Following the decision by the Solicitors Regulation Authority to drop the proposed requirement for Participating Insurers to have a minimum rating, the SRA launched a new consultation on 7th May. The consultation has a very short window for responses (closing date 18th June) as the SRA are hoping to implement the resulting measures in time for this 1st October renewal.
The Consultation Proposals
There are five main proposals:
1. Reduce the level of mandatory PII cover to a limit of £500,000
2. Introduce an aggregate limit on claims – suggestions for aggregate limits of £1.5M or £5M
3. Mandatory cover only for claims by individuals, small and medium-sized enterprises (turnovers up to £2M), trusts (with a net asset value less than £2M) and charities (with an annual income of less than £2m)
4. Reduce run off cover to a minimum of three years from six years
5. Amendment to the Code of Conduct to require firms to assess the level of cover appropriate to their firm beyond the minimum
Consultation Objectives
The SRA have stated that they want regulation of client protection arrangements to be targeted and proportionate. This is a laudable aim, and responds to significant criticism of recent regulatory changes as prejudicing smaller firms.
However if the SRA's objective of these proposals is to reduce the cost of PII, Lockton do not believe that they will achieve the desired outcome in the short term.
While many of these proposals will be welcomed by insurers and may help encourage new entrants to the market, there are consequences for the profession with each of these proposals:
Level of Mandatory Cover
The current minimum limit for compulsory cover is £2M for partnerships and £3M for incorporated firms. The proposal to reduce the limit to £500,000 for any one claim would be leaving firms exposed to uninsured claims. While the majority of claims in the 1990s were settled at under £500,000, factoring in claims inflation for the past 14 years, we believe this limit would provide inadequate protection for both clients and law firms in the majority of cases.
A firm with a poor claims track record would still be highly rated whether they were buying cover for £500,000 or £2M/ £3M. Although the severity risk to a single claim in excess of £500,000 would be reduced, the most significant risk for insurers is at the lower bands of insurance cover. For practices deemed 'high risk' (by dint of claims or work profile) the premiums sought by insurers will remain high, notwithstanding a significant reduction in the minimum level of cover.
Firms with poor claims records, who bought the lower level of cover as a way to reduce the cost of PII, would be leaving themselves exposed to a greater risk of insolvency. The cost of the uninsured claims will ultimately have to be borne by the profession due to increased payments from the Compensation fund.
Aggregate Limit
The existing limit is provided on an "any one claim" basis without any cap on the number of limits available in the period of insurance. This sideways exposure for insurers is currently only restricted by means of the aggregation clause which can aggregate common causes/losses into one claim. The proposal is to restrict the number of limits to possibly three limits i.e. £500,000 x three or perhaps an overall aggregate limit of £5M. This may help high risk/distressed risk firms obtain cover, however if the aggregate limit is set too low, consumer protection will be threatened, leaving clients without financial compensation in circumstances where a firm has had a number of claims.
The majority of firms are unlikely to see a premium saving benefit for an aggregate cover, but does allow insurers greater flexibility to structure the cover for more challenging firms.
It remains to be seen how larger commercial clients would respond to a reduction in aggregate insurance cover.
Mandatory cover for claims by individuals, small and medium-sized enterprises, trusts and charities
The restriction of cover to these types of clients may help reduce claims from say lenders, which according to Lockton claim statistics represent half of all conveyancing claims. However the consequences for firms who are only offered cover for individuals, small enterprises and charities, may well lead to a loss of the work from those lenders. Only last month the Yorkshire Building Society stated that they would require any firm on their panel to be insured with an insurer with a minimum security rating of Standard and Poors "A". It can easily be foreseen that such lenders would also require firms to confirm cover for them as lenders or face being removed from their panel.
In principle such an arrangement may make sense; however the loss of work from financial institutions and other corporations would most likely affect smaller firms, as insurers withdrew coverage from firms least able to negotiate the wider cover. Des Hudson Law Society chief executive recently commented that plans to prevent mortgage lenders from claiming on solicitor's compulsory indemnity insurance will "destroy high street conveyancing".
Run off cover for a minimum of three years
The reduction in the number of years run off cover must be maintained to three years, would be welcomed by insurers; however we are doubtful that such a move would lead to a reduction in cost to the profession. Indeed we believe the problem is merely shifted elsewhere as the profession would pick up the cost of claims notified after the three year period expired, either through the Compensation Fund or though some other form of levy.
The SRA acknowledge that claims are concentrated in the initial years after closure of a firm and according to the data analysed in the Charles Rivers Report a large proportion of claims, 60% are made in the first three years. In light of the fact that such a high proportion of claims are made in the first three years coupled with the perennial problem that insurers rarely receive the run off premium when a firm closes down due to financial problems, it is unlikely insurers will make significant reductions to the cost of the run off premium.
Currently cover beyond six years is provided by surplus funds in the Solicitors Indemnity Fund (SIF). Those firms, who had run off policies that have expired, are protected by the SIF up to 2020. If the run off after three years was transferred to the SIF arrangement, it is quite conceivable that without further injection of capital in SIF, it would be unable to meet its liabilities within a fairly short time. Such additional capital would need to be found and no doubt a cost ultimately borne by the profession.
Code of Conduct to require firms to assess the level of cover appropriate to their firm beyond the minimum
These proposals provide flexibility for insurers to structure cover for each firm as they see fit. A proportionality approach makes a lot of sense. However it would be interesting to consider whether it has implications for reputation of the profession. Certainly, commercial clients will be even more astute in their analysis of the differential protection afforded by different firms- and will likely make puchasing decisions, at least in part, on this basis.
It also opens firms up to increased scutiny regarding their PII cover from a regulatory perspective - requiring them to ensure that they have the leve of cover they require, and justify that to their regulator.
Conclusion
The timing of the consultation is of concern, as there is a danger that all the consequences of these proposals if implemented will not have been thought through fully. The responses to the consultation will go to the SRA Board on 2nd July and then on to the LSB for approval shortly thereafter.
The proposals if ratified would be implemented in early August 2014, which would leave both insurers and the profession just eight weeks at most to digest and implement.
We believe these proposals need safeguards to be built in to protect the profession and their clients .
These proposals will not be the panacea to immediate savings in premium. While some firms would definitely see some savings, small low risk firms are already rated to reflect the fact that the exposure to large claims is very low.
If changes to the Minimum Terms and Conditions are carefully considered and not rushed through we believe it will achieve a more stable market in the long term and one where new entrants will be less wary from entering.
Have your say
Lockton are hosting a Forum on the Future of Solicitors Professional Indemnity Insurance, on 16th June, with attendees fromt the SRA and Law Society amongst others. To attend, register here. Alternatively you can submit any questions you may wish, direct to me.
Steve Holland is a Practice Group Manager in the Solicitors Team at Lockton.