SRA Consultation – Future Client Financial Protection Arrangements
2nd March 2011
SRA Consultation – Future Client Financial Protection Arrangements
The British Insurance Association (BIBA) is the UK's leading general insurance organisation representing the interests of insurance brokers, intermediaries and their customers.
BIBA membership includes 1,700 regulated firms. Insurance brokers and intermediaries distribute nearly two-thirds of all UK general insurance. In 2007, insurance brokers and intermediaries generated £1.5 billion of invisible earnings and they introduce £22 billion of premium income into London's insurance market each year.
BIBA is the voice of the industry, advising members, the regulators, the Government, consumer bodies and other stakeholders on key insurance issues. BIBA provides unique schemes and facilities, technical advice, guidance on regulation and business support and is helping to raise, and maintain, industry standards. BIBA works closely with the Chartered Insurance Institute to provide training to those working in the industry and actively participates in helping the industry and its customers deal with some of the major issues of the day.
BIBA members provide professional advice to businesses and consumers, playing a key role in identification, measurement, management, control and transfer of risk. They negotiate appropriate insurance protection tailored to individual needs and operate to a very high standard of customer service with the aim of ensuring peace of mind, security, financial protection and the professional advice required.
The role of the insurance broker in the distribution of PII for solicitors is limited to comparatively few brokers, many of whom specialise in PI insurance, generally. We are aware that some of these brokers will be submitting their own replies to the consultation document.
However, BIBA has consulted regularly with brokers closely involved in solicitors PII insurance as well as consulting with the Law Society and the SRA in early 2010. Accordingly we have taken a close interest in this subject because brokers bear the brunt of the frustrations and brickbats both from insurers and solicitors arising from the increasingly testing times that have occurred at successive renewals over recent years.
Brokers have a valuable insight to the underlying dynamics of any insurance marketplace and, collectively, can be a valuable source of information unavailable from any other source.
We recognise that the interests of insurers and the interests of insurance brokers are not the same and the interests of insurers and the interest of the Law Society members (solicitors) are also very different in many respects. Nevertheless the interests of brokers are closely associated with the interests of the solicitors who are the clients of the brokers and expect the best advice and service from them.
As has been apparent to the Law Society and the SRA in recent years the service available from brokers has been severely compromised by the market conditions which have included insurers delaying renewal quotes and utilising other market tactics to help preserve their premium pot and market share and this has been at the expense of the solicitor and to the detriment of the broker trying to give of their best. It is in this context that BIBA takes a significant interest in the SRA consultation.
We have answered all the questions in the consultation document but we would like to record, in advance, that we are particularly concerned about:
- the Assigned Risk Pool,
- the compensation fund,
- the proposal to withdraw of coverage for financial institution clients.
It is evident from CRA’s report that the fundamental problem, from which everything else flows, is the losses and claims occasioned by firms with less than five partners in general, the very small firms and sole proprietors, in particular, and solicitors engaged in conveyancing and exposed to lender claims.
BIBA makes the observation that it is essential for the economy of England and Wales that competent solicitors operating alone or in small firms should be able to maintain their part in the community serving, as they do, a very wide range of clients for whom the small firm practice is ideally suited to their needs and budget. It is therefore essential that their needs are properly catered for by the insurance industry.
We feel it is very important that the consultation take into account the need of the small firms for certainty of cover, reliability of insurer’s claims and defence service and security of the insurers seeking their business.
The recent entry and demise of one insurer exemplifies the damage that can be caused by a new entrant to the insurance market with no previous experience and a determination to make a profit by buying in business at very low prices.
We fully support strong competition between insurers but as experienced representatives of the broking industry we are not advocates of reckless and cynical price cutting
We would be happy to meet with the SRA to discuss any of our views or recommendations.
We are firmly of the opinion that the ARP is not working in its current format and other models like an FSCS customer compensation system should be considered. If the ARP is to be retained it must be remodelled to provide its original purpose and not the one for which is has become used and abused since 2000. Our reasons for this are explained below.
We are firmly of the opinion that there should be more attention paid to the security and FSA registered status of insurers permitted to become qualifying insurers. Our reasons for this are set out below.
