Profit for purpose
10 September 2012 | By Katy Dowell
9 September 2013
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19 December 2013
25 November 2013
Professional indemnity insurance is in the spotlight, with collapse and consolidation in the solicitors’ sector forcing insurers to focus on firms’ profitability
PI insurers are getting tougher on their solicitor clients as a wave of consolidation and even collapse in the law firm sector rings alarm bells. While there have perhaps been fewer claims than many thought, the limitation period following the financial crisis has not yet run out and more claims could come through the system, pushing up costs for firms.
The collapse of Halliwells, the demise of Dawsons and mass consolidation within the profession means that underwriters are placing greater scrutiny on financials than ever before when deciding how to rate professional indemnity premiums.
While most brokers are predicting increased competition in the insurance sector for legal business from 2013 some suggest insurers are amending underwriting criteria for the modern world.
“Nobody wants to insure a business where profits have been flat for three or four years – they could end up with another Halliwells on their hands,” one broker warns. “Underwriters are looking at how profitable firms are and what their business plans are.”
Lockton professions director Steve Holland agrees, saying: “Insurers are being more careful about analysing the financial stability of firms and are asking for copies of the latest accounts to determine the financial strength and net worth of the business. They are asking more questions if they find that the firm has not made any profits in the past couple of years.”
The fear in the insurance market is that a bad risk could end up costing an insurer for years. Under the current rules governing solicitors’ professional indemnity insurance (PII) lawyers are under obligation for claims going forward six years.
Clyde & Co partner Richard Harrison believes insurers are looking to cut more costs.
“There is a renewed focus within the insurance market on overall costs,” he says.
In financial markets this is known as reducing the burn.
“It means reducing the cost of insuring the insured,” explains Harrison.
Those additional financial burdens include adjusting potential claims – claims that may not ever make it through the court doors.
Insurers also think consolidation within the profession is reaching unprecedented levels. This alone is causing underwriters to reconsider the risk profiles of their firms.
Marsh & McLennan European practice leader for solicitors’ professional indemnity Sandra Neilson-Moore says that mergers “make the markets less happy because premiums are reducing”. The Lawyer understands that one mid-tier firm which merged in the past six months saved more than a million pounds in premiums through the deal.
“It really is a factor for consideration when lawyers are doing their due diligence on mergers,” one market source comments.
It also is a consideration for underwriters who do not want to be exposed to new risks.
“How these mergers work out will be interesting,” comments Neilson-Moore, adding that insurers are wary of such deals not only because they cost them valuable premium income but also because they can expose them to unknown risks, including new clients with dubious backgrounds. According to Harrison, underwriters like the certainty a solid client base provides.
It wasn’t too long ago that Mishcon de Reya, for example, had a client list chock-full of one-offs as opposed to repeat business. This is an unattractive proposition for an underwriter because it has an impact on profitability and sustainability. The firm has worked hard to change its profile and, while it still has a number of one-off clients, its books are now better balanced.
That said, comments Andrew Carpenter, managing director in Marsh’s financial and professional practice, “there is an enormous push within the larger firms to conduct good risk management”.
Mergers and acquisitions within the profession have shone a light on risk management – something that is further compounded by the SRA’s outcomes-focused regulation (OFR) initiative. The regulatory framework was introduced in April last year, bringing about a fundamental shift in how firms are regulated. Instead of prescriptive rules the SRA introduced a raft of principle-based guidelines. The aim was for the regulations to better fit a varied profession rather than be too heavily focused on the high street sector. Already, the initiative is having an impact on how insurers approach firms as risks.
In the next year all firms will have to appoint an SRA-approved compliance officer for legal practice (Colp) and compliance officer for finance and administration (Cofa), both positions of prominence when it comes to risk management. Originally, the SRA gave firms until 31 October to make the appointments, but delays in processing practising certificate renewal applications mean it is now on hold until 30 January 2013. The nominations have been made, however, and now the SRA is considering the appointments.
Once in place the Colp and Cofa will be responsible for reporting breaches of the SRA’s code to the regulator. For underwriters the positions will be essential in helping to prevent insurable risks from arising. The details of responsibilities are still unclear, but the chosen candidate will have to take into consideration a series of points when it comes to deciding whether there has been a breach or not. These include whether clients’ interests are at risk and whether there is a risk to client money.
All lawyers are under an obligation to inform the regulator where they feel there has been a code breach, but the SRA does not put the onus on them to report breaches to internal Colps.
According to the SRA a number of firms adjusted their employment contracts in April this year to make this provision, although it is not a necessity. When it comes to renewing insurance policies, however, it can’t be damaging to premium levels.
