Accountants offer safe SIF example
17 February 1998
As the SIF shortfall reaches new depths, Emile Woolf asks what lawyers can learn from the experience of accountants. Emile Woolf is chairman of the personal injury requirements committee of the Institute of Chartered Accountants in England & Wales and head of litigation and insurance services at Kingston Smith, chartered accountants.
All the major professions are experiencing the consequences of growing exposure to litigation.
This is partly due to working in a commercial environment, in which the stakes have been raised to unprecedented levels, and partly due to the infiltration into the public mind of the impersonal "no-fault" liability syndrome.
Quite simply, incidences of loss and targeting of recourse are now automatically twinned, and it is not surprising that the insurance industry is restive at the prospect of more to come.
The Law Society's mutual system, which provides solicitors with professional indemnity cover, is now undergoing urgent review following recognition of a funding deficit to the order of £450m.
Reviewers challenged with the task of having to come up with preferable alternatives are clearly interested not only in analysing the claims profile afflicting solicitors generally, but also in learning from the insurance strategy adopted by other professional bodies.
The three Institutes of Chartered Accountants (England and Wales, Scotland and Ireland) were effectively obliged to introduce compulsory insurance for their members some nine years ago, following implementation of the financial services and companies legislation of 1986 and 1989 respectively.
The Companies Act 1989 initiated audit regulation, which in turn required audit firms to take reasonable steps to secure their ability to meet claims arising from audit work.
One such step was the purchase of PI cover and the Institutes have widened this to embrace all professional business rather than just auditing.
Rather than opting for a simple mandatory mutual system, the institutes decided to allow members a choice of insurers from those on the "participators' list".
The criteria for becoming a participating insurer includes a commitment to underwrite a share, based on market presence, of the "assigned risks pool" (ARP) in which firms are placed if cover on normal, or indeed any terms, is declined due to the underwriters' perception of the risk.
This has the considerable merit of allowing the market to discriminate against risks considered to be unacceptably high by declining to provide cover on standard terms. For example, a firm with known BCCI or Barlow Clowes links (to cite two, hopefully historic sagas), or simply with an adverse claims record, may be consigned to the ARP and charged a commensurate, often severe premium.
Cover in the pool is both expensive and short-term, with a maximum tenure of 24 months. It is certainly not a soft option, and independent peer investigations into the nature of a firm's problem must be endured and paid for before leaving the pool to obtain cover on normal terms once again.
This risk-related discrimination therefore serves to overcome well-ventilated criticisms of the lawyers' scheme that firms operating in less vulnerable areas are effectively subsidising those with a poor record. A firm's own perception of "area risk" is not necessarily reliable anyway.
For example, small accountancy practices providing basic accounting services have a poor record, due mainly to reliance on lenders; yet many in this category believe that they are largely immune from negligence claims.
The arrangements described compel participating insurers to provide cover for every firm, either on normal terms (for the vast majority) or through their compulsory sharing of cover for insureds in the ARP.
The risks surrounding millennium compliance represent a prime example of informed discrimination. Instead of accepting blanket exclusions on every accountant's policy, the Institutes are discussing the use of "reasonables" questionnaires that could risk triggering off a millennium-related exclusion only in extreme circumstances, such as where a firm displays complete ignorance of potential impact, either for itself or the clients whose accounts it is auditing.
Accountants' claims (like solicitors' claims) are cyclical Lloyd's audits and net-worth certifications are two obvious examples that blighted the early years of this decade.
Although insurers reacted by rating the firms accordingly, insurance premiums over this period have generally declined for the vast majority of accountancy practices.
Rates of 0.75 per cent of gross fee income for the mandatory £1m of cover (the primary layer that firms are obliged to purchase from insurers on the participating list) are now commonplace, compared with 3 to 5 per cent 10 years ago.
Nor are participating insurers able to mitigate underwriting losses simply by offering more restrictive policy wordings.
Every year a "minimum wording" is agreed between the Institutes and representatives of leading insurers.
Although insurers are free to devise their own wordings (often more advantageous to insureds than the agreed minimum) all policies must incorporate a "difference in conditions" endorsement, which effectively substitutes the minimum wording for any clause that could be construed as less favourable.
Some commentators have suggested that the primary cover which solicitors are obliged to purchase through the Law Society scheme should be reduced from £1m to, say, £500,000, thereby affording firms greater choice for the higher layers.
Although the proposal is understandable, such a change would not, if accountants' claims experience is anything to go by, make significant inroads into the scheme's current deficit since the vast majority of claims would still strike the primary layer, even if set at a lower threshold.
Indeed, the cost of cover for a firm, even if rated favourably, could rise significantly.
An appropriate forum for open and frank debate between the professions' and insurers' representatives is essential if a market-based scheme is to operate successfully.
The institutes' representatives and leading insurers meet for this purpose twice each year, and this arrangement has served to overcome any dangers of unwarranted repudiation of indemnity on grounds of, say, late disclosure, or demands for firms to carry high policy excesses indeed the institutes' scheme allows a maximum deductible of £20,000 per partner to be included in the calculation of required cover.
The insurance markets have a highly effective mechanism for differentiating risk levels and acting accordingly.
The associated dangers can be ameliorated by a focused and hands-on involvement on the part of the professional bodies themselves, as nearly 10 years of accountants' experience clearly demonstrates.