurred from the failure of a single builder – retains 39% of the estimated maximum loss, yet recoups only about 10% of premium revenue.

It says the current system “cannot be relied upon to provide a long-term and stable consumer protection mechanism”.

The ERA recommends a model that separates construction risk and warranty risk. Private sector insurers would cover the construction phase, while the building sector, through its industry associations, would provide warranty insurance for the six years of coverage after the work is completed.

It believes there will be a “reasonable level” of interest from insurers.

QBE says it is committed to working with the WA Building Commission to find a sustainable long-term solution.

“Providing insurance for the construction-period risk alone would be more attractive to the insurance market, because the risk exposure is limited to the construction phase, which is usually one to three years”, a QBE spokesman told insuranceNEWS.com.au.

BWI can be difficult for insurers because the number of builders providing premium income is relatively small and many are vulnerable to collapse in economic downturns.

WA’s 10 largest builders account for almost 80% of the houses constructed in the state, and the ERA notes builder failure is highly concentrated towards a small number of large risks.

It says BWI risk can be difficult and costly for insurers to calculate. They must also hold significant capital reserves – given the potential for large losses – relative to the size of the market and the premium pool it generates.

Protecting consumers from losses in what is likely to be the biggest investment they ever make is important. But as has been demonstrated across Australia over the past few years, the fluid nature of many elements of the building industry also makes it too much of a gamble for a competitive insurance industry.