Regulation of professional indemnity may be in flux, but this year’s renewal market is expected to be benign. Grania Langdon-Down reports.
The Solicitors Regulation Authority has been under fire from all quarters for its last-minute plans to change the minimum terms and conditions (MTC). The Law Society, the Council of Mortgage Lenders (CML), the Legal Services Consumer Panel, as well as some insurers and brokers, have all been highly critical of the changes, and the speed of the consultation and its timing so close to the renewal round.
Some of the pressure has been taken off following the SRA’s decision to limit the changes this year to a reduction in the mandatory minimum level of compulsory cover to £500,000, bolstered by a new requirement that firms must ensure they have an ‘appropriate’ level of indemnity insurance cover.
The regulator has deferred proposals on eligibility criteria, aggregate limits and shortened run-off cover until 2015 as part of a wider review of indemnity insurance arrangements. This was welcomed by the Society, which has warned that the changes could pose a ‘serious threat’ to clients, firms and the reputation of the profession.
Lobbying for the £500,000 proposal to be deferred as well now moves to the Legal Services Board (LSB), which will decide whether or not to ratify it in August.
Critics argue that the reduction in the compulsory minimum layer will not result in significant savings in premiums – one of the key rationales for the change. Most claims already fall within that limit, they stress, while nothing is being done to tackle issues around non-disclosure and misrepresentation, and continuing problems with conveyancing claims.
While some sole practitioners and niche practices have welcomed the £500,000 change as appropriate for their business models, key players among participating insurers say the uncertainty it has created means they may make offers based on last year’s MTCs.
This latest controversy comes hard on the heels of the SRA’s proposal that PI insurers should be required to have a B+ rating. This followed last year’s Balva/Berliner debacle, which left hundreds of firms scrabbling to find a new home, but was subsequently dropped amid concerns it would disproportionately affect smaller firms.
So, is the market ‘broken’, as some in the profession and insurance industry believe, or does it just require adjustment? And is that adjustment feasible without putting practitioners or their clients at risk of uninsured exposure that could financially cripple individuals or damage the profession’s reputation?
‘Broken,’ says Mark Carver, a professional indemnity specialist with Miller insurance and reinsurance brokers, which has a small market share of the top 250 and was involved in the Law Society’s Chancery Pii initiative. From a relative outsider’s perspective, he cites the high turnover of insurers, the penetration of unrated insurers, the exclusive arrangements between brokers and insurers, and the SRA’s ‘track record’ of ignoring opposing views.
‘Broken,’ agrees Frank Maher, a partner with risk management and professional indemnity practice Legal Risk. He alludes to the profession’s continuing ‘addiction’ to unrated insurers, whose market share increased from 16% to 22% in the last renewal round – primarily among sole practitioners (23%) and 2-4 partner firms (25%).
‘The evidence the market is broken is the number of firms with outstanding claims on policies written by Lemma, Balva, ERIC and, arguably, Quinn,’ Maher says. ‘The collapse of so many insurers has caused untold misery that those unaffected can barely contemplate.’
‘Broken? Nonsense,’ counters Sandra Neilson-Moore, Marsh’s head of solicitors’ PII for Europe, Middle East and Africa. There are clearly issues still to be tackled about the breadth of coverage, she says, but it is still a market insurers want to be in. ‘In the large firm bracket, there is so much capacity and so many people wanting to write this coverage, our difficulty is trying to find spaces for them all.’
And when it comes to smaller firms, John Kunzler, Marsh’s UK head of regulated professions, points out that the vast majority of firms caught up in last year’s problems found new homes.
‘There is a core group of bad people who need to be out of the profession and who benefit from having cover when they shouldn’t,’ Kunzler says. ‘But that doesn’t mean by any stretch of thinking that the system, which has been working as an open market for over a decade, is broken.’
‘Not broken but certainly capable of further improvement,’ avers Law Society chief executive Desmond Hudson.
‘Firms perceived as high-risk continue to have problems and, in a hard market, some firms have struggled. I am acutely aware of how unremitting this market can be for those firms. We can best help them by securing an open competitive market and supporting our members in preparing for renewal.’
At the SRA, executive director of policy Crispin Passmore says: ‘We hear people saying it is broken and we can see the number of insurers in the market – and each year hear the fears about how many will write policies for small firms in particular. They seem to be real fears and we need to think about what we can do to tackle that.’
