Covering costs

It is likely that over the coming years, the single factor that will most influence the nature of professional practice is the professional indemnity (PI) industry. One wonders whether it is entirely coincidence, or an ‘act of God’, that at a time when client demand/dissatisfaction has reached new levels, the insurance industry itself has faced such enormous demands upon its reserves caused from events as diverse as flooding in Yorkshire to the downturn in the FTSE100.

Whereas the cost of PI insurance used to factor as an also-ran on the balance sheet, it is now one of the major considerations facing any firm at the time of setting its annual budget – assuming, of course, it is available at all. Since the Law Society withdrew from the marketplace, the unthinkable is beginning to happen – it is no longer the case that every solicitor will be able to satisfy the minimum requirement of raising £1m of cover.

Perhaps even more worrying is the need to provide for additional reserves on the balance sheet to cover the contingency of the claim that is not worth claiming. Is it worth blighting next year’s negotiations by seeking to recover a sum that is slightly in excess of this year’s excess?

But how will this affect the way partnerships practice in the future? It is no doubt already accepted that the clubbable days of practice are already long gone, except in all bar the smallest partnerships.
However, there are still partners who, having taken a number of years to climb the ladder and reach the giddy heights of partnership, would like to believe that they have some autonomy. This might relate not only to the way they undertake the work, but to the nature of the clients for whom they agree to act. But risk assessment is with us all and those who are not prepared to toe the line may find that not only do they suffer the internal humiliation of facing a claim, but also the risk of bringing the entire pack of cards down when the PI negotiations are relaunched next year. How long will it be before the heavy arm of the managing partner cracks down and declares that certain work types or client bases are too risky for their firm to tolerate? What happens if this includes your favourite client?

The effect of the change to the marketplace has already been seen across the entire spectrum of the profession, from the smallest firm to the largest. At the lower end of the scale, it can be almost impossible, and certainly expensive, to provide even the basic level of cover. The days of a partner being able to break away from a larger establishment and to set up in single-handed practice might almost be behind us as any individual who is able to secure cover at all would find that they would have to spend at least the first few months of the year working to pay for their premium.

High Street solicitors are recognising the need to ‘sharpen up or get out’. The domestic conveyancing marketplace is facing radical change and any firm that wishes to remain in the marketplace is having to consider the creation of a specialist unit. Ironically enough, many of the staff employed to process such transactions will, for cost reasons, be non-lawyers. However, with huge investments in IT, and the establishment of risk awareness programmes, it can still be possible to make a reasonable profit, notwithstanding the Yellow Pages approach of the client base.

But what of the larger commercial-based firms? We are already seeing the emergence of limited liability partnerships (LLPs), but what impact will these have on the nature of professional practice? How comfortable will colleagues be to bounce ideas off each other if there is the prospect that this could lead to personal liability? Rather than a passing chat in the corridor, will a formal memo be required rehearsing the history of the case and setting out the pros and cons of various arguments?

What about the notion of capping liability? This might be rather more difficult to sell to the client than the idea of an LLP, where at least in theory there is some element of unlimited liability, albeit contained. While we, the lawyers, might recognise that we are not interested in clients who are only interested in our level of PI cover, how long will it take the clients to recognise this?

No matter which way the cards are stacked, it is evident that the only real way forward is the route of specialism. Long gone are the days of the general practitioner – everyone has to be a specialist in something. But quite how specialist is specialist? A property lawyer used to be able to handle an entire transaction, ranging from the acquisition of the site, the funding of the scheme as a whole, including acting for the mortgagee, the grant of any leases and the landlord and tenant litigation process flowing from this. These days, the same transaction is likely to necessitate a real estate expert, a landlord and tenant negotiator, a property finance expert and a landlord and tenant litigator – in addition to at least one other set of solicitors acting for the funders. Against that background, is it any wonder clients are becoming more concerned about costs? At the same time, the lawyers need to ensure that they are covering their overheads in order to pay the additional expenditure they face arising from staff, premises and IT, not to mention PI cover, and there is a risk that we will all end up in ever-decreasing circles.

So how do we break the cycle and find a route forward? The first point is undoubtedly to maintain the necessary specialism at all levels. This might mean firms incentivising partners to cross-refer cases to other partners, or indeed to other firms on a referral fee basis. It might also extend to the profession recognising that it cannot afford to continue to undercut fees, which ultimately is bound to lead to lower standards and more claims. Recent reports have brought news that there has already been a degree of retaliation in this respect, with lawyers refusing to accept instructions from panel suppliers of work because their fees are not sufficient to enable the job to be undertaken properly. It goes without saying that in an industry that is required to take risk, there has to be a certain level of profit in order to make it worth undertaking at all.

Another means of moving forward is to consider other, more cost-effective ways of providing PI cover. More firms these days are considering providing alternative means of buying the first, and most expensive, chunk of their insurance by means of setting up a protected cell company in an offshore jurisdiction that has the authority to run an insurance business. The idea behind this is that rather than paying the premium to a UK-based insurance company, which is then lost, the firm effectively self-insures. It is to be hoped that the pot will grow to a sufficient size to cover the level of insurance that would have otherwise been effected, without a claim being made against it. Naturally, a system of this nature is highly complex and has associated costs that also have to be factored into the budget, coupled with discussions about how the pot might be used if not required to fund a claim.

So, what does the future bring to professional partnerships as a result of the impact of the PI industry on the marketplace? The answer seems to be larger, more specialist practices, the greater need for risk assessment, a more sophisticated approach to insurance, and, perhaps the hardest point of all, better education of the client marketplace as to the costs they should expect to pay for good quality service.

Lynne Abess is head of the partnerships practice at Hempsons