Law firms should ensure they find the right professional indemnity insurer, one that will be around to pay out when claims arise, and not necessarily the cheapest. Chris Rathbone outlines what to look for




It is widely – and mistakenly – believed that because an insurance company is under the jurisdiction of a strong regulatory body, the possibilities of insurance company failure are minimal. This is a big mistake.



Insurance companies fail for all manner of reasons, including fraud, inadequate reserving, asset diminution and natural disasters, despite close regulatory supervision. Losses arising from a contract can take many years to develop and then suddenly become a full-blooded claim or claims.



In this article I will highlight some key points that will enable the legal profession to choose carriers with a good chance of being able to pay claims, whatever the time scale.



When choosing an insurer, the legal profession should pay special attention to the long-tail nature of potential professional indemnity (PI) claims.



Putting it kindly, being a solicitors’ PI underwriter has not been a bed of roses recently. Combined ratios (the industry benchmark of whether a company is underwriting profitably or not) have been very disappointing and companies have not been making money out of this business, even adding back investment income. For example, in 2006, the combined ratio for solicitors’ PI business in the UK was a jaw-dropping 160% – for every £1 of premium received, insurers have to pay out £1.60 in claims and expenses – and 2007 looks as if it may prove to be just as disappointing.



Fundamentally, an insurance intermediary aims to provide its clients with the most suitable cover at a competitive price. Solicitors’ PI is a difficult class of business to underwrite and, if priced incorrectly, can contribute to the insolvency of unwary carriers. As a consequence, companies writing long-tail risks are subject to particular scrutiny by rating agencies and intermediaries alike.



In the world of PI insurance, never has the adage of ‘if it’s too good to be true, it generally is’ been more applicable. There are numerous examples of failed companies that offered broad coverage at bargain prices, which ignored the full enormity of the potential loss and just hoped that the investment return would more than offset the (inevitable) poor underwriting performance. Lower interest rates and volatile investment markets soon put paid to that.



It is for this reason that insurances should be placed with large, stable, well-established insurance entities that are sufficiently diversified to be able to ride such a prolonged downward spiral in the cycle. Quality, not price, should be king.



Since insurance is a ‘promise to pay’ in the event of a natural disaster or other insured event, it is essential to find insurance companies where there is a strong likelihood that claims will be paid. The fact that claims may emerge many years after the insurance policy was written means that it is vital that intermediaries use markets that are solvent and likely to remain so going forward.



Offering dubious insurance markets is a quick and effective way of destroying the reputation of an insurance intermediary (not to mention leaving the client exposed). A prospective client needs to evaluate the services offered by its intermediary and ensure that it properly monitors the markets it uses.



Just because an insurer is on an industry-approved panel, it should not be assumed that it would be used by your chosen intermediary. No intermediary will get it right all the time, but the security departments of the major intermediaries are continually evaluating the markets used, and adding and removing companies from their individual lists of acceptable markets.



It is axiomatic that the starting point for any analysis of a company is the annual report and accounts, and regulatory returns. These form the basis of any review and are the most visible ways of measuring the success or otherwise of management.



The analyst distils this data into fact sheets that are available for clients. These factsheets give details of the size of the market being used, various financial ratios and other relevant information.



Leading up to the renewal, solicitors must ask the following questions of their prospective insurer:

l Is it a strong company in terms of the capital base?

l Do the technical reserves appear to be sufficient for the type of business being written?

l Is the company part of a large insurance group that can reasonably be expected to be trading in 20 years’ time?

l What is the opinion of the rating agency on a particular carrier?



However, analysis of a company is not confined to mere number crunching, although this will form a significant part of the evaluation process. In addition, the analyst looks at relevant industry competitors to identify anomalies and will also consider the rating agency opinions on insurance companies.



Many clients insist that the security provided by an intermediary has a minimum rating provided by one of the major rating agencies, such as AM Best or Standard & Poor’s. Ratings can be helpful as confirmations of the market security process or as red flags when those opinions are divergent from those of the rating agencies.



You will note that no comment has been made to date in respect of assets and asset allocation. Ten years ago, the analytical emphasis was very much geared towards reserving, and less so in respect of the assets behind these technical reserves. Now, analysts give great attention to asset allocation and matching with liabilities, the split between bonds, equities and other forms of investment such as hedge funds and sub-prime exposures.



To summarise, ensure that your intermediary offers you only well-capitalised and established companies for your insurance programme. You may pay more, but you will sleep better at night.



Chris Rathbone is head of international market information at broker Aon