Law firms held 'captive' over high insurance cover

As 11 September pushes premiums up, Naomi Rovnick reports law firms' plans to go it alone

A clutch of top law firms are considering setting up their own 'captive' insurance companies in response to the hardening professional indemnity market.
Lovells, Osborne Clarke, Charles Russell, Halliwell Landau and Cobbetts are among the firms looking into this new idea. Following the collapse of the Law Society-controlled Solicitors Indemnity Fund (SIF) in 2000, law firms are now indemnified on the open insurance market, which has taken a battering after 11 September, causing premiums to increase by as much as 400 per cent.
After staff and premises, professional indemnity insurance is a typical law firm's largest cost. According to Post Magazine, law firms insured for between £10m and £100m which paid £100,000 per £1m of cover last year, could pay as much as £400,000 for the same amount of cover this year.
According to Osborne Clarke managing partner Leslie Perrin, a top-30 UK law firm will generally need cover running into at least nine figures. Cobbetts is insured for £90m, while national firm Hammonds is understood to be indemnified for £200m.
Firms can set up captive insurers by putting money into a company, possibly registered offshore, to pay out for future claims against them. This will allow them to largely turn their backs on the open insurance market. Firms would still need to buy some of their cover on the open market and could probably buy reinsurance on the open market through the captive.
Lovells, Osborne Clarke, Charles Russell, Halliwells and Cobbetts were firms canvassed by The Lawyer, as together they represent a broad spectrum of the top 100 firms. They by no means form an exhaustive list of law firms considering setting up captives.
A Lovells partner said a captive insurance company was one option among several that the firm has had under review. The other firms are understood to have just started looking into the idea in response to their insurance payments being set too high on 1 September this year.
Law firms are not alone in looking towards alternative methods of insurance. Last week, the Financial Times reported that beleagured technology company Celltech had become the first biotech company to set up a captive.
The bad luck of listed companies such as Celltech is the root of the average managing partner's ire at being insured on the open market.
“The irony is that we were better off under SIF, which was much maligned because, as larger firms with good risk management systems, we had to share risk with one-man-bands who may be committing huge conveyancing frauds. We are now suffering from the vagaries of the entire insurance market. If some idiot flies into the World Trade Center, that affects our insurance,” said Charles Russell managing partner Grant Howell.
Privately, even insurers will agree with Howell. An insurance consultant who wanted his comments to remain anonymous said: “Be it the hardening market, or 11 September, all premiums have gone up for solicitors – in some cases by 400 per cent. Solicitors are saying, 'Why should this happen when my claims profile has been modest, and why are insurers passing on their inefficiencies to everyone concerned?'”
If other law firms follow the lead of the five mentioned here and set up captives, their insurers are not likely to lose business, according to Perrin.
“Insurers will simply set up businesses selling captives. Then we'll end up buying them from the very people who are charging us huge premiums at the moment,” he said.
Insurers who specialise in captives are already beginning to advise law firms on the topic. Risk and Insurance Research Group (RIRG), part of Aon, specialises in consulting on captives. It is linked to Aon Insurance Management, which manages captive insurance vehicles.
According to a senior RIRG source, there is no simple formula for setting up a captive insurance company for a law firm.
“Taking on your own risk needs capital and this is where law firms could fall by the wayside. No firm has enough capital to resolve an Andersen situation,” the source said.
Broadly speaking, if law firms are to begin setting up their own insurance companies they will mostly be on their own. According to the RIRG source there are no off-the-peg products yet.
Are law firms capable of insuring themselves? And should they, just because they believe insurers who have been in the market for years are not getting it right? Linklaters litigation partner Mark Humphries has serious misgivings.
There is a minor generational problem with captives, he explained. If an equity partner puts money into the captive and during their time with the firm there are no serious claims, have they paid for the future mistakes of others? Humphries said this could be resolved in principle by an equity partner being able to sell back their stake in the captive on retiring. But much more serious an issue, according to Humphries, is determining the value of this stake.
“If a law firm sets up a company, then equity partners have a share in that company. On leaving a firm, a partner would sell the shares back. The real question is, 'What is the value of those shares?' It would be a complex actuarial exercise to determine this. Does the average law firm really have the time or the resources to do it?”