Challenges for start-up firms

A start-up firm can only open its doors
and commence practising once it has arranged a professional indemnity insurance (PII) policy for the minimum level required by the Solicitors Regulation Authority (SRA). The compulsory limit of indemnity for sole practitioners and partnerships is £2m, which is increased to £3m if operating as an incorporated firm or a limited liability partnership (LLP).

Although the process of applying to insurers for quotations is very much the same as for an existing firm, a start-up firm does face additional challenges. An insurer generally underwrites a firm based on its risk profile of past work, revenues, historical claims, and financial stability, among other rating factors. For start-up firms, these criteria are not available and so they must present themselves to insurers based on what they project will be their business model and risk profile.

Insurers are inherently cautious about insuring a business without any proven track record. An insurer's underwriting model is to always base their premiums on historical information of the firm, which is then analysed from their actuarial data. Absent this information, a start-up firm must do more than complete a proposal form for insurers: it must create a positive impression of the proposed new firm. The time taken to provide a comprehensive submission to insurers is essential and may make the difference between insurers offering a quote or declining to insure them at all.

Business plan

A business plan is a key document that will allow insurers to gain an insight into how the principals will manage and grow the business. An ill-thought-out business plan will be a red flag to insurers, resulting in more questioning about >> >> the capability of the principals in running their own business. This may appear excessive; however, insurers know that once they have issued a policy, it cannot be cancelled and they are committed to offering six years of run-off cover, whether the premium is paid for or not.

The business plan to present to insurers
should include the following key components:

• Business description: An outline of the areas of work that will be carried out, the experience of the fee earners who will undertake the work, and the type of clients the firm expects to act for (e.g. blue chip companies versus small and medium-sized enterprises, high-net-worth versus high-street clients);

• Market analysis: A description of the market research carried out to underline the knowledge of the target sector. Are there existing clients or will the firm be starting from scratch? If there are existing clients, are there any non-compete agreements with former employers?

• Organisation and personnel: An outline of the management structure together with a list of qualified staff, and details of the key fee earners' respective roles and experience; and

• Financial: Information on how the business will be funded over the next one to three years. Will the firm be an alternative business structure with external investors or will it be financed through a bank loan? Details of how these funds will be used and what will be the main overheads should be given. Are there lease commitments or will the business be run from home?

As insurers do not have any historical claims information, they will also want to see the CVs of the principals in the business. This should also be accompanied by details of claims that have arisen against them at any previous practices where they undertook the work or where they were the supervising partner. The summary should include the type of work, the cause of the claim, and the outcome - i.e. was it defended successfully or was it settled, and, if so, for how much? Insurers will also wish to understand what lessons have been learned and what is being done to prevent similar claims arising in the new firm.

Risk management

A new firm must be able to demonstrate that it takes the management of risk and compliance seriously. It is a requirement in any case in
chapter 7 of the SRA Code of Conduct, entitled 'Management of your business'. Specifically, rule 7.8 states: 'You must have systems for supervising clients' matters, to include regular checking of the quality of work by suitably competent and experienced people.'

The new firm will need to address key areas of risk management, including:

• Systems to prevent negligence claims occurring, such as case management systems, which will also help improve efficiencies;

• Monitoring procedures to demonstrate that the systems are followed;

• Peer reviews and file audits; and

• An open 'no blame' culture to encourage fee earners to report any issues early.

Achieving an accreditation, such as Lexcel or Conveyancing Quality Scheme, is viewed positively by insurers, where it forms part of a meaningful and demonstrable risk management strategy. Even demonstrating that a firm is working towards these standards, or will be, can influence an insurer's perception of the firm.

For sole practitioners, a 'buddy up' with another practice in the area can help when a second opinion can provide reassurance or a method of file review.

If there are to be multiple offices, it is critical that the principals show how these offices will be managed, with standards and supervision applied consistently throughout the firm.

Above all, it is important to seek advice from a specialist PII broker, who can offer guidance through the process and assistance with the submission to insurers. They will be able to advise on the most suitable and financially rated insurers for start-up firms.

If the business profile is likely to change, it is important to understand the risk appetite of the insurer. All insurers have their own underwriting criteria and if the business is likely to grow into a particularly high-risk area of work, it is essential that the insurer is comfortable with that risk profile.

Although a policy for a new firm will be for 12 months, the purchase of PII should be viewed as a mid to long-term decision, where the firm and insurer build up a relationship for a greater understanding of the business as the firm
grows. SJ

Steve Holland is senior vice president of global professional risks solutions at Lockton Companies