When the profession ditched the Solicitors Indemnity Fund (SIF), a compelling reason for the move was that many good firms were paying for the failures of the few. Now, a decade later, solicitors are back in exactly the same position. Only, the ‘few’ could become substantially more over the next few months.

‘The assigned risks pool (ARP) is now regarded as the root of all evil,’ says Martin Ellis, head of the solicitors’ practice group at broker Prime Professions. After several years when there were no more than 30 firms in the ARP – the last resort for firms which cannot find cover on the open market – in 2008/9 there were 140, some 259 in 2009/10 and, it is feared, many more joining them this October.

With Quinn almost certain to leave the market following its administration in Ireland, and Hiscox having already waved goodbye, an unprecedented 3,200 law firms could be looking for a new insurer this year. Though Prime Professions, for example, has done a deal with Travelers to offer terms to suitable sole practitioners, nobody predicts that all of the ex-Quinn firms will be successful, especially as the Irish insurer specialised in smaller firms that many of its competitors shied away from, and at premiums which pushed them further still from such practices.

Steve Holland, executive director of broker Lockton’s professions and risk solutions practice, says underwriters are predicting up to 750 firms in the ARP this year, a figure backed by Mark Carver, head of financial lines at Allianz.

Jon Davies, general manager at Travelers Professional Risks, reckons that the real problem is lender claims. Last year, there was a great fear of a tide of such claims, but others in the market say that so far this has yet to occur, despite lenders trawling files. This appears due in part to the fact that lenders have yet to crystallise their losses, with either political pressure or simply the state of the housing market discouraging them from reselling repossessed properties.

Another reason, says Davies, is that the immediate response to those claims that have been made is to request sight of the lender’s underwriting book to see if there might be an argument that it lent money recklessly. This has stopped them in their tracks, at least temporarily.

Grossly insufficientBut fear of lender claims remains high and a rise in the number of firms in the ARP, however it comes about, will cost the profession dear. As a condition of being allowed by the Solicitors Regulation Authority (SRA) to do business with solicitors, insurers have to underwrite the ARP in proportion to their market share.

The current estimate for the 2008/09 account is liability of more than £40m. The premiums charged to ARP firms, though punitive, are grossly insufficient to cover this and in any case most do not pay them, making the cost to insurers even greater.

This is predicted to have various effects. First, rates will go up. They were probably going up anyway because of the claims experience, says Ellis, but ‘most insurers will try and work in an extra 10% for ARP exposure’. Overall, Ellis predicts a 20% rise in the overall premium take for the compulsory level of insurance for 2010/11, taking the figure from £249m – itself a 10.5% increase on the year before – to around £300m. Mark Carver says that, while the increase mainly fell to smaller firms last year, in 2010 it will be felt across the whole profession. Second, insurers will be reluctant to increase their market share. There is talk of some looking only at renewals and not new business. Finally, it may drive some underwriters out of the market altogether. ‘If insurers don’t have an answer to their worries about the ARP, we will see more exiting the market,’ predicts Holland.

Simon Lovat, divisional director at United Insurance Brokers, says the profession has had 10 years to sort out the ARP, but ‘largely done nothing’. He continues: ‘It���s getting to the point where insurers are asking why they are doing this business.’ He talks about one big insurer that has some legacy business and firms it covers to maintain a relationship, but otherwise ‘it doesn’t want to be in it’.

In a report to this week’s Law Society Council meeting, regulatory affairs board chairwoman Helen Davies says her board was told last month that ‘a number of insurers were considering whether to stay in the market’ and that the board has asked for further work to be done on planning for a major drop in capacity in the market.

Insurers regularly complain that solicitors have the worst claims experience of any profession, with a loss ratio of over 90% in many cases. This means that, for every pound in premiums they collect, they pay out 90p in claims, and that is before expenses and profit are factored in. What used to make it worthwhile nonetheless was receiving a large pile of money on a single day each year which could be invested, safe in the knowledge that payouts were some time in the future. The period between premium and payout is shortening, however, while the recession has badly hit investment returns.

