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18 November 2013
Predictions of significant premium increases for professional indemnity insurance are becoming increasingly confident, and law firms are being presented with some interesting choices.
No business wants to see its costs slant upwards, but what is the alternative? Law firms cannot practice without cover for their potential mistakes, so they look to the Law Society-approved providers, pay their premiums and go about their business. But some firms are beginning to abandon the norm and investigate alternative options.
Current opinion suggests an increasingly hardening market. The idea of taking some of your insurance commitments out of the commercial market is thus gaining in both credibility and appeal.
The majority of professional indemnity insurance providers face the renewal and renegotiation of their reinsurance arrangements at the end of the year. By January, those insurers will be better placed to assess the need to pass additional costs on to clients.
Since the dissolution of the Solicitors Indemnity Fund, law firms, on the whole, have witnessed lower premiums. A marked increase in insurance spend would come as an unpleasant shock, particularly for those partners already anticipating the impact of a slower economy.
Insurance is one of the top five areas of a firm's expenditure, behind salary bills and rent. The desire to keep this particular expense stable could be satisfied by taking commercial insurance rates out of the equation. It would be a risk, but that is what insurance is all about.
Davies Arnold Cooper (DAC) partner David Hertzell is an advocate of the 'captive' solution. A captive is essentially a formal savings account set against the possibility of claims occurring below the level of catastrophic risk. They are generally located offshore to take advantage of tax breaks.
Having reviewed its loss history over a 15-year period, DAC decided to set up its own captive. It did so on the basis that the start-up costs did not outweigh the premium saved.
Hammond Suddards Edge is also exploring the pros and cons of a captive. Insurance partner Edward Coulson is charged with assessing the firm's options. On the one hand, lawyers are concerned about a hardening professional indemnity market and the implicit increase in cover costs. On the other, there is no guarantee that setting up a captive is a cheaper option. A captive has to be capitalised and that ties money up for its duration.
One of the strongest arguments against captives comes from the way firms are set up. As partnerships, law firms face the thorny issue of equity over generations. Should one generation subsidise another?
The cohort of partners establishing the captive would have agreed to a substantial outlay, eating into their share of the profits. The captive would build up capital reserves as not all monies invested would be spent on paying out claims. But should partners be able to demand a share of this capital when they retire and new partners buy into the captive?
DAC has addressed this problem. The firm had to ensure that shares in its captive were not held as personal investments by each individual partner. The captive is treated as an asset for the enduring benefit of the practice. New partners contribute to the premium paid and gain cover. Retiring partners are not entitled to a personal share of the captive assets.
Taking responsibility for your own liabilities gives lawyers a greater stake in controlling risks. A common gripe from insurers is that some firms see their policy as a risk management strategy - in the event that they cock up, there is an arrangement to mop up the mess. Firms with captives own their risks. They have a common objective in seeing that claims and the causes of claims are kept to the barest minimum. This is no bad thing for a profession that is fast becoming the preferred target for disaffected litigants.