Blog: Don’t get it wrong on referral fees!

The government is right to be moving towards banning or capping referral fees. But there is a real danger that this could badly backfire unless it is approached with the whole picture in mind.

Reducing referral fees alone, without at the same time reducing the scale of fees that solicitors charge to insurers, will neither reduce claims costs nor insurance premiums. In fact, because insurers would end up paying out the same level of claims costs at the same time as getting reduced revenues from referral fees, it’s a double whammy that would probably push premiums up even higher than they are today!

Not only could this increase motor insurance premiums but it would give solicitors a huge windfall profit by reducing their biggest overhead (paying a referral fee) while still allowing them to charge the same fees. While it may be stating the obvious, it is still worth making the point crystal clear: if a solicitor currently has to pay out a fee of say £700 to buy a claim and charges a basic scale fee of £1,200 to the third-party insurer, this results in a gross margin of £500 out of which the solicitor has to pay their processing and overhead costs and make a profit. If you remove the referral fee of £700 without any reduction in the scale fee that the solicitor is allowed to charge, this increases the solicitor’s gross margin from £500 to £1,200.

So the effect of removing referral fees in isolation to reducing solicitors’ fees would simply be to create:

1. Even higher motor insurance premiums, and

2. A golden windfall for solicitors.

This cannot be the desired effect. Admittedly, there are a large number of factors that also have to be taken into account, like the effect of investment into new law firms following the delayed (any coincidence?) deregulation of the legal services market, but the above factors remain at the core. The desired outcome must be to reduce excessive farming of injury claims by cuttng out the profiteering by those who have the most to gain from the current excessive level of referral fees. If this result is to be achieved, the government must not get it wrong by ignoring what is actually pushing up the costs, namely the level of legal costs that the insurer has to pay when their policyholder has caused the accident.

The right answer must be to make sure that any ban or reduction in the level of referral fees is matched by an equivalent reduction in the level of solicitors’ fees payable by the fault insurer. In fact the exercise could be achieved quite simply by reducing the allowable solicitors scale costs such that the referral fee is naturally reduced by market forces.

Whichever way it is approached, a reduction in solicitors’ costs will take the biggest element of claims expense out of the market, remove companies that farm claims to cash in on the current excessive levels of referral fees and give insurers the tools to compete for new business through lower insurance premiums.

This is the government's opportunity to get it right. Please don’t get it wrong.

Peter Ashdown-Barr is chief executive of InterResolve.