28 June 2004
The Solicitors Indemnity Fund (SIF), the mutual insurance company that traditionally provided professional indemnity (PI) cover to lawyers, closed for business almost four years ago on 31 August 2000.
Its closure was supported by more than 70 per cent of the profession and resulted in a new insurance regime offering law firms the opportunity to buy their PI insurance from a panel of 17 qualifying insurers on the open market.
There are few other changes to the way PI insurance is purchased. Just as with SIF, firms still have to buy minimum primary layers of cover worth £1m and can choose to purchase excess layers in addition.
However, since the introduction of the open market, PI insurance rates have risen, with many firms believing the increase to be excessive. But has the profession benefited from the change?
By nature, insurance is a global market and since September 2001 the insurance market has suffered. Much of the capital that provides its capacity to cover risks has either been withdrawn from the market or lost to a weak stock market. With the inability to cover the shortfall, typical market forces of supply and demand inevitably took hold of the market and premiums for all types of insurance increased.
However, in the same way as most markets, trends in insurance are cyclical and a number of new insurers have entered the PI market, resulting in a return to healthy competition.
Cost of insurance
For the primary £1m layer of insurance, firms are paying comparatively less than they were at the time of SIF’s closure. During its final year of operation, the profession paid premiums of £258m to SIF, yet the primary layer insurance premiums for the whole profession were only £245m in the year to 31 August 2003. This is despite what must be two years of the toughest insurance market in living memory.
Primary layer insurance was also cheaper in the year to August 2003 despite the profession’s fee income having risen significantly from the last year of SIF to roughly £7.04bn today.
There is no doubt that firms have changed the way they buy insurance to try to keep the cost of cover down since the open market began operating. Deductibles, for example, have increased and firms are paying more for their excess layer. However, the cost of the excess layer has little to do with SIF’s closure as it was generally bought in the open market even when SIF was in operation. Had SIF not closed, the cost of the excess layer would probably have increased by a similar amount anyway.
Figures show that generally, the cost of insurance for law firms starts at approximately 3 per cent of fee income for lower-risk firms, rising in accordance with the level of risk a firm presents to an insurance company.
The advantages of the open market: an end to cross-subsidies
By the time SIF closed, firms of all sizes were complaining that they were being unfairly penalised and were paying to cover the risks of other firms in the profession. Figures available today suggest that, in fact, the top quartile of firms were paying more for their insurance under SIF and were subsidising the rest of the profession.
This is no longer the case under the open market. Every firm is rated on its own merits and risk profile and does not subsidise other firms. This means that firms active in lower-risk areas of professional practice, such as immigration or crime, pay lower premiums, while higher-risk practice areas, such as personal injury, pay higher premiums. The result is that firms pay what they should rather than cross-subsidising others.
Choice of specialist insurers
Under the open market, solicitors benefit from a choice of insurers specialising in their own practice area and bringing knowledge and expertise to the process of buying the most appropriate insurance. For example, Hiscox specialises in insurance for sole practitioners, but will also consider 2 to 10-partner firms. Alternatively, Zurich and The St Paul will insure firms of virtually any size.
In the same way as law firms, insurers have their areas of expertise and rarely quote for business outside that area. Approximately half the qualifying insurers will quote for firms specialising in high-risk areas, such as personal injury, while others will not.
Should a review of insurers be required, it is essential that the firm appoints a broker with expertise and access to the full markets available.
Improved standards of practice management
As in any insurance industry, an atmosphere of healthy competition between insurers means they are keen to cover firms with the least likelihood of claims. Firms with good claims records and demonstrably high standards of risk management find it easier to buy insurance and have more bargaining power when negotiating their premiums.
The result has been a general improvement of practice management across the profession and poorly managed firms are being driven out of the profession for the benefit of all. Under SIF, every firm was guaranteed PI cover regardless of their practice management standards. With the introduction of the open market and the Assigned Risks Pool, poor firms are being forced to improve or face the consequences.
A commercial approach to dispute settlement
Insurers are keen to ensure that claims are dealt with quickly and efficiently in order to avoid the risks that long and drawn out disputes bring and which drive costs upwards. This commercial attitude has also meant that there is pressure on legal panel firms to deliver highly-competitive fees, saving the whole profession cost, delay and expense.
The open market has delivered a variety of benefits to the profession, despite the switch from SIF to open market insurance taking place during the toughest period in insurance for many years.
The market is now on the turn and solicitors can expect premiums to level off. Some firms with good claims records practising in low-risk areas might even find insurers competing for their business.
There is a warning, however. Firms should think carefully before changing insurer for a small saving as there are many hidden costs, such as different claims processes, representatives from the new insurer having to take time to understand existing claims, transfer of and familiarity with files, lack of protection against late notification or inadvertent non-disclosure of claims and circumstances.
Despite rising premiums, the open market has greatly benefited the profession and with a positive outlook for the future, it will continue to do so. Well-managed large practices are no longer subsidising other firms and badly managed firms are being driven from the profession, improving standards across the whole profession.
Trevor Moss is a director of professional indemnity and general insurance broker at Alexander Forbes Professions