On 2^nd July 2014, the SRA announced the results of its consultation into the Minimum Terms & Conditions for Professional Indemnity cover for the profession.

Of the five main proposals  only two are currently being taken forward.  The main change is the reduction in the minimum level of cover to £500,000, which is accompanied by a new requirement for firms to assess the level of cover appropriate to their firm.   The other proposals are to be the subject of further consultation in the future.

There is no doubt that for many smaller firms, the reduction in cover will appear very attractive.  Lockton would caution such firms that the premium benefits are likely to be much less than they might expect.

It is also vitally important that firm's consider carefully what level of cover is suitable for them before making the decision to reduce their level of cover - to ensure that they are not (i) in breach of their regulatory requirements to ensure that they have 'appropriate' insurance cover; (ii) that partners are not leaving themselves exposed to undue risk in case of a major claim and (iii) that clients are not unduly prejudiced by the reduction in cover.

Premium Savings?

Evidence from insurers and the SRA confirms that the majority of claims fall within the proposed £500,000 limit.  Insurers already take into account the likely potential claims figures in relation to a particular firm, and therefore the reduced limit leaves little room for insurers to reduce their premiums significantly. The SRA estimate that the premium reduction for the lower limit will be circa 5%.

A 75% reduction in the limit of indemnity for a partnership with cover of £2M to save 5% would hardly seem to justify the loss of peace of mind by retaining the higher level of cover.

Clients demanding more cover

Firms undertaking very low risk work (e.g. criminal law practices) already typically achieve very low premium rates.  The firms that in our experience would most benefit from a significant rate reduction are those that undertake a significant percentage of conveyancing work.   Lenders and the CML have already made it clear that they are unlikely to instruct firms with PII cover at the reduced level suggested by the SRA.

With approximately 6,000 firms undertaking conveyancing (the vast majority of which are small firms), reducing the cover to just £500,000 could place many at serious risk of failure if a claim or claims are greater than this level of cover. Where losses are incurred that are not covered by a firm's PII policy, they will increasingly be transferred to the Compensation Fund.   This will not provide any comfort to commercial clients however, as the eligibility criteria is also being changed so that only applications from individuals and small businesses, charities and trustees (where turnover, annual income and trust value do not exceed £2 million) will be offered compensation.

We therefore envisage that all commercial clients will be paying far more attention of law firms limits of indemnity than previously, even for relatively small-scale transactions.  Firms will need to consider very carefully whether reducing their level of cover will adversely impact on their ability to attract work in future.

Partnerships and Incorporated Firms:  Partners personal assets more at risk

The requirement to maintain cover at £500,000 does not differentiate between partnerships or incorporated entities. When the aggregation clause (a clause that enabled insurers to aggregate multiple losses emanating out of the same/similar causes and therefore treat them as one claim) was introduced in 2005, the limit of indemnity was raised from £1M to £2M for partnerships and £3M for LLPs. The rationale was that a client had less recourse to an LLP due to its limited liability status whereas a partnership meant each partner was personally jointly and severally liable and did not therefore need to maintain the same level of cover. The SRA decision to reduce the limit has taken no account of the status of the law firm or the consequences for its clients.

Clearly partner's personal assets will be more at risk than those firms who were in an LLP if limits of indemnity are reduced. We may see more attempts by claimants to hold individuals personally liable and this may not be restricted just to partners. Claims against the individual fee earner who caused the loss may be in the firing-line, regardless of whether they are a partner or not.

Change to the Code of Conduct

The SRA are relying on the new code of conduct requirement that firms should maintain an "appropriate cover" rather than rely on meeting mandatory requirements. Many firms, already carefully consider their PII requirements, and take a precautionary approach. There will however inevitably be firms that do not follow the same rigorous approach, and we believe that it is likely that the SRA will be unable to effectively monitor compliance with a less clear-cut compliance requirement, given current resourcing constraints. While claims could still be made against a firm, notwithstanding it was inadequately insured, the reality is that partners in such firms will not have the resources to meet such claims.

We believe that the SRA should provide clear and specific directional guidance to firms to assist them in determining what would be an "appropriate level of cover" for a firm.

What should firms consider before reducing their limit of indemnity?

Any decision to reduce the limit of indemnity should only be done after careful consideration and in conjunction with the firm's insurance broker. The areas we think should be addressed include:

• Consideration of work done in the past and into the future - the minimum number of years (we would suggest 6 years) that a practice should go back when considering the value and nature of transactions (including those of any predecessor practices in the same period);
• The type of work undertaken (e.g. criminal work would be lower risk, and claims would tend to materialise more quickly than in residential or commercial property work);
• Consideration of average and maximum claims reserves and payments over a similar period;
• Any contractual provisions (eg imposed by commercial clients) requiring the firm to maintain a particular level of cover for a particular period;
• Requirements to re-evaluate the risk exposure of files (property values may have increased significantly over a 4-5 year period; private clients circumstances may have changed substantially since the date of an initial instruction, and potential losses in a trust or probate or matrimonial case may be far higher than when the case was undertaken);
• If a particularly high risk/high value piece of work was undertaken within (e.g. a 10 year period), there is an argument that firms should be expected to maintain cover unless they can demonstrate that they have audited the file very carefully prior to reducing their level of PII cover;
• Consider the effects of losses emanating out of similar or the same work/transactions that may be aggregated together
• Where a firm elects to take cover less than the current £2/£3m minimum, the firm will also lose part of the defence costs coverage, in the event that a claim exceeds £500,000.

New client vetting and the new matter instructions will need to be even more robustly monitored to ensure that a firm does not take on work where the exposure could breach the firm's limit of indemnity.

Any firm that decides to maintain minimum cover only will need to be very transparent with clients within their terms and conditions on the level of their PII.

Impact on your 1^st October Insurance Renewal

The SRA change to the limit has still to be approved by the Legal Services Board which is anticipated to take place at the end of July. It is understood that the Law Society will be making a final case to the LSB to delay the introduction of the changes until further research can be conducted into the impact of the reduced limit.  Even if the MTC changes do go ahead in time for this 2014 renewal season, we do not envisage any significant impact on their PII renewal for the vast majority of firms.

Restricted Market for lower levels of cover

There is likely to be a restricted (largely unrated) market for firms seeking to take advantage of the lowest levels of cover.

Many of the established insurers are likely to approach renewal as business as usual and are unlikely to be willing to offer terms at the reduced limits of indemnity unless there is a very strong case for them to do so.

Run off cover

Excess layer insurers may encourage to sit above a minimum limit of £500,000 on the basis that they do not have to write the policy on the Minimum Terms and Conditions especially as they do not have to provide run off for six years.

Primary layer Insurers are however likely to take advantage of only having to provide run-off cover for the lowest mandatory limit especially where there has been non-payment of the run-off premium.

More information

If you are considering altering your level of cover as a result of the SRA proposals, or have any questions on the impact of the changes on your renewal process, you please get in touch with your Lockton broker.  You can also read the advice from the Law Society following the announcement of the SRA consultation outcome.