Risky business

The Solicitors' Code of Conduct (the Code) came into effect on 1 July with Rule 5 imposing, for the first time, a commitment to making claims prevention an essential element of firms' conduct obligations.

Rule 5 purports to regulate the supervision and management of a firm by imposing requirements to maintain competence among its fee earners and establishing plans for rationalising its internal business arrangements.

Rule 5 sets out responsibility

The rule aims to set out responsibility for the overall supervision and management framework of a firm by establishing minimum requirements that have to be met for an individual to be qualified to supervise others and the minimum standards to apply in the supervision of clients' matters.

In addition the rule establishes the minimum requirements 'considered essential to good practice and integral to compliance with supervision and other duties to clients'.

The architect of the Code, the Solicitors Regulation Authority (SRA), has prioritised risk management through effective practice management, with firms required to put in place, and follow, plans for fee earner supervision and to minimise the impact on service provision of absences and emergencies.

While the method of delivery is a matter for each firm, there is an expectation they will be able to demonstrate that they have implemented an effective risk management approach which is subject to regular reviews of its effectiveness.

So the proposition that well-managed firms will wish to manage risk appropriately has become a conduct requirement that goes beyond minimising professional negligence risk and encompasses other client and

business-related risks, such as practice succession. Through Rule 5, The SRA has imposed on firms an obligation to put in place systemic arrangements to enable them to assess the risks that attach to each area of their business. However, it is not enough to create a system and sit back; risk management measures are unlikely to be considered adequate unless those measures are subject to periodic review.

In recognition of the difference in sizes, resources and abilities within firms, if an unforeseen risk materialises which the firm's systems had not catered for, this would not necessarily constitute a breach of Rule 5.

Nevertheless, regardless of size, profile and practice area(s), the SRA expects there to be reviewable mechanisms and structures in place to identify and, importantly, address risks that practices face.

Risk management

Essentially risk management is the process of analysing exposure to risk and deciding on the mechanisms required to meet that exposure. Most practices have ignored the former and concentrated on the latter and bought insurance intended to meet exposure. This ignores the fact that not all types of risk are insurable and for those that are the cost of insurance is only one aspect of the cost associated with the insured event occurring.

For example, in the event of a successful claim under a professional indemnity (PI) policy, the claimant's costs and damages together with the firm's costs would be met under the policy. However a successful claim leads to other ancillary costs that would not be met under a PI policy such as excess fees and resulting increases in the cost of cover.

In addition, depending on whether there has been either a total or partial failure of consideration, the fees paid by the client would be returned in whole or in part and, in many instances, the firm would lose the client to a competitor.

Effective risk management identifies and quantifies the entire risk and develops strategies so that the risk to which the business is exposed and the potential impact to the business is minimised.

And business gurus (rather than lawyers) will tell you that the acquisition of insurance comes at the end of the risk management process, rather than at its beginning because the cover acquired is a reaction to an unidentified risk manifesting itself in loss. So, in order for any risk management strategy to work effectively it needs to become an integral part of the culture of the firm and to be supported and driven by the firm's managers (generally its partners or members), who should take ultimate responsibility.

Profit not risk management

The problem with Rule 5 is that it fails to recognise, unpalatable as it may be to admit, that solicitors have never been in the business of managing risk.

The only way to completely remove risk from any business is to shut up shop and head to the golf course. Since that is not much of an option, the efficacy or otherwise of Rule 5 will have to be considered in light of the fact that the real incentive for all but a small minority of lawyers is, actually, to turn a profit.

This is borne out by a survey recently conducted by Legal Week which found that over 1,000 City solicitors are earning £1m or more each year.

The incomes generated in the City pale into insignificance, however, when compared to the extraordinary returns generated by some firms, a number of whom are under investigation by the SRA, who have profited from a government scheme to compensate miners suffering ill health.

Certainly City firms are already firmly committed to risk management '“ but then they have no choice as the corporate world has itself become increasingly familiar with risk management concepts.

