Changing times of solicitors' PII

The 2014 professional indemnity insurance (PII) renewal for solicitors in England and Wales is lining up as another challenging time. Last year many firms experienced a ‘hardening market’ and early indications this year from participating insurers are that rates are being driven up due to the continued deterioration in loss ratios on the back of recessionary claims.

The expectation that removal of the assigned risks pool (ARP) (the safety net for uninsurable firms), would lead to an influx of new insurers into the market failed to materialise in a meaningful way last year. In fact, many existing insurers reduced their exposure to solicitors’ PII, either by restricting their appetite to ‘lower risk’ categories of firm, or pulling out of this segment of the market completely. One of the most notable movements last year was XL Insurance who reduced market share to two per cent from 16.5 per cent the previous year, following their decision to withdraw from the one- to three-partner firms.

Forced closure

The 90-day extended indemnity period (EIP)/ cessation period (CP) that replaced the ARP has resulted in more cautious vetting of firms, as insurers became wary of a risk they may find themselves ‘on the hook’ for six years ‘run-off’ for a firm in receivership or otherwise uninsurable. The demise of the ARP led to the forced closure of 136 firms, as they were unable to obtain cover beyond the 90-day period.

Since last renewal, any firm that finds themselves underwritten by an insolvent insurer no longer has the safety net of the ARP. There is now only a one-month window to seek replacement cover, before having to commence wind-down procedures to close the practice.

No other profession is so dependent on unrated insurers, who currently account for 12 per cent of the market. With the forced withdrawal of Balva and Berliner in the lead up to the 2013 renewal causing major difficulties for many firms, it is disappointing to see that the outcome of the SRA consultation on unrated insurers has been to drop the proposal for minimum rating requirement.

PII is a long-tail business, so the level of security rating is more important than in most other classes of insurance. Clearly, there can be no guarantee that those insurers who meet certain security levels today will remain solvent in the future (as we saw with Independent Insurance Company who had an ‘A’ rating before it went into forced administration). However, firms should think carefully before accepting a cheaper quote provided by an unrated insurer, as this may ultimately cost the partners dearly if the insurer fails, with the consequence of them having to pay for their PII twice in one year, or worse still, close the practice completely and leave the partners personally exposed.

Another notable change in 2013 was the introduction of variable renewal dates. From
1 October 2013 solicitors were free to choose when they would like to renew the PII. This followed growing pressure from some parts of
the profession to ‘stagger’ renewal dates in order to alleviate the perceived difficulties in securing cover before the single renewal date. In reality,
less than five per cent of firms moved their renewal date away from 1 October, which, according to the SRA, represented just 433 firms out of around 10,700 firms in England and Wales.

Single date

There are pros and cons of moving away from a common renewal date. In a soft market where there is strong competition among insurers, the single renewal date can help to keep premiums down, as insurers, uncertain of what market share they may secure, are more likely to cut their premiums as the single renewal date approaches.

Further, insurers are geared up to offer quotes for a 1 October renewal, so there may be less choice for smaller firms if renewal is moved away to a different time of year.

In a hard market where there is a lack of capacity, the single renewal date means that
firms can be left with little choice, so can be forced to accept whatever is quoted, as experienced in 2002 and 2005. However, the underlying trend
in insurance market cycles does favour the insured: soft markets tend to be prolonged over many renewals; hard markets tend to be short
and sharp.

Staggering renewal dates throughout the year would relieve the pressure created by a single renewal date and allow insurers to consider each business more carefully. This would be of most benefit in a hard market, for those firms that, on the face of it, do not have a great risk profile, either because of their claims history, or the work they carry out. An underwriter will be able to spend more time understanding the risk profile of a firm, which he/she may have previously dismissed due to lack of time. This will help some firms to gain cover at a more affordable level.

Insurers have offered periods of insurance
up to 18 months to move away from 1 October. This can be very attractive if the firm is able to lock into a low rate for the extended period, especially if the firm’s gross fees are anticipated to increase significantly over that period. Insurers may
require payment of the 18-month premium
from inception, so cash flow will need to be factored into the decision, however, some insurers are prepared to stagger payments to alleviate
this problem.

Consultation concerns

In place of the proposal for insurers to have a rating, the SRA launched a new consultation in May that closed on 18 June. There are five main proposals:

1. reduce the level of mandatory PII cover to a limit of £500,000;

2. introduce an aggregate limit on claims (suggestions for aggregate limits of £1.5m
or £5m);

3. mandatory cover only for claims by individuals, small and medium-sized enterprises (turnovers up to £2m), trusts (with a net asset value less than £2m) and charities (with an annual income of less than £2m);

4. reduce run-off cover to a minimum of three years from six years;

5. amendment to the Code of Conduct to require firms to assess the level of cover appropriate to their firm beyond the minimum.

The SRA has stated that they want regulation
of client protection arrangements to be targeted and proportionate. However, if the SRA’s objective is to reduce the cost of PII, the proposals will not achieve the desired outcome in the short term.
The proposals will be welcomed by insurers
and may help encourage new entrants to the market, however, there are consequences for
the profession.

The timing of the consultation is also of concern, as there is a danger that the changes
will not have been thought through fully.
The responses to the consultation will go to
the SRA Board on 2 July and then on to the
LSB for approval shortly thereafter. If ratified,
the proposals would be implemented in early
August 2014, which would leave both insurers
and the profession just eight weeks at most to digest and implement.

Safeguards need to be built in to the proposals to protect the profession and their clients; insurers are most likely to be happy to accept the proposals as it gives them the ability to underwrite the risk both from a pricing and coverage standpoint.

These proposals will not be the panacea to immediate savings in premium. Small, low-risk firms are already rated to reflect the fact that the exposure to large claims is very low. The premiums are calculated on the basis that a firm doing low-risk and low-value work will not have a claim for £2m or £3m and, consequently, they are unlikely to see significant savings in premium.

If changes to the minimum terms and conditions are carefully considered and not rushed through, it will achieve a more stable market in the long term and one where new entrants will be less wary about entering. SJ

Steve Holland is the senior vice president of global professional risks solutions at Lockton Insurance Brokers ?www.lockton.com