Reality bites

Many law firms are chewing fingernails over PI premium rises, but as Jon Robins reports, there is an acknowledgment that it will still be better than living under the shadow of SIF

There are not too many lawyers in the City that would have expected to rue the day that the Solicitors’ Indemnity Fund (SIF) was disbanded. Nevertheless, two years after the big move from mutuality to open market, the size of this year’s premium hikes – on average, at least 30 per cent up on last year, without even taking into account dodgy claims records – will be leaving some with a distinctly queasy feeling as well as something to think about over their summer holidays.

Insurance brokers are already reporting horror stories; and it is not just the usual high street suspects that will be clobbered by the premium hikes. Since September 2000, the first year on the open market, the larger firms benefited from overenthusiastic insurers quoting unrealistic levels of premiums to make a good impression on wealthy new clients. Unsurprisingly, they are not feeling so generous this year.

For many firms, indemnity insurance is their third-largest expense, after office accommodation and staff, and so the severe increases make for a fairly grim picture. So is life post-SIF any better for the profession?

Some professional indemnity (PI) lawyers treat reports of the “spiralling costs” of indemnity as unnecessarily alarmist. Edward Coulson, senior insurance partner at Hammonds and SIF-sceptic (“That’s putting it mildly,” he says) calls for a bit of perspective. “It’s worth bearing in mind that in the last year of SIF, the total premium paid by the profession was £250m; and in the first year of the approved insurers’ scheme, the premium dropped to £150m; and last year it was £175m,” he says. “So if you’re talking about a rate increase of 30 per cent to that, the profession’s paying very substantially less than it was paying for SIF.”

Elizabeth Mullins, former SIF director and the newly-appointed executive director of Aon Professional Risks, resists the annual bout of crystal ball gazing. “One of the consequences of being in the open market is that you have to go through the harder cycles of the market, especially when it contracts,” she says. “But, essentially, the good firms that have the good risk management procedures and those that run their practices well should continue to do well even in a hard market.”

Barney Micklem, a PI partner at Reynolds Porter Chamberlain, believes that the 2003 quotes will be the acid test for the profession. His view is that the premium hikes are “more in the range of readjustments that reflect the capacity in the market, the number of insurers available in the market and a realisation as to the level of claims.

“I see it more as an attempt at re-establishing reality rather than it being the first rung of a ladder of swingeing increases,” he adds.

Insurance brokers attest to the lack of reality in evidence from certain insurers over the last two years. “Premiums being quoted seemed to defy logic,” reports Jeremy Wilson, a chartered insurance practitioner at Reading-based Goss Insurance Brokers. “You could present one solicitor to one company and they’d come up with a premium of £30,000, then present it to another and they’d quote £3,000.”

According to Coulson at Hammonds, when the mutual fund was scrapped it was apparent to all that the PI market was soft and lawyers would be handed a short-term benefit. “PI had for some years been very soft and therefore unprofitable for insurers, and capacity tends to the more profitable areas of business cover,” he says. As he points out, the insurance headaches of lawyers are as nothing compared with other areas of employers’ liability. Wilson reports that many insurance brokers saw their own PI insurance double last year.

The events of 11 September sent shockwaves through the insurance market and both insurers and reinsurers started to look more closely at reinsurance contracts. Couslon says: “Since reinsurers are the wholesale providers of capacity to the insurance market, that’s been very significant. Both insurers and reinsurers are putting their money where their mouths are and moving to more profitable areas, and that’s putting the squeeze on professional indemnity.”

He adds: “Frankly, I think that 11 September was the occasion, rather than the cause, of the increase.”

Trevor Moss, director of insurer Alexander Forbes Professions, predicts “a double bubble” effect, with big increases in premiums on the primary layer of insurance cover for the £1m cover required by the Law Society, but far larger increases for excess cover. Many firms have been enjoying bargain basement prices for this top-up insurance along the lines of £1,000 for £1m worth of cover. Not any more.

“While firms may well be bracing themselves for increases on the primary, it’s the excess layers where it’s really going to hit hard for them,” says Moss. He predicts that firms should be expecting to pay 2 per cent of fee income for such cover. “And that’s going to be a significant difference; and it’s an area where 400-500 per cent increases could apply for anything over £1m for many firms that have been buying this cover at unrealistic prices for many years,” he says.

Micklem at Reynolds Porter also believes that the costs of excess layers of insurance will “certainly double, if not more” this year. He continues: “The upper layers are going to be significant this year because there’s much less capacity; and firms that want more than £100m for each and every claim might well struggle to get it because of the reduction of capacity in the reinsurance market.”

As for the insurers, they are being fairly open about the likely hikes. But The St Paul, the market leader and joint venture partner with the Law Society, which is required to offer cover for all sectors of the profession, claims that any rises will be due to general changes as opposed to being tailored specifically to the legal profession. “Analysts were predicting a hardening in the market even prior to some of the catastrophic events of last year,” says communications manager Richard Gerrard. “We’d hope that, overall, our rates rises will be governed by external factors; and certainly we aren’t having to make any adjustment to cover any previous years that may have proved to be unsustainable.”

David Coughlan, head of solicitors’ indemnity at Zurich Professional, lists the usual post-11 September reasons for premium rises. But he also says: “What we haven’t seen is any material improvement in firms’ risk management; and the mistakes they’re making are the same mistakes.” He offers a predictable litany of cockups, such as failing to meet time limits and “those errors of omission which are the ones that are easy to address through proper risk management”. “Unless we see an improvement for risk management of firms and the removal of the standard and easy errors, then the impact on their premiums will continue to move them upwards,” he adds.

