With the legal services industry set for a structural shake-up, Mike Willis and Lindsay Bowskill consider the impact on its insurers.
Last year, several key insurers announced they were 'curbing' their appetite to write new business in the solicitors' professional indemnity insurance sector. New capacity was found for the renewals in October 2010, but a recent Association of British Insurers survey suggests that the position has not improved.
Therefore, the Solicitors Regulation Authority's consultation on proposals for major changes to the rules and structures for solicitors' compulsory PI insurance — including changes to the assigned risk pool, coupled with the imminent introduction of alternative business structures and reforms to solicitors' practice regulations — is timely. The big question though, is whether they will work to invigorate a sustainable market for this cover, or simply generate a new range of problems and controversies that do little to improve insurers' confidence.
Proposals for compulsory insurance changes from October 2011 include the idea that the single renewal date of 1 October is to be abolished. Allowing a flexible renewal date should, ultimately, relieve the annual crisis for many law firms, because insurers will be able to take more time in considering the risks they are underwriting. Arguably, this should improve a firm's prospects of negotiating premiums that more accurately reflect its risk profile.
The greater flexibility will also mean that insurers can review their rates throughout the year and be more reactive to the changes in the market, or particular spikes and flat-lines in a firm's claims experience, while premiums could more easily be reviewable following an influx of claims in a particular area of practice. Insurers could also offer longer-term continuous policies to 'lock-in' good insureds.
A more controversial proposal is to remove cover for claims by 'financial institutions' from the scope of the compulsory minimum terms for law firms' insurance. This is a difficult and potentially large class to define and is already being debated.
The proposal is primarily targeted at lenders in the context of residential and commercial conveyancing. Firms wishing to undertake lender work will have to ensure that they negotiate a necessary endorsement to the standard policy with their insurer.
Although firms with a good risk history and management infrastructure are expected to obtain cover without difficulty, firms that fail to present themselves as a good risk are unlikely to secure the additional cover they need, jeopardising their whole business or at least their ability to practise in the conveyancing field.
The proposals have been described by the Law Society's president as "potentially a disaster for high street conveyancers", and of limited benefit to the profession and insurers generally, particularly as the changes would not provide any relief to the market in 2011 from lenders' claims arising from the recent recession.
The ARP has never been more unpopular, with one insurer reported as saying: "The ARP isn't a hospital, it's a hospice. Firms go in there to die. And it's costing the profession a great deal of money." Claims against ARP firms are significant: for the 2008 policy year, indications are that insurers will be required to fund claims of £45.8m — the equivalent of 20% of the total market premium for that year.
The SRA's proposal is that the length of time that firms can stay in the ARP be reduced from 12 months to just six. This should reduce the cost to insurers. Firms will also have to work quicker and harder to turn themselves around if they want to stay open for business.
The Law Society has set out its own proposals: in an attempt to reduce the burden on insurers and to encourage more meaningful steps to recovery for the firms in question, it is suggesting that no ARP be offered at all. In the alternative, the society proposes that if insurers are not willing to renew for a particular firm, then an extended three-month grace period is provided during which the firm can either seek alternative cover or explore merger or takeover with another firm.
Should the firm fail to find a satisfactory option within the three months then they will be forced to close their doors and the insurer will remain on the hook for the mandatory run-off cover. Under this system, insurers would at least only be insuring firms they originally chose to cover.
From 6 October 2011 non-lawyers will be able to fully own or invest in law firms. Insurers are presently able to take comfort that all insured law firms are owned and managed by practising lawyers with a vested interest in the risk management of the firm. After 6 October, insurers may find themselves insuring a firm which, during the term of a policy, becomes part of a more complicated corporate structure, whose proprietors and stakeholders are too diverse to nurture a risk-conscious approach. The SRA's proposed changes also mean there is nothing to prevent insurers from setting a condition that cover will cease if a firm accepts outside funding, or some other similar defined event occurs, undermining the firm's insurance coverage commitments to its clients.
Evolution not revolution
The introduction of these alternative business structures is likely to be an evolution rather than a revolution. High street firms are expected to be first affected, with prospective takeovers and conglomeration by enterprises enriched by economies of scale taking over the mainstream areas of legal work. This will leave the more rarefied work to be carried out, at greater expense if at all, by a rump of specialised practices. Larger firms may also be ripe for outside investors, especially those with high shares of specialised markets.
Regulation of the profession is also changing to an outcomes-focused approach. The emphasis is on meeting a required level of performance or outcome rather than adhering to a prescriptive procedure. A new practice handbook is in preparation for adoption by the profession from October 2011. This is likely to be more broadly drafted than current codes, effectively to reduce or replace restrictions and prohibitions of behaviours, by instead putting firms on their mettle to avoid unhappy results. There is some concern that these wider parameters will expand their risks of service complaints and liability claims.
The SRA's consultation period closed on 28 February. There are numerous amendments proposed, many of them contentious and the debate regarding the future of the ARP is unlikely to be resolved in time for this year's renewal. With so much uncertainty for law firms' insurers, it is expected that October 2011 will be another difficult renewal. In the longer term, insurers may get a better deal; but will they want to weather the storm in the meantime?
Mike Willis is a partner, and Lindsay Bowskill a solicitor advocate, in the professional risk group at law firm Beachcroft
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