Just how bad can indemnity insurance woes get?

On 1 November 2013, firms of solicitors that have been unable to find professional indemnity insurance (PII) for the forthcoming year entered a cessation period of 60 days.

During this period, they will be unable to accept new instructions and will only be able to perform work connected to existing instructions. Firms that cannot secure cover within the 60 days will have to cease practice.

As it turned out, of the 226 firms that notified the SRA that they had not secured insurance by 1 October, 153 appeared to still be without it on 30 October and were deemed to have entered the cessation period. This is a critical situation, so how on earth did we get here?

The origins of today's problems with PII can be traced back to 1 September 2000, when the way in which solicitors are insured changed. Between 1989 and 2000, compulsory cover was provided via the Solicitors Indemnity Fund (SIF) with a minimum level of cover of £1m per claim (since raised to £2m).

Free market

Under pressure from many larger firms, which realised that they could obtain cheaper cover from the commercial market, firms moved to the open market and SIF was closed. Since then, some smaller firms have had difficulty in obtaining cover. In 2011, the SRA made the decision to have a phased closure of the assigned risks pool (ARP), which meant that firms who could not find cover would no longer have '¨a place to go in order to '¨continue practising.

The original aim of the ARP, to rehabilitate struggling firms, simply failed. It could be argued that it has taken 13 years, from the point where the free market on PII was first embraced, for the full consequences to be realised.

Some solicitors are understandably bitter. A solicitor friend, who did not wish to be named but had been able to secure cover, put it this way: "Solicitors are required to carry PI insurance and because of the specialist nature of the insurance the insurers can charge what they like. Smaller firms are paying 50 per cent of their pre-tax profits in insurance just to be able to practise. Not surprisingly this gets passed on to the clients." The insurers take a rather different view, pointing to the economic depression of the last five years and the poor claims records of many small firms.

Law Society CEO Des Hudson has pointed out that there are two insurance markets operating now, with large firms able to obtain cover easily but a segment of firms at the other end of the market really struggling. As Hudson observes: "It is likely that most firms unable to secure affordable quotations or any quotation at all are small and medium-sized."

The official position of the SRA is that, as at 31 October, 226 firms had entered the new extended indemnity period (EIP) which gives them 30 days to find cover. Of these, 73 found insurance since entering the EIP. Firms unable to obtain insurance outside of the EIP and 60-day cessation period will have to cease practising immediately and their existing insurer will be required to provide them with six years' run-off cover.

Those close to the coal face tell me that a number of firms having difficulty with their PII have not declared themselves to the SRA yet, mainly due to concerns about the consequences with the regulator. There are suspicions that the true number is closer to 400 than 200.

Unless some positive action is taken to prevent it, some 200 to 300 law firms could go out of business at the end of this year. This may be the first year of what becomes an annual cull of small and medium-sized firms which cannot obtain cover. Not a happy thought. SJ