Taken to the limit – growing risks for law firms

A buyers’ market for professional indemnity cannot hide law firms’ exposure to growing risks

For a profession often accused of being overly obsessed with risk when advising clients, it is ironic that law firms are taking on uncharted levels of risk themselves.

As firms continually adjust to a new reality of operating across multiple jurisdictions, deploying lower-cost structures and offering better value to clients, it inevitably pushes them into a riskier environment. Despite this, the professional indemnity insurance (PII) market for law firms is regarded as soft, and buyers are able to take advantage of heated competition for business.

Insurers still view the legal profession as a low-risk sector, given that significant claims against major players have been few and far between. Only the hike in insurance premium tax from 6% to 10% is likely to add significantly to law firms’ annual costs.

‘It’s very much a buyers’ market. There is a lot of competition and capacity,’ comments Sandra Neilson-Moore, managing director of the financial and professional liability practice at Marsh.

Recent economic turbulence has not induced a creeping up of premiums and in many respects law firms themselves deserve much of the credit for this. ‘Claims numbers are down which is a good thing and that is a result of very good and prudent risk management structures that larger firms have put in place,’ comments Michael Silcock, executive director of professional indemnity at Willis Towers Watson.

Alison Smith, head of professional indemnity at Eversheds, believes that the current climate is especially attractive to insurers as the legal sector is not exposed to any obvious headwinds: ‘As part of the [insurance] renewals process we are not seeing any questions that are different to the norm. When Lehman happened, insurers asked about your exposure and when Halliwells collapsed they asked about financial stability. There isn’t really a hot topic that they are asking about now. It feels like a steady year so far.’

But while Legal Risk partner Frank Maher accepts that claims frequency is down, he argues ‘the incidence of high-value claims is on the increase’. In December last year, Clifford Chance settled a professional negligence claim against it over the high-profile Excalibur dispute brought by the case’s funders and Greek shipping tycoons, the Lemos family, for an undisclosed sum, avoiding the prospect of a costly public trial. Meanwhile, in November last year, the Court of Appeal dismissed an appeal by Withers against a decision awarding a former client £1.6m in damages following a professional negligence claim relating to the drafting of an LLP agreement.

With further administrative risks associated with globalisation, Andrew Clark, partner and general counsel (GC) at Allen & Overy, believes that firms cannot expect insurance premiums to stay low for long: ‘It’s a relatively flat market at present, but may well harden over time. There are more substantial claims around than people say. It’s hard to get from insurers what claims are out there and, of course, firms don’t advertise what there is. I envisage that the market may well harden if significant claims come through.’

Managing risk

The benign conditions for professional indemnity cover appear to be out of step with the heightened risks that law firms are facing. Fees are being heavily negotiated down by clients leading firms to delegate work to more junior lawyers. At the same time, clients are proving unwilling to accept liability caps from their legal advisers, further elevating a firm’s risk exposure (see box, ‘That awkward conversation’). Another difficulty for firms is where a client instructs it selectively on a case or transaction and where responsibilities between the in-house and external legal teams are not clearly defined.

Angela Robertson, Taylor Wessing’s GC and director of risk, says that firms are having to accept more risk while charging less: ‘What concerns me is when clients say: “We don’t want a Rolls-Royce job, we just want a few bullet points and not a textbook response”. There is an obvious risk in doing that, but interestingly we are not seeing claims arising from those situations. It may just be that from a client’s perspective, if the law firm delivers what it wants, then you have a happy client.’

She believes the law firms are doing a more effective job of risk management. ‘It has taken a few years for risk teams to gain recognition in law firms along the same lines as other business services functions. Risk is now right up there and reports into the executive board.’

There is a widespread belief that a more constructive attitude towards risk management has contributed to persistently attractive professional indemnity premiums. But one of the principal challenges that firms now

face is understanding the true extent of their cover. For example, with the rise of cyber crime it is not clear where professional indemnity cover ends and new cyber insurance cover begins, and whether a potential claim could fall between the cracks.

‘It’s relatively flat, but there are more substantial claims around than people say. The market may harden.’
Andrew Clark, Allen & Overy

 

 

While professional indemnity is thought by firms to cover client losses, and not a firm’s losses, there is no defined precedent. Insurers are still struggling to clarify the circumstances in which a standard indemnity policy would cover a cyber event and where separate cyber coverage comes into play. Until this is tested with a law firm getting a hefty cyber claim, it will remain ill-defined.

Smith says cyber policies are not the norm at present, but are gaining interest: ‘Cyber insurers have panels of experts that can help deal with an incident quickly and help limit the reputational damage, but otherwise firms have to put their reputation first and know that is not insurable as such.’

Most firms have established systems to limit the chances of a cyber breach, to prepare for an attack and how to respond to it, but the limits of their professional indemnity and cyber cover have yet to be properly tested. Simon Thomas, a partner at Carter Perry Bailey, says there is little appetite for cyber insurance at this point, one of the reasons being that no major firm has publicly-declared having been hit by a claim that the minimum terms of its professional indemnity policy didn’t cover. That said, it is taking over risk teams’ agendas. ‘We are devoting a large amount of resource to it. It dominates our risk register,’ says Andrew Cheung, Dentons’ GC for the UKMEA region.

