Moving the Goalposts – Risk Management Survey Part 4

Discussion over scrapping the single professional indemnity insurance renewal date and consigning the assigned risks pool to history has reignited. LB reassesses the state of play

In our report last year, it seemed that the debate over whether to move away from a single renewal date for law firms’ professional indemnity insurance (PII) had been settled. Insurers, brokers and risk advisers, such as Marsh, felt that it hadn’t been thought through properly. Risk managers at the top-150 law firms surveyed couldn’t see the benefits of staggering renewal dates. Even the Solicitors Regulation Authority (SRA) itself, after taking advice from various corners of the industry, declared the likelihood of scrapping the single renewal date for solicitors’ PII as ‘improbable’.

What a difference a year makes. In December 2010 the SRA announced a consultation paper proposing to abolish the single renewal date for PII for firms from October 2011, giving firms the freedom to renew their PII cover at any time and for any period they want. The proposals came after the SRA commissioned global research firm Charles River Associates in July 2010 to undertake a ‘root and branch’ review of the current financial protection arrangements. Among other findings, the review concluded that the single renewal date offered no regulatory benefit but rather caused problems for solicitors, insurers and brokers alike. ‘None of the market failures identified… are solved through the use of a single renewal date,’ the report says. ‘This alone indicates that there is no reason to restrict the market in this way.’

Sandra Neilson-Moore at Marsh can see both sides of the argument, the upside being that once the renewal dates are more spread out no firm should find that it is getting late quotes, or no quotes, simply because of the pressure of numbers with which underwriters have to contend. ‘However,’ she says, ‘firms will still get late quotes, or no quotes, if they leave it to the last minute to provide underwriting information and do not keep on top of their brokers or underwriters to ensure that they receive their quotes on time.’

The downside, she feels, is that many firms will lose the benefit of being part of a large portfolio of business that has to be renewed on a single date. ‘Good brokers will continue to use their own portfolios of business to the advantage of their clients, but firms that deal directly with the underwriters will lose whatever advantage is conveyed by a single renewal date,’ she says.

ARP under fire

The SRA’s review of financial protection came about because of the difficulties many smaller firms face in getting PII. It has also been suggested that a single renewal date for cover creates unnecessary pressure on the industry with firms flooding the market at once to seek renewals. The number of firms that fail to get appropriate cover then increases the huge cost of the assigned risks pool (ARP), the repository funded by all qualifying insurers for firms that cannot find cover.

All of this points towards an acceptance by the SRA that the problems faced by smaller firms in getting insurance are having a knock-on effect on the top-150 firms surveyed in this report. All qualifying insurers must cover a proportion of ARP firms relative to the total sum of the premiums that they write.

With the likelihood of more firms failing to find insurance and entering the ARP, practices at the top end of the market could face increased premiums. Although firms going into the ARP are typically smaller high street practices, with 85% of the profession made up of firms of less than five partners, the knock-on effect for large numbers of smaller firms going into the ARP should not be overlooked.

It is worth pointing out that despite fears that the number of firms that fell into the ARP in 2010 would reach unprecedented levels, as at 15 October only 396 firms were in the pool, up on last year by around 100 firms but way below expectations.

Firms at the top of the market are split on the effect the ARP is having on them: 38% of those surveyed say the number of firms entering the ARP has had an inflationary effect on their PI premiums, while 38% argue it hasn’t.

‘We know some quotes from underwriters are including an uplift to cover ARP costs and some insurers were deterred from quoting premiums or seeking to increase their market share due to the ARP,’ says one respondent to the survey. Another City firm comments: ‘We don’t perceive a direct inflationary effect, but the very existence of the ARP must affect every firm’s premiums.’

‘The ARP is a big problem,’ says Neilson-Moore. ‘There are too many firms in it and they have been allowed to stay in it for too long and continue to practice, even when they have not paid their premiums. Because it is the qualifying insurers who support the ARP, this burden falls back on the qualifying insurers in any case. Ultimately, this must result in an inflation of the premiums of the non-ARP firms, because someone has to pay the bill. This effect has been muted however, because the competition for law firms, particularly for the larger law firms, is so intense. Only firms with no real competition for their business saw increases last year.’

One large regional law firm sums up the widespread sentiment about the ARP: ‘It should be a short-term default only, not a repository for the uninsurable.’ That’s a sentiment that others echo. At a recent Association of British Insurers (ABI) event on PII reform in January, Mark Casady portfolio manager at QBE insurance was quoted in The Law Gazette as saying of the ARP: ‘It’s not a hospital, it’s a hospice – firms go there to die.’

The SRA has realised that a tougher stance on the ARP is crucial and the top end of the profession suggest this is about time, with 65% of respondents to this survey feeling that the SRA has not done enough to keep firms out of the ARP.