Overstated concernsCapacity has tightened over the years anyway, points out Carver. In 2000, the top 10 insurers had 75% of the market; last year, they had 83%.

Law Society chief executive Des Hudson has also heard talk of other insurers exiting the market, or at least having a reduced appetite, but feels that ‘concerns about capacity may be overstated’.

It is fair to say that many times new insurers have ridden in late in the day as white knights for many firms – last year it was XL and Hannover. Mark Humphries, who chairs the SRA’s financial protection committee, says the SRA has received indications of interest from new insurers this year too. But some feel the profession is relying too much on the hope that a new insurer will decide to throw its hat into the ring.

The SRA has made some changes to the ARP for this year. Firms will only be able to shelter there for a year, rather than two, while new practices will not be allowed to enter the pool. But few observers reckon this will make enough of a difference, and so are now looking to the SRA’s review of client financial protection (see this week’s PII supplement) for the reform they think is needed (indeed, for many the necessary reform is scrapping the ARP altogether).

Changing landscapeHumphries will not predict the outcome of the review – whose recommendations will take effect for the 2011 renewal season – but says he expects ‘dramatic change’. Everything is up for grabs, even whether insurance should be comp­ulsory, although Humphries expects that to remain the case.

Clearly, the ARP will be a critical element of the review, which is being conducted by a senior member of staff with the support of external consultants. Humphries acknowledges that when insurers ask why they are expected to fund the ARP, ‘it is not an easy question to answer’. Rather than tinkering, the review offers the opportunity to ‘change the entire landscape’.

As a theoretical example, he says that if the review discovers that many ARP claims arise from conveyancing work done for lenders by small law firms, the question would arise as to ‘whether such firms should continue to be allowed to do such work in particular structures’, such as solo practices.

Others are also thinking radically. Des Hudson too has some sympathy with insurers over the ARP and says he has ‘a very open mind’ to alternative ways of funding it, including a direct levy on the profession. This might help concentrate minds on ways of covering the losses, such as through stop-loss insurance or establishing a ‘cash buffer’, and of dealing with firms in the pool, including ‘what risks you allow firms to create for you as members of the ARP’.

If the ARP is to stay, many want to see greater controls on the firms in it. Hudson says he is ‘bemused’ that the SRA does not feel the need to make a supervisory visit to all ARP firms – adding that Chancery Lane has offered the SRA extra funding, if needed, to do so – and says the regulator should deal ‘expeditiously’ with those not paying their premiums. There is a widespread feeling that the SRA should simply be closing down such firms.

Humphries, however, does not see the need for automatic supervision visits because membership of the ARP is not necessarily an indicator of problems – it can be a sound firm that had a problem with a particular member of staff, for example. However, non-payment of premiums is a different matter. Humphries says he has been ‘mystified’ how firms can enter the ARP and not pay (he only took on the role at the start of this year when the new SRA board took office), and says the board will this month be looking at its enforcement strategy.

Regulatory burdenOf course, under the minimum terms and conditions of insurance set by the SRA (dubbed the ‘maximum’ terms by some), firms that do not pay their normal premiums remain covered. This is a unique provision much detested by insurers, as is their inability to void policies on the grounds of fraud or misrepresentation.

It is a level of consumer protection that Hudson describes as ‘unparalleled in what it offers’ and he praises the SRA for standing firm in the face of demands for a relaxation.

The latter would be high on most insurers’ wishlists for the SRA review and Lovat argues that such a step would increase competition (because at the moment there is not much for insurers to compete on beyond price) and reduce premiums. Martin Ellis reckons that, if insurers could void the policy for fraud and misrepresentation, and the ARP were scrapped, it would bring new players into the market.