So, against that background, how do insurers, brokers and practitioners view the upcoming renewal season? Predictions are that the market this year will be relatively benign – with Neilson-Moore saying larger firms will find it ‘exceptionally soft’.
Hudson says there are positive early signs. Informal soundings from the insurance industry suggest that capacity should be less of a problem this year; variable renewal dates, though slow to get off the ground with just 5% of firms switching dates, will ease pressure; and new, rated insurers are said to be entering the market.
The message for practitioners, however, is unequivocal. Don’t let the uncertainty over the MTC put you off preparing early for renewal, particularly as insurers say they will be focusing ever more intently on firms’ financial stability – in light of extensive merger activity and law firm failures over the last year – with one already warning it is adding two pages to its proposal form.
Demonstrating financial stability will be critical, agrees David Johnstone, managing director of PI-Solutions, which provides a ‘structured exit’ for firms seeking to leave the personal injury market.
The collapse of so many insurers has caused untold misery that those unaffected can barely contemplate
Frank Maher, Legal Risk
He predicts the number of firms specialising in this area will drop dramatically over the next two to five years because of the changes LASPO brought in. ‘Unless firms can demonstrate they are financially stable with robust systems to avoid undersettling or missing deadlines, they will either fail to obtain a premium or face a very high one,’ he warns.
Viv Williams, managing director of the 360 Legal Group, predicts the fallout from this year’s renewal round will be considerably higher than last year’s 136 firms. ‘Insurers will be probing more and more about financial stability and who will be doing the work,’ he says.
‘The housing slump has left a shortage of good property lawyers so partners are overworked with too many files and turning to unskilled staff. This is a replica of the last recession, when claims from their work rocketed. I suspect insurers, who have long memories, see this trend happening again.’
The CML has stressed its disappointment that the SRA is going ahead with the £500,000 proposal. The key, says Kunzler, will be whether lenders will be comfortable allowing someone on their panel who only has relatively limited cover, particularly if the firm gives or takes undertakings: ‘They will be asking “how sure am I that this is an insurance-backed promise?”’
However, Passmore defends the SRA’s decision to press ahead in the face of strong opposition. ‘This was a consultation, not a referendum,’ he says. ‘We were asked tough questions which did make us stop and say this needs more work, such as reducing run-off cover, changes to aggregation and excluding lenders from PI cover which would have a real impact on lender panels.’
Choosing a date
Less than 5% of firms have chosen to move their renewal date from the ‘bun fight’ of 1 October.
The most popular date was the end of February, largely driven by Travelers’ offer of a 17-month policy which attracted nearly two-thirds of the 432 who switched. SRA figures show the second most popular date was the end of the financial year (135). Others chose the end of the calendar year (8), or the end of the practising certificate year (3), while 26 firms went for a policy of under 12 months to set a new date for future renewals.
Three-partner practice Legal Risk opted for an 18-month policy to tie in with its financial year-end. ‘We are jolly glad we did as we will be out of the fray this autumn,’ says partner Frank Maher. ‘There is a steady number of new firms setting up and these may choose renewal dates based on their start-up date. However, I don’t expect the majority of firms will find any great reason to change.’
LawNet members stuck with 1 October. Outgoing chief executive John Thomas says: ‘It’s important we go to the market together as a group, to benefit from the bulk placing of limits which together exceed £1bn in covers – 1 October remains a good time for the exercise, as it avoids all holiday periods and financial year-ends in firms.’
Some of the panel firms with PI-Solutions have terms in place which take them through until next year, says managing director David Johnstone. ‘But for many firms, this is a price-sensitive issue with cashflow implications and it can be hard to find payment plans to cover extended periods. But over time, professional indemnity insurers will want to encourage this to reduce the autumn bottleneck.’
Travelers offered extended policies to existing, trusted clients only, on a straight pro rata basis. Firms needed to have a credit facility in place or pay upfront.
Elite chief executive Jason Smart says it did a very small number of 18-month policies. ‘The uncertainty of the market this year might encourage firms to think it would be good to be out of the pack,’ he believes. ‘We are very happy to do it as it spreads the September bun fight and enables us to give better service levels.’
For Lockton partner Brian Boehmer ‘it would, arguably, be great for the broker if firms move their renewal dates because the competition would be less likely to realise when your clients are renewing so you can protect your portfolio. But is that in the client’s best interest? It has to be on a case- by-case basis, not a broad-brush approach.’