Among the other proposals put forward in the SRA’s December consultation paper is a reduction in the time firms can spend in the ARP from 12 months to six. The paper also suggests that ARP firms should be required ‘to develop and implement effective plans to either exit the ARP into the open insurance market or undertake orderly closure’. The SRA also wants insurers to inform it about firms that fail to pay their premiums and firms that insurers believe may have misrepresented information. Beyond the immediate goals for 2011, the SRA has also mooted the possibility of ending its role of providing qualifying insurance completely, limiting its role to the provider of client protection to firms that do not have PII. This would mean any firm that failed to obtain insurance from the open market would be required to close. Either a direct levy on the profession or a levy as a percentage of insurance premiums could fund the ARP shortfall.

However, there is some scepticism over how strongly these new proposals will be enforced. ‘Historically the SRA has not stuck to the “one year only in the ARP” rule,’ says one respondent to the survey.

Nick Starling, the ABI’s director of general insurance and health, said in December: ‘These proposals need to go further if we are to build a stable and sustainable market for solicitors’ indemnity insurance. With the market facing its third major economic crisis in the past 25 years, the regulator must grasp this opportunity and act decisively to deliver much-needed reforms that will encourage insurers back into this market.’

In February the Law Society made its position clear, proposing its own alternative to the ARP which, at press time, Council members were due to debate. Its proposal would mean legal practices unable to find PII cover in the open market would be given a minimum of three months and a maximum of six months by their insurers to either find alternative insurance, merge with another practice or cease practising. Significantly, under these proposals the current insurer would provide the mandatory six years of run-off cover if the firm ceased practising, in place of the ARP.

Law Society chief executive Des Hudson recently stated that the alternative could provide both the protection for firms and their clients but also help to cut the cost of the ARP. He said: ‘In recent years, the cost and poor regulation of the ARP has been a factor in insurers’ decisions to exit the market or reduce market share and also operates as a deterrent to new insurers looking to enter the solicitors’ PII market.’

He added: ‘Under this possible approach insurers will only be liable for the risks of firms they actually cover; removing liability for pooled risks that they did not insure in the first place. This gives insurers an incentive to write risks in contrast to the current situation where ARP uncertainty exposes insurers to risks of others and provides a perverse incentive for insurers to limit market share.’

Reduced appetite

The cost of carrying firms in the ARP is just one factor that is driving insurance premiums up for law firms. Although this year’s premium for the compulsory layer of cover was initially reported as £214m – actually a fall from £246m in 2009/10 – the consultation paper says the SRA estimates that the true figure for 2010/11 is about £260m. ‘Our view is that a number of insurers have structured policies this year so as to reduce the level of premium payable for the qualifying element of the insurance in order to limit their exposure to the ARP,’ it says. The SRA recently began an audit of insurers to check this.

Other factors that have driven up insurance premiums include the collapse of Irish insurer Quinn in 2010, which indemnified around 3,000 firms in the UK. The flood of firms formerly insured by Quinn onto the market led to a huge uptick in demand. It also coincided with more insurers withdrawing from the legal sector. In July, Zurich, which insures 13% of the law firms in the market, said that it would be reducing the amount of new business it took on this season while two other insurers, Catlin and Hiscox, withdrew from the market altogether last year. The ABI also reported recently that another four insurers of solicitors were unsure of their continued commitment to the industry.

But with an overwhelming number of the top-150 firms (91%) saying that they think their insurance is reasonably priced and 74% suggesting that they think the market is competitive, it is clear that the problem with finding well-priced PII is less of a problem among the top-150 firms than it is for smaller firms.

‘I don’t think there will be a great impact at the upper end of the market,’ says Jonathan Westwell, general counsel and partnership secretary at Baker & McKenzie in London, of the proposed scrapping of the single renewal date for PII. ‘The largest firms tend to get airtime with brokers anyway because of their size. I expect there may be a significant effect at the smaller end of the market, however.’

Neilson-Moore says it is important to understand the distinction between the larger, more complex firms and the vast number of smaller firms that provide ordinary, everyday legal services on the high street. ‘With the former, underwriters have always taken an individualistic approach,’ she says. ‘With the latter, underwriters originally believed that these could be looked at as a portfolio, with minimal distinctions between firms. This has turned out not to be the case, because of a relatively small number of firms which, based on size and area of practice, look the same as any other such firm, but have produced large numbers of claims. The underwriters are determined to weed these out.’

With more time to focus on each individual firm over a longer time period, Neilson-Moore believes a ‘fairer’ result should be produced for each firm individually. ‘This does not necessarily mean that lower premiums will result however,’ she warns. ‘If anything, most firms will pay something more for the added work of individual, rather than portfolio, underwriting.’

However, there is some concern over the shrinking bank of insurers in the sector. As a major national firm says: ‘Some competition would be nice – our choices are limited.’ A major City firm argues that there are ‘few insurers for large law firms’.

It is incumbent on the SRA to get its reforms to financial protection right. With the burden of struggling smaller firms reducing insurer appetite and decreasing competition in the wider market, the effect on those at the top of the profession will be more keenly felt in years to come. LB

mark.mcateer@legalease.co.uk