The ARP is on its way out and law firms are becoming more commercial, which should make renewals less fretful
The 1 October renewal period for solicitors’ professional indemnity insurance is fast approaching. Underwriters are predicting a turbulent year as
the Assigned Risks Pool (ARP) is phased out, bring about increased competition and lower premiums
The solicitors’ professional indemnity insurance (PII) market is mid-way through its biggest structural change in a decade.
Underwriters are hoping that the end of the assigned risks pool (ARP) in 2013 will mean lawyers will see rates level out, but not before a stormy renewal season this year.
For the past decade the insurance market has tussled with the Law Society and the SRA over the insurance demands put on the market and the increasing costs of the ARP. Back in 2000 the Law Society embraced commercial insurers when it closed the mutual Solicitors Indemnity Fund (SIF). Improved competition in the market, it was thought, would bring market pressure to bear on the sector and rates would decline.
More than a decade on, the premium drop has failed to emerge. Instead of rates falling there has been uncertainty as underwriters move in and out of the market; the number of firms opting to use the insurer of last resort, the ARP, has fluctuated; and complaints have emerged about the standards of regulation.
The Association of British Insurers (ABI) summed up the situation when it stated that the market suffered from “periodic crises caused by a combination of poorly enforced regulation and restrictive policy requirements, such as insurers’ requirement to stay on cover when premiums aren’t maintained, and exacerbated by significant increases in claims in recent years”.
The SRA refused demands from the market to lower cover requirements on all firms and stagger the 1 October renewal date to relieve pressure on the sector. The watchdog did not want to compromise consumer protection by changing the standard of cover.
Instead, it commissioned a report that formed the basis for the current round of reforms (see box).
From 2013 the SRA will operate a system whereby insurers offer a three-month extended policy period to firms that cannot obtain PII for the following year. Firms unable to get insurance on the open market face the prospect of being closed.
That shows the power the solicitors’ PII market has over the profession and underlines why it is so important for there to be open dialogue between the regulator and the market.
PII underwriters and claims handlers are closest to their insured firms. Strategic plans, new offices, the story behind the annual financials, the claims and the rogues are all monitored by the firm’s chosen insurer. This knowledge helps shape a firm’s insurance policy and, ultimately, decide price.
For many insurers market exposure is also a consideration when it comes to deciding price. Disciplined underwriting has become a buzzword in the market and it is something the big PII players – Travelers, QBE and Zurich – are keen to hammer home.
Market sources say insurers that dip in and out of the insurance class do much to destabilise the sector because insureds are unable to build relationships with their underwriters. Claims records go unnoticed and underwriting discipline goes out the window.
When Quinn Insurance went into administration in 2010, for example, it did so leaving many firms at risk of being uninsured.
For some time Quinn’s competitors had complained about unrated insurers participating in the market and shouted that those who cut rates to grab a slice of PII sector were doing it a disservice. The fallout from Quinn’s demise could have been a lot worse had the lawyers it covered not been able to find insurance elsewhere.
It served as a wake-up call and, some suggest, was another motivating factor behind the SRA’s review.
Travelers assistant general manager for professional lines David Sawyer says it can take up to seven years for underwriters to get to know their clients properly.
“Continuity is something we encourage – we like to build relationships with our insureds,” Sawyer states.
When the ARP ceases to exist, he continues, insureds will no longer be liable for losses suffered by their counterparts.
As lawyers and underwriters well know, a downturn is likely to trigger a wave of claims against professionals and the 2008 crash was no different. While court statistics show the number of claims being filed is in decline underwriters say exposure sharply increased following the Lehman collapse.
“We saw a spike in claims after the credit crunch,” comments QBE portfolio manager Grant Clemence, adding, “We’ve seen some big matters come through.”
So large, in fact, that Lloyd’s of London underwriter Beazley reckons it moved back into the black after cutting its exposure to professionals who are more prone to claims during the dip.
