Associate Insight: The path to profitability

After a number of years of frantic merger activity within the Legal Profession, recent reports indicate a decline in the number of firms now looking to merge. The SRA's official figures indicate that there were 176 mergers last year, down from 196 the previous year.

It now seems that smaller firms are turning their attention away from mergers towards other areas to improve or maintain profitablity. Having said that, some reports still indicate that 60 percent of firms are still considering mergers.

Whether profitability is sought from increased marketing, alternative management structures and the like, or through merger, firms need to consider carefully the risk implications involved and the potential Professional Indemnity Insurance issues.

Mergers/Aquisitions

When it comes to mergers or aquisitions there are many issues surrounding the PII successor practice requirements and the opportunity to use run-off cover where feasable and practical. This is an area in which firms can benefit from clear, professional advice. It is dangerous to assume that insurers will necessarily want to insure the new entity (this is also the case with conversion to ABS). Insurance due diligence should be performed at an early stage in order to flush out any potential issues. What is the real exposure to claims from past work for both firms? How will the excess structure work for claims emanating from work done prior to merger? Should there be different excesses, different aggregate limits? There is a considerable checklist to address in order to ensure the risks are identified, managed and transferred appropriately. These include ensuring no gaps occur; that the cover is placed on the best terms to prevent any friction should claims occur; that the right insurer is chosen: one that understands and meets your requirements today and in the future. There needs to be a clear strategy for integration including training on systems, procedures and risk culture. Understanding and managing these risks professionally can have a significant effect on profitability both in the short and long term.

Cost control and profitability

There are alternative ways firms seek to improve profitability, should merger not be the favoured option. Willis's Risk Barometer Report 2015 highlighted the amount spent by firms across the profession on risk management and insurance. Both are a substantial overhead for firms and are areas that can sometimes be improved considerably.

Due to economies of scale, large firms typically allocate a much smaller percentage of revenues to risk management than small or mid-sized firms. Our survey data reveals that, on average, law firms with over 100 Partners dedicate 1.2% of total revenues to risk management. This increases to 1.9% for firms with 11-100 Partners, 3.5% for firms with 2-10 Partners and 6.0% for Sole Practitioners. A clear divide also exists between small and large firms in terms of their plans for future investment in risk management. Three quarters of surveyed firms with more than 100 Partners plan to increase investment in risk management during the next 12 months, similarly 55% of surveyed firms with 11-100 Partners plan to do the same. In contrast, under a quarter of surveyed firms with less than ten Partners plan to increase investment in risk management during the next 12 months. This could be considered imprudent in light of the emergence of new risks in the cyber space topped with a changing regulatory landscape.

Risks involved with growth

We have seen an increase in most firms' fee income over the past 2 years and this is predicted to continue (with a note of caution that at the time of writing we are on the verge of a potential Greek exit from the euro, which may have an impact on future growth across Europe). As these fees climb, insurers will inevitably wish to increase premiums payable. But should this be pro rata? It will be important to explain clearly where the growth has come from and that it is carefully managed and properly resourced. For example, there have been areas of the UK where the increase in property work has been met with a shortage of qualified staff in that area. Ensuring we do not overstretch staff involved in conveyancing (once again) is an important factor in preventing future increases in insurance costs. Growth brings with it new risks: both from new clients and from a resourcing and management standpoint. Explaining how these are managed to insurers is an important consideration when entering renewal negotiations.

Equally, it is important to keep control of marketing and business development departments to ensure the right work is attracted at the right fee. Website material and promotions should not describe solicitors as specialists when they are not, as this can potentially raise the expectations of the client and increase the liklihood or outcome of a claim made against the firm.

Preparing for renewal

There are many aspects involved in ensuring law firms obtain the protection their business needs at the most competitive premium. Value will mean different things to different people and some will always buy the cheapest available.

A law firm's relationship with its broker will depend on the specific needs of the firm itself. Some will require international capabilities but many do not. Either way, however, we believe that large firms and small firms alike will have a better experience the more they engage with their brokers from day one. Good brokers can provide risk advice, take firms through their day to day claims process, provide guidance and options throughout the renewal process, provide input on strategy, review draft documents and attend conferences with counsel to ensure their client's interests and reputation are protected at all times. If you have a claim that approaches your total limit of indemnity, you'll certainly be pleased to know you have a quality insurance specialist on your side.

We are now presented with risks from the next phase of the economic cycle. We are also facing increasing cyber risks and ever changing regulation. As such, the role of a risk and compliance manager in a law firm has never been more challenging.

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Colin S Taylor is an Executive Director at Willis (www.willis.co.uk)