The professional indemnity market is likely to remain soft this year, but steep premium hikes may lie ahead in 2009. Grania Langdon-Down reports


Law firms have been enjoying low professional indemnity insurance (PII) premiums for the last few years – but in the light of the current financial markets crisis, is this the calm before the storm?



The indications are that the market will remain ‘soft’ this year, with premiums staying low. But there are warning signs that the current level of premiums may not be sustainable in 2009.



Brokers and insurers are warning that if the market hardens next year because economic conditions worsen, or there are increasing notifications of claims (and there are already worrying signs that the spectre of mortgage fraud is clanking its chains again) that hardening is likely to happen quickly, resulting in a sharp hike in premiums. If this happens, it will be the well-run firms with good risk management and compliance systems that will find some measure of protection.



Frank Maher, partner with Liverpool risk management law firm Legal Risk, says the problem for law firms is that, ‘like steering a ship away from an iceberg, it takes time for risk management measures to achieve results’.



While the next renewal round is unlikely to be more expensive than last time, he adds, firms with significant exposure to property-related claims could find it harder to obtain cover. ‘2009 is likely to be much tougher and could see more firms unable to obtain insurance through the commercial market,’ he warns. Last year at this time 2008 was expected to see some hardening of the market, but so far those predictions have been staved off.



Sandra Neilson is head of Marsh’s lawyers practice in Europe, the market leader among the top 100 law firms according to Legal Risk's 2008 Top 100 Professional Indemnity and Risk Management Survey. ‘What happens this year is still anyone’s guess. But if insurers are right and a correction is required, my suspicion is that it will be more than the insurers are saying they need. They are very worried about being seen to collude, but there is a groundswell when this happens.



‘So, when a rate correction comes, it could be quite shocking – with increases of 10, 15, or even 20% in premiums, and it could happen quickly.’



Steve Holland, executive director of the insurance brokers Lockton, third in the Legal Risk survey behind Marsh and AON, says the market should remain soft this year, barring catastrophes. But, he says, qualifying insurers have been warning since last year of the need for premium increases to avoid ‘suicide’ pricing and the potential destabilisation of the market.



The last ‘hard’ market in solicitors’ PII was 2002/03, when premiums rose in the aftermath of the World Trade Center attacks and Enron’s collapse. Cyclical in nature, the insurance market has been ‘soft’ for several years since then, as the reduction in major catastrophes has driven down premiums and increased the amount of risk capital in the market. The question now is: is that cycle coming to an end? Mr Holland says that, with the total costs of claims for UK solicitors estimated at £280 million a year and the total premium pot estimated at £204 million, many insurers are writing their solicitors’ PII business at a loss.



‘There is also a perception that too many bad risks are being underwritten by the market,’ he adds. ‘All the indications are that a market which is underpriced due to the influences of competition and increased capacity cannot be sustained for much longer. Higher rates are looking more and more likely – whether this will happen in 2008 remains to be seen.’



James Jack is business development manager at insurers Zurich Professional, market leader across the profession since 2002, with 19% of the primary compulsory layer of cover. He agrees that the market appears to be peaking for buyers. ‘Premiums fell again in 2007, as there was an abundance of underwriter capacity, particularly among the ‘SME’-sized firms,’ he says, ‘as well as increased competition between brokers hungry for market share from the top 100 down.’ With price the main determining factor for smaller clients, brokers were often forced to show their clients a saving, even in instances where the risk did not actually merit one.



‘Some of the premium rates don’t appear sustainable in the medium or long term. Our market share has reduced as we protect our bottom line – and our clients – by maintaining a solid technical pricing position.’



He believes it will be economic conditions that provoke a change in underwriting strategy. ‘It’s sensible to expect an increase in losses for professionals as the housing market in particular begins to show cracks. The breadth of cover afforded by the solicitors’ policy wording will leave no place to hide for insurers.



‘It stands to reason that underpriced books of business will suffer and, as a result, solicitor firms that have enjoyed large savings may well find that the bubble bursts.’



Trevor Meadowcroft is PII underwriting manager for Travelers, formerly known as St Paul’s Travelers, one of the top three firms providing the compulsory £2m primary layer across the profession. Having the renewal date in October works in solicitors’ favour, he says, because it would be very difficult to replace that income so late in the year. ‘The question is: when will someone blink? There must be some people out there who are hurting,' he warns.



One consequence of the availability of cover at relatively low cost has been an increase in indemnity limits from the compulsory £2 million for partnerships and £3 million for limited liability partnerships (LLPs) and in top-up insurance. The Legal Risk survey of 64 of the top 100 law firms, including 22 of the top 30, found 25% had bought more cover, with 14% buying over £20 million.



Firms are also becoming increasingly likely to cap their liabilities. The Legal Risk survey found that all those responding now limit liability contractually at least some of the time. Five years ago, few firms capped liability because they thought clients wouldn’t accept it, says Mr Holland. ‘However, with the growth in LLPs, partners have been thinking if clients are prepared to accept them with LLPs, why not with partnerships?’



Other developments have included the growth of ‘lifeboat’ policies, a term first used by Travelers, which protect members of LLPs from residual personal liability. The survey found 16% of respondents had taken out this cover, while 44% of firms had purchased directors and officers/trustees liability cover, 11% management liability cover and 17% employment practices liability cover.



