Let’s reminisce for a moment. Do you remember the days when a quickphone call to your friendly bank manager was all that was needed torequest some partner capital or to extend the overdraft, with little needto produce financial information to back up the request? It may wellalso be a distant memory that, in August each year, you would renewyour professional indemnity insurance (PII) with a quick chat with yourbroker, sometimes there was even the odd discount thrown in for goodbehaviour (no claims), and that was that. Many solicitors thought theassigned risks pool (ARP) was an over zealous health and safetynotice at the local swimming pool! There have been 15 years ofprosperity and economic growth where legal work was in abundance.Conveyancing transactions were flowing with the property boom andlegal aid had its biggest ever budget. Insurers were underwriting mostlaw firms despite their credibility and risk profile, as the solicitors’business was seen as sound due to the low claims frequency and highlevel of capacity. Not anymore. The ARP is common knowledge andnow firms, particularly the small to medium practices, realise theinfluence that banks and insurers, as stakeholders, have in theirbusiness in today’s environment. Banks now require regularmanagement accounts reporting as a ‘health check’ on the practice’sfinances and liquidity, as banks themselves are under immensepressure to write good sound business, as they look to stabilise theirbalance sheets.

So let’s now concentrate on professional indemnity insurance. Insurersare the providers of one of your biggest overheads and, in some cases,can determine whether you carry on trading. Like the banks, insurersalso have their own legislative regime occupying their minds. InJanuary 2013, Solvency II comes into play which is aimed at makingsure insurers have adequate capital and risk management standards inplace to avoid a Northern Rock (and the other banking disasters ofrecent months) from occurring in the Insurance industry.

This year, insurers were hit with extreme weather damage; theJapanese earthquake was the most expensive (est. $35bn liability forinsurers) natural disaster ever; the Euro sovereign debt crisis; andrising fraud. So it’s no surprise that insurers have had many decisionsto make when identifying business areas and products to underwrite.

Insurers who jumped into the solicitors’ market ‘feet first’, when it firstwent to the open market, are now finding the water far too choppy andare sailing towards calmer classes of business. Last year saw Quinngoing into administration, the withdrawal of Hiscox, Catlin and ACE,with many others only writing existing business or drastically reducingtheir scope. This year we have already seen the exit of SIMA, theSolicitors Indemnity Mutual Insurance Association.

WHat CauSeD tHe exoDuS of inSurerS?

There are two overriding factors for the exit of insurers from the market,and the lack of appetite for underwriting solicitors that has caused sucha hardened market – the assigned risks Pool (arP) and claims.

Insurance

18 • September/October 2011 LEGAL ABACUS

MORE INSURERS

PLEASE!By Richard Hill, ILFM Vice Chair

State of the market

Deterioration in claims

• ½ claims are property and ½ of those are lender claims• Fraud and dishonesty claims• Recessionary claims

High Court statistics for negligence claims against

solicitors

• 2009 – 210• 2008 – 80• 2004 – 12

Premium rates

• 1 – 3 partners highest rates• 4 – 5 partners 2nd highest• 6-10 partners highest rate increases• 11-25 partners 2nd lowest increases and premiums• 26 partners or more enjoy the lowest rates of all

CAUTIONARP!

LA Sept/Oct. QXD:layout1 17/08/2011 14:16 Page 18

1. arP

Any firm that cannot gain cover in the open market due to poor claimsrecords enters the ARP. The premium is 27% of income and it isestimated that only 3% of ARP firms survive. The problem is clear fromfigures 1 & 2. There has been a rapid increase in firms entering withpremiums not being paid and claims paid are reaching into millions.Insurers currently pay into the ARP relative to their market share. Thecost of ARP for 2008 is set at a staggering £55m (800% loss ratio)which provides no incentive for new market entrants to compete forsolicitors’ business having to pay a “subsidy” to the ARP. This year,qualifying insurers will have to pay £38.6m to fund the ARP. TheCharles Rivers report (commissioned on behalf of the SRA) referred tothe cost of the ARP as a “perverse disincentive” to writing solicitors PIbusiness. Although, let’s not forget, it is the professional that ultimatelypays as insurers pass the costs onto solicitors anyway with 10-16% ofthe premium going to the ARP. Even so, the predicament has led toallegations of insurers using mitigation strategies (sometimes known as“flipping”) by under declaring their premiums/business underwritten tolower their % contribution. Between 2007 & 2009 the total premium potfor solicitors increased by 20% to an all-time high of £245 million. Atthe last renewal the declared premium suddenly dropped to £220million and commentators believe the true figure to be in the region of£260m due to these mitigation strategies.