Increased claims activity coupled with an uncertain economic future doesn’t bode well for the 2012-13 renewal season. Across the spectrum firms are working to improve their risk profiles and minimise exposure, but will that put pressure on rates on 1 October?
Rate hikes ahoy
According to insurance broker Prime Professions the early signs are that rates will rise again this year, albeit possibly at a lower rate than previous hikes.
Director Richard Brown says the annual rush to renew started early this year.
“That usually means underwriters are concerned about what’s going to happen,” he explains. “They want to get the renewals done so they can work on what’s happening with the rest of the market.
“At the higher end of the market in terms of pricing, the sector will have to work off the problems of the past two years.”
In other words, lawyers will have to top up the claims pot with their premium if they are going to pay for the six years’ worth of run-off cover they are obliged to cough up.
It is not all doom and gloom, however. Sawyer and Brown agree that the end of the ARP will attract more insurers into the market, creating the competition needed to drive prices down. Lloyd’s insurer Liberty last year only wrote £1m of business in the sector. That is expected to change as it diversifies its book. Likewise, Axis Insurance and Elite – which traditionally writes after-the-event cover – are both looking to expand market share.
Ultimately, says Brown, “competition is what will drive the market down”.
Allianz Global Corporate & Specialty (AGCS) is an example. The insurer entered the market in 2009 keeping its exposure small and underwriting €11m (£8.6m) worth of premium, or 4.2 per cent of the sector. A year later and this increased to €16.5m, but by 2011 the insurer introduced caps on the number of conveyancers it would allow and streamlined its broker panel.
Head of PII David Cable says that pattern will repeat in 2012.
“It will be a controlled group,” he explains. “We have the capacity to write more business, but we need to do it in a controlled manner.”
Cable believes there could be a spike in the number of firms unable to get cover this year as insurers offload bad risks into the final ARP. Nobody wants to be left with bad risks on their books, after all. Sawyer, however, highlights again that even if firms are pushed into the ARP all lawyers will end up picking up the tab for the next six years.
For AGCS, it seems, the market is being tested. Underwriters believe lawyers are becoming more commercial in their approach to management, Sawyer highlights.
“Law, as a profession, has matured in the way it runs itself as a profession and as a business.”
The regulator is becoming more adept at enforcing its decisions and outcomes-focused regulation put compliance at the top of the law firm agenda. All this makes for a good underwriting season.
The profession may still have a few hurdles to leap as the 2012-13 renewal approaches, but the pressure is easing.
Top tips for reducing your premiums
Aside from keeping claim records low, brokers say there are a number of things insureds can do to improve their premium levels
– Maintain insurer continuity
– Take risk management seriously and ensure staff and lawyers are aware of what your policy is. Keep evidence of everything you do.
– Manage risk throughout the cycle, not just when times are good
– Train staff on risk awareness programmes, keep evidence
– Build a relationship with your underwriter
– Outline what you are doing to lower your risk profile above and beyond the cover application in a letter to your insurer
– Keep your underwriter aware of your firm’s strategic plans and structural changes within the firm
– Live by the principles of the SRA’s outcomes-focused regulatory code
The new system
Richard Collins, executive director, SRA
One of the big challenges we have faced in recent times as a public interest regulator has been to ensure we have professional indemnity insurance (PII) arrangements in place that provide the required level of consumer protection and are sustainable for the long term.
Last year we decided to overhaul the system, with the phased closure of the assigned risks pool (ARP) at the centre of the changes. It had become clear that the ARP system was no longer sustainable, and was significantly hampering the operation of a competitive and sustainable market for solicitor PII.
So what will the new system look like?
– The amount of time a firm can stay in the ARP has been reduced from 12 to six months.
– From this October to October 2013 the ARP will be funded by the profession and qualifying insurers in an agreed, alternating, layered approach of £10m tranches. The profession’s contribution for 2012-13 will come from the Law Society, provided by releasing funds from the Solicitors Indemnity Fund.
