Are there hidden dangers in opting for 'cheaper' quotations? It is easy to be enticed by low premiums when exploring your professional indemnity insurance (PII) coverage options, especially for small practices that are looking to minimise overheads.
We understand the pressures on small firms, but discriminating purely on the basis of price may be a false economy, and may cost you dearly in the long run.
It is imperative, therefore, that you take appropriate measures to evaluate the financial security of prospective insurers.
What's in a name?
A 'qualifying' insurer is authorised by the Financial Conduct Authority to conduct business in the UK and has agreed to write solicitors' PII policies. Many solicitors take comfort that their PII provider bears the tag, ‘qualifying insurer'. However, providers are neither approved nor vetted by the Solicitors Regulation Authority (SRA).
On the contrary, the SRA merely require transparency of insurers' financial security ratings; the regulator does not specify a de minimis rating, or indeed that there need be any rating at all. For this reason, the Society has asked the SRA to change the name to ‘participating insurer' for the 2013 renewal, as this is more reflective of an insurer's actual role.
Do your homework
While an insurer's rating is not definitive in itself of a firm's financial liquidity, it is one way of satisfying yourself that a prospective insurer is viable. The Law Society has become increasingly concerned, however, that many firms continue to seek cover without recognising the import of an insurer's financial standing.
In 2012-13, 16 per cent of firms used unrated insurers, which marked an increase from 9 per cent in the previous renewal season. The Law Society's 2012-13 PII survey indicates that small firms are more likely to use unrated insurers; that is, 22 per cent of sole practitioners and 13 per cent of 2-4 partner firms, compared with 5 per cent of 5-10 partner firms and 1 per cent of 11-25 partner firms.
The survey also indicates that price is the most influential factor in solicitors' purchasing decisions.
Don't just look at the price
The demise of solicitors' PII insurer Lemma was a sobering wake-up call for all firms, and further highlighted the dangers of failing to conduct financial due diligence on insurers.
If your insurer were to become insolvent during the current term, you would be obliged to arrange alternative cover within a month and to pay a second premium, which is likely to be at a distressed rate. Further, if your provider were to become insolvent after 1 October 2013, and you are unable to acquire alternative cover within four weeks, you will have to cease practice.
These consequences should be particularly alarming for small practices and sole practitioners, for whom bankruptcy and firm closure may quickly follow, if the worst should happen. Equally, partnership should be mindful that they are jointly and severally liable for any uninsured losses of the firm.
It is the entire profession that ultimately may end up footing the bill for those who do not extend caution. In the wake of proliferating claims on the Irish Compensation Fund following the collapse of insurer Quinn, a 2 per cent levy was imposed on all insurance policies within the Irish Republic.
So it follows that related costs are passed onto policyholders, while premiums are ramped up. Inevitably, smaller practices will feel the pinch more than larger organisations.
Limited recourse
The Financial Conduct Authority regulates insurers in the UK. The SRA is reliant upon the Financial Services Compensation Scheme (FSCS) to provide protection against uninsured loss when a provider becomes insolvent or ceases trading.
Where a claim cannot be defended by your insurer, this is cold comfort for many. Although the FSCS does cover some small businesses - those with annual turnover of £1m or less and £1.4m in net assets or less - it will pay no more than up to 90 per cent of an eligible claim, leaving your firm liable to cover the balance.
Depending on your firm's eligibility, you may even find yourself wholly uninsured.
Our advice to you
The financial strength of your PII provider will ultimately determine whether a claim can be paid. And given the long-term nature of solicitors' PII, particularly run-off cover which must be provided for six years, it is crucial to consider your insurer's financial viability.
The most objective measure of a firm's standing is their credit and financial strength rating, disclosure of which the SRA made mandatory in October 2012. You should check your insurer's rating. Although it does not guarantee solvency, a rating confirms that a provider has been assessed by an independent agency. At the other end of the spectrum, selecting an unrated insurer will inevitably launch your firm into uncharted waters, and you must seriously consider this risk when exploring your options.
Making the best use of your accreditation
This year, the Law Society is focusing on ways to promote the importance of choosing a stable and rated insurer to 1-4 partner firms.
This means that, for 2013, we will not be providing a dedicated PII facility for Lexcel and CQS members. Achievement of Lexcel and/or CQS accreditation stands as a sign of good risk management practices. We encourage you to use your accreditation as a selling point to insurers when negotiating your premium and to use brokers who will recognise the value of your achievement. In particular, we recommend you consider the financial security of your insurer as part of your purchasing decision.
Download the PII insurer insolvency guide (PDF)
See more PII information and support