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Solicitors' professional indemnity - gravity defied?

March 2011

by Edward Coulson & Ken McKenzie, Davies Arnold Cooper LLP

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As the legal profession considers new proposals from the SRA to address the continuing issue of spiralling PII premiums, Edward Coulson and Ken McKenzie of Davis Arnold Cooper review the potential for title insurance to play a significant role in resolving the issue.

It is difficult to view the outcome of the 2010 renewal of solicitors' compulsory professional indemnity insurance without concern. The total premium for the profession's compulsory cover has declined from about £246m to £213m but insurers are reporting loss ratios in the region of 150% to 160%. In other words, for every £1.00 of premium received by an insurer, some £1.50 to £1.60 is paid out in claims. In ordinary circumstances it is difficult to see how any business could be sustainable on this basis. Those losses may be reduced by investment income and profits but in today's financial markets they are likely to be small.

The reduction in premium income is even more difficult to explain against this background. Why would an insurer writing loss-making business want to reduce his premium? The explanation may in part lie with large firms "flipping" their compulsory insurance, i.e. putting it in a higher excess layer in their programmes, but that is likely to be only part of the story of a 13% reduction in premium income.

Against that background, it is difficult to avoid the conclusion that at some point in the near future the profession is going to receive a very uncomfortable surprise in the form of suddenly and significantly increased premiums for primary layer professional indemnity cover. However, that was exactly what, with some exceptions, failed once again to materialise this year.

The SRA has recently reviewed the profession's professional indemnity insurance arrangements but neither the 180 page report prepared for the SRA by Charles River Associates nor the SRA's subsequent consultation paper reveal any proposals to tackle this looming problem - or, indeed, any awareness of it at all. The key note of the report suggests that the current approved insurer system is working well and alternatives such as a master policy scheme or an insurer funded by the profession are likely to be significantly more expensive. Given the problems outlined above, the latter point is almost certainly true but the current and hitherto effective system is being forced close to breaking point. One critical factor is the qualifying insurers' obligation to fund the growing membership of the profession's last-chance saloon, the Assigned Risks Pool ("ARP"), a cost which in one way or another was yet again passed on to the rest of the profession this year. Another unwelcome factor is the continuing trend towards a cross-subsidy by well-managed and efficient firms of those who are not - and who form the membership, actual and potential, of the ARP. And a possibly unwelcome consequence of this is the continuing trend to commoditisation of most aspects of this, as with other types of professional indemnity insurance. More than one commentator has observed that we are back to the position under which SIF passed the baton to the open market in 2000.

The Charles River report does, however, identify problems with professional indemnity insurance in terms of client protection - basically, the current system provides liability insurance for the insured solicitor which only pays out when the client establishes liability on the part of the solicitor or is able to persuade the solicitor's insurers that he or she will be able to do so. It is also recognised that a very large proportion of solicitors' claims are attributable to residential conveyancing. The statistics are limited, but Charles River's estimate that 50% of all claims by value are attributable to this source sounds about right. Of that, it is said that 50% (or 25% of the total) are claims made by institutional lenders.

One solution to the problem identified by Charles River is extended title insurance providing "first party" cover to the client for diminution in the value of property attributable to a wide variety of problems including (but not limited to) solicitor's negligence. The Charles River report acknowledges this possibility and suggests that it could be achieved at a comparatively modest premium of £250 or 0.1% of purchase price if greater.

Cover of this type is now being offered by First Title and no doubt others will follow if it takes off. The product was inspired by experience in Ontario in the 1990s, when practitioners found their professional indemnity premiums increasing significantly due to claims connected with residential conveyancing. The Law Society of Upper Canada's professional indemnity insurer, LawPro, introduced a title indemnity insurance scheme. An important aspect of the title indemnity product is that the insurer agrees to waive its subrogated claim against the solicitor except possibly in cases of fraud by that solicitor, and that the claim will be paid swiftly on a no-fault basis. The scheme in Canada enjoyed considerable success, not least because the product was integrated with the professional insurance offering (bearing similarities perhaps with current obligations to advise litigation clients of the availability of legal expenses insurance).

There may be problems persuading solicitors to market policies to their clients providing cover against their own negligence and at premiums that represent a significant proportion of the fees charged by many conveyancers.

One solution might be to split the comparatively modest cost of these policies between the client, the lender and the solicitor (who could expect a reduction in his overheads resulting from a decrease in professional indemnity premiums), thereby reducing the impact of the premium on each of the parties involved in a residential conveyancing transaction. An important point is that policies of this nature cover other risks alongside the conveyancer's negligence, including a broad range of problems normally covered by conventional title insurance. A difficulty would be sorting out transitional arrangements.

The product does offer the prospect of "one off" cover for practitioners in respect of each transaction - something that has been requested by the profession from time to time but which a liability policy is not designed to provide. It also offers the possibility of weighting costs towards risk to a greater degree than is perhaps permitted by current PI rating models and taking some of the burden off the shoulders of the beleaguered PI market.

The Charles River report goes on to make a number of proposals to fine-tune the existing insurance arrangements. Possibly the most dramatic is the recognition that those arrangements provide extraordinarily extensive cover to the profession and that "... it is appropriate to limit the regulatory requirement for PII to cover for individual clients rather than corporate clients."

This proposal has been re-cast in the SRA's subsequent consultation paper, where it resurfaces as a proposal to enable approved insurers to exclude from cover all claims by institutional lenders. This will take effect from 1 October 2011, although cover would remain in place for work carried out by solicitors for lenders before that date. The SRA then proposes to review the minimum terms again before 1 October 2012 with a view to extending the permitted exclusion to all corporate clients. The effect of this will be to limit a solicitor's professional indemnity insurance cover under the minimum terms to cover for claims by private clients alone in the case of a solicitor taking out a policy with the full range of permitted exclusions. The definition of "private clients" has yet to be finalised.

The SRA's intention is to enable law firms that do not carry out any conveyancing work to exclude any liability in respect of such work and, thereby, secure a reduction in their premium. Firms that do carry out conveyancing work would, however, still be required to secure professional indemnity insurance providing cover against lenders' claims - any residential conveyancer acting for purchasers will almost inevitably act for their lenders as well and will be exposed to claims by them.

That said, one of the main objectives of both the Charles River report and the SRA's consultation paper is to increase the flexibility of public protection and the adoption of a "risk-based" approach to regulation. That just might open up the possibility of providing alternative "first party" insurance cover for a solicitor's clients (both purchaser and lender) in a residential property purchase by providing them with extended title cover rather than the (indirect) benefit of the solicitor's full professional indemnity cover.

Accordingly, the title insurance option could be the lifeline that makes this option workable and revives the fortunes of hard-pressed high street conveyancers. The dividend for the profession is considerable. The burden of paying premiums for residential conveyancing claims would be lifted from those sectors of the profession that do not undertake residential conveyancing (some 50% of total claims by value). That burden would then be borne by the sector of the profession that does undertake that work and those practitioners would then be left to sort out the burden of allocating the cost of providing cover between themselves and their borrower and lender clients.

None of this is going to be easy but the current problems of the profession's indemnity insurance arrangements call for dramatically new thinking if a catastrophic increase in premiums is to be avoided. Title insurance just might be the answer to this conundrum.

“This material is intended to provide general information only. For specific coverage and exclusions, refer to the policy.”

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