So far, around 10 of the 35 approved insurers that claimed a stake in solicitors’ PI work have left the fledgling market. Most recently, insurance giant Axa (which provided Clifford Chance with cover) became the latest provider to withdraw from solicitors’ PI when it decided to pull out of the wider UK market earlier this year. Cox Insurance, the sixth-largest provider, abandoned the market at the end of last year following the exit of Independent Insurance in the wake of its collapse last year.

Coulson is unsurprised by the slimming down of the providers of solicitors’ PI. “The truth of the matter is that in order to make any money out of this, you have to write it in sufficient volume to generate the profits you need to justify doing it,” he says. He reckons that 30-plus insurers providing cover was too many. “Frankly, it was inevitable that, given the passage of time, it was going to slim down; and I suspect that once the market has shaken out you’re going to end up with two or three large-volume carriers, like Zurich and The St Paul, and then maybe half a dozen others writing more specialist, selective risks, concentrating on market sectors.”

Whether this leaves an insurance market finely attuned to the needs of the profession or a worrying lack of choice depends on your point of view. Certainly, a 25-partner firm might now have only a couple of choices of insurer because of the way that insurers specialise or exclude areas of practice.

Many firms are taking a more imaginative look at their indemnity arrangements in response to the recent change in conditions. In particular, the likes of DLA, Hammonds, Mills & Reeve and Wragge & Co are all exploring the option of setting up their own captive insurance schemes – effectively, their own insurance companies set up by each firm to insure themselves, generally located in a tax haven such as Bermuda or Guernsey to take advantage of tax breaks. Others are looking at mutual insurance schemes, possibly along the lines of the Solicitors’ Indemnity Mutual Insurance Association (Simia), and even limited liability partnerships.

“We haven’t formed any conclusions but we’re certainly looking at captives carefully,” says Mark Hick, head of PI at Wragges. The pressure is off the firm – temporarily at least – because it entered into a two-year deal on its indemnity insurance, not just for the first £1m as in the cases of a number of other firms, but also beyond. “If one had the foresight, as we did a year ago, it was clear that things were getting tougher and the thing to do was buy a two-year policy,” he comments. “Whereas some people are undoubtedly going to face colossal premium increases,” he says, “we’ll only face an increase for that part of our insurance programme which is not part of the two-year deal.”

But it is the events at the other end of the law firm spectrum that is really exercising the insurers at the moment, particularly the performance – or otherwise – of the assigned risks pool (ARP).

The ARP caters for those firms unable to find indemnity insurance on the open market. It is variously described as “an intensive care unit” or a “sulphuric bath”, through which beleaguered firms bounce back into the free market or shut up shop for good. There is little incentive to linger, with premiums in the region of 25 per cent of a firm’s annual fees. However, there are around 45 firms in the ARP and half of the £2.7m in premiums charged for this year and last year remain unpaid. According to insurer critics, the net effect is that the many end up paying for the few, which of course echoes the fundamental problems that many solicitors had with SIF.

“The total cost of the ARP and the expense of running it are shared among the qualifying insurers who write business in the market in proportion to the their own market share,” explains Coughlan at Zurich. “Essentially, the cost of the ARP, if premiums aren’t collected, will fall on the firms who have paid their premiums and complied with the solicitors’ indemnity rules.”

As firms are only allowed two years in the pool, it is time for those that run it to make some tough decisions. Mullins at Aon points out that approved insurers signed up for the “whole of solicitors’ risk”. “The market was hungry for it at the time and now it’s hardening slightly,” she says. “I’m sure that the leading insurers who write this business will be looking very hard at what’s happening to those firms, and at the moment they’re being supported by everyone else just as they always were.” As she points out, the problems have not gone away – they have just moved to the open market.

Life after SIF: Elizabeth Mullins

Who better to ask about the quality of life after the Solicitors’ Indemnity Fund (SIF) than its former managing director Elizabeth Mullins? “Well, what we can say as a matter of fact is that firms for the last two years have clearly done better,” responds Mullins, who this week became executive director of Aon Professional Risks, following another stint as the managing director of Zurich Professional.

Commenting on her appointment, Paul Milton, chairman of Aon, expressed his delight that such a “well-known figure, with extensive experience and understanding of solicitors’ professional indemnity (PI), should join the team”. He added: “It also comes at a time when market conditions for all professionals are very difficult, and we recognise the need to bring all appropriate expertise to bear on behalf of our clients.”

“What we can see, and have seen in other classes of PI, is much harder rates, and solicitors are now hitting this for the first time post-11 September and post-Enron,” Mullins says. “We can see that all indications are that there’ll be adjustments; and where the differentials in those adjustments are going to be much more heightened, it will be in favour of those firms with good risk management records and procedures.”

It will be those firms that can best demonstrate good risk management systems that will receive the most competitive quotes. “Insurers really will hit this in terms of selection this year,” she predicts.

“The reality that everyone has to focus on is that the insurance market is living in a different world today than it was this time last year,” Mullins says. “And all insurers will be looking at their profits and the risks they want to write and the premium they need to charge.”

On the Assigned Risks Pool (ARP), which deals with those firms that cannot find indemnity insurance on the open market, Mullins believes that the Law Society and the ARP managers will have to make some tough decisions this year, as firms are allowed only two years in the pool. “Here we have a market which has taken the whole of solicitors’ risk; it was hungry for it at the time and it’s now hardening slightly,” she says. “I’m sure that the leading insurers who write this business will be looking very hard at what’s happening to those firms, and at the moment they’re being supported by everyone else just as they always were.” As she points out, the problems have not gone away but have just moved to the open market.