We strongly advocate increased regulation and increased powers for the SRA to intervene in solicitors firms:-
- who are reckless as to their conduct,
- fail to embrace reasonable standards of risk management and
- who fail to pay their premium or self-insured excess.
The cost of these as identified by CRA’s report is being paid for by the solicitor firms that are competent, professional and pay their way proportionately to the risk they pose. Our reasons for this are set out below.
We fully support the separation of the insurance of conveyancing practice and would go further than the CRA recommendations. We recognise that a significant part of the loss arises from undertakings given by practitioners to lenders and we believe that this is a discrete issue that could be addressed without any impact on the rest of the profession.
What is an ABS?
We recognise that the SRA will be regulating ABS s in the latter part of 2011. There will be some new insurance and insurability issues to be considered but the market has not yet addressed them. However, we believe that the strengthening of the SRA's regulation of firms, per se, will be to the overall benefit of ABSs.
Principle and Outcome based regulation
We recognise too that the SRA will be adopting a Principle based method of regulation. Whilst we agree with the rationale behind principle based regulation we know from our experience as brokers in other fields that people do not embrace principles and outcomes as well as they embrace rules because the former require them to think for themselves about what they should do to control conduct and risk.
Evidence has proven that the majority of firms with less than 5 partners eschew any kind of risk management because it is time consuming and eats into income. Ergo, identifying principles and outcomes and acting upon these will require, we believe, increased levels of vigilance and supervision as well as education, by the SRA.
Solicitors and management
There is a concern that some solicitors tend not to be interested in or particularly skilled in business management. They also tend to work in isolation from each other and these factors are a major contribution to the risks they present to themselves, their clients and, of course to underwriters.
The underlying risk
If we have one single observation to make about the CRA review (not the report per se) it is that there has been too little attention paid to the underlying risk presented by solicitors and how that underlying risk can be reduced. This, above all else would result in the 8 objectives being more successfully met.
- Do you agree with the objectives and principles?
The objectives of the scheme are generally sound. The second objective, “to maintain the confidence of the public in the regulated profession” should be reconsidered. The current system has the opposite effect because it fails to deal firmly with dishonest firms, of which the CRA report suggests there are too many.
We do not think that the scheme should or can encourage competition between different legal service providers and nor can it encourage an independent strong diverse and effective legal profession. These are things that the Law Society /SRA should be looking at and should not be the responsibility of the insurance industry.
The only part that insurance can play is if the Law Society and SRA support insurers in removing solicitors who are dishonest, repeatedly negligent or incompetent.
We do however agree that the scheme should “provide appropriate incentives for lawyers to undertake risk management.” However, this has singularly failed because in fact the only practical incentive that insurers could offer is a reduction in premiums and there is no scope for reducing premiums in a scheme under such enormous financial pressure. There are better ways of doing this. Lexcel we understand is adopted by less than 15% of the profession after some 20 years in existence. It speaks for itself.
- Do you have any comments on our views about the future development of the financial protection arrangements?
We support the SRA’s recommendation to tailor policies to the needs of solicitors’ firms.
will have the following beneficial effects:
- It is likely to make it easier for firms to the get the insurance cover they need for their business requirements
- It should make risk assessment easier for insurers
- It will help solicitors to manage their risks more effectively
This will be particularly important in assisting solicitors’ firms to react to the changes in their market to come.
Greater flexibility in PII arrangements is a good idea, in principle, but care should be taken that "flexibility" does not open up the scheme to abuse by firms and insurers each interpreting "flexibility" to their own ends. The use of the expression "appropriate cover", in paragraph 1.21 and 1.24, for example, gives us cause to be concerned as to how that will be judged, in each case, with hindsight.
The nature of claims against solicitors (and indeed other professions) is that they all cost similar sums of money to investigate and defend. This is where the attritional loss to the scheme will always be. Limits of indemnity reflecting multiples of largest fees have worked for over 30 years and it has been very rare indeed to find underinsurance being a problem.
- Do you have any comments on the wider regulatory issues addressed here?
We would like to see the SRA exert enforcement powers more readily to remove firms or individual practitioners where their competence or conduct falls short of the standards that ought reasonably be expected by the public.