As Holland points out, “The Colp and Cofa are in the firing line – it does concentrate the mind to know that all the right reporting lines are in place.”
Take claim, fire
Lawyers are being asked on all levels to look at their exposure to potential professional negligence claims. The past decade has given the established qualified insurers an opportunity to monitor market trends and they are predicting a fresh wave of recession-related claims. The past two years have been relatively benign when it comes to claims against lawyers. In the immediate aftermath of the 2008 market crash, however, the view could not have been more different.
Doing the sums retrospectively paints a clear picture. Total insurance premiums paid by the profession increased by 10.5 per cent from 2007 to 2008, from £204.6m to £226m. This increased again in 2009, to £245.6m before easing off in 2012, to £220m.
At the same time the number of lawyers being unable to get cover on the open market declined so the number of firms moving into the ARP increased from 26 in 2007-08 to 166 in 2008-09, peaking at 302 in 2010-11.
Instantly, this had an effect on the participating insurers’ exposure to claims, because those are the ones responsible for picking up the tab – a cost that should theoretically be passed on to firms through premiums.
From 2007-08 to 2008-09 the value of claims against the ARP rocketed by 318 per cent, from £10.1m to a high of £42.2m. In 2009-10 the value receded slightly, with total claims valued at £27.2m. It is important to remember that the years of account remain open for claims until the six-year limitation period ends.
This was already a bleak picture so when Quinn Insurance, a player in the solicitors’ PII market, went into administration in 2010 the outlook was miserable. The market had never before been in a position where an overseas insurer, unrated by Standard & Poor’s or Moody’s, had disintegrated.
“A lot of unrated market players are based overseas and are passported into the UK market under the guise of EU law,” says Mike Perry, a partner with broker JLT. “We’re still not sure whether they will be covered by the FSCS [Financial Services Compensation Scheme] if they go into administration.”
While there was concern and uncertainty about what might happen neither the Law Society, the SRA nor the FSCS needed to answer the question because the Irish government stepped in to indemnify Quinn’s policies.
Nevertheless, the market could find itself with similar problems should another unrated market participant get into hot water.
XL Group chief underwriting officer for international professional William Wharton says: “When an insurer withdraws from a market in such circumstances there are some scenarios that will result in coverage ceasing without refund, meaning a new policy must be purchased. The bottom line is that if a firm wants to avoid taking the risk that it may have to purchase insurance twice, the purchaser needs to make sure the policy is underwritten by a rated insurer that can prove it is in a financial position to pay claims.”
As The Lawyer went to press questions were being raised about the financial stability of Gibraltar-based Lemma Europe Insurance Company, a company that pulled out of the market this year but nevertheless has a number of firms on its books.
So why would lawyers opt to use an unrated insurer knowing it carries a risk of being left uninsured? It all comes down to price. But, as Wharton points out, an unrated insurer also carries the risk of having to pay premiums twice.
The end of the ARP in 2013 is expected to attract a raft of new insurers to the solicitors’ PII market. Sources contacted by The Lawyer refuse to name names but each says it had held discussions with major players about their plans for the new market.
With the insurer of last resort being phased out some brokers warned that 2011-12 could be a bumper year for the ARP, pushing a one-off monumental cost onto insurers and frightening new entrants away. Writing in The Lawyer in August last year QBE schemes portfolio manager Mark Casaday warned: “The SRA’s policy statement deferring change could see hundreds of firms jettisoned by insurers in the knowledge of the future termination of the ARP.”
His was not a lone voice. Six months ago all brokers were anticipating that insurers would offload bad risks into the 2011-12 ARP in a bid to escape future claims. That rush, however, has failed to materialise and the number of firms in the risks pool contracted to approximately 30 last year, a low figure that is expected to remain flat this year.
Underwriters are wary that a new wave of recession-related claims are in the pipeline, however, as the limitation period post-2008 looms closer. The megaclaims are yet to emerge but all brokers believe there to be some deals-related issues working through clients’ balance sheets.
One broker says: “Litigation isn’t at the top of the list of priorities when you’re in financial strife, but once stability returns management looks at what went wrong and considers bringing cases.”
With that warning ringing out firms will do well to demonstrate a picture of strong financial stability and sustainability when it come to negotiating premiums.
Yet, as more insurers move into the market in 2013 and standards of risk management improve within firms, the forecast for the solicitors’ PII sector is rosy. Not even alternative business structures, which are being put through the regulatory washer, can upset the outlook.