Firms should be adopting a risk management strategy to improve business efficiency and service delivery, and not simply to convince underwriters to reduce premiums, says John Verry


In the not-too-distant future, partners throughout England and Wales will be reaching for their cheque books. The time has come to pay the professional indemnity insurance (PII) premium.



Often this will be the second or third largest overhead faced by a law firm. Talk of a ‘soft market’, ‘cheap premiums’, and ‘you have never had it so good’ will cut little ice with many firms as they wave goodbye to tens or hundreds of thousands of pounds.



As with every substantial overhead, the firm will look for ways of saving money in relation to that particular expense. After changing insurers, the one course of action many often consider is risk management. Indeed, risk management expertise is often sold on the back of promises that it will reduce premiums.



However, if this is the sole reason a firm embarks on the creation and implementation of a risk strategy, then the reasoning is flawed. Risk management is about improving the firm’s business efficiency and service delivery, ultimately therefore improving profitability.



In any event, just how much attention do underwriters pay to risk management when rating a firm to assess premium? As a standalone factor, probably not much. But when considered in the light of a firm’s claims history, what they do in terms of risk management will have a much greater bearing on the underwriting process. This is because the claims history will be evidence of how well the firm is performing in terms of risk management.



Many proposal forms contain a risk management section. Reading the completed forms may cause one to wonder why there are any claims against law firms for negligence at all. Every firm has a diary system, yet missed time limits is still one of the most common causes of claims. Almost every firm carries out some form of file review, yet delays still account for a disproportionate number of claims.



A firm must be in a position to demonstrate to the underwriter that they practise what they preach. A good claims history linked to a demonstrable system of managing risk will help to show that the firm has had no, or a nominal number of claims, through good practice as opposed to luck.



Insurance is simply the transfer of the risk from the firm’s balance sheet to the underwriter’s balance sheet, so its risk profile directly impacts on the underwriter. If the firm can show its risk is being managed effectively, with a good claims (and complaints) history to back this up, the underwriter will be much more relaxed. This fact is likely to be reflected in the rate applied to the firm and the resulting premium.



Some firms may feel that they are getting competitive premiums in the current market irrespective of risk management. In fact, they will not be doing so well as those that are well managed in terms of risk, although the difference may not be that marked. But that in itself is a real danger to the unwary. PII is in the grip of the softest insurance market that has been experienced for a long time.



A soft market means the availability of plenty of capital, lots of competition among underwriters and reducing premiums. Indeed, experts are forecasting further reductions in rates this year of some 10-15%.



The market has continued to soften over the past three years, but this will end as it always does. Insurance is cyclical in so far as ratings (and thereby premiums) are concerned. A correction will come, rates will rise, and premiums will increase. Unfortunately this is not usually a gradual process; it tends to be immediate and, as one expert commented, savage. A hard market sees capital in the insurance market reduce and competition reduce.



This environment enables underwriters to put up rates, as well as become more choosy as to whom they offer terms. Suddenly, firms with good risk management and claims histories become the only attractive risks. The others may be offered terms, but at a price.



The moral is therefore that just because it is currently a soft market, it is neither safe nor sensible to ignore risk management. Now is the time to be assessing your firm’s risk profile, to create and implement an effective strategy to manage risk.



It is not only a requirement for your PII insurance, but from 1 July, rule 5 of the new Code of Conduct requires that ‘you must make arrangements for the effective management of the firm as a whole, and in particular provide for (amongst other matters)... the management of risk’.



So, how can a firm demonstrate to an underwriter that it does what it says in terms of risk management? The simple answer is a quality assurance standard, such as Lexcel, ISO or Investors in People. However, those standards are not necessarily the right solution for all firms. There is perhaps room for a new ‘law firm-specific’ quality mark other than those in existence at present.



Another solution is to meet with the firm’s existing or prospective underwriter – your broker should be able to arrange this. This will give you the opportunity to explain in person what the firm does in terms of managing its risk profile.



If the firm has experienced claims, notwithstanding the existence of risk management, then explain to the underwriter what went wrong and why, and what has been done to reduce as far as possible the risk of reoccurrence.



What is not an option is to do nothing. The firms that do choose this option or exaggerate their risk management capacity will pay, and pay dearly, when the hard market returns. It will, and probably sooner than many think.



John Verry is a director of broker Lockton