Desperately seeking cover: PII renewal in times of crisis

A seemingly minor change took place last month on the professional indemnity scene when the Solicitors Regulation Authority made it a requirement on insurers to inform the regulator if their credit ratings dropped. Companies would also have to inform all the firms that have taken out policies with them.

But there is more to it than just a new reporting requirement. Behind the new rule is the forthcoming scrapping of the assigned risks pool in October 2013. Instead of a risks pool compulsorily underwritten by qualifying insurers, the ARP ?will be replaced by a scheme where insurers will have to continue to cover firms which cannot obtain cover for an extended three-month period.

Firms will be covered for one extra month after their policy expires during which they will still be allowed to take on new business. If they still haven’t secured cover at the end of this period, they will remain covered for two further months but won’t be able to take on new business, only tidy up current work in progress. Insurers will remain liable for run off for six years but for a law firm with no cover at the end of that extended three month period there is little choice other than to conduct “an orderly closure”, in the words of the SRA.

As with the present ARP system, firms will underwrite the risk; not collectively but individually. Now they can just say no. This new risk architecture has led to speculations that, without any compelling reason to incur the associated cost, insurers will simply refuse to quote or pitch quotes at unaffordable levels. The result: a lot more firms could end up having to close down, raising fears of indirect cleansing at the lower end of the market.

There are only three firms in the ARP at the moment, a significant reduction compared with 50 this time last year. This doesn’t mean that those outside it are safe or will be able to secure cover come October. Smaller firms are like 18-year-old drivers, not all of them will wrap their car around a tree after a night out but they are statistically more at risk as a group. With the recession now in its fifth year, insurers will be more demanding, looking in greater detail at how sustainable a firm’s business model is.

New entrants

Why then would insurers be interested in entering the market at this point? The SRA’s new handbook, outcomes-focused regulation and new reporting officers – COLPs and COFAs – probably account for a significant part in creating basic confidence in the market. The new approach shifts the regulatory compliance burden on to law firms but this in ?turn should heighten their levels of responsibility and encourage firms to manage the risk more actively.

Richard Spencer is professional indemnity manager at Elite, which entered the smaller firm market earlier this month. The company will be targeting firms with up to eight partners on the back of its after-the-event business. That’s about 2,500 lawyers specialising in personal injury.

“The tougher regulatory regime introduced by OFR is likely to help firms manage their risk properly,” he said, “and the fact that the legal ombudsman will be handling ?complaints against claims management companies should also benefit good personal injury firms.”

Even where firms rely solely on referrers – and may see a drop in income as a result of tighter regulation – it should still be of benefit to them, he said.

Cross-selling to its ATE client is likely to help Elite make a better informed assessment of the risk is takes on. The company has also set defined underwriting guidelines. It will consider enquiries by firms doing private client work and will not take on firms focusing on corporate or financial services work.But Spencer says the replacement of the ARP with the new three-month scheme could leave firms without insurance and driven out of business.

“Firms will have to prove to insurers that they’re taking appropriate steps to manage risk. Some will struggle and will have to cease practice if they can’t find cover. Every risk is writable but there has to be some give and take,” he said.

Two other A-rated insurers to enter the market, both through broker JLT, are AmTrust, which will be focusing on sole practitioners, and Aviva – in this case a return to market – which will be focusing on smaller firms.

JLT partner Mike Perry said the lower end of the market has not always been well served, with insurers like Zurich pulling away and many being reluctant to quote for firms with fewer than five partners.

The arrival of Axis, another A-rated company, and several non A-rated others demonstrated that this segment was less risky than it is usually perceived, he suggested.

Perry said smaller firms had to be treated as individuals, with each quote being looked at by underwriters rather than being “churned into a ratings engine”. “Underwriters should be interested not just in hard fact but also in the story behind them and take an enlightened view,” he said.

But how does he suggest insurers should square up this approach with this traditionally riskier segment? “Firms with a poorer risk profile should be quoted accordingly,” he replies. Typical factors include the type ?of work undertaken by the firm, how long the partners have been qualified and – ?obviously – the firm’s claims history. But the main criterion is how well the practice runs as a business.

“Firms that operate professionally as a business are likely to have fewer problems,” Perry continued. “If a sole practitioner or small firm are worried about how they’re going to pay their bills their focus is not on service to client and preventing risk.”

Perry was less concerned that more firms would have to cease practice as a result of the demise of the ARP. He estimates that only between 20 and 30 may end up in this position. But, he continued, “if the firm is so poor that there is no insurer prepared to take them on, it’s probably a firm that ought not to be trading in any event. There may be bad luck involved but it’s a matter of public policy for the protection of consumers.”

Miscalculated risk

Steve Holland, senior vice-president at brokers Lockton, takes a less sanguine view of the current situation.

“New entrants tend to gravitate towards the smaller end of the market, which generates greater competition,” he says. “By virtue of that, insurers will have to offer bigger discounts, so it’s not necessarily a profitable part of the market.”

Holland points out that established insurers got their fingers burnt and now prefer to focus on firms with more than ten partners, which usually have better management processes in place. He agreed that OFR has raised the bar, as firms now have to demonstrate they’re well run, but that the requirement to have COLPs and COFAs poses unprecedented organisational challenges for smaller firms.

So while the new regulatory framework creates a new structure for safer practice, it does not guarantee that it will be risk-free and insurers should take particular care in their assessment procedures. “Insurers have taken on what they believed was a ‘good’ risk before, in return for lower premiums without generating profitable portfolios. Such miscalculation could be particularly costly in the current economic climate,” Holland warned.

In addition to looking at profitability in the way qualifying insurers used to, insurers have been and should be looking at credit risk too. “Look at the health of balance sheet, look at outstanding debt: if it’s greater than 90 days there is a risk that this will cause cost,” he said.

“In the past, businesses deemed safe have taken insurers by surprise when they turned up with big claims

OFR has not been popular with law firms but it has gained the trust of insurers who see it in the way the SRA intended it: give firms responsibility for their risk management and the result should be a more compliant sector. Insurers also welcomed the decision to scrap the ARP but far from minimising risk, the new scheme could be storing it up.
Instead of suddenly becoming an attractive proposition, smaller firms could end up ?being a honey trap for unsuspecting insurers keen to enter the solicitors’ professional indemnity market.