Editor's blog | Unrated insurers: the warped Balva economy

Balva has been officially in trouble since 1 March, when Latvia’s Financial and Capital Markets Commission stopped it from writing any new business in the UK. It took six weeks for the news to percolate through to the SRA, who responded with a letter urging caution.

Understandably the SRA is keen to contain any panic. And it cannot officially declare the news as an ‘insolvency event’ under indemnity rules until it has received further information from Latvia. Only then will this move the situation to the critical stage where Balva policyholders will be given four weeks to find alternative insurance or fall into the assigned risks pool.

Four weeks is not very long, particularly where you think that Balva policyholders are mostly small firms or firms operating in high-risk areas – often both. Their risk profile is not particularly attractive to other, rated insurers who, if they accept the business at all, charge cripplingly high premiums. So they went to Balva for the cheaper premiums.

It is difficult not to think that the SRA could do more to support these firms, particularly in the light of the Quinn debacle last year, and Lemma earlier this year. It is one thing to re-state an insurer’s obligation to provide cover for 90 days, as well as run-off cover, but such assurances will be worthless if this insurer becomes bankrupt and your firm suddenly faces a claim. There would be nothing inappropriate on the part of the regulator in advising the firms affected in unambiguous terms that they should to start looking at alternative options right now.

But for the profession as a whole there is an even bigger concern. The Balva debacle has revived the argument started when the professional indemnity fund was wound down and professional indemnity insurance became an open market.

Much as the fund had become an unjustifiable safety net for poorly managed firms, Balva’s demise reveals a warped, unsound balance in the professional indemnity market. For firms whose finances are tight, buying PII cover from an unrated insurer is part of the survival plan. It’s a pragmatic decision, a calculated risk. But it can also be a false economy.  Opening up the PII market  has had one terrible consequence: for a lot of smaller firms premiums are not about compulsory insurance but simply about buying another year of being in business, a kind of additional pc fee.

Unfortunately, none of the alternatives are palatable. Going back to a closed market where the profession underwrites itself would be an admission of failure. Abolishing compulsory indemnity insurance would be an enormously risky step into the unknown. And only allowing rated insurers to become qualifying insurers would shift the responsibility onto ratings agencies, narrow options and potentially reduce competition – and that would be incompatible with the basic principles of market economy.

One thing is sure, it’s that the system cannot carry on like this. To start with, financial services regulators across Europe could start reviewing the rule allowing insurance companies to be passported into other EU countries. It may be ungentlemanly to question the authority of fellow regulators but it would undoubtedly help prevent further Balvas.