The dust has now settled on the October solicitors’ professional indemnity insurance policy (PII) renewal season. The solicitors’ PII market has continued to harden by all account, with some firms facing a 30% increase in premium for their primary layer cover.
In circumstances where some law firms are failing due to Covid-19, or are at greater risk of doing so, it is unsurprising that insurers have been scrutinising the accounts of law firms more closely. After all, under the Solicitors Regulation Authority’s (SRA) minimum terms and conditions of professional indemnity insurance (MTC), participating insurers are required to provide 6 years of run-off cover to firms that close down, even if the run-off policy premium is not paid.
6 years run-off cover, all for free?
Run-off policy premiums can cost 2½ - 3 times more than a firm’s annual premium. According to a 2017 report prepared for the SRA1, the percentage of law firms that fail to pay their run-off premium varies from insurer to insurer. However, some insurers report that over 50% of their policyholders who close their businesses fail to pay their run-off premium. According to the same report, some law firms do not pay because they do not have the resources, others fail to pay because they do not realise they need to, or because they think they can get away with it.
Didn’t pay, couldn’t pay
For those firms that can afford to pay, one would think that a mixture of education and disciplinary action from the SRA should be enough to change behaviours. Admittedly, for those wilful non-payers that are retiring from the profession, the threat of disciplinary action may not be enough, but for many it should be all that is needed.
So, what do you do about those that cannot afford to pay? Allowing insurers to refuse to provide run-off cover would leave clients with no real protection at all and so is likely to remain a bridge too far for the SRA.
A more palatable option may be to raise premiums such that they cover any firms entering run-off, thus doing away with the need for the payment of a separate run-off premium. The obvious downside of this is that those firms that never would have paid for run-off cover are effectively being subsidised by those that play by the rules. However, to an extent that is already the case.
Other suggestions for change include: (1) reducing the length of time of the run-off policy period from 6 years; and/or (2) changing the scope or extent of the run-off cover provided.
Claims data indicates that 30% of claims against firms arise in years 4-62. Therefore, reducing the run-off policy period to (say) 3 years could potentially leave clients with no protection for claims made in years 4-6. This is particularly so if the law firm was an LLP or a limited company – there is unlikely to be any money to pay claims, or assets to enforce against, if the business was wound up years earlier.
Changing the scope of the cover could help strike a better balance between protecting law firm clients and making sure that insurers are not left unfairly shouldering a significant financial burden when a law firm fails to pay the run-off premium, but still faces claims.
A reduction in the limit of cover to an aggregate limit, inclusive of defence costs, would provide greater certainty for insurers and potentially reduce run-off premiums. Yes, it would represent a risk for clients, but if the aggregate limit is set following a careful analysis of the claims data across the profession and the participating insurers, it should be possible to achieve a fairer and more sustainable outcome than we have at present.
A minimal capital requirement?
Another possibility is for the SRA to require law firms to hold a minimum level of capital to ensure they are able to close in an orderly way including covering the cost of a run-off policy premium. A focus on good financial management should also mean that, in times of financial adversity, firms that are not planning to close (say, due to retirement) can trade through difficult times, making it less likely for them to ever need run-off cover.
Minimum capital requirements are a fact of life in the financial services sector and in other sectors too. If you want to operate a haulage or bus company, for instance, you need to hold a minimum amount of capital to demonstrate to the licensing authority that your business has sufficient resource to operate safely.
A minimum capital requirement for law firms could be linked to the size and activity of the firm. You could also vary the requirement according to the life cycle of the business. You may, for instance, require a sole practitioner planning on retiring in 5 years to steadily increase the capital they hold in the run up to retirement.
Insurers already ask law firms in proposal forms if there are expected to be any significant changes to the business (covering things like retirement, a merger etc.). However, if law firms were required by the SRA to make formal declarations on such things (in addition to a duty under the Insurance Act 2015 to give a fair presentation of the risk), such a requirement could inform the minimum capital requirement set for the firm by the SRA.
The SRA’s MTC do not allow an insurer to cancel a policy on the ground of non-payment of premium. Before Covid-19, some insurers were already experiencing as many as 50% of policyholders failing to pay their run-off premium upon closure. Against the backdrop of Covid-19 and the possibility of a sustained recession and an increased risk of law firms failing, making no changes does not seem like a realistic option in the longer term.
There is no easy answer when you are balancing client protection against commercial risk for insurers. The risk if the SRA does nothing is that insurers vote with their feet. The lion’s share of law firm PII renewals are still dealt with in October. However, between now and next October, the incumbent participating insurers have time to take stock. If they look at other markets and see the opportunity to replace premium income elsewhere, with lower risks and greater certainty, they may take those opportunities. If that then prompts a withdrawal of insurers from the market that will create instability for law firms. It is also likely to drive rates higher and may leave some firms unable to find cover.
1Potential options for SRA PII requirements: A report for the Solicitors Regulation Authority by Kyla Malcolm of Economics, Policy and Competition (May 2017), p44.