Co-publishing feature
Changes for PII as renewal season begins
– Mark Aizlewood and Simon Thomas, Carter Perry Bailey

Crime statistics have become heavily inflated by cases of online fraud and cyber attacks and Ryan Senior, leader of Aon’s professional services group, is concerned that the legal profession is being caught out: ‘Individuals often operating out of highly organised operational centres have recognised the financial rewards that can be achieved by compromising client accounts. We see this type of crime as being an enduring feature of the legal profession’s risk landscape. What is disappointing is that many of the losses stem from low-tech telephone scams or transferring money to different bank accounts without any checks. With the right staff training and awareness programmes, these are entirely avoidable.’

Cyber breaches are closely linked to reputational risk, another significant concern to firms that has received additional prominence following the Panama Papers scandal linked to the data breach at Mossack Fonseca. ‘Reputational risk is all,’ says Maher. ‘As a law firm, the only thing we have to sell is our reputation. City firms are acutely conscious of this and it is reflected in a growing interest in legal ethics. Client due diligence these days goes far beyond regulatory compliance in areas such as anti-money laundering. It is not just a question of “can we act?” but “should we act?” As seen from the parliamentary report on BHS, parties will seek to leverage their position by instructing leading professional services firms.’

In this case, Olswang and Linklaters will not have enjoyed the parliamentary scrutiny and media attention over their association with the demise of BHS. The parliamentary report suggested all advisers were ‘culpable’ in the collapse of BHS and that advisers to BHS’s buyer, Dominic Chappell through his investment vehicle Retail Acquisitions, were ‘preoccupied with how their fees would be paid’.

Partnering up

While reputational risk cannot be insured against, firms are seeing greater value in tighter engagement with brokers and insurers, which are more active in helping with risk management programmes. Firms are moving away from off-the-shelf PII policies based on cost and coverage, and looking towards tighter business relationships with insurers. What used to be a fairly remote relationship with the broker sitting in the middle, is now a much closer connection.

Cheung says that firms are having to share much more information with their insurers, which are more attuned to a firm’s management structure, working arrangements and approach to organisational risk. ‘Underwriters want to know much more about the fundamentals of the business and how it operates,’ he says.

‘It has taken a few years for risk teams to gain recognition in law firms. Risk is now right up there and reports into the executive board.’
Angela Robertson, Taylor Wessing

 

 

While professional indemnity policy renewals season, which is in full swing for 2016, is generally a well-oiled process, it does require significant engagement from the firms looking to renew their cover. Although Travelers and QBE are the dominant primary insurers to the top City firms, there are a growing number of competitors in this segment, notably Libra, Allianz, Zurich and Aviva. Primary insurers tend to insure top City firms up to the first £10m of a claim and although competition at this level is comparatively limited against the excess insurance market, firms recognise that there is enough competition to ensure that insurers do not take advantage of longstanding relationships.

One of the bigger challenges that brokers and insurers have faced in the last two decades is to obtain global cover that is not excessively costly. Cheung says that the 2013 merger between SNR Denton, Fraser Milner Casgrain and Salans that created the current incarnation of Dentons was problematic from a professional indemnity perspective and that the combined firm had to consider accommodating multiple policies to ensure total cover and to limit costs. ‘We weren’t confident it was possible at the time to construct a global programme that had such a large US component, while retaining the terms and conditions of each legacy firm. However, we challenged the status quo and ended up with a very good global policy that delivered considerable cost savings. The US has much less favourable terms and much higher premiums, because it is a much more litigious environment, but we were able to improve the terms for the US while reducing our overall premium.’

Having worked on the insurance component of a major transatlantic law firm merger in the early 2000s, Silcock says that the availability of global cover has improved enormously in recent years. He suggests that such mergers can be especially testing from a PII perspective because the buying habits of US firms compared to UK firms were fundamentally different. ‘The US-based firms tended to buy lower limits on an aggregate basis. They would have one pot of money available for all the claims and they tended to keep or have larger self-insured retentions and deal with smaller claims themselves. Even now, more of the US-driven mergers result in UK firms losing some of the comforting elements of their coverage. The availability of single policies to cover all jurisdictions has become increasingly sophisticated. You can have US lawyers here in London or in Hong Kong, it doesn’t really matter and you don’t have a claim falling down between two policies.’

The increasingly globalised nature of the profession is one significant reason why firms face more risks than they did before internationalisation took hold. Assembling an advisory team across multiple offices clearly heightens administrative and operational challenges, and as a consequence professional peril. That said, the enthusiasm of insurers to offer PII policies to an industry that they regard as low risk, provides vital comfort to a fast-evolving profession.

With prudent risk management strategies and a buyers’ market for PII, firms might expect to have their cake and eat it. Yet with the scarcity of liability caps, firms are taking on levels of liability that are disproportionate to their fees or the extent of their actual responsibilities. With the perennial competition among law firms for clients’ business, this is a buyers’ market that does not work in their favour. LB

//