He says some of the finance houses have been accommodating in offering payments for 18-month policies over 15 months, so the monthly cost to the firm is the same as a year-long policy.
But, having made the decision to go ahead with the other two changes, the next step, he says, will be to issue a call for evidence before the end of July. This will seek views on what other parts of the MTCs could be changed and what should not be touched. That will lead into another consultation before Christmas, with proposals for further change either in 2015 or later.
‘To me, there are questions to be tackled about the requirement to provide cover if run-off premium isn’t paid, cover for partner fraud and misrepresentation on proposal forms,’ Passmore says. ‘I am not saying we should change them but we should discuss them. People have challenged us to engage more, so this is their opportunity to come to us and make their points.’
However, Hudson is not prepared to accept the £500,000 minimum as a fait accompli and will be lobbying the LSB to defer it. ‘It is all very well to say, “let’s monitor the situation and see if the new limit works in practice”. If this results in the Daily Mail headline scenario – “85-year-old grandmother loses home” – damage will be done to the reputation of the profession, and to trust in the profession and in the regulator.’
Passmore counters that the new responsibility placed on firms will provide better client protection than currently exists. But he acknowledges: ‘We have to be realistic that some people won’t take out the appropriate cover. I doubt at the moment that we will put in a requirement that firms must report their level of cover this October, though we might do that next year.’
He adds: ‘However, over the next 12 months you might see some targeted work. For example we could engage with all firms doing catastrophic injury work. If we find they have appropriate cover it will provide reassurance to firms and consumers and if we find people who haven’t we will tackle that.’
But what about the risk of uninsured exposure? ‘Time for honesty,’ Passmore says. ‘That risk exists already if you have people doing £5m conveyances, probate on estates over £2m, clinical negligence over £2m. That risk is real now and, by making firms take responsibility, we are starting to tackle that risk.’
With partners’ own assets potentially at risk if a claim exceeds the level of indemnity, Jonathan Bogan, director of brokers Apex Legal Risks, relates: ‘In light of the reforms, most of our clients are looking to incorporate and there appears to be some urgency in doing so.’
Maher agrees: ‘I think it is imperative for small firms to incorporate and for partners even in large firms not to take personal appointments such as executor/trustee. It is rare for a cut in red tape to make lives harder for people, but the SRA has achieved it.’
The current MTC levels are considered sufficiently comprehensive by almost 75% of firms, according to the Law Society. However, many firms are used to buying top-up cover – 94% of 11-25 partner firms, according to the PII survey. Members of buying group LawNet must have a minimum of £10m cover.
If the compulsory minimum is reduced, insurers will not be bound to write policies above £500,000, so firms may have to go to another insurer for top-up cover. Others will just take out a policy for the total cover rather than split it.
However, insurers may favour splitting the policies because it limits their exposure. Under the MTCs, they cannot void a policy for non-disclosure or misrepresentation, but they can exclude that exposure in any excess policy. Firms will have to negotiate over the small print and exclusions.
Others are more positive about the change. A sole practitioner commenting anonymously on a Gazette feature, said: ‘As I recently incorporated, I am required to have £3m of cover, when all I do is employment law. I don’t have the sort of client base which ends up on the evening news having won £1m at tribunal, so the £500K proposed cover would be more than adequate… For years I have paid out for the one-size-fits-all requirements, so I am [very] glad that, finally, the SRA has figured out we are not all the same.’
Neilson-Moore also sees the change opening up opportunities for insurers to differentiate terms for criminal defence firms, sole practitioners or those working part-time to keep their practising certificate. ‘A new underwriter might even say I am going to make that my target business and compete for it.’
The SRA backed off pursuing its proposal to put a cap on sideways exposure by limiting aggregation this year. But this issue will come to the fore in November when Godiva Mortgages Ltd v Travelers Insurance Company Ltd is heard in the High Court.
In this case, the insurer’s interpretation of the aggregation clause – that the activities of one partner could be aggregated as ‘one claim’ so it refused to pay sums beyond £2m – could have such widespread significance the Law Society and SRA have intervened.
Trending in the market
Cost remains the most important factor when deciding which insurer to use, according to the Law Society’s latest annual PII survey.
Nearly 600 firms ranging from sole practitioners to 25-partner practices were quizzed on their experience of last year’s turbulent renewal round, which resulted in 17% changing insurers compared with just 6% in the previous year.
