Unintended consequences: The LSA's impact on PII

David Simon, managing partner at Robin Simon, discusses how '¨the Legal Services Act has affected professional indemnity insurance in the UK

Personal indemnity is a fundamental aspect of professional life and a key factor in the management '¨of professional businesses. All firms should be '¨asking themselves:

• Who is going to protect the firm’s reputation and the reputation of key staff? '¨

• Who is going to manage the financial costs to insurers (and to the firm, ultimately) of that protection?

With the Legal Services Act now in full effect, this is an appropriate time for UK firms to ask themselves those questions and to speculate how their answers will change over the next few years. Two major factors will affect responses:

1. for law firms: the implementation of outcomes-focused regulation (OFR); and '¨

2. for all professional firms: the advent of alternative business structures (ABSs).

PII under OFR

If professional indemnity insurance is a part of the habitual make up of a professional practice, so too should be a regime of risk management. Many firms in the past have paid lip service to this but the identification, monitoring and management of risks is now required by the Solicitors Regulation Authority (SRA) under OFR.

One of the changes that all law firms will have to take on board is the creation of specific risk management roles in the shape of new compliance officers (COLPs and COFAs).

These compliance officers play the role of outsourced regulators. They wear two hats: although they are part of the firm (and are required to be in a senior position), they have a duty to inform the regulator if things have gone awry in terms of meeting regulatory requirements.

They also have to submit an annual return on the state of health of the business in relation to OFR criteria. This is self-regulation and self-policing with a vengeance.

Many of the requirements of OFR are geared toward ensuring that law firms are run on a sound financial basis, with good risk management structures in place. This may be music to the ears of professional indemnity insurers that have had to pick up the pieces for many years when an insured firm has failed.

In future, there will likely be a significant overlap between the sorts of questions that compliance officers have to ask of law firms in order to meet the annual return and the sorts of questions that law firms are used to answering their PI insurers in their increasingly-weighty proposal documents.

Indeed, many PI insurers may in future want to see the submissions made by law firms to the regulator, particularly submissions of the ominously-titled breach register. This is an internally-prepared record of what the firm itself views as breaches of its regulatory regime. An insurer (prospective insurer) would be interested in such a document.

If you are the managing partner of a law firm (or the managing director of an ABS), you should be paying very close attention to the overlap on the tie-up between the firm’s obligations of disclosure to the regulator and its obligations of disclosure to the PI insurer.

This can be justified on the basis that your insurer has a shared objective with the regulator, namely to be assured that the purveyors of legal services have well run and highly organised businesses that place great reliance on effective '¨risk management.

Insuring ABSs

The next big question to be answered by the PI market is '¨what will happen when there is wider acceptance of new '¨ABS vehicles.

To date, only a handful of applicants have been licensed and it appears that over 200 bodies have embarked on the arduous process of applying for recognition as an ABS.

Under the ABS model, the provision of legal services is no longer restricted to firms of solicitors but is permissible from corporate vehicles whose ownership comprises either no lawyers or a very small number of lawyers. These businesses, however, will have to operate in exactly the same regulatory regime as traditional law firms.

The opportunity exists, therefore, not just for external capital to come in to provide a financial boost to law firms, but also for different professions to band together to provide their services as multidisciplinary businesses.

There are a number of issues that are causing the insurance market to go back to its roots in terms of its thinking, including the following.

 1. How does an insurer provide cover for a business that is providing services from different professionals, all of whom may be governed by different regulatory codes and where, arguably, slightly different standards of care apply? '¨

It is even more difficult to determine the impact of the different insurance requirements of various professions. The legal profession has managed to negotiate an extremely generous wording (known to insurers with a weary groan as the minimum terms). But if a firm of accountants and solicitors starts doing business, will '¨the coverage revert to the lowest common denominator '¨or the widest possible coverage?'¨

A number of policies provide for representation cover in relation to disciplinary and regulatory investigations; if there are different professions, there will be different disciplinary issues.'¨

2. Another issue is that there are different legal issues as to privilege between the legal profession and between other professions. How will this be managed in the context of a professional indemnity case, where the ability to view clients’ confidential documents could be highly relevant?'¨

3. Is there going to be a revolution in the way that the claims function of PI insurers is handled? Are we going to see more outsourcing to multidisciplinary businesses?'¨

The answers to some or all of the above can be summed up '¨as: no one knows at the moment.

In many ways, all of these issues are collateral fallout from the Legal Services Act, which was intended to open up the legal profession and make it more accessible to consumers. Once, however, you create these new structures, they will be capable of being used in lots of different ways, not just for the purposes of broadening the offering to the man in the street.

The answer to the hybrid insurance policy is that underwriters will find a way of writing such policies, leaving it '¨to the claims function to wrestle with the issues in practice. There is already at least one hybrid policy in the market that '¨has adopted some pretty commonsense ideas and it appears '¨to be working satisfactorily.

There could also be a revolutionary change in the approach '¨to PI claims handling and settlement. The way in which professional indemnity claims have been handled by the '¨London market has been inefficient and this inefficiency '¨has become built-in.

Liability insurers are one of the few organisations '¨whose business case involves the certainty of litigation '¨and, in the past, they have tried to handle it by a multiplicity '¨of bodies working to that end. Thus, they have employed '¨claims managers, engaged loss adjusters and created '¨panels of law firms – all collectively (and often concurrently) '¨to deal with the defence of claims.

None of this has been joined up and yet the cost '¨of defending the litigation, including the sums paid to '¨claimants’ lawyers, typically amounts to 80 per cent of '¨the underwriting income.

There has traditionally been a bar to law firms working '¨in partnership with other professions. Under the ABS '¨regime, it will now be possible for there to be a defence business operating for insurers in a joined-up way, providing outsourced claims handling, risk management, audit, loss adjusting and legal litigation defence work.

A number of businesses are seeking to put this into '¨effect – the ultimate multidisciplinary partnership of professions. It is pretty scary being at the forefront of a revolution, although parts of the insurance market have recognised that it is no '¨good simply waiting for the next hard market to come along to get them out of the doldrums. They need to manage their business models better so that they can take advantage of these new service providers, entering into wide-ranging '¨deals that will give them some element of certainty over '¨the overall cost.

This should be good news for insured firms. Of course, '¨we don’t want to throw the baby out with the bath water. We don’t want to lose the comfort that a number of professional firms derive from their representation by law firms when the going gets tough and they are facing litigation.

There will always be a place for a specialist defence practice. It has an important role to play, which can be enhanced by being part of a multidisciplinary function where other professionals (financial and construction experts, for example) work alongside lawyers and take a lead in tackling issues head-on to nip claims in the bud.

This is a long way from the original genesis of the Legal Services Act, but the revolution in the provision of legal services is well underway. It is right that it should give rise to some new and innovative thinking in the very conservative insurance industry.

david.simon@robinsimonllp.com