The Solicitors Regulation Authority (SRA) has launched a new consultation: “Protecting the users of legal services: balancing cost and access to legal services”, which proposes a number of changes to solicitors' Professional Indemnity Insurance (PII). Following analysis of a decade's worth of insurance claims, the SRA suggests that their current approach to PII is “too rigid”, claiming that the cost of insurance is too high, especially for smaller firms or those working in low-risk areas, which acts as a barrier to a truly competitive legal services market. It is also reviewing how the Compensation Fund functions in a changing risk landscape.
Lockton has considered the SRA consultation and we are of the opinion that the extent of research undertaken and data used to support it is lacking. Most notably, there are significant gaps in the ten years of claims data analysed, from 2004 to 2014. In the data, the SRA did not include insurers who no longer write this class of PII, including several who are now insolvent. It would be reasonable to assume that these insurers found their portfolios to be adversely effected by claims, and so their claims data is, in our opinion, crucial information for the purpose of this consultation. By not including or considering this data, we are concerned that the consultation's findings are based on an incomplete picture of what is the situation actually is.
Whilst the Legal Services Board (LSB) did block the SRA's previous attempt to implement a similar PII consultation, the presumption can't be that they will do so again. We urge all concerned solicitors and other stakeholders to read the consultation and respond before 15 June 2018, to make sure your voice is heard.
Key proposals and potential issues
The consultation proposes a number of changes to solicitors' PII to tackle difficulties around pricing and competition. The four key changes are:
- Reducing the claims limit: Currently, firms are required to have minimum cover of £2m, rising to £3m depending on the firm's structure. The SRA proposes reducing this threshold to £500,000 for all firms (apart from firms engaging in conveyancing services, explained below).
- Higher limits for conveyancing: Firms carrying out conveyancing services must have a minimum of £1m cover, reflecting the fact that this area of law poses a higher risk to customers and to ensure the public are always protected.
- Flexibility of insureds: Removing the requirement for minimum terms to include cover for financial institutions, corporate and other large business clients. A conveyancing component has been proposed, so only firms that need cover for this work are required to buy it.
- Changes to run-off: The SRA are looking to keep the six-year run-off period, but aim to tackle the problem of how expensive purchasing run-off cover is by proposing a £3m limit for firms previously engaging in conveyancing services, and £1.5m for all other firms.
Aside from the fact the consultation has not considered all relevant claims data for the purpose of the consultation, it also does not seem to have considered several significant and recent economic and market changes that also affect the cost of PII:
- Rising house prices: According to HM Land Registry, Registers of Scotland, Land and Property Services Northern Ireland and Office for National Statistics, in 2005 the average UK house cost £150,633, with the average London house costing £220,000. By January 2017, these figures had respectively risen to £218,255 (+44.9%) and £491,000 (+123.2%).
- Claim severity: In recent years we have been in a relatively benign claims environment where the number of claims has decreased. However, since 2014, the severity of these claims has increased.
- Changing risk landscape: Emerging new risks faced by solicitors are not included in the claims data that the SRA has analysed, such as “Friday afternoon fraud”, which has dominated headlines in the press. These types of claims became prevalent from 2012 and our own data indicates that these types of losses did not peak until 2015-16 – one to two years after the SRA's cut-off point for considering claims data.
- Aggregation clause: The SRA has not considered the aggregation clause contained in the minimum Terms and Conditions wording of the PII policy. This clause allows for multiple claims to be treated as one, if they are linked by a unifying factor. The advantage of this clause is that there is only one excess/deductible payable, but this is outweighed by the firm being under-insured as a result. If the proposed £500,000 (or for conveyancing, £1m) minimum cover requirement was in place, this could mean that firms are at an increased risk of being under-insured.
Several questions arise from the SRA's proposals. For example, it is unclear whether firms who have succeeded other firms, who might have undertaken conveyancing in the past should have £500,000 or £1m of cover. Firms who are unsure about their previous conveyancing activities might be overinsuring themselved in an effort to be safe. The SRA has not specified how they would ensure firm have the right levels of cover in place.
Similarly, there is no indication of what happens to clients who presumed that the firm had a certain level of cover when they sought their advice. Should firms write and advise clients if the limit stated in their retainer has since changed? What impact could this consultation have on the public?
The SRA has not clearly defined if the demands of lenders/financial institutions requires firms to source more coverage. Will there be even more scrutiny on firms in terms of panel membership as a result? It is also not clear how the proposed changes to run-off cover will affect retired solicitors.
The PII market and small businesses
While the consultation claims that the current PII market does not favour small businesses, there are at least 15 insurers that will consider a smaller practice depending upon work profile, almost double the number of options available when the profession first came into the commercial market. With far more rated capacity, practices of all sizes should now be better protected.
