The Times They Are A-Changing’… Or Are They?

By Kevin McParland
The Old Bailey reflected on a window

2011 will be an interesting year for the legal and insurance professions with regard to professional indemnity insurance. Could we be heading towards the biggest shake-up since 2007?  In this article, we will examine the evidence.

‘The times they are a-changing’: those of a certain age may fondly remember the likes of Bob Dylan, Joan Baez and other artistes known as Protest Singers.  For those who wish to indulge in a little nostalgia, what could be better than drifting back to the sixties and wallowing in the dulcet tones of Dylan delivering songs such as Subterranean Homesick Blues – naturally remembering the good times and consigning the bad ones to the furthest recesses of the mind.

There are those who mourn the passing of the mutual Solicitors Indemnity Fund (SIF) and although that was far more recent than the sixties, it can evoke similarly selective nostalgia among those wishing for a return of the single insurance market that, in their current opinion, had served the profession so well.

As with the sixties, there has been a process of change but in reality the Mutual concept for the legal profession could not have survived for much longer and would have been an even greater millstone for the profession to have to carry than the current situation in which it finds itself.

For it to be successful, the Mutual concept relies on identifiable, acceptable risk parameters, normally very low and benign, running alongside disciplined underwriting and with effective regulation where necessary.  A Mutual cannot, by its very nature, survive in a volatile and undisciplined environment.

Lately during the 10-year period since the SIF was wound up in 2000, there have been some quite seismic events which, in my opinion, have come close to bringing the very subject of solicitors’ professional indemnity insurance and the insurance market into disrepute.

Without repeating the whole sorry tale, which has been the content of previous articles, I will dust down a few of the key points:

  • when it was decided to allow legal firms to purchase cover in the open market, the immediate first year’s premium saving was in the region of £95m for the profession as a whole;
  • despite inflation, and particularly claims inflation resulting from the increased frequency and quantum of claims; despite increased numbers of legal firms; and despite the requirement to purchase higher limits of indemnity, the total premium spend is only just reaching the pre-2000 levels.  This in reality means rates have more than halved over the last decade;
  • few legal firms have sought to make themselves better insurance risks by investing some of the premium savings in compliance and risk management;
  • compliance, risk management and capital adequacy are three of the main criteria perceived by the insurance market as evidence of well run practices;
  • insurers at first saw a golden opportunity to grow by acquiring some of the new tranche of business represented by solicitors’ professional indemnity insurance and for a number of years abandoned underwriting discipline in favour of chasing market share;
  • as a consequence of the short-sighted greed of the insurance market, the profession as a whole has been heavily subsidised by mainstream insurance markets subsequently haemorrhaging vast amounts of cash to indemnify practices for the increasing cost of claims;
  • the nonsense of the common renewal date has added fuel to the fire;
  • while this scenario has been playing out, first the Law Society, then the Solicitors Regulatory Authority (SRA) have appeared to be in denial about or oblivious to what was occurring;
  • following inadequate regulatory action, and the indiscipline of the insurance market, the profession now has to bear the burden of the Assigned Risk Pool (ARP).  How can the profession have allowed a relatively small number of rotten apples to rack up potential claims in excess of £50m per year for 2008/9 and 2009/10?  The economic downturn has had an effect but the danger signs were evident long before that occurred. (As an aside, I am pleased the SRA has commissioned an audit of the books of qualifying insurers to ensure they are making their equitable contribution to the ARP, there having been suspicions of manipulation by participants.)
  • while the mainstream insurance markets are coming to realise their earlier folly – and paying dearly for it – they at least have stayed the course for 10 years and one would hope they will continue to do so, otherwise there will be catastrophic problems.  These insurers include Zurich, Chartis (formerly AIG), Travelers, RSA and Aviva;
  • although it is difficult to conceive how this can be so, other more opportunistic entrants to the market are at the same time making those same mistakes and rapidly expanding their market share with an underwriting philosophy which appears to amount to “we will beat whatever renewal terms you have been given”.  How quickly the demise of Quinn Insurance, and the reasons for it, have been forgotten.

In summary, therefore, the parties concerned, ie the legal firms, the SRA and the insurers, have not covered themselves in glory by their whole approach to the risk transfer process, which is meant to protect the profession’s customers.

How does the picture look going forward and will significant changes be made?  The simple answer is: Yes, but probably not enough and the picture may be quite confused, depending on the nature and timing of the changes and/or of the announcement of the changes.

The SRA commissioned Charles River Associates (CRA) to review the current situation and prepare a report, which they did, and which has subsequently formed the basis of a consultation document advocating certain changes. The key issues of this report are:

  • a determination that the current model was the most appropriate (i.e. a semi-open market, as opposed to mutuals, captive insurers, a master policy for the profession, or any other options).  It apparently passed the CRA “objective and assessment criteria”;
  • the funding of the ARP was highlighted, suggesting that the risks presented by firms in the ARP should be properly  underwritten (as happens with the chartered surveyors’ ARP operated by the RICS), perhaps with a levy also being imposed on the profession;
  • there is a suggestion that the SRA’s Minimum Terms & Conditions (MTC) require review, some of the considerations being:

–      conveyancing: MTC not to apply to work done for corporate clients, and additional cover for this work to be purchased by firms where necessary;

–      common renewal date: identified as being problematical for the insurance market and not beneficial to legal firms;

–      failure of firms to pay premiums: removal of the requirement for insurers to continue cover despite premiums not being paid;

–      Qualifying Insurers: there is currently no requirement on the SRA to ensure that Qualifying Insurers have an adequate credit rating;

–      level of cover: considered adequate;

–      payment of claims excess: insurers still to be responsible for the whole claim in the first instance;

–      material misrepresentation of the risk or non-disclosure of information: insurers still to be prohibited from avoiding the policy and/or claims;

–      fraud by partners: not regarded as being a problem. (It certainly is by insurers!)

–      regulation: possibly should evolve and be more risk-based, taking into account firms’ activity profiles and, as a consequence, allow more flexibility in the MTC;

–      in the longer term it is considered that the need for both a compensation fund and an ARP should be reviewed.

The consultation paper will generate a multitude of responses, one of the most prominent being put forward by Desmond Hudson of the Law Society.  His suggestion is to make Qualifying Insurers responsible for providing “run-off” cover for their own policyholders when their practices are discontinued.  While there are some technical difficulties to overcome, this would give insurers a longer vested interest in the legal firms they take on as customers and would undoubtedly lead to better underwriting.  One of the Qualifying Insurers’ main complaints about the ARP is that it causes them to provide insurance to firms whose applications they had already declined when made through the front door.

Howsoever the goalposts are moved, nothing will work in a sustainable fashion unless:

  • regulation improves and the profession rids itself of the ‘rotten apples’ despite any other political pressures;
  • sensible Minimum Terms & Conditions are evolved. At the moment the MTCs are so gold-plated that a gold-plated cost must be passed on to the profession; further, there is a good argument this can lead to a reduction in professional standards, and thus adversely affect customers who then have to pursue claims;
  • firms take a much longer term view in improving their compliance, risk management and capital adequacy.

Are the ‘times a-changing’?  I think I will stick with Subterranean Homesick Blues for the moment.

Kevin J McParland

Managing Director

McParland Finn Ltd

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