Lovat adds: ‘If you said to the market that you were going to throw away the minimum terms and left them to get on with it, you would retain 95% of the minimum terms and see premiums fall 25%. The regulatory burden the SRA puts on the professional indemnity market means premiums are excessive compared to solicitors’ peers, and makes a tight and difficult market even tighter and more difficult.’

Jon Davies has a lengthy list of ways he would reform the system, including: lender claims should fall on the compensation fund, rather than insurers; exclude awards for inadequate professional service from cover; if a firm does not pay its premium, it should not receive run-off cover, with any claims falling to the compensation fund; requiring a solicitor to have six years’ post-qualification experience before setting up a firm, rather than three as now; giving insurers full access to pending Solicitors Disciplinary Tribunal activity so that they can underwrite properly; allowing solicitors to be a partner of one firm only (‘there is a link between mortgage fraud and being a partner in more than one firm,’ he says); and all qualifying insurers having a recognised rating.

Scattergun approachBut none of this will happen, if at all, until next year and so will do nothing to help those firms facing a tough renewal in 2010. The Law Society’s annual indemnity survey found that 79% of firms reported no difficulty in renewing in 2009 – even though rates went up for many – but Hudson reckons that figure might fall this year. ‘Giving your full attention to renewal has never been more important,’ he says.

Choosing a broker is obviously vital, and last month the Law Society produced a guide to doing this in association with the British Insurance Brokers Association. Lovat advises solicitors to call four brokers, do proper due diligence on them, choose one or two to deal with and then not speak to anyone else.

Steve Holland of Lockton also warns against a ‘scattergun’ approach. ‘The temptation will be to put proposal forms into as many brokers as possible, but it will turn off an insurer if they’ve seen the same proposal 10 times.’

Lovat adds that proposal forms are becoming much longer – ‘as the industry starts hurting, it starts collecting more data,’ he explains – with questions about financial stability featuring more prominently, a concern exacerbated by news of the much-publicised financial travails of Halliwells.

Every year there are countless stories of proposal forms being badly prepared. Colin Taylor, head of risk management services at Prime Professions, says that 60% of the 6,000 proposal forms his company saw last year were incomplete or contained errors. As well as basic mistakes such as not answering all the questions and not signing the form, there are flippant answers – such as ‘stupid question’ – and plainly uninformative ones. Simon Lovat adds: ‘Those people who spend time getting the presentation [of their firm] right will be on the top of everyone’s list because they are the easiest to deal with.’

Super-confidentThen, even if you have received a quote, an increasing number of insurers want payment up front because of the credit risk some firms now pose and the fact that non-payment of the premium does not void the policy. Philip White, chief executive of finance provider Syscap, says the fact that many insurers only provide a quote in September, regardless of when the proposal was put in, gives firms very little time either to consider the quote or look around for alternatives.

‘We have already had approaches from firms who do not want to find themselves in this position again. They have recognised that having their finance agreed in advance, independent of an insurer, is the most sensible way to give themselves some breathing space before the renewal deadline.’

The contentious issue of late quotes links in with the ongoing question of whether the SRA should retain a single renewal date, as insurers have to deal with a deluge of proposals in a short time. This should also be swept up by the fundamental review, and the Law Society and many insurers will be hoping that the SRA will change its position on this.

In previous years, solicitors have left their proposals late deliberately, because there were bargains to be had in the run-up to the deadline as insurers jockeyed for market share. That changed in 2008 and Hudson says firms would need to be ‘super-confident’ of their position to leave it late in a hard market like this.

According to Jon Davies of Travelers, an analysis of the past 40 years shows that the solicitors’ indemnity market tracks the troughs of property prices. The early 70s property crash led to the introduction of compulsory insurance, the early 80s crash to the creation of the SIF and the 90s crash to the end of the SIF. Soon we will find out what the most recent crash will bring by way of reform, but one thing seems certain: after what is likely to be the hardest renewal season in a decade, change cannot come too soon.

Neil Rose is a freelance journalist