The collapse of several insurers won’t worry the smart set, but it is likely to be a problem for smaller law firms
Lawyers on the hunt for professional indemnity insurance (PII) this year will find a market divided, with those in The Lawyer’s Top 100 likely to find increased competition for their business while firms with fewer partners will find it more difficult to get cover.
The Solicitors Regulation Authority (SRA) had hoped to eliminate this sector division when it decided to scrap the assigned risks pool (ARP), but insurance brokers are warning that too many firms will be left with little option but to use an unrated insurer.
Insurance cover is the third-biggest overhead for any firm, coming in behind people and premises. Unlike architects and accountants, lawyers are required to have in place a standard insurance policy at all times – be they a one-solicitor high street firm or a 150-partner City litigation practice. For many insurance buyers in the profession price determines the chosen underwriter rather than service offering.
And it is because of price and availability that 12.5 per cent of the profession is currently underwritten by unrated insurers. Unable to get cover in the rated market, firms are left with little option but to look for an alternative.
For some time brokers and underwriters have complained about the presence of such insurers in the market. The SRA, they say, has a responsibility to ensure that firms are getting cover from a solvent insurer that will pay out in the event of a claim. But the SRA is clear that its remit does not extend to the financial regulation of insurers. That is better left to the domestic regulator or, in England and Wales, to the Financial Conduct Authority (FCA).
In June the Latvian financial regulator, the Financial and Capital Market Commission (FCMC), withdrew the operating licences issued to insurer Balva “in order to protect the insured persons”.
This came as little surprise to the SRA. The regulator wrote to all Balva’s policyholders in April informing them that it had been prevented from writing new business in the UK. Just a few days later the FCMC temporarily suspended its operating licences, raising the prospect of Balva policyholders facing substantial unbudgeted insurance premium and claims costs. In June the licence withdrawal was made permanent.
This obscure Latvian insurer was unknown to many in the domestic profession, but The Lawyer revealed that Balva had on its books 9 per cent of the professional indemnity market in England and Wales – 1,300 firms.
The situation, as The Lawyer went to press, is that Balva is yet to be declared insolvent, a move that would trigger all the firms that it insures to find alternative cover in the live market within 28 days or be forced into the ARP where policy rates are charged at a premium. The SRA is understood to be keeping an eye on the situation and says it will inform those firms affected if an insolvency occurs.
The troubles at Balva follow the decision in 2012 of the Supreme Court of Gibraltar to appoint liquidators to establish the financial position of Lemma after the company had been wound up. Lemma was another unrated insurer.
In the build-up to the 2010 insurance renewal date Ukraine-based Lemma increased its capacity from £4m to £20m. It ended up writing more than £6.2m of cover to UK firms that year. By the 2011/12 renewal deadline the insurer had just one firm on its books and when it went insolvent the SRA granted that firm extra time to find new cover.
The 2,911 firms that insured with Irish insurer Quinn, another unrated institution, before it was forced into administration by the Irish Financial Regulator in March 2010, were faced with a similar problem.
All this has piled the pressure on the SRA to look again at which insurers should be participating in the market. It says it wants to fulfil its public interest duties by ensuring that consumers are not affected by such insolvencies.
The Law Society has welcomed this, but brokers say it is not enough to protect consumers from an insolvency event. Too many firms are chasing too little capacity at the bottom end of the PII market and this is having a knock-on effect.
Hands off the SRA
“The SRA is getting a lot of pressure it doesn’t deserve,” argues Sandra Neilson-Moore, Marsh’s head of solicitors’ PI for Emea.
Many brokers are mindful that the regulator does not have the statutory backing to be able to rate insurers and, even if it did, that would not guarantee it would have sufficient funds to pay claims.
The biggest concern around such carriers is that they do not have the financial depth to cover major losses. But, as Lockton executive director of risk solutions Steve Holland points out, having a rating did not stop Independent Insurance from collapsing in 2001 – in fact, the insurer was highly regarded.
According to RK Harrison account director Paul Crilly, “most brokers align themselves with an insurer and they’ll push that forward using whatever they can”.
Brokers that complain about the presence of unrated insurers in the market, he continues, are able to complain because they are aligned with rated underwriters.
“If you look at the past 13 years since the demise of [the Solicitors Indemnity Fund] there have only really been a handful of insurers in the market,” he says. “Unrated carriers began to appear around 2006.”
Crilly says insurers such as Quinn and Lemma were able to cut deals on price, an attractive proposition for firms in a market sector where rates are rising all the time.
Faced with the prospect of either paying a premium to use the insurer of last resort, the ARP, or choosing an unrated underwriter, many will do the latter.
Crilly emphasises that, of the 10,500 firms in England and Wales all but 200 have fewer than 10 partners. In fact, 4,500 are sole practitioners and a further 4,000 are two-partner firms.
“There are a considerable number of firms in this area that would be willing to go to an unrated insurer,” he says.
Marsh & McLennan UK regulated professions practice head John Kunzler, who looks after firms with fewer partners, says the broker, along with others, only recommends underwriters that carry an A rating. But he agrees that unrated carriers offer a lifeline to some sectors of the market.
Simon Lovat, a PII expert at UIB, adds that while many firms aspire to buy cover from an A+ rated insurer, it is not always possible.
“A lot of [underwriters and brokers] will talk about the need for rated insurance, but when it comes down to it they are the ones who just don’t want this type of work,” he says.
While debate rages in the legal market about how the SRA would rate underwriters, brokers are focusing instead on the standard terms of cover that each firm is obliged to purchase.
