The centre cannot hold

To say there is a crisis brewing in the solicitors’ professional indemnity (PI) market is something of an understatement. Like saying that Jordan doesn’t mind getting her name in the papers.

Solicitors’ PI was already in a state of turmoil long before this year’s renewal round. Premiums had been soaring on the back of recession-inspired litigation, which prompted insurers to take fright at the sharp increase in claims against solicitors, most of which stemmed from the UK property crash.

Last year, more than 200 lawsuits were brought against solicitors in the High Court. Prior to the financial crisis, the annual figure was around 30.

While law firms complain about the rise in prices and some fear they may not get cover, insurers insist that the basic problem is a small number of dishonest law firms: “Rogue lawyers who cost their insurers millions of pounds each year and, all too often, disappear into thin air” as one insurer describes them.

Insurers argue that these bad apples have contaminated the sector to such an extent that legitimate, well-run firms, generally smaller practices of around four partners or less, can no longer be guaranteed cover.

In addition, the spectacular demise of Irish insurer Quinn’s UK operation, which provided cover for 2,911 law firms across England and Wales, has exacerbated an already alarming crisis.

In short, the market is in an awful mess, and looks set to come to a head at the end of next month, when solicitors’ PI renewals must be completed.

The Quinn factor

In May, the administrator handling Quinn said that the stricken insurer would have to increase its UK commercial premiums by up to 2,000% to make the business viable.

Quinn’s UK commercial book lost £23.3m last year, and solicitors’ PI was the company’s worst-performing class. Indeed, its losses in this area were so bad that even those massive increases outlined by the administrator would not be enough to make it pay and, while some parts of Quinn’s UK operation have reopened, the administrators have no plans to restart its solicitors’ PI business.

“The problem post-Quinn is that a small number of brokers are looking for a home for almost 3,000 law firms that need PI cover, and terms from other insurers for those former Quinn clients may be very difficult,” Lockton’s director of risk solutions, Brian Balkin, explains. “There will be many good firms [in that group]. However, there will also be a small number of badly performing firms that are underpriced.”

Zurich’s head of professional and financial lines, Stuart Quinlan, agrees. “In practical terms, the impact will only be felt this renewal, when 2,911 small firms are looking for cover with an alternative insurer. Our knowledge of the market suggests that capacity at this end of the market will be tight, and these firms could find it difficult.”

All this begs the question whether at least some of those law firms insured by Quinn’s massive loss-making operation should have been entitled to cover at all. It is worth pointing out that Quinn’s woes also appear to have prompted rivals Hiscox and Catlin to throw in the towel on solicitors’ PI and abruptly exit from the market as well.

Between them Hiscox and Catlin only accounted for less than 5% of the market, but their exodus has left a diminishing pool of meaningful players covering the sector. Despite this, virtually no one in the industry believes capacity will be an issue next month. “It’s entirely about risk,” one broker says. “The underwriter either accepts the risk or he doesn’t; capacity has nothing to do with it.”

Bill Wharton, chief underwriting officer of professional lines at XL Insurance’s UK operation, which currently accounts for around 7% of the market – agrees. “Despite some recent departures, we believe there is still significant competition in this field,” he says.

Balkin echoes that view. “There’s enough capacity in the market, but whether insurers will underwrite at a price that suits consumers is the question. Insurers clearly don’t want to underwrite every law firm, but you could argue that if firms that can’t get cover go into the ARP [Assigned Risk Pool] then, under current arrangements, insurers end up doing that anyway.”

There are also new entrants to the solicitors’ PI market, most recently Vision Underwriting, part of US giant Liberty Mutual. But no one is going to increase capacity merely to provide cover to struggling firms.

“Insurers can’t suddenly say ‘I’m going to underwrite another £100m worth of premium’,” Balkin says. “They need to maintain a balanced portfolio and, basically, 1,000 sole practitioners do not necessarily balance your portfolio.”

Zurich’s Quinlan puts it even more succinctly when asked if other insurers should take up the slack. “No, because each insurer needs to determine its own appetite. There is no guarantee that all insurers would act in this way. It’s a guessing game we are not prepared to play, and risk acquiring an increased share in the ARP,” he says.