Put simply, well run firms should not subsidise weaker firms. The ARPis a hospital for dying firms and it’s not fit for purpose.

2.Claims

The biggest contributors of claims come from residential conveyancing,trust and probate, personal injury and litigious matters. But, winning theunwanted accolade of top contributor by some distance, is residentialconveyancing as it accounts for half of all claims. With the propertycrash people want someone to blame. Nearly half of all the propertyclaims are in relation to lenders, most notably the buy-to let market andfrom subprime lenders. High loan-to-value ratio mortgages areextremely risky when the market declines and the incredibly onerousobligations placed on solicitors (mainly parts 1 & 2 of the Council ofMortgage Lenders Handbook) can lead to a slip up.

A number of recent high-profile mortgage fraud cases have highlightedthe final financial impact of mortgage fraud for lenders andhomeowners.

The long tail back nature of conveyancing claims is the real fly in theointment for insurers. There is a general consensus that although thefrequency and severity of claims are better than this time last year,there are still a large number of claims waiting to pop their nasty headsout of the woodwork. As Warren Buffet said “It is only when the tidegoes out do you discover who's been swimming naked”

PII policies are also on a “claims made” basis i.e. it is when the claim isreported rather than when the alleged offence took place. In general aPII claim takes on average 6-8 years to resolve which shows theresources that can potentially be consumed.

So WHat iS being Done about it?

Already some firms have been murmuring about whether we shouldcontinue insuring firms in the open market or shift back to the solicitors’indemnity fund. However, I don't agree with this. Generally speakingthe open market has produced the best results for most solicitors witha smaller percentage of income going on PII than SIF. As an examplethe actual cost of the open market was £226 million in 2008. The

solicitors indemnity fund (SIF) equivalent is estimated at £557 million!Going back even further in time, the master policy would have cost anestimated £412 million for 2008. Eye opening figures when youconsider the open market is estimated to have saved the legalprofession £2.1 billion! The market can only be improved with theabolishment of the ARP which should encourage new entrants andtherefore increase competition and choice.

Sra Consultation and changes

The SRA, realising the necessity for change, carried out a consultationon PII with the profession, and were advised by Charles RiversAssociates (CRA). Here is a timeline of the proposed changes.

2011 – 2012

Firms will still enter the ARP if unable to obtain cover but will only beable do so for 6 months (reduced from 12 months].

Removing the liability on qualifying insurers to meet the ARP liabilitiesof any other qualifying insurer becoming insolvent.

2012 – 2013

The ARP will still be around but to lessen the blow for insurers, theSRA have committed the profession to paying £30m of the first £50mof the ARP. This will partly be met with the surplus remaining in theSolicitors Indemnity Fund (SIF) and that will cover the first £10m. Itremains to be seen that if the further £20m become liable, whetherthere would a levy on the profession to cover this?

2013 – 2014

The time has come that many insurers have been calling for - ARP tobe abolished! But what happens to firms that cannot sweet talk theirbrokers to provide cover? The ARP will be replaced with a systemwhere the current insurer offers a three-month extended policy for firmswho cannot obtain cover the following year. After 2 months the firmswill have to wind/close down. For SRA guidance go tohttp://www.sra.org.uk/solicitors/code-of-conduct/guidance/Closing-down-your-practice.page.

The exclusion of claims made by financial institutions in 2011 and non-individual client in 2012 have at the moment been scrapped. A reviewof the regulation of conveyancing is to take place this year and thesepermitted exclusions will be reconsidered for 2014.

LEGAL ABACUS September/October 2011 • 19

Insurance

After the last renewal nearly 90% of the market is in the

hands of just 8 qualifying insurers.

