Law firms of all sizes, and in particular smaller practices, will have to be fully armed with transparent, firm-specific information on their risk profiles once the PI revolution takes effect.
Upcoming changes to the way solicitors buy professional indemnity (PI) insurance are far-reaching and will have a significant effect on small and medium-sized firms. Risk management will have to become a core skill for all practices if they are to navigate the PI market successfully in the next few years.
It seems that 2013 will be a watershed year for solicitors and their insurers. This is when the Assigned Risks Pool (ARP) will be scrapped and uninsurable firms will remain with their last insurer and close after a 90-day extended policy period.
There will no longer be a common PI cover renewal date. In the run-up to these changes, from 2011 firms will only be able to remain in the ARP for a maximum of six months.
For law firms, this means that ’good’ firms will no longer be propping up poorly run ones that cannot get insurance on the open market, and this will help to moderate some of the upward pressure on insurance premiums. In the meantime, if the claims experience of the ARP’s 2008 year is to be repeated, 20p in every pound of solicitors’ premiums will continue to be diverted into funding the ARP.
Of greater significance is the ruling that the last insurer will have a six-year run-off liability for losses arising from firms they decline at renewal and which cannot find an alternate insurer and so are forced out of business. This long-tail liability is expected to have a significant impact on how insurers assess and price risk for renewals this year and in 2012. Whereas in the past they might have taken a ’see how it goes’ approach with a higher initial premium or a larger excess, at the next renewal insurers will be making decisions on every firm as if they might be on their books for the next eight years.
Concern over the long-tail liability and costs associated with supporting firms in the ARP that they did not want to insure has made many insurers withdraw from the market or reduce their participation. As a consequence, every firm will face closer scrutiny from current or potential insurers at renewal.
According to Lockton research on how different-sized firms fared at the last renewal, it seems likely that smaller and medium-sized firms will be the worst affected by these changes.
There are around 7,500 smaller practices with between one and three partners in the UK, many of which have struggled to find cover at acceptable prices because of poor risk management , claims and lack of capacity in the market for small firms with high proportion of property-related work. These firms pay on average 5 per cent of their gross fee income in PI premiums – more than any other size of firm. By contrast, firms with four to five partners paid on average 3.5 per cent of their gross fee income in PI costs last year, but experienced an 8.5 per cent rise in premiums.
Firms with six to 10 partners – the category that used to be the insurers’ favourite – paid 2.7 per cent of gross fees but saw rates rise by an uncomfortable 16 per cent. Many of the firms in this bracket are high street businesses specialising in conveyancing, and have been particularly badly affected by the recession.
These trends are likely to be accentuated at the 2011 renewal. Small to mid-size firms with heavy exposure to conveyancing, pressure on fees as a result of the recession and experiencing greater competitive pressure from an influx of new service providers – possibly operating under alternative business structures – may represent a relatively poor risk for insurers. For firms in these groups that also have poor financials, claims and risk management records, the PI renewal may be challenging.
Insurers are asking more searching questions about firms’ financial standing, risk management procedures and loss histories. Firms will need to give careful consideration to their PI renewal process, providing accurate financial information and demonstrating strong risk-management techniques offering greater transparency for insurers on how their risks are and will be managed.
Solicitors specialising in less favoured areas of law, such as conveyancing, will need to demonstrate their competence, perhaps via membership of the Conveyancing Quality Scheme, provide detailed insights into risk-management procedures and offer evidence of robust financial planning.
For firms of every size the presentation of claims records will be key. To attract the best deals firms should review notifications, trying to close as many as possible and offering an analysis of both closed and open matters, including information that will help insurers to reserve appropriately. Underwriters can take a hard line and this is where brokers’ advice can be particularly useful in helping firms put their best foot forward.
Some smaller firms may look at bringing their renewal dates forward. This will allow them to start discussions with insurers while capacity is unallocated, although on the downside they can expect more scrutiny from underwriters under less pressure to process a large volume of renewals.
Well-run law firms of all sizes would do well to scrutinise insurers’ offerings with care. The quality of security and the longer term commitment of some newer entrants are yet to be tested. For all parties, the next two years will be very much a case of caveat emptor.
Steve Holland and Brian Balkin are directors at Lockton