Indeed, listed companies are subject to the terms of the Financial Services Authority's Combined Code of Corporate Governance. It therefore comes as no surprise that companies subject to that code wish to see a similar commitment to risk management from the firms they instruct '“ and the value of the work they offer means it makes sense for City firms to have invested heavily in

putting in place business systems that are acceptable to their blue chip clients. So for the City, perhaps, risk management is a means to an end rather than the end in itself.

Equally, one would expect that the administrative burden associated with the effective management of a bank of unqualified staff may well be a price worth paying. Particularly for, say, a four member limited liability partnership supported by less than 20 qualified staff which, in a single year, was able to generate £16.8m in profit for its senior member from processing personal injury claims.

But what of the remainder of the 14,000 legal practices whose offices are situated in the less salubrious environs of the City or the former mining regions and which generate less eye-watering profits?

Unfortunately for the SRA, a survey published by risk managers Aon suggests that, for those firms, risk management advice lags fourth in the driver for their PI insurance renewal. Price remains the main consideration followed by the professional qualification of their claims handler and speed of their broker's response.

So it is to these price conscious firms that Patrick Hearn, director at Aon's professional services group, speaks when he says: 'Some firms have embraced quality assurance through the Law Society's own Lexcel standard, ISO 9001, Investors in People or the Legal Services Commission's 'quality mark' for publicly funded work. Others have not recognised quality assurance as necessary for their business but this has to change. Rule 5 demands that law firms look at their client and business related risks. Firms must consider how insurance can be supported with risk management advice to conform to the new Code of Conduct.'

All well and good, but with cost of cover the main concern, the Code will only be a success in shifting risk management up practices' list of priorities through financial policing by the insurance market. But the timing is all wrong.

Aon reports that during the 2006 renewal season the marginal cost of some firms' cover reduced by more than 30 per cent on the previous year with total premiums paid for compulsory cover that year 15 per cent lower than those of 2005.

The company adds that competition in the market which is driving down cost cannot go on indefinitely and there has to be a correction.

But, Aon says: 'We do not believe that the correction will happen at the 2007 renewal. However, you should take a long view, and be cautious about your budgeting for the 2008 and 2009 renewal premiums.'

Andrew Nickels of Zurich Professional says Rule 5 represents 'a fantastic opportunity for principals to sit down with everyone in the firm to discuss how things are being done and how they could be done better.

Firms that purport to deliver high standards of client care have to be committed to risk management. The two are inextricably linked'.

Nickels hopes that the new rule will lead to fewer negligence claims against solicitors: 'If principals accept responsibility for the management of risk and error prevention is embedded in all of the internal systems and controls of every legal practice, then we should see a corresponding reduction in errors that lead to allegations of negligence.'

Cheap cover

For each of the six years since the Solicitors' Indemnity Fund (SIF) ceased providing new cover and the PI market was opened up Zurich Professional reports that residential conveyancing and remortgages were the most frequent source of notifications accounting for 35 per cent of all the claims and circumstances notified in 2006.

Claims in litigation cases, mainly for missing time limits, came next in the list accounting for 22 per cent of claims and circumstances notified.

In both instances the tendency of some firms to use unqualified staff is likely to be a contributory factor and make a compelling argument that a greater emphasis on supervision will lead to a reduction in claims.

But risk management is not a new discipline. Since SIF closed in 2000, practices which have been able to demonstrate to the PI insurers for whom it matters that a low claims history is not just a lucky coincidence have hoped to benefit from reduced premiums.

The problem is that in a highly competitive PI market with the cost of cover in free fall, a good claims record has not been sufficiently well rewarded.

And the profession's regulator has shown itself singularly ill equipped to act effectively and quickly against firms that breach its codes of conduct.

So for Rule 5 to work as the SRA wants, PI insurers have to do more than spread cost of insurance across the profession. Instead it is up to the market to reward firms that adhere to acceptable standards of business management and price those firms with a consistently poor record out of business.