PII Focus: small firms

In 1999, when the legal profession voted in favour of creating an open market for professional indemnity insurance, thereby ending the monopoly of the Solicitors Indemnity Fund, it is unlikely that anyone really considered the consequences this would have for small firms. For many of these practices, the annual negotiation of their professional indemnity insurance presents not only uncertainty, but also one of the biggest risks their practice can face.

Not just risk management

The solicitors’ profession deserves credit for the improvements made to standards of risk management since the advent of the open market in 2000. Across the board, most experienced underwriters and brokers would agree that the risk management of firms has improved significantly over the past 15 years. On paper at least, the profession appears to be extremely well managed. However, it is important to recognise that risk management is just that – it reduces and manages risk. Risk management can never eliminate risk entirely and the reality is that negligence claims will continue to be brought against law firms, regardless of the risk management of the practice.

The importance of risk management can be seen at each renewal, with every proposal form asking many questions relating to risk management. As the profession’s risk management has improved, so too has the underwriter’s view of acceptable risk management. Therefore, what may have been considered to be good risk management in the past is no longer the differentiator in an underwriter’s perception of risk.

While it cannot be denied that good risk management benefits all parties, there is a perception in some quarters that it has become a ‘tick-box exercise’ and the only thing that firms have to consider. It is important to recognise that risk management is just one of a number of tools available to solicitors in reducing their risk profile.

Research into the cause of claims has indicated that two of the biggest claim triggers are poor communication between the solicitor and client, and a lack of expertise in dealing with a specific area of law. Neither of these claim-triggers relates directly to risk management, but instead they point towards service and experience, neither of which should be overlooked.

 How do you compete?

The commercial reality is that consumers expect not only value but also high service levels. The result is an increased commoditisation of the legal high street, with more emphasis on value. This poses the question of how the law firm can compete, with ever-decreasing fee levels, while maintaining quality and experienced fee-earners.

For every piece of legal advice there is associated risk. Paradoxically, in respect of solicitors, the highest risk areas of practice are also some of the most competitive, with the fees derived bearing little relation to the risk assumed.

Nowhere is this better illustrated than in respect of conveyancing. Post Office Money and the Centre for Economics and Business Research recently reported that the average conveyancing fee was £1,419. In real terms, solicitors are earning less from conveyancing than they were 10 years ago, with average fees increasing by 36.5% while inflation has gone up over the same period by 40.63%. Solicitors are paid less for conveyancing than in 2004 and the potential consequences are significantly higher, driven primarily by the increases in property prices (see box, below left).

While there are regional property value differences, it is apparent that conveyancing fees have not kept pace with the potential exposure for a negligent transaction. In other words, solicitors who undertake conveyancing are taking on more risk but this is not reflected in the fees. This is supported by statistics which indicate that 43% of claims notifications and 70% of claims payments, at an average cost of £41,000, are generated by conveyancing.

Dangers of going unrated

It is unsurprising that firms are looking for value in terms of their insurance premiums and that many smaller firms have at some point chosen an unrated insurer. However, as a number of these smaller firms have learned in the past (particularly those affected by the failure of Quinn, Lemma and the debacle of Balva/Berliner) the purchase of insurance itself can present a risk. Any firm that has had to purchase cover mid-term following the failure of an insurer will know this to be true. The best possible outcome in this scenario is that a firm ends up paying their premium twice, with the worst being that they have to close if they are unable to secure cover. It could also mean increased exposure to claims, with the Financial Services Compensation Scheme by no means obligated to pay an entire claim.

Firms also risk being excluded from lender panels due to the inadequacy of unrated insurers. While there is a difference in price between unrated and rated insurers, from an insurance business perspective, the risks associated with using unrated insurers have increased.

Unpopular with both insurers and solicitors are the mandatory six-year run-off provisions, which present a risk for start-ups and for those firms wishing to cease with no successor practice. Technically, in such cases the partners of the firm would be liable for between 250% and 300% of the annual premium to pay for such costs.

For a start-up firm this risk should be considered at the outset, because, in the event that the firm ceases, such costs will have to be met. Non-payment could lead to regulatory problems, causing issues for partners wishing to continue practising elsewhere. For those looking to retire, the costs could stop them from doing so, particularly if their claims experience has been poor before ceasing.

What is in store for 2015?

The outlook for the 2015 renewal is that the market should continue to be benign. But there is evidence to suggest that the market cycle brings about a contraction every four years, which means this period of calm could be short-lived. With this in mind, small firms need to consider the balance of risk and reward more carefully than ever before choosing an insurer.

 Mark Carver is a 1-4 partner firm professional indemnity specialist at managing general agent Chancery Pi