The government is planning changes to the Policyholders Protection Act 1975 which would remove the safety net for partnerships claiming under professional indemnity policies in the event that their insurer had gone into liquidation.

The government proposes to reduce the level of protection for partnerships to the minimal level given by the Act to limited companies.

This follows the House of Lords Ruling in Scher v PPB (No.2) [1993] 4 All ER 840 and substantial pressure from the insurance industry. A Bill is expected shortly that would amend the Act.

If the current proposals were implemented in the Bill, the effect would be that any partnership that faces professional negligence or misconduct claims would not be entitled to receive any compensation if its insurer went into liquidation.

Responsibility for claims that were covered by a policy with that insurer would fall directly upon the partners, potentially giving rise to personal financial ruin in the event of a large claim.The government's comment has been that most partnerships, like corporate policyholders, ought to have sufficient knowledge to be able to judge the stability of individual insurers and to take professional advice before putting insurance in place.

We believe that the government is taking an unrealistic view of the ability of partnerships, particularly the small and medium-sized, to assess the long-term solvency of their insurers.

The reaction of professional partnerships arranging top-up cover should be to write to their brokers making it clear that they are relying on their brokers' assessment of the financial position and management of the chosen insurers.The current position is that under the Act the Policyholders Protection Board provides compensation to policyholders, including partnerships, which suffer as a result of insurers going into liquidation.

Partnerships are currently treated as 'private policyholders' for the purpose of the Act and therefore attract the same protection under the Act as private individuals who find that their insurers are unable to pay.

By contrast, limited companies receive minimal protection.The Act currently provides protection to policyholders in three main areas where the insurer goes into liquidation.

The first is that all policyholders, including limited companies and partnerships, are protected by the Act in relation to compulsory insurance policies.

The second is that protection for claims by holders of non-compulsory insurance policies is specifically limited to 'private policyholders'.

It is under this head that partnerships, such as law firms, will normally seek indemnity for professional misconduct and negligence claims.

The third is protection for holders of long-term policies, in particular life assurance policies.

As the beneficiary under a life assurance policy is normally a private individual, there is no private policyholder limitation.The new proposals were mooted in a consultative document issued by the Department of Trade and Industry (DTI) in July 1994 which described potential changes to the Act.

This review was prompted principally by the case of Scher v PPB (No.2), which related to the collapse of the KWELM group of insurance companies and concerned claims by certain North American partnerships insured by the group.

The House of Lords held that the protection of the Act for general business non-compulsory insurance policies could only extend to partnerships that did not include partners who were established as professional corporations.

This is a form of incorporation available in the USA principally adopted for tax reasons.

The House of Lords ruling would not normally have any bearing on the vast majority of partnerships in the UK.

However, it has been used by the insurance industry as a ground to press the government to exclude all commercial entities and, in particular, partnerships, from the substantial protection afforded by the Act to private policyholders of non-compulsory insurance, the second area of protection described above.

Compensation payable to policyholders under the Act is funded primarily by levies imposed by the board on all insurance companies.

The motive of the insurance industry in pressing for change is clearly an attempt to reduce these levies.In a DTI press release in October 1995 the president of the Board of Trade, Ian Lang, announced that he proposed to restrict protection afforded to partnerships by the Act.

His stated intention was to put partnerships on an equal footing with limited companies by restricting the compensation payable to partnerships to compulsory insurance classes.Further, Mr Lang's press release also appeared to suggest that the protection relating to individual key-man life assurance policies taken out by partnerships might be removed as part of the planned changes, although the proposed summary amendments attached to Mr Lang's statement only indicated that the status of 'private policyholder' be removed from partnerships.

This would be an area of concern for some partnerships and the position needs to be clarified.Although the consultation period on the proposals has expired, the Department of Trade and Industry has recently indicated that it would still be prepared to consider further comments.

Write soon to Stephen Ratcliffe, Insurance Division, Department of Trade & Industry, Group Reference No.5D17, 1 Victoria Street, London SW1H 0ET.