– In October 2013 the ARP will cease to provide policies of qualifying insurance and be replaced with a system whereby insurers offer a three-month extended policy to firms that cannot obtain PII for the following year. A firm may continue to practise while it attempts to obtain a qualifying insurance policy for the first 30 days of the extended indemnity period. For the remaining 60 days, the ‘cessation period’, the firm may only work on existing instructions while it attempts to find insurance or conducts an orderly closure of its practice in the case that insurance is not obtained.
– The single renewal date will be maintained until October 2013 to facilitate the transition, but is then likely to be removed.
– The existing ‘side arrangement’ whereby coverage is provided to uninsured firms that have not applied or are not eligible to enter the ARP will be withdrawn with effect from 1 October 2012 and instead claims arising from such firms will be met by the Compensation Fund.
– For the 2012 renewal and onwards insurers will be required to disclose their credit ratings in the interests of transparency.
Our view is that implementing these arrangements will: create conditions that increase the likelihood of insurers remaining in the market; boost the number of insurers entering the market; and encourage competition for business between them, while continuing to provide redress when something goes wrong.
We have opted for a phased approach to closing the ARP to ensure a smooth transition and stability in the PII market. For us to facilitate the changes to the arrangements that will take place on 1 October 2013, changes have had to be made to the indemnity period starting on 1 October 2012. This is to mitigate consequences for the market during this time and ensure the profession and insurers are not at risk of increased liabilities.
While seeking to put a system in place that ensures protection for clients and sustainability in the longer term, we have taken steps to increase the transparency of the information firms receive about qualifying insurers. Although it is not the role of the SRA to regulate qualifying insurers, they need to provide better information to the profession, including financial strength information. We were encouraged by overwhelming support for the introduction of the requirement for insurers to disclose credit ratings, and from this October all qualifying insurers will have to make this information available.
At the heart of these changes is the principle that the best way of ensuring client protection is through a competitive and open insurance market.
That said, we will be carefully monitoring the effect these changes have on the market. We have also put new systems in place for insurers to alert us at an early stage when firms are experiencing problems. This means we can provide early support to firms and, where necessary, protect consumers from sudden and disorderly closure, consistent with our risk-based approach to regulation.
It is a perverse truth that the highly laudable attempt to reduce business risk can, on occasion, give rise to new risks. This does not by any means defeat the object of risk management, but it does mean insurance underwriters must pay close attention to structural changes in the name of risk mitigation that occur in their marketplace.
Take the introduction of COLPs and COFAs within UK law firms. These two roles – compliance officer for legal practice and compliance officer for finance and administration – have been made mandatory by the Solicitors’ Regulatory Authority (SRA) in order to provide, what SRA executive director Samantha Barrass describes as “a focal point in the firm for thoughtful engagement with our regulatory regime”. It is a commendable approach, and one that has found many supporters in the financial services market, where mandatory compliance roles were introduced some years ago.
Creating management positions which could be brought into conflict with the directors or partners of a law firm or regulator throws up the potential for litigation and its attendant costs. Consider where the regulator finds a COLP or COFA responsible for a breach of regulatory duty. This could leave the post holder liable for legal costs as they fight their corner. Yet few solicitors’ professional indemnity (PI) insurance policies provide cover for an individual officer’s legal costs.
Travelers has addressed the issue by developing a two-tier offering – an endorsement adding back regulatory defence costs will be offered to smaller firms, and a full management liability policy will be available for larger firms.
How frequently these internal disputes arise will be seen by many as an indicator of the effectiveness of the new compliance roles. But their potential does show how risk has a habit of bubbling up when it has been suppressed elsewhere.
As a result, underwriters will be monitoring the market closely, looking for signs of any other unforeseen tensions that originate from the new roles. Having a team that includes many qualified solicitors can help Travelers spot these ripples early, but the market will experience a period of scrutiny as the effectiveness of the new roles is considered by PI insurers. Their outcome is not easy to predict.
David Sawyer, Assistant General Manager, Professional Risks, Travelers Insurance Company