Making waves

The SRA’s recent changes to the ‘last resort’ assigned risks pool (ARP) have divided lawyers and insurers. The legal sector has been broadly supportive of the board’s decision, greeting it as long overdue, while the ABI has been left wanting, branding the reforms “too little, too late”.

So, has the SRA gone far enough to secure a fair policy both for firms and insurers or should it have gone further?

The ARP has clearly been viewed as the chief cause of problems in the market and it seems to have been universally accepted in the consultation responses that change was needed. The original purpose for having an ARP was to ensure that firms would always have access to insurance and therefore it would not be insurers that determined which firms could or could not practice. It would also give firms in the ARP time to resolve any problems that prevented them from obtaining insurance in the open market and to then allow the firms to return to the open market once the problems were resolved.

However, statistics have shown that only a small proportion of firms in the ARP were actually rehabilitated and the majority of firms in it eventually closed anyway. Furthermore, it should not be the role of the regulator to provide an insurer of last resort to help firms that can’t get PII cover stay in business. By way of analogy, a firm needs banking and finance facilities to operate. Should no bank be willing to provide such finance, it is not the SRA’s role to step in to provide such finance. Why should insurance be any different?

Increased premiums, reduced competition

The main complaint of insurers was that they are currently responsible for the pooled liability of firms in the ARP that they have never chosen to insure and indeed may well have refused to insure. The cost involved has caused insurers either to exit the market altogether, reduce their market share or only insure certain types of firm.

New entrants to the market have also been deterred. This has the effect of increasing premiums for insured firms, reducing competition and limiting availability of cover for the profession. The SRA was also concerned that the current system created opportunities for insurers to adopt pricing methodologies, such as ‘flipping’, to minimise their share of declared premiums and to limit their ARP exposure.

Ultimately, one must not forget that the primary purpose of these arrangements is client protection and the SRA has had to bear this in mind as one of its key regulatory objectives. However, the impact on firms and insurers cannot be ignored and the SRA has accepted that it needs to provide clarity to all stakeholders affected and consult further on the detail of the changes to be implemented over the course of the next three years.

The SRA has decided to maintain an open-market system of insurance as it provides indemnity cover at a lower cost overall to firms in a way which supports good risk identification and management and in such a way that the cost of PII to each firm is related to the level of insurance risk they present.

However, the problems and cost of the ARP has meant that good, high-quality firms have had to bear the cost of low-quality and/or dishonest firms, a situation unfair to those firms that take risk seriously. Indeed, one of the main arguments put forward in favour of moving away from the SIF to the open market was to avoid such a situation arising. So, it is right that change was needed. Without it, the open market would become unviable.

Time limit

The decision to reduce the permitted period in the ARP from 12 months to six months has been made to reduce the cost of the ARP in the interim and provide a transition path towards the 2013 closure of the ARP.

For insurers, the closure of the ARP needed to happen this year and the delay will inevitably mean that some firms will face the same difficulties as they have faced over recent years in finding cover in October 2011. The warning is that the situation could deteriorate even further in the short term – not good news for the profession. However, while no doubt unhappy with the delay, insurers thankfully have not gone as far as to say that they will leave the market (perhaps because they have ultimately got what they wanted in seeing the ARP close, albeit later than they would have hoped).

In the longer term, however, it is hoped that removal of the ARP will result in new insurers coming into the market, thus increasing competition and benefiting those smaller firms whose choice of insurers is currently limited. The SRA will expect insurers to be able to demonstrate that the market is fair and open to all and that underwriting decisions are founded on objective and justifiable criteria.

Meeting the shortfall

In an attempt to appease insurers for the cautious and slower approach to change, the SRA has decided that from October 2012 the cost of funding any shortfall of premiums paid as against claims made in the ARP is to be shared jointly between the profession and the insurers. Currently it is met solely by the qualifying insurers.

While the detail is still to be finalised, the SRA is hopeful that the potential liability both for insurers and the profession will be capped in real terms. The plan is that the first £10m of the shortfall will be met by the profession, the next £10m by insurers (in proportion to their market share) and that this layering will continue up to £50m. Any amount above that would be met by the qualifying insurers. Funds are still available from SIF which will be used first and so hopefully will limit the potential exposure to an additional levy on the profession, which we could all do without.

The changes will mean that insurers will need to take account of the fact that, should an insured firm be unable to obtain insurance with a new insurer at the end of the period of insurance, that insurer will have to provide run-off cover. This will inevitably lead insurers to review their risk assessment and underwriting criteria. In turn, firms will need to be taking steps now to ensure that they are presenting themselves in the best possible light to insurers and doing all they can to minimise risk. Avoiding entering the ARP in the next two years has to be a key priority for firms.

It was always going to be difficult for the SRA to get the right balance between the profession’s needs and the insurance market’s demands, and there is still more work to be done. The SRA accepts that there are risks with maintaining the ARP until 2013, not least the uncertainty of how insurers will react to the delay, but as there are still practical arrangements to be worked through and consulted upon, as well as all the other regulatory changes the SRA is currently involved in with OFR and the introduction of ABSs, the transitional timetable was perhaps inevitable.