We agree with the ABI comment:
"Our members have identified significant regulatory issues in the areas above and we expect to see firm action. Insurers are keen to do what they can to support good regulatory outcomes, without being responsible for the weeding out of poor firms, which has been the case in recent years. We are confident that with the right incentives for both solicitors and insurers, and with the right controls on entry to the profession, the ability to start businesses, and greater oversight of the financial competence of solicitors, a virtuous circle can be created which will benefit consumers and all stakeholders in future years.
We would add to the list above the need to address the problem of phoenix firms and sham partnerships. Further examination is also needed of the question of whether it should be permissible to have a partnership in more than one firm."
- Do you agree with the SRA’s two-stage approach to developing the financial protection arrangements?
We agree, in principle, with the comments of the ABI.
Paraphrased:- "We do not agree that a two-stage approach is necessary or desirable.
- Change in this market is overdue and urgently required.
- We are concerned that spreading out the change required in the market over two years will prolong uncertainty and dissipate the current clear understanding of the need for reform.
- The introduction of ABS and the switch to outcome-focused regulation, both due in 2011, are fundamental changes, but they do not require a slower approach.
- We argue that it would be better to bring in the new indemnity arrangements alongside these other moves.
A further important point is that once the single renewal date is removed, then other change becomes slightly more confusing to introduce, with policies having to make allowance for such change part-way through a policy period. It would be create more certainty if all changes were to be made at the outset."
- Do you agree with our conclusions that we should maintain an open-market system of PII?
We entirely agree with this. Without question; there is no better solution, as has been proven.
- Do you agree with our conclusion that we should maintain a Qualifying Insurers Agreement?
The QIA is necessary to ensure a level playing field as between Qualifying Insurers but the devil is in the detail. If the QIA is too restrictive on insurers it will be self-defeating in its purpose. In our opinion the burden upon insurers has become too great and when leading, long term and reputable insurers (e.g Hiscox) withdraw from the market and others withdraw from sectors of the market the restrictions need a serious review.
The key point to being a QIA is a satisfactory security rating. Overall we do not believe it is good husbandry by the SRA to require of insurers that they should be the financial banker of last resort to solicitors who will not or do not:-
- pay premiums,
- pay self insured excesses,
- take care to avoid loss
and run their practice with reckless disregard for the consequence secure n the knowledge that insurers will pick up the bill paid for by the well disciplined majority of the profession.
- Do you agree with our conclusion that we should not place additional criteria on insurers in order for them to be eligible to be a qualifying insurer?
Insurers that are eligible to become QIs ought to be proven insurers of PII. Some people have argued that some recent insurers were not suitable.
The public and the solicitors relying upon insurance ought to be able to feel secure that and QI is not only authorised to underwrite insurance in the UK but also has the knowledge, experience and skill to provide a consistent level of insurance service as befits the defender of a firm of solicitors seeking professional protection against the allegations made against them.
For this reason we believe that insurers should provide evidence of their experience and the SRA should canvass confidential opinions from all leading brokers for their opinion on the suitability of a new entrant to the market. The SRA would be able to make a safe judgment based upon this information.
Otherwise, we agree with ABI's remarks:-
"Insurers must be authorised to trade in the UK, whether that be by direct authorisation and regulation by the Financial Services Authority, or by ‘passporting’ in from another jurisdiction. Wherever they are regulated, insurers are subject to principles-based regulation, which is currently being tightened, particularly in the sphere of capital adequacy.
While recent events raised questions about the current practice, we do not see any strong justification for restricting the ability of insurers to become qualified in this market. The threats to insurers’ business are carefully managed, and it is worth noting that no insurer has been unable to meet its obligations in this market during its ten years of operation."
- Do you agree with our conclusion that we should maintain the function of the ARP in meeting claims against uninsured firms?
We are firmly of the opinion that the ARP is not working in its current format and other models like an FSCS customer compensation system should be considered. If the ARP is to be retained it must be remodelled to provide its original purpose and not the one for which is has become used and abused since 2000. Our reasons for this are explained in appendix 1.
- Do you agree with our conclusion that we should maintain the function of the ARP in providing run-off cover to firms that do not have open-market run-off cover?