1. Chartis

2. Inter Hannover

3. XL

4. Zurich

5. Travellers

6. QBE

7. Allianz

8. Aviva

Remaining 10% is insured by 12 insurers

figure 1

figure 2

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20 • September/October 2011 LEGAL ABACUS

Insurance

From 2013, the SRA will again consult the profession and insurers onremoving the single renewal date, assessing the pros and cons.

ConveyanCing

As mentioned above, it is well documented and publicised thatconveyancing is the real thorn in the side for underwriters. Somesolicitors have in turn swapped regulators by moving under the Councilof Licensed Conveyancers (CLC) regime who arrange theirprofessional indemnity insurance through the CLC scheme. Some firmshave shipped their conveyancing business into a separate regulatedvehicle. Larger firms have reduced their exposure to RealEstate/Property or have seen confrontation from other departments aspartners are not happy with the added pressure a Real Estatedepartment brings.

Undertakings are another significant issue in conveyancing. Thesolicitors promise to ‘undertake’ an action can create an unlimitedfinancial liability and exposure to loss. Insurers are covering thesepromises with no limits. As mentioned earlier in this article, banks andinsurers have solvency capital requirements and I wonder whether asolicitor, armed with an undertaking, could one day start calls forsolicitor firms to have solvency capital requirements as a provision forthese potential liabilities.

A review of the conveyancing process is underway with the SRAdrafting the supervision and enforcement strategy for conveyancing inorder to get the ball rolling, after advice from the CRA. www.sra.org.uk/conveyancing/. Hopefully, we should have enough timebefore the next property dip as it can be argued that the property cyclerepeats itself every 18 years (14 years up then 4 years down) with thesolicitors insurance arrangements coming under the same scrutinyeach time. We must create an insurance scheme robust enough toweather downturns in economic and property markets.

So what is being offered to help in the meantime?

Home Owners Protection Policy (HOPP) – diverting risk to other

insurance products.

First Title in association with AON Corporation have launched theHome Owners Protection Policy (HOPP). For homebuyers and lenders,the HOPP is an insurance policy that protects and covers a wide rangeof risks they may encounter in the course of buying, mortgaging orusing a residential property. This includes risks that even the mostdiligent solicitor cannot prevent, such as forgery, identity theft, fraud,misrepresentation by a seller, boundary disputes, and lack of planningpermissions and building regulation consents for previous alterations.For conveyancing solicitors, the HOPP has been promoted as the bestpossible risk management solution for clients and lenders. It offersgreater protection to a client than Professional Indemnity Insurance(PII), and allows consumers to claim on a 'no fault' policy, thereforeremoving the need for a client to bring a negligence claim at their ownexpense.

Put simply, HOPP is intended to have a twofold purpose, to protectconsumers (and lenders) from risks that are impossible or difficult toidentify or solve during the conveyancing process and to createstability in the conveyancing market, in terms of PII premiums andpredictability of claims.

The concept of transferring risk from PII to a legal indemnity productsounds wonderful in theory but in practice may be a different outcome.First of all, who pays for the policy? When a home buyer has alreadypaid out for stamp duty, estate agents fees, searches, a mortgage etc,will they be willing to spend another few hundred pounds on thisinsurance policy when they expect their conveyancing solicitor toproperly advise them. More realistic would be the sharing of costs withlenders, solicitors and homebuyers. There will need to be a clearexplanation as there is a real consumer blind spot about the subjectand, after all, it is their biggest financial commitment.

That is not to say it has never worked. In 1995, against a backdrop ofeconomic instability and huge premium spikes in the PI market, thesame concept was introduced in Canada. By 2001, the base premium,for a sole practitioner with a CAN$10,000 excess, early lump sumpremium payment and early filing of PII application, had halved andhas remained stable ever since.

Conveyancing Quality Scheme – improving standards in

conveyancing

The Conveyancing Quality Scheme was launched by the Law Societythis year to provide a quality standard for residential conveyancingpractices. The standard will look to improve conveyancing procedureand service. The Council of Mortgage Lenders (CML), BuildingSocieties Association and Association of British Insurers are all said tobe backing the initiative and offered specialist advice and guidance forthe scheme framework. The aim is surely to enhance the reputation ofconveyancing solicitors in the conveyancing community and two veryimportant stakeholders, lenders and indemnity insurers.