- The financial stability of an insurer is becoming an increasingly important factor – the proportion of firms rating this as the biggest influence on their choice doubled to 20%;
- Smaller firms still spend a greater proportion of their gross fee income on PII than larger firms, though the amount fell slightly.
- Just 9% of sole practitioners had experienced a claim against them in the last year, compared with 15% of 2-4 partner firms, 47% of 5-10 partner firms, and 68% of 11-25 partner firms.
- Almost one in twenty firms entered the extended policy period - 6% of 2-4 partner firms, 3% of sole practitioners, only 1% of 5-10 partner and none from 11-25 partner firms;
- 1% went on to enter the cessation period. All had experienced risk factors in recent years.
Go to the Law Society PII surveys.
Behind much of the debate over reforming the market is the question of whether it is the very breadth of solicitors’ PII that makes it a selling point. Accountants will soon be competing for probate work and Hudson argues that the PII cover for members of the Institute of Chartered Accountants in England and Wales is inadequate and does not compare with solicitors’ cover.
In the meantime, the role of unrated insurers remains contentious, with lenders starting to require firms to insure with a rated insurer if they want to be on their panel.
While Marsh will not recommend an unrated insurer, Neilson-Moore says the SRA was right not to make it a requirement to have a rating. ‘It is not the SRA’s job to decide which insurers are good enough to write this business,’ she says. ‘Insurers are naughty to say they want the SRA to eliminate unrated competitors on the supposition that they are trying to help the profession. It is up to the consumer to decide if they want to choose an A-rated or an unrated insurer.’
Obligations under the EU Solvency ll directive are intended to protect insureds, says Brian Boehmer, a partner with brokers Lockton, by restricting the policies an insurer can write unless it has sufficient capital to protect those liabilities. But Kunzler warns that will only work if every country enforces the requirements as rigorously as the UK.
Unrated insurer Elite had 8% of market share last year, with its core clients in the 1-4 partner bracket. Group chief executive officer Jason Smart says it is aiming for a similar market share this year but will be tightening its underwriting criteria and posing additional questions, such as what software firms use to protect against Mitchell-style issues.
He dismisses claims that firms only go to unrated insurers because no one else will insure them and that it allows risky firms to continue practising. ‘That is absolutely not true,’ he says, pointing out that Elite declines 60%/70% of applications. ‘We don’t go for rubbish firms.’
Where the SRA made an error was in setting the bar too high at a B+ rating, he says. ‘We would have supported a B rating, though we don’t believe a rating is necessarily relevant in this market. Where we were very critical was with those brokers who were punting low-grade paper with Balva and Berliner when they should have been making sure those insurers could cover the required levels of liability.’
He adds: ‘But we were conscious we risked sounding hypocritical because, ironically, we are in the process of preparing our financials to seek a rating, though this has nothing to do with solicitors’ PII. We are a major player in the bonding and surety market in Europe, where a rating is an advantage in what is a huge growth area.’
Looking ahead, Neilson-Moore says Marsh is seeing some positives, with a reduction in the frequency of claims following the spike after the financial crisis and big improvements even among firms with bad claims experiences.
Problems are arising, says Maher, in the area of coverage disputes with insurers, particularly issues over late notification or inadequate disclosure on the proposal form. ‘We are handling a number of multi-million-pound disputes on behalf of law firms at the moment,’ he says.
At least the impact of Mitchell (see news focus) will not be as severe as some had forecast. Clients have started to sue for negligence, according to Elite’s Smart, but a ‘Mitchell-lite’ result in the Court of Appeal ought to limit the damage.
Hudson says the profession needs to decide where it wants to be. ‘My guess is if you ask solicitors and their clients, they would prefer the certainty of the solicitors’ PII arrangement and the regime whereby it is the solicitor who pays the penalty for misrepresentation and not the innocent claimant,’ he says. ‘But are consumers sophisticated enough to appreciate this? If the SRA proposition goes ahead, there will need to be a consumer education campaign.’
As thoughts turn to renewal, the advice is clear: do not just look at what you pay in premiums. ‘Focus instead on what insurers pay on your claims, including defence costs,’ says Maher. ‘In reality, when insurers pay a claim, they are only lending you the money. The insurance industry will get it back off you – and more – in due course.’
To see the rest of our PII special, go to the practice management section
Grania Langdon-Down is a freelance journalist