Stormy weather: new rules for professional indemnity

The storms that shook the insurance market last year, combined with the closure of the assigned risks pool and ongoing concerns over financial stability, should act as reminders that professional indemnity must be an everyday matter, says Gary Horswell

Solicitors must feel like hard-pressed house owners in the flooded Somerset Levels, surrounded by challenge on all sides and wondering what's coming next.

When it was announced that the assigned risks pool (ARP) was being removed from solicitors' professional indemnity insurance (PII), many firms hoped that this would lead to better times but there is little sign of this yet. For years, insurers complained that their cost of the ARP net was climbing sharply and that the ARP forced them to cover a share of the risk of firms they would ordinarily refuse to insure.

The safety mechanism replacing the ARP and allowing firms to remain insured while in transition, the Extended Policy Period (EPP), has generated equally strong comment and resulted finally in the orderly closure of 136 firms along with the promise of "robust" action against others from the SRA for lack of cooperation with the regulator.

This is a personal tragedy for all affected by the closures but it represents a small group of the 10,726 operating firms reported by the SRA in October 2013. The overall reduction in the number of firms, down by about 400 compared to October 2012, is surprisingly low and offset by the queue of ambitious lawyers who, despite everything, still want to set up their own practice.

No overnight change

So many factors contribute to the climate in the PII market that the introduction of the EPP alone was never likely to transform the situation overnight. Insurers see it as a step in the right direction in creating a timeline and plan for the orderly closure of firms. In time, it might encourage greater care in risk assessment as insurers satisfy themselves that they are prepared to cover the firm for the 90-day EPP as well as the compulsory six-year run- off period beyond.

Insurer availability - or the lack of it - was the stand-out feature of the 2013 renewal season and this was not good news, especially for smaller practices. The reported 1,300 firms that had bought policies in 2012 from Latvian-domiciled Balva were faced with replacing cover when the insurer was ordered to wind itself up by its home regulator. Firms affected were initially offered a replacement policy by another unrated insurer, Berliner, in June, only to find out in the final weeks before renewal that Berliner themselves had to withdraw, leaving many scrabbling for cover and at the mercy of a sellers' market.

The cost of cover is always emotive. Firms forced to buy a replacement for Balva/Berliner found themselves having to pay much more than their 2012 premium with limited choice. Some insurers seized the opportunity to write more business but their perception of firms that buy cover from fringe insurers with no credit rating is that they do so because of cost often driven by financial duress.

Financial management

The risk of claims arising from criminal, family, intellectual property, commercial and conveyancing work is closely tracked by participating insurers but they are equally focussed on the financial health of the firm.

High profile failures such as Cobbetts, Halliwells and more recently, Linder Myers, illustrate that factors beyond the cost and availability of PII can bring a firm down. The SRA Risk Outlook in July 2013 ranked financial difficulty and dishonest misuse of client money or assets as being at the top of its list of current risks and both are of major concern to PI insurers.

The post-Solicitors Indemnity Fund (SIF) era for professional indemnity has been littered with claims arising from dishonesty and financial stress of the firm or principal is often a factor. A single errant principal or trusted key member of staff can cause losses for insurers running into many millions. Claims of this scale are hard to predict and difficult to assess when underwriting a proposal.

SRA's Risk Outlook for 2013 certainly emphasised the point clearly to insurers by stating that approximately 2,000 firms were believed to be at increased susceptibility to financial difficulty due to factors such as reliance on legal aid or the type of work undertaken. Key characteristics of firms at financial risk were said to display:

• Management weaknesses;

• Accounting weaknesses;

• Weaknesses in adapting to change.

Looking good

So what does a 'good firm' look like to insurers? The historic partnership model where nearly all profit was stripped out annually, with little provision for future investment and unquestioning reliance on a continuous flow of business, is a picture guaranteed to make insurers cautious.

The ideal profile will show:

• A positive balance sheet with funds available to weather unexpected storms;

• Healthy cash balances demonstrating effective credit control;

• Effective management oversight of the finances of the firm to minimise unpleasant surprises;

• Forward thinking investment.

A poor financial profile leads insurers to wonder how well the business is run in other respects. A sound financial footing is a must not only when looking for the best PII terms available at renewal time but throughout the year to show awareness and effective management of risk.

Cultivating the right relationship with the firm's accountant is one of the best investments for a law firm and also gives the opportunity to generate complimentary business opportunities. Accountants with a specialist focus on the legal profession can provide invaluable support.

Renewal 2014

Looking ahead to the renewal climate in 2014, there are no signs of wide ranging premium reductions on the horizon and improving PII market conditions still look to be some way off, but the prospect of new insurers might help some.

Claims continue to roll in

The shrinking size of XL's portfolio at the 2013 renewal from being the biggest insurer by market share with 16 per cent falling to 2 per cent of law firms was reportedly being driven by its claims experience and they are not alone in this respect. Some insurers who left the marketplace years ago are still running off historic claims and it can take 10-15 years to completely close the account, a factor undoubtedly putting some off the idea of re-entering.

Insurers tend to be guarded when discussing their claims experience for law firms but a major participant in 2013 commented that for every £1 collected in premium they were paying out or reserving £1.30. Since the financial meltdown, insurers have been able to rely less on investment income to balance any shortfall of claims compared to premium adding to the pressure to raise premiums.

Ebbing of unrated insurers?

The SRA PII review will now include the question of whether insurers with no credit rating should be permitted in the market given that most examples post SIF (Quinn, Lemma, Balva) have ended up relying on financial compensation frameworks as the policies often delivered limited future financial security for claims that typically take years to settle after first notification. The review is due to report in time for the 2014 indemnity period starting on 1 October.

Some unrated insurers are seeking to obtain a credit rating allowing them to remain but others may decide that the cost and transparency involved is too much of a burden and exit.

No new insurers on the horizon

Some heavyweight insurers may consider entering the marketplace (they do annually) but much will depend on the position of the SRA towards unrated insurer capacity from its review. Removing unrated insurers is likely to force premiums up which may be seen as more favourable by potential entrants. Allowing unrated capacity to stay might help contain premium rises.

More mergers

Successor practice rules make it hard to expunge the past claims record of a firm but a merger can create a new firm with more dispersed risks and greater continuity along with economies of scale.

Start now

In practice, you should not wait until close to renewal to prepare and you should make a start with your finances now.

Unfortunate policyholders who thought they had bought a policy from Berliner in the early summer, and returned from holiday only to find that they had to start again from scratch, highlight the need for planning and early action to avoid being caught out.

Even though most insurers will not be ready to discuss your renewal until May or June at the earliest, it would pay to start preparing in March or April by speaking to your broker and considering the need for a more immediate financial review with your accountant.

 

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Gary Horswell ACII CDir is managing director at professional indemnity broker Ntegrity

www.ntegrity.co.uk

 

 

 

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