Trouble indemnity

With the shrinkage in the professional indemnity market and rates rising sharply, experts agree that the sector is set for a rocky ride. By Katy Dowell

Solicitors’ professional indemnity (PI) insurance underwriters are warning that this renewal ­season will be the toughest in years. Smaller firms in particular will face growing insurance premiums as the big insurers lose appetite for their ­business. When the solicitors’ PI market last shrank, firms faced rate hikes of up to 40
per cent.

The underwriters, represented by the Association of British Insurers (ABI), want the Solicitors Regulation Authority (SRA) to reform how the PII market operates to encourage greater competition in the sector.

The SRA has responded by issuing a crackdown on firms that participate in the assigned risk pool (ARP), the insurer of last resort, which is funded by insurers that underwrite the profession.

In this PI Special Report, Steve Holland, executive ­director of professions and risk solutions practice at insurance ­broker ­Lockton International, provides an ­overarching assessment of the sector, Davies Arnold Cooper partners Edward Coulson and Phillip Murrin examine the challenges ­facing the solicitors’ PI market, while ­Norton Rose ­partner Susan Dingwall looks at the legal problems facing firms.

Steve Holland, executive director of the professions and risk solutions practice, Lockton International

PI costs at an all-time high

2010 is shaping up to be a year of ­significant change in the PI market. Rising claims, problems associated with the ARP, diminishing investment returns and major insurers exiting this class of ­business mean premiums are set to rise by at least 10 per cent on top of record increases last year. It is likely that many firms will ­struggle to get insurance, ­particularly in the smaller one to five-partner bracket, according to ­insurance broker Lockton’s report on the solicitors’ PI market.

Drivers of the increase

Insurers are concerned that claim ­notifications arising from fraud, dishonesty, property, commercial and mortgage-related work in particular are rising fast, while their return on capital invested is reducing.

Concern continues about lender claims and the potential for the aggregation of losses from a single event, such as a fraud conveyancing ring. The relative values of residential property claims can be low but frequent, whereas the severity of claims from commercial work is high. In recessionary times these claims surface and reveal the full extent of property-related fraud involving developers, surveyors and solicitors, among others.

In addition, Quinn Insurance, which currently insures 2,900 law firms, is in administration, while two other insurers, Hiscox and Catlin, are also exiting this arena. This reduction in capacity, as well as the laws of demand and supply, mean that, with no new entrants this year, and even without the other issues affecting insurers and the profession, there will be upwards pressure on premium rates.

The main area of disquiet is the impact of the ARP. In addition to the rising ­number of notifications and their values, insurers are experiencing increased ­difficulty collecting premiums from firms in the ARP. In past years insurers received less than 50 per cent of the premium owed. However, for the 2008 year only 15 per cent of the total premium due has been collected. For insurers this is ­unacceptable when ARP firms ­accumulate claims that currently stand at more than £40m for that year – a figure that is projected to deteriorate to more than £50m shortly.

The number of firms in the ARP looks set to rise, possibly to 500 in 2010. If this prediction is accurate, the ARP will account for 10-15 per cent of the total premium; and the good firms, as in Solicitors’ Indemnity Fund (SIF) days, will be forced to subsidise the poor performers.

Winners and losers

Firms involved in property work are likely to bear the brunt of the rating increases, as will practices that undertake commercial work. In addition, firms with poor claims histories, especially with claims from property work, should expect to come under close scrutiny; and all firms, no matter what size, will need to be prepared to answer questions on their risk profiles, business processes, liquidity and the ­quality of their lawyers.

If last year’s renewal is anything to go by, the firms likely to perform best at renewal are the larger practices with 11-25 partners or more. The hardest hit will be smaller firms with one to five partners. Smaller firms tend to have less strong risk profiles – especially sub-five partners. Some 77 per cent of firms in this bracket experienced higher premiums overall.

The impact on the profession

All practices can expect to face an ­increasingly litigious claims environment. This situation, combined with a reduced insurer appetite for solicitors’ PI business, mean firms will need to review carefully how they present their proposals for ­coverage to their insurers.

Firms may need to consider how much risk they can afford to retain on their ­balance sheets, ie their self-insured excess. Partners will also need to consider how to manage their insurance costs ­better, and large firms may contemplate self-insurance through cell captives.

Assessing the strength of firms’ risk management will be a key deciding factor when underwriters set premiums or decide whether to quote for business. A good claims record remains the fundamental factor in keeping the cost of premiums down. However, good claims records will need to be underpinned by demonstrable and robust risk management infrastructures. Insurers will expect law firms to focus on improving risk management and will want to see evidence that firms have taken into account the risks associated with practising in high-risk areas such as conveyancing and commercial.

There can be little doubt that this year’s renewal will be challenging for all firms. 2010’s PI premium spend is set to rise to at least £275m, up by around 10 per cent on 2009’s premium spend. Partnerships will need to pay as much care and attention in compiling their PI proposals as they would a new business tender document. They should begin their renewal processes early, but given the number of firms looking for a new insurer this year, it may well take longer than in previous years.

Sailing between Scylla and Charybdis: PI renewals in 2010

This renewal season brings an unusually hazardous voyage across the shoals and reefs of PI ­insurance. Two factors rooted in the ­economic downturn have contributed to the grim outlook.

First, the cost of the ARP has spiralled – insurers have paid £50m to date to the ARP, the membership of which has increased dramatically. Many insurers are levying a supplemental premium for their ARP contributions. There were 140 ARP firms in 2008-09, 259 in 2009-10 and a forecasted increase to 750 this year.

Second, many insurers are questioning the market’s viability. With low interest rates and concerns about the equity market, insurers can no longer rely on an investment profit.

They have to make an underwriting profit and can only do so by ensuring that ­premiums alone exceed claims.

Both factors should push up ­premiums. The only ­countervailing pressure would be an increase in ­supply, ie new insurers entering the ­market. This has been a ­consistent feature recently. But that would have to more than offset the reduction in supply caused by insurers leaving the market. Quinn, which insures 2,900 firms, or 10 per cent of the market, is likely to leave, but other insurers such as Hiscox have also ­signalled withdrawals. It is ­uncertain whether new entrants have a ­sufficiently significant appetite for new ­business to offset this reduction in ­supply. As ever, there are rumours of new entrants.

Premiums probably need to rise ­significantly anyway. The SIF’s premium income in 1999-2000 (its last year) was £256m. Ten years later the profession’s total ­premium is £249m, despite ­doubling the cover, an increase in the number of insured firms, very significant growth in fee income and with it the ­frequency and size of claims (with lenders’ claims prominent). Some ­brokers forecast a 20 per cent premium increase to £300m.

Insurers, the SRA and the Law Society recognise that there is a problem, but cannot agree on the ­solution. Recent adjustments to the ARP rules have been described by one underwriter as a “sticking plaster”. Return to some form of the SIF is unlikely to ­produce a solution: a new SIF would still need to reinsure in the insurance ­market, where exactly the same market forces will come into play. Further reform of the ARP and the solicitors’ PI ­insurance system is likely. The SRA has announced a toughening of the ARP’s approach to its members, but the scope of reform is unclear and significant ­tensions remain about the scope of cover, the delay in closing down rogue firms and complaints of ­discrimination from minority ethnic firms. The battle-ground between the SRA, the Law Society and insurers remains vast. A significant ­problem is that, if the current members of the ARP are forced out of practice, they will end up with six years run-off cover with the SRA ­promising “dramatic change”.

These tensions will not, however, be resolved before October and solicitors are being advised to seek renewal terms early to avoid capacity problems later.