Indemnity market must be liberalised
THIS year’s round of Professional Indemnity Insurance (PII) renewals promises to be one of the most turbulent ever, but it could spur much-needed changes to the way the system is run. All law firms in England and Wales have to renew their PII by 1 October, but last week insurer Zurich, which insured 13 per cent of law firms in England and Wales in 2009/10, said it will reduce its participation in the market. This follows Catlin and Hiscox pulling out of it altogether. In March, Quinn, the insurer of about 3,000 of England and Wales’ 11,000 law firms, went into administration.
Martin Ellis from Prime Professions, an insurance broker that looks after a round a quarter of the law firms in England and Wales, estimates that up to 800 firms could find themselves without insurance. These firms will then be insured by the Assigned Risks Pool (ARP), an option of last resort, where all active Qualifying Insurers cover a proportion relative to the total premium written. The ARP was designed to help distressed firms unable to obtain insurance from commercial insurers. The figure as of February 2010 was 241. Absurdly, this October the ARP could become one of the main insurers for law firms.
This is not just bad for firms who will find themselves in the ARP but the whole industry, because the ARP’s costs are borne by other law firms. Martin Ellis estimates that the pot of premium will go up from £246m at present to nearer £300m. This is very unwelcome. In 2009/10, 21 per cent of firms already had problems in renewing their PII, and 62 per cent said premiums rose. The median PII went up by 33 per cent, says the Law Society. PII is already the third-biggest cost for law firms after rent and salaries and the estimated 20 per cent increase in premiums could well force smaller firms out of business.
Why has this happened? Partly because insurers are worried about residential and commercial property deals done before 2008 leading to claims against solicitors. But the problem is deeper. The PII market is dysfunctional and the ARP doesn’t work. Firms in the ARP have to pay a punitive 27.5 per cent of their gross income in premiums, but as at 14 June, out of £6.5m of ARP premium due for the 2008/9 indemnity year, only £2m had been paid. Even pre-2008, only 6 per cent of firms that entered ARP would emerge in good shape.
What is the solution? One school of thought says that the ARP should be closed down. After all, if a firm can’t find an insurer on the open market, does it deserve to survive? The ARP is expensive, doesn’t work, and creates moral hazard – the existence of a safety net encourages risk-taking. But it would be unjust that small firms that have been around for 40 years without a claim go out of business through insurers’ risk-aversion. And as Des Hudson, chief executive of the Law Society, points out, the ARP protects consumers from reckless firms. Plus, losing small firms would reduce consumer choice.
The PII system needs reform, and two basic things need to happen. Firstly, the ARP regime should be more punitive. The Solicitors Regulation Authority (SRA), which runs the PII system, has already started to make it so, by reducing the time a firm can spend in it from 24 to 12 months. And it said last week that firms which have not paid their premiums by 1 October will be shut down. This needs to go further, to reduce moral hazard.
Secondly, the SRA must free up the insurance market. Currently, Qualifying Insurers’ (QI) policies have to meet minimum terms and conditions (MTC), but these are inflexible and prevent insurers from offering firms bespoke insurance products. Loosening the MTC would allow QIs to better reward good, innovative risk-management with lower premiums. The industry is fast becoming more risk management-aware: with the onset of outcome-focused regulation next year dedicated risk-management departments will become more widespread. Some insurers discount 30 per cent on premiums for those with good risk-management. The PII market should be used to encourage this trend. A better market would attract insurers, increase competition and reduce costs for law firms and consumers.
Belatedly, the SRA is coming round to this way of thinking. It is carrying out a review of the PII system and its executive director of corporate regulation Samantha Barrass recently suggested that it will bring in a more open market. She said that the current system “introduces distortions” into the insurance market, and “generally reduces the incentives for all parties to manage risk”.
A decade ago the legal profession moved away from the industry funding the ARP itself, to the current market system. It now has to go further. True, some of this year’s problems are caused by insurers pressurising the industry. But they are right to try to force change. Solicitors will have to grit their teeth and pay up this October, but it is vital that when the SRA’s review comes out in Spring it introduces a more flexible, market-based PII system – and one that is in place for next year’s round. If not, it will face questions from the City law firms which are funding a bankrupt system