If the withdrawal of Lumley Insurance and CGU rattled the market for privatised builders’ warranty insurance, then the departure of Vero threatens to shake it to its foundations.

Vero is the country’s dominant provider of builders’ warranty insurance, which is a mandatory cover everywhere except Queensland and Tasmania.

Its decision to close the books on new business from July 1 has sent shockwaves through the residential building industry, where builders must hold the cover before starting any work of significance.

Under the privatised last-resort system, builders’ warranty cover provides a capped payment to consumers to finish incomplete or defective works should the builder die, disappear, or enter insolvency.

Almost 10 years on from the collapse of HIH Insurance, another crisis in coverage now threatens to bury the last-resort privatised system just as it did its first-resort counterpart. (Only Queensland retained a state-run first resort system as other states moved to privatise last-resort systems in the wake of the insurer’s collapse.)

Doubts about the continued viability of the privatised market intensified last year when major providers CGU and Lumley Insurance both announced plans to exit the market within the space of a fortnight. At the time, Lumley said the cover comprised less than 2% of premium income.

The NSW Government eventually responded to builders’ supply concerns by introducing a state-underwritten scheme, which takes effect in July. Removal of the most populous state from the warranty market is an obvious blow to private sector profitability.

Vero’s decision to head for the exit could prove the final stroke. The Master Builders Association of Victoria certainly thinks so, calling for major reform of the system.

Such concern is valid. Only QBE and Calliden will remain in the privatised builders’ warranty market beyond July, faced with underwriting all residential projects in most states of Australia.

Whether QBE has the appetite for the lion’s share of a builders’ warranty insurance duopoly is not entirely clear, although initial indications are at least positive. On Friday a QBE spokesman told insuranceNEWS.com.au the insurer “will continue to provide builders’ warranty insurance to any applicant that meets QBE’s underwriting standards”.

Calliden Group Executive Marketing and Distribution Mike Hooton told insuranceNEWS.com.au the smaller player will do all it can to support the industry.

Building groups currently appear unconvinced, and are putting increasing pressure on state governments to step in and resolve the issue.

Government reform of the system would at least allow the opportunity to improve the scope of the cover, as well as its availability. There is little doubt that the policy’s tight criteria has led to a dearth in consumer awareness, with questions over the extent and quality of builders’ warranty leading as far as a Senate inquiry into the product.

Official reports provide further insight. A Financial Ombudsman Service report found 45% of all claims were rejected in the year to June 30 2008, while a Victorian Essential Services Commission last year revealed just 20% of claims were accepted between 2002-08.

This is grim reading for an industry that typically pays out more than 98% of all claims.

Consumer advocates argue the problem goes way beyond mere communication. They maintain the product is essentially a sham, handing easy profits to insurers in the absence of any real risk. On the other side, insurers and product brokers argue the product does exactly what it was designed to: provide a commercially viable last-resort form of consumer protection. A potential supply crisis now adds to the controversy.

With question marks hanging over the continued viability of builders’ warranty insurance, Master Builders Association of Victoria Executive Brian Welch says the “only acceptable outcome” will be a scheme “where no builder is disadvantaged and consumers are adequately protected”.

“The most likely outcome will be a state-backed, last resort scheme,” he told insuranceNEWS.com.au on Friday.

If Victoria follows NSW, the remaining states are likely to fall into line.