A weight off your mind
Neilson-Moore speaks for many when she says: “Very broad terms of cover is very costly and many firms will want to get the cheapest deal. If cover wasn’t compulsory would law firms still buy it? The answer is yes, they would.”
She argues that, in having insurance in place, firms are effectively taking risk off their books – an attractive option.
Crilly points out that by changing standard terms of cover, some firms could find it almost impossible to get cover, with insurers refusing to cover certain practice areas. For example, if the insurance market refuses to cover the conveyancing sector en masse, what would the implications be for solicitors working in that market?
Standard terms of cover were a result of the 1974 property crash, explains Kunzler. By standardising wording the Law Society was ensuring the future of the high street solicitor. Taking that away could have huge implications.
As the 1 October renewal date gets closer, brokers are suggesting that capacity which many thought would emerge because of the end of the ARP is just not available. Aviva is just one insurer that is reducing its exposure to the SME market, shedding £30m-£35m of premium and up to 20 staff in a bid to restore profitability to its PI book.
Research by Lockton suggests that for every pound paid in premium in the live market, around 20p goes towards covering the losses incurred by firms in the ARP. This was one of the reasons, the Law Society and SRA agreed, that insurers were staying away from the market.
However, Holland says the scrapping of the ARP has not created the rush to market that some had envisaged.
“We haven’t seen that many new entrants. Insurers are taking a cautious approach,” he says.
It is clear that it was not just the ARP that was discouraging insurers from getting involved in the solicitors’ PII market.
Lovat contends that in breaking the standard terms of cover, the SRA would attract many more insurers to the market and stimulate competition for business.
“If you let this market operate as a market it would act like a market,” he says. “It’s no good the Law Society getting on its high horse about rated insurers – the fact is it created the animal and now it says it doesn’t like it.”
Such is the pressure at the bottom end of the sector that many predict the rate of consolidation is bound to increase.
“For many firms, consolidation is the key,” says Lovat. “The cost of insurance will never go down.”
A wave of claims at the bottom end of the profession is driving this trend. While there may be one or two multimillion-pound cases against the top 100 firms, it is the six-figure claims against smaller firms that are driving underwriting trends.
In addition, firms coming out of the profession without first selling the business will be held liable for run-off cover for the next six years. This means that many retiring partners could end up paying big insurance sums for years to cover the risk of long-tail claims.
All right for some
While doom lurks for many outside the UK 200, those in the top 100 will find a buoyant market. As usual, it is those with long-term relationships with their underwriters that will get the best out of their renewals. One source suggests that the £140m claim being levelled at legacy Herbert Smith and Freshfields Bruckhaus Deringer by London Underground in a case that is due to be heard in October would have little impact on premiums for the top 100 firms.
The source says such claims are usually weighty in terms of figures, but once the nitty-gritty is sorted in court they turn out to be much lower in value. The defendant firms would have excess levels of insurance in place to cover such an eventuality, and there is plenty of competition for that excess layer of cover.
Neilson-Moore, who specialises in arranging insurance for the top 100, says: “Notwithstanding that there are a large number of claims around, there is still a lot of premium attached to large firms. There is a huge world outside the standard PI pot and the big firms will buy up £10m of primary cover to add to the premiums they have built up over many years.”
Lloyd’s of London underwriters are looking to attract firms that want excess layers of cover. In this market there is plenty of capacity available.
“The big firms won’t have a hard time this year,” agrees Holland. “Premiums will be flat. It will be individual claims experience that will drive the premium price.”
The polarisation of the PII sector is certainly a dilemma for the SRA and solutions are not easy to see. Reducing the standard terms and conditions could have a fierce impact on certain sectors, but it may be the only way to ensure protection for all.
What next for lawyers and insurers?
The changes coming in on 1 October this year regarding the abolition of the fixed renewal date and the assigned risks pool (ARP) are likely to affect the relationship between law firms and their insurers. These effects will take time to work through the system but should ultimately result in a more stable insurance market.
The level of claims generated by firms residing in the ARP in certain years placed a significant burden on qualifying insurers (QIs). The structure was intended to be the place of last resort for law firms that could not purchase insurance in the commercial market. The poor performance of these firms created a cost to all QIs that was ultimately passed on to firms that had purchased insurance in the open market. This additional cost also had the effect of deterring other insurers from applying to be a QI, so ultimately reducing the amount of competition in the marketplace.
With this ‘safety net’ removed the incentive moves back to law firms to tell their story and ensure they are in a position to get insurance. There are no second chances this year, with the ultimate penalty of business cessation within 90 days from 1 October.
The decision to remove the automatic renewal date of the 1 October will also have a significant impact on the renewal cycle moving forward.
Allowing insurers greater flexibility over the periods they can offer cover for means firms have the option to move to a renewal date that better suits their needs. Without the rush of all law firms renewing their insurance on a single renewal date, firms will have the opportunity to fully explain their businesses to insurers. Insurers in turn will have more time to assess the risks involved. For some insurers this could result in law firms being subject to more scrutiny and insurers taking a more measured approach to underwriting the risk put before them. Other insurers will continue to demonstrate the consistent approach to underwriting they have adopted for many years. Either way, the onus is on law firms to make sure they have insurance with a QI before their current policy expires.
The relationship between law firms and insurers has had its ups and downs, but the removal of the single renewal date and the abolition of the ARP will hopefully lead to a more stable insurance environment which can only be good for both parties in this relationship.