SIF: time to trade in the Rolls Royce?

Should the SIF continue with its “socialist” policy of covering every firm or has the time come for those with bad records to pay?

The figures say it all. The Solicitors Indemnity Fund now estimates that the total shortfall on all likely claims for the 10 years of its existence has reached £454m. That represents £17,000 per partner in practice in England and Wales.

On top of that, just to keep the shortfall stable, the fund has asked the Law Society to increase the annual contribution for 1997/98 to £269m to cover liabilities of £344m.

That would represent a figure of £10,000 per partner – an increase of 80 per cent – although the Law Society is trying to find a way of softening the blow.

If the shortfall is paid off over six years, as has been suggested to the society council, with annual contributions continuing at the same rate as 1997/98, a three-partner practice (the average size of a firm outside The Lawyer Top 100) can look forward to annual indemnity insurance premiums of £38,400.

If a practice with a good claims record was eligible for the maximum discount, premiums would still add up to £25,000. If it had a poor claims record the bill could rise as high as £77,000.

An accountant, by contrast, can buy professional indemnity insurance on the open market for as little as £200 a year, rising to about £1,000 in special circumstances.

Two years ago, a spate of malpractice scandals in the personal pension sector led to the dissolution of the Financial, Investment Management and Brokers Regulatory Association (Fimbra). Yet a life insurance salesman registered with Fimbra's replacement, the Personal Investment Authority (PIA), can currently buy professional indemnity insurance for about £1,200 per year.

Tim Readman, chair of the Law Society sole practitioner committee, says: “It will undoubtedly be difficult, and in some cases impossible, for small practices to find the extra money. The day has come when firms with bad records should be made to pay.”

Nigel Knowles, managing partner at Dibb Lupton Alsop, estimates that the SIF is costing his firm a “substantial six-figure sum” over and above what he would need to pay on the open market. Since speaking out on the issue, Knowles says that he has been surprised by the number of letters of support he has received.

To be fair, the £454m is not currently owed to actual creditors. Insurers typically account in three-year periods, “closing” each period once it is reasonable to assume that all or most of the claims for that period have been settled.

The shortfall on claims for SIF's closed years – 1987/88 to 1993/94 – has now reached £248m. The estimated £454m shortfall assumes claims will continue at the same rate in the subsequent open years, 1994/95 to 1997/98. This may not happen. The core of the increase stems from claims made against conveyancers by mortgage lenders on transactions which fell apart during the recession. However, conveyancing claims are traditionally made mainly by purchasers and as the property market recovers these may begin to flow in again.

“We didn't have to look at the open years,” says managing director Elizabeth Mullin. “But clearly, when we got into those sort of figures, we felt we had to make as good an estimate as possible and tell the profession.”

Although there is no suggestion that the fund is in any way illiquid, the enormity of the sum has led to questioning of the fundamental purpose of the SIF. Strictly speaking there is no legal need for it, yet it provides more comprehensive cover than anything available to any group of professionals anywhere in the world.

All solicitors are automatically included, regardless of the risk of their type of business, of their claims record, even of whether they are in default of their premiums.

This is, in effect, the Rolls Royce option. It is what Michael Payton, senior partner at Clyde & Co and a leading authority on indemnity insurance, describes as a “socialist or welfare” approach.

“There were certain firms whose records were so bad they couldn't get cover,” Payton says, referring to the establishment of the SIF. “To have forced them out was thought ungentlemanly.”

Not only is the SIF at the high end of available options, it was set up in 1987 in response to the refusal of commercial insurers to cover solicitors as a whole with anything less than a £300m excess. But if commercial insurers were unable economically to cover solicitors as a body, why did solicitors imagine they could do it themselves and in such a “gentlemanly” way?

The risk is such that since 1991 the SIF has been unable to buy reinsurance. It is therefore an unfunded, one-policy insurer with zero-risk diversity, covering a profession involved in every aspect of economic activity. The fund also holds more public money than any sector other than the banks. Except that a bank such as the SIF would not be allowed to exist.

Mullins admits that commercial insurers have found law-yers, covered as a body, expen- sive risks. “The cost of that reinsurance came into account,” she says. “What was happening was that reinsurers were being stung in relation to previous years from negligence claims. The determination was that liability could not go above £300m.”

In response to criticism that low-risk firms are over-subsidising high-risk firms, the SIF is creating “bands” which will attempt to reflect the varying risks attached to different types of business. But this action may turn out to be missing the point.

Although it is true that there are differences in the level of risk for various types of business, the real risk, the element that separates solicitors from other professions – which is what imposes a premium of £13,800 instead of £200 – is the sheer volume of assets which pass through lawyers' hands. Mullins, for example, explains that, historically, conveyancing has been a below-average risk.

Equally, lawyers should be in no doubt that open commercialisation of solicitors' risk insurance will lead to the closure of high street firms and radical changes in most that are left. It may be the end of the profession as a universally available public service.

Other changes are also under way, as described in a report issued by a committee led by David Ward, a past chairman of the SIF. Earlier this year the committee looked into the origins of the shortfall. As a result of its recommendations, the SIF's board will in future be given more and better information, a wider range of projection techniques will be used and outside actuarial consultations will increase.

Perhaps most importantly, the roles of the underwriter – the person who estimates liabilities – and the managing director have been separated. John Speedman, the recently retired managing director of the SIF – who did not reply to requests to be interviewed for this article – combined the two roles.

The Law Society, meanwhile, has established a review group under council member John Appleby to study the need for further reform. A task force has also been set up to find ways of easing the burden of current payment.

The debate over the SIF is inevitably being drawn into what is becoming a bitter contest for the presidency of the Law Society, with candidate Martin Mears stepping up his campaign on the issue. He has called for the resignation of SIF chair Andrew Kennedy and issued a pamphlet accusing the Ward committee of using Speedman as a “scapegoat”.

Clyde & Co's Payton, who headed a professional indemnity review committee under Mears presidency in 1995, confirms that Speedman's estimates had been considered in the City to be high. “There was some surprise when it was learned they were too low,” he says.

“If you ask me if I have confidence in SIF, the answer is no,” says Mears. “The remit of the Appleby committee is too narrow. The Ward committee were insiders. The task force knows nothing about insurance. It would be foolish of me to say I knew the answer, but my job as president would be to seek the best possible advice.”

But Appleby insists that his committee will examine fundamental principles, not merely reform of the present structures. “We have been charged with investigating the need for compulsory insurance, and if there is a need, the scope of that cover and the justification for mutuality. We recognise that we have a problem, a reasonably sizeable problem.”

Kennedy – whose term of office has only a few weeks to run – dismisses the call for his resignation and replies that insurance may be a buyers' market now, but the SIF must provide cover over the long term, including periods when the open market hardens.

He also points out that SIF premiums as a percentage of gross fee income will remain broadly in line with what they have always been. “There is no question of personal responsibility and, besides, the board has asked me to stay.”

Phillip Sycamore, the incumbent Law Society vice-president and Mear's rival in the current election, says: “We must face the question of whether every firm is insurable and I am determined to take measures so that good practitioners don't end up paying for bad. But a knee-jerk reaction to attack or abolish the SIF is not the answer. The problem in the commercial market would be just as acute.”