In the consultation, the SRA claims its changes would encourage competition, but we are concerned that it could dampen it. For example, a start-up Alternative Business Structure (ABS), undertaking low to medium-risk work with a modest fee income, could pay a premium of c. £3,000 (plus taxes). Assuming that the proposed changes provide a 10% saving on premium (£300 in this example), the SRA suggests that it will result in an influx of new ABS's being formed. If this was the case, there is no evidence to suggest that these new businesses would provide better value legal services than what is currently available on the market.
We do not believe that by reducing the compulsory limit of indemnity from £2-3m to £500,000-1m will also reduce the cost of premiums. Insurers already factor in the likelihood of claims when deciding the cost of premiums. If there are not many claims that exceed the £500,000 limit, any saving to the compulsory primary limit will naturally be quite modest, given the SRA's assertion that 98% of the claims in their analysis would have fallen into the first £500,000 of coverage.
Contained within their proposal the SRA also state that based on the claims data reviewed, there could be 2% of claims that would potentially be uninsured. There is no indication of how 2% was settled on as the acceptable number of uninsured claims. Creating an environment where there could be uninsured losses is not the most responsible or forward-looking way of making this PII more streamlined and affordable.
The Compensation Fund
In the SRA's words, the Compensation Fund is crucial to protect the public and small businesses, and maintain trust in the profession for those who have lost out financially as a result of money not being accounted for, or in some cases misappropriated. In its consultation, the SRA has suggested the following changes to the Fund:
- Greater focus on hardship: There are plans to narrow the eligibility of those who can claim against the Fund to only those people and businesses that need the most protection. The SRA considers this as anyone with assets less than £250,000. Barristers and other experts also could not claim.
- Reducing the maximum payment: Currently the maximum sum receivable from the Fund is £2m. The SRA propose reducing this to £500,000.
- More robust claims assessment: The SRA want to strengthen its approach to making sure the Fund is not available to people or businesses whose own actions could have prevented a loss. For example, did the applicant, looking to make very high returns from a dubious investment take steps to check the legitimacy of the scheme and any products, as well as the solicitors' involvement? The SRA do not believe that the Fund is intended to protect dubious investment schemes, even if a solicitor is involved in some way.
The proposed changes to eligibility will have a dramatic effect on all claimants. Some may argue that the proposed changes are a form of discrimination, as the vast majority of home owners in London and the South East would not be eligible, given the rising house prices we have described above.
Businesses with £2m turnover would also not be eligible if they were to suffer from wrongful advice. When does a business become too big to seek compensation, is it at the point the advice was given or at the time when a claim is to be made?
One of the reasons the SRA is proposing changes to the Compensation Fund is “changing risks and higher value claims”. If this is the case, it is concerning that it does not also appear to consider this a factor when addressing compulsory limits of indemnity for the compulsory Minimum Terms and Conditions.
Some practices are already experiencing a hardening of rate for the “working layer”, which is the first excess layer above the compulsory minimum of £2m or £3m. Most notably, the hardening of rate is due to a number of insurers exiting the market due to claims activity and the modest premium levels charged. This working layer can quickly become loss-making for an insurer. The existing insurers included Brit Insurance, who were the largest provider of excess layer insurance for the Legal Profession of England and Wales. Brit Insurance is not the only insurer to exit this space; at least three other insurers have also stopped writing this area of PII for similar reasons.
With competition already reducing for the “working layer” we are seeing signs of the cost of this insurance rising. If the compulsory limit is reduced, this not only could see significantly higher increases but perhaps, more alarmingly for some, is that the availability of such insurance will become sparse. Changing the working layer does not seem to help the situation at all.
Our understanding is that the SRA's core responsibility is to regulate the profession in the interests of client protection, however we believe that these changes could create client confusion and an increased number of uninsured losses.
The proposed plans could have a serious impact upon the reputation of the legal profession and, for all of the reasons stated above, we believe that it is that the changes will struggle to achieve the proposed objectives.
Please do not hesitate to get in touch with a member of the Lockton Solicitors team if you would like to find out more about our perspective on the proposed changes.
 Solicitors Regulatory Authority, Protecting the users of legal services: balancing cost and access to legal services, March 2018, p.5, sra.org.uk.
 Ibid, p.14.
 Ibid, p10.
 Ibid, p.9.
 Ibid, p.50.
 Ibid, p.10.
 Ibid, p.16.
 Ibid, p.11.
 Ibid, p.11.
 Ibid, p.34.
 Ibid, p.9.