At the last count this month over 1000 firms had applied for the CQSscheme with 320 being accepted. Let’s hope the CQS is a Standardwith substance, improves the conveyancing process and it is not justanother tick box approach. So many conveyancing claims are not theresult of poor knowledge of the law but administrative or procedureerrors, such as a failure to undertake searches or delays in registrationof titles or charges.

With conveyancing firms being under pressure from all angles - the cullof law firms from the lenders panels, enhanced money launderingchecks due to high risk label, demand for legal services shrinking andthe added threat of the ‘brands’ entering the high street to add to theones already mentioned – I hope the CQS will help in some way toreinstall confidence back in the market.

CloSure, Merger or inSolvenCy

With the consolidation of the fragmented legal market and therecession sieving out many weak firms, we have seen closures, firmsshut down through the ARP, bankruptcy orders and mergers. There isno doubt this will continue but this triggers two obligations - run offcover and the Successor Practice Rules. With the abolishment of theARP and the need for orderly closures of practices, this will become afuture topic of discussion.

run off cover

When a firm ceases trading and there is no successor practice theprincipals are obliged to pay for run off cover for 6 years to pick up anyfuture claims by clients. The premium is on average 220-250% of thelast year’s premium.

Successor Practice rules

Insolvent firms can put up for sale their client portfolio to settlecreditors. Yet there is one hurdle that firms need to carefully consideras business acquisitions are not as easy in the solicitors’ world. Firmswill be labelled as a “successor practice” lumbering them with liabilitiesand responsibilities created by the regulatory complexities of closingdown a firm. As an example, a client can make a claim against the firmfor a negligent act performed by the previous firm. This is yet anotherhurdle which is very relevant in today’s climate of insolvencies andsurely there should be a solution where these liabilities can be ring-fenced as an option to attract a buyer.

ConCluSion

Insurers have reacted and expressed their disappointment at the SRAchanges. The ABI (Association of British Insurers) said “the changes

were a missed opportunity for the long overdue reform which is so

badly needed. It is hugely disappointing that they have behaved so

timidly considering the advice they received from their advisors,

Charles River Associates, last autumn – that immediate and far-

reaching change was needed”.

Whether you agree with the swiftness of SRA’s approach it is importantnot to forget that insurers have their own agenda. Underwriters areunder growing pressure to achieve a turnaround in profits on theirsolicitors’ portfolio due to poor recent performance. Insurers havesuggested the industry is probably £80-100 million short of where itshould be, which has many insurers touting premium increases neededto make the market more stable in the long term. Underwriters willassess firms more commercially and look for profitable legal portfolios,but if the market sees the arrival of new entrants how will insurers reactto the added competition? We have already witnessed in the 2010renewal new US giant XL insurance gain market share with verycompetitive pricing through their exclusive scheme with AON. Then lastyear, Hanover Re (through Lockton brokers) carried out a penetrativepricing policy to pick up a large order book.

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Insurance

LEGAL ABACUS September/October 2011 • 21

So whilst the SRA, insurers and the profession seek to implement afairer and less volatile PII system, where stronger firms do not shore upthe weaker firms and firms are individually underwritten based on justtheir own claims experience, we still have this year’s renewal and Ithink it is fair to say the next 2/3 years will still be a challenging marketfor both solicitors and insurers.

What to do for this renewal?

Insurers will monitor and evaluate risk more forensically than ever andbe selective in their underwriting.

• Meet to discuss the PII renewal and get their advice on how topresent your firm.

• Treat your proposal form as a tender for work. Present well, error free and structure properly.

• Review other brokers that have exclusive deals that your broker or other brokers don’t have access to (e.g. AON exclusive arrangementto approach QBE and XL insurance).

• Do not instruct many different brokers to go to the open market asyour proposal form will keeping landing on the underwriters desk andthey will not offer favourable terms.

• Provide your own views on claims and circumstances notified• Explain remedial action taken to prevent recurrence and any trends in

your claims (areas of work, individual etc).• If you have a good claims record calculate your premium to claim

ratio.• Request your broker to compare your firm with industry benchmarks.• Do not leave until last minute to try and get better deal as higher risk

of entering ARP.• Ensure finance in place as insurers will not ‘hold cover’ without

cleared funds.• Ensure you understand the new Outcome Focussed Regulations

coming in on 6th October and the added focus on supervision and risk management that will be top of the agenda for underwriters.

