Balancing risks: How the SRA's FP2 affects PII

As the 2012 renewal season approaches, those of you who have kept an eye on the ever-changing realities ?of the solicitors professional indemnity insurance market will be aware that the Solicitors Regulation Authority (SRA) has, over the past few years, been undertaking a ?holistic review of the financial protection provisions governing solicitors’ mandatory professional indemnity arrangements, which augured significant change. This process has now ?been fundamentally completed and we can begin to consider what the ramifications may be.

It is broadly accepted by all stakeholders, including the ?Law Society, that such a review was necessary and timely, given the increasingly polarised state of the market in terms of coverage for segments of the profession and the stultifying effect of a bloated assigned risks pool (ARP).

There remain strong and divergent views expressed by insurers, brokers, the regulator and the profession itself as to what the breadth and depth of the mandatory coverage should be, given the changing legal landscape heralded by the Legal Services Act 2007, the effect on insurer confidence of high incidences of conveyancing-related claims as to the perceived risks posed by some firms and, indeed, with reference to insurance industry norms.

In the end, the review has proposed a raft of changes to the qualifying insurer’s agreement (QIA) and the indemnity insurance rules – a number of them quite fundamental in nature. It has also established some expectations as to the SRA’s short to medium-term thinking on a number of contentious issues.

Regulatory changes

So how have we got to the position that we have arrived at?

In April 2011, further to its initial consultation exercise and the review by Charles River Associates, the SRA published a policy statement setting out its broad direction of travel for the financial protection regime. The key decisions within the statement were:?

• the reduction from 12 months to six months of the maximum time that a firm could spend in the ARP in any five-year period as of October 2011; ?

• the joint funding of the 2012 ARP by qualifying insurers and the profession; ?

• the transition of claims for non-applied firms (those without qualifying insurance but not eligible for the ARP) from the ARP to the compensation fund;?

• the replacement of the ARP from October 2013, with a three-month extended indemnity period (EIP);?

• the removal of the single renewal date as from October 2013; and?

• a clear expression of intent not (as had previously been mooted) to exclude financial institution clients from protection under the minimum terms until at least 2014.?

The Law Society was very much in agreement that the ARP ?had to go. From its intended purpose as a vehicle for rehabilitation of a small minority of firms back into the open market, it had clearly become a clearing house for firms that were in many cases uninsurable – either as a result of their own poor claims experience or as a consequence of a hardening market that had turned against firms that fit a certain profile.

However, it was clear to the society that a ‘safety net’ from the whim of the market was still fully in the interests of the profession and that, in an open market system, it was appropriate for insurers to carry the cost of that mechanism. ?As such, the society lobbied both the market and the SRA for the introduction of what has become known as EIP.

In basic terms, this mechanism requires the current insurer to provide an additional three months of cover post 1 October, in the event that it does not wish to renew cover for a firm and that the firm is unable to obtain market coverage elsewhere. After the three-month period, the firm must close or be intervened in by the SRA, and the insurer is required to ?provide the mandatory six years of run-off coverage.

As referenced above, this process will come into effect from October 2013. It is our hope and intention in advancing this alternative to the ARP that a proper balance has been struck between the needs of the profession, public protection and recognition of the fact that the ARP was damaging the market for insurance in this area on account of the uncertain exposure it posed for insurers – particularly in light of the increased capital adequacy requirements of Solvency II.

It is hopeful that the demise of the ARP will, as far as possible, assist in stimulating the appetite of new insurers to enter the market to write solicitors’ business at all levels.

The advantage to insurers serving larger firms is clear, as they were required to contribute to the ARP, even though their client base was very unlikely to avail themselves of it. In addition, the additional costs were passed on, at least in part ?to these firms (particularly post-SRA reforms to prevent so-called flipping to reduce the level of declared premium by insurers for the purposes of determining the ARP share).

It will also hopefully serve to encourage a broadening of capacity at the small end of the profession, which is currently restricted to a small number of providers.

Further initiatives, including those being considered by ?the society, may be required to maximise opportunity and choice for smaller firms, but the signs post-announcement ?of the ARP’s demise are encouraging, with a number of new ?providers suggesting a potential willingness to add capacity ?at the smaller end and indeed across the market.

Of the other substantive changes proposed in the ?2011 statement, the society accepted the rationale for ?shared liability for the 2012 ARP year, on the presumption ?that the arrangements would engineer a genuinely equitable division between insurers and the profession and were a pragmatic alternative to wholesale liability being imposed ?on the profession.

It is hopeful that, in the context of the final arrangements decided by the SRA for sharing liability, this presumption of ?an equitable outcome holds good, given that the ARP is ?likely to be significantly smaller this year.

The society also welcomed the SRA’s clear statement to the effect that it would not consider excluding financial institution clients from mandatory coverage until at least ?2014 and subsequent to further consultation and review. ?Such a move would, the society contends, have proved devastating for conveyancing practitioners and their clients.

The road ahead

In April 2012, the SRA instigated the second stage of its review, aimed at determining the methodology for implementing its 2011 policy statement. It has largely confirmed the direction of travel, with some minor amendments, and set out the mechanisms for implementing the proposed reforms.

Further to an open and engaged consultation process, the society was able to secure a number of technical amendments to better facilitate the operation of the EIP for all stakeholders.

The society also supports the SRA’s proposal to require insurers to be transparent about their credit rating, if any, as a positive initiative to enable solicitors to make more ?informed purchasing decisions around the cost of cover as compared to the realistic level of comfort offered by the paper on which it is written. There remains, however, a few areas ?of concern.

Specifically, the society maintains its original objection to the transfer of the existing ‘side arrangement’ for non-applied firms from the ARP to the compensation fund. The SRA has responded to the society’s further lobbying on the point and has agreed to narrow the scope of eligible claims via this route to firms that are actually authorised rather than ‘authorisable’, but the transfer to the fund remains the SRA’s policy.

The society does not accept that this change is a necessary or proportionate step at this time. It contends that any change to the fundamental role and purpose of the compensation fund, such (as would be the case here) as introducing consideration of negligence to the scope of eligible claims, should be subject to specific detailed review. ?The SRA is poised to commence such a review of the compensation arrangements and, on that basis, the society have taken the unusual step of raising its concerns formally with the Legal Services Board.

So what of the 2013 renewal? It is of course difficult to predict the state of the market this far out, but this year’s renewal is expected to be similar to last year’s. That is to say, more benign than in the period 2008 to 2010.

There are strong indications of new insurers interested in writing solicitors’ business, thus engendering increased competition and the potential for premium reductions for the best risks. A further spike is likely in 2013 once the ARP ends.

Some insurers are looking to tie up early renewals for the best-performing risks in their books and, although building a sustainable relationship with an insurer is beneficial to a firm, there can be advantages for the right firms in shopping around sensibly. There are mixed views of the extent to which conveyancing-related claims have been flushed through and insurers remain cautious of this area of work.

In all, it is largely a case of ‘as you were’, but in the context of reforms that potentially herald a significant shift in the market in the next few years.