What the ERP would mean for the solicitors' PI industry

Solicitors’ professional indemnity causes a headache for all qualifying insurers. The scramble to quote for the annual 1 October deadline along with the cost of meeting claims from the assigned risks pool (ARP) make solicitors' PI a tough market for the few insurers still prepared to write the risks.

The widespread concerns about the existing set-up has prompted the Solicitors Regulation Authority (SRA) to draw up a two-stage plan for market reform last year. The SRA wants to cut the length of time a law firm can stay in the ARP – the safety net for solicitors unable to find cover – from 12 months to six from 1 October 2011. From 2012, the SRA has suggested limiting the ARP’s role to protecting the clients of law firms without PI cover.

Figuring out a solution

The SRA put out a consultation paper last December, inviting comment on its suggestions. The Law Society responded with proposals to completely scrap the ARP and set up an extended renewal period (ERP), which would provide an alternative safety net for law firms unable to find PI cover.

Under The Law Society’s plans, the ERP would give law firms at least three months' cover from the end of their existing policies to find alternative cover or make plans for merger or winding down the business. The insurer would also have to give a notice period of six months if it decides not to renew the client’s insurance. The insurer would have to keep providing cover during these six months, although the three-month ERP period could run alongside.

In addition, the duty of covering claims would be shifted to the individual insurers, rather than each insurer picking up the cost of the ARP according to market share.

Finally, during the three months after a law firm applies for protection under the ERP, the Law Society proposes that the SRA would help such firms seek cover. If a firm is unable to secure PI insurance after this three months is up, they would be forced to shut down.

The harsh reality

Will the ERP solve the problems that have arisen out of the existing ARP system, or create new ones? Insurer and broker feedback has raised some issues.

The first issue is a practical one. Insurers currently decide whether to continue cover, cut cover or raise premiums when a law firm submits a proposal form. The Law Society suggests that solicitors should do this three months before renewal, giving the insurer ample time to make an informed decision about cover, in theory.

The problem, suggests Zurich legal professions manager Jenny Screech, is that even very good law firms will find it hard to submit a proposal three months before renewal: “It’s not realistic to expect that we are going to receive those proposal forms three months in advance.”

This leads to another problem. If a law firm cannot find insurance and invokes its emergency ERP cover, the insurer would have to provide PI cover for at least three months at the same price as the existing rates.

If a law firm gives little notice to their insurer, then the chances of the ERP being activated could increase, and it is insurers that will pick up the tab for the ERP cost.

Clear Insurance Management professional risks director Daniel Innes says: “If you have a client that has a £1m loss, you’re obliged to continue to underwrite that loss – even though you know it’s poor – for six months at the rates you’ve already been charging.”

Dangerous ground

There is a further danger to the proposed new system. For example, there is nothing to stop an unscrupulous law firm that knows it has some upcoming claims, which could cause its insurer to deny it cover, from submitting its proposal form at the last minute, thus invoking the ERP. The law firm in question would be able to enjoy a few months of guaranteed insurance at pro rata rates while it looks for cover elsewhere.

And, despite some feeling that the ERP is a better option than the ARP, the solicitors' PI market is not going to get any easier. Datamonitor has recently published research which says that claims against solicitors are expected to rise as a result of the recession, and will not level out for another 18-24 months.

Datamonitor associate analyst Donna Stephens also predicts that more qualifying insurers will drop out of the market as a result of rising claims and excess capacity keeping rates down.

Hope ahead

Even though The Law Society’s proposals have not met with a universal welcome from the insurance community, Screech is heartened that a consensus is forming around the need for a reform of the current system.

“It seems that the market, the SRA and The Law Society are now on the same page to the extent that the ARP must change," she says. "Hopefully there will be an opportunity for some more dialogue in the next four-to-six weeks to see if a solution can be found.”