• Don’t be surprised if brokers request a set of accounts, business planand cash on balance sheet.

INSURERS’ QUESTION TIME

We have mentioned two of the major influences over the few years,ARP and claims. The other is Alternative Business Structures. Oneinteresting structure created by the Legal Services Act 2007 are Multi-Disciplinary Practices where solicitors can go into business with otherprofessionals. Will insurers create specialist insurance products tocover these firms with different industry insurance obligations? TheMTC for solicitors in England and Wales provides the widest coveravailable in the world. We asked Eliott Lake at Lockton - Will you

bring out an insurance product for Multi Disciplinary Practices?

“The SRA are not presently looking to regulate non legal services

carried out by Multi Disciplinary Practices (MDP's). We envisage that

an MDP will have different professional indemnity covers in place for

their separately regulated arms. This will either be accommodated

within a combined Multi section policy that meets the minimum terms

as set down by each Regulator or separate policies designated for

each regulated business. Insurers are not at present launching any

new products to cover MDP's, however Lockton will be working with

their clients who intend to become MDP's to tailor the professional

indemnity wordings to meet their diversified business structure.”

www.lockton.com/Services-and-Solutions/Professional-indemnity

The possible removal of the single renewal date will beconsulted in 2013 so we asked Peter Cattrall at CarrollInsurance - Do you think it would be beneficial to remove

the single renewal date?

There are three major problems with solicitors' professionalindemnity insurance free market ("SPI") mechanics which needsorting - first, the disastrously unwieldy ARP; second, theuniquely commercially unreasonable Minimum Terms & third,the unrepresentative nature of the market for smaller practiceswhich still comprise the majority of 11,000 practising firms.

“There has been a single renewal date since SIF days pre

2000. The date was 1st September but shifted to 1st October

in 2004 (not without difficulty). A single renewal date focuses

minds, creates a level playing field, concentrates

administrative effort & enables the proper workings of the

annual regulatory cycle. Rolling renewals would create more

problems, different commercial markets & the likelihood of

competitive unfairness. The annual renewal season (with its

single renewal date) is demanding. But the market is dynamic,

the same for everybody & has stood the test of time.

Removing the single date is unnecessary tinkering. I/we

support its retention.”www.carrollinsurance.co.uk

As mentioned First Title in association with AON have launched

the Home Owners Protection Policy. We asked Nick Skey at

AON - Do you think there is a realistic opportunity for the

Home owners Protection Policy to work in the uK?

“Conveyancing claims make up around 40% of all PI claims and

the main reason the PI market is in such a bad state. This

product genuinely transfers risk away from a solicitor's PI policy.

Logically PI claims will reduce and this, depending on market

conditions, should be reflected in premiums. When it was

launched in the Canadian market it achieved penetration of 90%

of conveyances within 5 years and had the effect of reducing PI

costs by more than 40% and the cost has remained stable ever

since.”www.rewritinginsurance.aon.co.uk/solicitors.aspx

Again another question on the Legal Services Act 2007 and theopening of the legal market door to non lawyers brought on by the Act.We asked Martin Ellis, MD of Prime Risk Solutions - How do

underwriters/brokers envisage the risk of non lawyer influence

in future legal practices?

“It is difficult at this stage to predict with any certainty the risk impact of

non lawyer influence on legal practices in the future. I would however,

state with some degree of certainty that the legal services regulators,

the SRA, the CLC or others will ensure with vigour that those

businesses falling into this category adhere to a robust compliance

culture. Professional Indemnity Insurers will need to fully understand

who the non lawyers are, their experience of management, the

business case behind such evolution and importantly the risk

assessments undertaken. It is fair to say that for some firms, individual

non lawyers have been in senior management position for many

years. In my opinion, significant influence on the management of risk

and compliance in many firms who resemble corporate structures in

terms of roles, responsibility, accountability and in general governance

of regulatory obligation.”

www.primeprofessions.co.uk

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