Two other options, says Mr Holland, include ‘renaissance cover’ to resurrect businesses and careers, and cover for dependants of partners in the event ‘Armageddon does arrive’.



So how do firms protect themselves if the storm comes?



This depends on the size of the firm. The notoriously volatile sole practitioner market saw many solicitors change insurers last year. Mr Holland’s market seems split down the middle – 47% of Lockton’s clients saw a rate reduction last year, while 46% saw rates rise. He says competition affecting premium levels was almost exclusively caused by new entrants to the market, with some insurers questioning whether the level of premiums being offered is sustainable, given these firms’ potential risk exposure.



While most two-to-four-partner firms saw rate reductions, underwriters are increasingly concerned about mortgage fraud, defaults and debt recovery. Most bigger firms also saw rate reductions, even though the frequency of notifications may be higher. What is crucial, says Mr Holland, is that firms notify all claims and circumstances at the earliest opportunity. ‘A firm which doesn’t notify and tries to deal with a problem that goes badly wrong may prejudice insurers who could then exercise rights of reimbursement against the firm and against individual partners and employees.’



The Solicitors Regulation Authority (SRA) has just issued its first regulatory health check to the profession (www.sra.org.uk/risk), which flags up concerns about claims arising from mortgage fraud, wills and probate, money laundering and delays which could impact on PII premiums.



David Middleton, head of legal at the SRA, says of the rise in mortgage fraud: ‘Reports of suspected mortgage fraud to the SRA Fraud Intelligence Unit rose from 85 in 2004 to 293 in 2007. Some solicitors are failing to warn lenders about suspicious features of transactions.



‘In the early 1990s, the solicitors’ profession was at the centre of the massive losses caused by mortgage fraud. This led to the highest-ever grants from the Compensation Fund [totalling] £29 million in one year. It is vital that this does not recur.’



Andrew Blair, professional liability partner with City firm Barlow Lyde & Gilbert, says fraud is ‘the hot topic of the moment. Good firms should have learnt their lessons from the last spate of mortgage fraud claims because what we are seeing this time isn’t any more sophisticated than last time’.



‘With professional indemnity being an open market, there should be more regard to individual firms’ claims histories, so those with a good record may be protected to a degree.’





Risk management is key

Katherine Rees, a partner with City firm Reynolds Porter Chamberlain’s lawyers’ liability group, says there are signs the market may harden, possibly as a result of the increase in mortgage fraud claims.



Given there is still a lot of residential conveyancing going on, she says firms should be ‘dusting down the Law Society’s Green Card, first issued in 1991 and still as relevant today, as the same scams are turning up as last time, and partners should make sure junior staff know the warning signs’.



‘What your insurers want to see are good risk management systems. The larger firms will already have those systems in place with a partner who does nothing else. Rule 5 of the Solicitors Code of Conduct now requires firms to demonstrate they have those systems in place.’



While the new code means risk management is no longer optional for solicitors, Mr Jack says that ‘many firms are unsure about the extent to which they fall short of the requirements of rule 5’.



‘Lexcel can provide an ideal framework or benchmark,’ he adds.



Mr Meadowcroft agrees. ‘A lot of claims are administrative mistakes and that’s where the benefit of some form of service standard, like Lexcel, can help.’ He adds wills and probate, as well as divorce, to the watch list. ‘It isn’t that solicitors are any more negligent than in the past, but the amounts being argued over are so much greater.



‘Also, with the Legal Complaints Service, we are being put under pressure to deal with more service-orientated claims. Although the amounts are relatively minor, any money we have to pay out will have an impact on premiums.’



But what is important, he stresses, is that ‘firms look on risk management as integral to their culture, and not as an appendage to save a bit on premiums’.



Ms Neilson says standardised risk management systems don’t suit the big firms, which have their own systems in place. ‘Risk management is an essential tool to be successful but claims are a fact of life, however good the firm. We haven’t seen any increase in notifications yet but, if the economy starts to unravel seriously, investors will look round for someone to blame and there will be a step up in claims against professional advisers. And, if some get the courage to sue the big investment banks, they in turn will sue their advisers.’



Her advice to firms is to start the process of renewal early. ‘If you are offered a good long-term arrangement with locked-in rates, I would consider it. Some commentators say prices are still going down, so wait before locking in. But that depends on what is important to you – stability or price.



‘Smaller firms should shop around, but price is not the only thing. Make sure you know your insurer. Qualifying insurers are approved by the Financial Services Authority on very broad terms, not by the SRA. You want someone whose name you recognise. Check how long they have been in the business and what their backing is. You would be surprised how few firms do that.



‘What is also crucial is that your application form is filled in neatly, is signed and dated and you have made full disclosures. You'd be amazed at the poorly prepared documents that come across underwriters’ desks.’



One consequence of the overly soft market is that insurers are pushing back on issues like disclosure and late notice, she says. ‘They can’t deny solicitors cover and they still have to pay the claims, but it doesn’t stop them being difficult about it.



‘And if the market hardens, they will be making the same money from fewer firms, so they will be more choosy.’



Grania Langdon-Down is a freelance journalist