ARP?reformed

That brings us neatly to the vexed issue of the future of the ARP and the series of reforms unveiled by the Solicitors Regulation Authority (SRA) earlier this month.

Last year’s renewal season saw the number of law firms in England and Wales entering the ARP – with its 27.5% premium rate for the first £500,000 of cover – doubling to around 500, or 5% of the total market. This year it could hit 10%.

Meanwhile, since 2000, insurers have had to pick up the £9.2m bill for unpaid ARP premiums, with default rates at 49%. Last year, there was a record £4.8m in unpaid premiums, while claims are forecast to come in at around £45m, almost 20% of the sector’s £300m annual premium value.

Bearing in mind that the crisis in solicitors’ PI has been brewing for some time now, no one could accuse the SRA of acting with indecent haste. Nor could it be said that it has thrown the baby out with the bathwater – “if only” appears to be the general sentiment of insurers.

The SRA reforms will basically force high-risk law firms to get their house in order and either obtain insurance or close down. SRA chief executive Antony Townsend insists that the reforms amount to a “tough enforcement strategy” that will ensure firms are in the ARP for as short a period as possible. But the industry is not convinced.

“The SRA amendments are not enough,” Balkin says. “The SIF [Solicitors Indemnity Fund – the mutual-based scheme that was abandoned in 2000 in favour of an open market for insurers] was voted out of existence because the good firms ended up paying for bad ones, but the ARP is going that way too. The scope of the coverage under the minimum terms has to change, and this will also attract new entrants at competitive prices.”

That view is echoed by Quinlan. “We welcome the changes that have been made, but these will be of limited impact and certainly will not address the current issues. The ARP cannot continue in its current form. The market cannot sustain losses at the current level. The ARP figures are being driven by lender claims, many of which involve issues of fraud and dishonesty.”

The alternatives

The Law Society supported the retention of the ARP when the SRA consulted on whether it should be scrapped amid last year’s turmoil. But a spokesman for The Law Society insists that the ARP needs to “deal with issues of non-payment and excessive claims generation”, which insurers insist the reforms fail to do effectively.

It is worth remembering that the decision to abandon the SIF was based on the simple premise that solicitors would enjoy considerable cost savings. But arguably the ARP has now metamorphosed into the old system, with both insurers and the better-heeled and lower-risk law firms carrying those that are neither.

You don’t have to be a cynic to see that the open market model for solicitors’ PI buckled the very first time it was tested – when the financial crisis made market conditions much tougher. Against a backdrop of tighter money and the collapse of the property market, a rather large bunch of chickens have come home to roost at the same time and the insurance market has reacted accordingly.

Is there an alternative? North of the border in Scotland, lawyers voted to retain the old system in preference to exposing the entire profession to the open market and, for the most part, Scottish law firms appear happy with that decision.

“We’re all still in it together in Scotland under a single master policy,” Brodies’ Alan Calvert, who is in charge of PI at the Edinburgh law firm, explains. “We have paid a wee bit extra for the privilege during good times, but there has been no terrible fall-out in bad times, so I’d say it has served us well.”

Few lawyers, certainly those that are getting competitively priced cover, and even fewer insurers want to return to the old system. But some argue that brokers could do more to improve things.

“A lot of brokers aren’t helping the situation and should be doing more for solicitors,” broker Cobine Carmelson’s managing director, Jason Cobine, says. “A lot of solicitors will end up in the ARP because too many brokers aren’t properly assessing and reducing their risk. Brokers should be finding out from underwriters what it is they want first and foremost, and then, based on that, work with solicitors to reduce risk. It won’t solve the entire problem, but it would be a start in solving some of it.”

Meanwhile, the outlook is set to remain bleak for some time as more claims against solicitors work their way through the legal system. “Lenders have been slower at advancing claims than the time of the last recession, and there are many more claims yet to be made,” Quinlan says. “This is a long-tail business, and when you have been writing solicitors’ PI for 10 years, you really understand how significant this is.” IT