No, the ARP is not a suitable vehicle for providing run-off cover. It should be required of a firm as a matter of regulation and in the event that the regulation is breached the SRA should have a sanction against the partners individually and the former partners, where applicable.
Claims that cannot be met, if they occur, should be paid by a compensation scheme. There is no difference to a claimant whether a firm defaults due to dishonesty or fraud and defaults due to a breach of regulation.
it would be possible to construct a specific compensation fund for this purpose.
- Do you agree that we should maintain the current approach to setting premiums for firms entering the ARP?
Not entirely. See our recommendations in Appendix 1
The objective of the ARP should be:
- Charge a premium of between 150% and 200% of last year's premium; this is rateably proportionate to the firm's ability to pay.
- Find out why the firm cannot get insurance in the normal way;
- ascertain whether it is in such financial trouble that it is unsafe to practice;
- SRA to require such action as befits the circumstances
- If the firm shows a willingness and ability to repair itself such that the market will take them back, all to the good.
- Otherwise, they should be given no option but to cease practicing.
- Do you have any comments on the proposal to remove the single renewal date and the impacts identified? Are there any further consequential impacts of this change that you believe we should consider?
We support the proposal to remove the single renewal date. As a result there should be little or no reason for firms not to get renewal terms in good time.
We would add that it should be recommended that policies should be for 12 months or more up to 15 months in order to accommodate preferred renewal dates. Short period policies will have unintended consequences of firms being able to be in breach for periods in a year in the supposition that SRA will not have the resources to check on the firm’s policy more than once a year and therefore they could escape without insurance.
- Do you have any comments on the proposal to make insurance cover for claims by financial institutions a permitted exclusion in the MTC and to apply this exclusion to policies of qualifying insurance provided by the ARP and the impacts identified?
We do not agree with this proposal. We are of the opinion that insurers should take firms as they find them and should not be able to select out the bits they do not like to insure.
In the insurance market this is known as a “buy back” option and these are notoriously risky.
We are concerned that clients of firms will not be aware that the firm is not covered for “Financial services work” and that this will lead to significant confusion and damage to claims negotiations.
Furthermore this will increase the cost of the insurance to the firms that need “Financial services” protection and may cause some of them to take the risk of being without it.
We fully recognise the additional risks associated with financial institutions and the demands they put upon solicitors (and other professionals, notably surveyors)
Whilst there is an understandable reluctance by insurers to insure firms in respect of claims made by financial institution clients we regard the suggestion that this protection should be excluded or segregated as fundamentally flawed. Brokers are highly experienced in recognising the elephant traps that arise by segregation of types of work or business emanating from any one professional practice. Litigation lawyers defending solicitors would recognise that this would lead to considerable extra work in separating the liabilities emanating from "financial institution", as defined and this would lead to all kinds complications as solicitors firms, lenders and insurers all seek to find ways round the segregation, as indeed they undoubtedly will.
If solicitors do not carry out any work directly or indirectly for financial institutions then underwriters can reflect this in their premium rating.
- Do you agree with the definition of “financial institutions” that we have proposed?
We do not recommend this approach.
- Do you agree with our proposed approach for implementing this change by way of a “permitted exclusion” from the MTC?
We do not recommend this approach.
- Are there any further consequential impacts of this change that you believe we should consider?
We have considered the ABI response to this matter and conclude that its answers show the difficulties that will emerge from this approach.
It does not need to happen straight away and it might be an option to review this in more detail in the next twelve months before making a decision. We fear this decision could back fire on the SRA.
ABI response "In order to provide certainty, financial institutions (FIs) will need to know who has the required cover. This should become a normal part of the way that FIs assess and manage their risks, in the same way that they would presently want to know that solicitors they worked with were capable of doing the work for which they are being paid.
There are different ways in which this information could be provided. Insurers are very content to do this through a clear statement on the policy documentation, which FIs could request to see as part of their risk assessment processes. Insurers will naturally provide this information to their own customers in any case. Whether this satisfies FIs is open to question but it should not be particularly onerous, and we would expect FIs to be carrying this out with other suppliers presently.
FIs have complained that they do not know who is in the ARP, and so cannot avoid using them. Were the ARP to be scrapped, as we propose, this problem would not arise.
There are other outcomes of this change that have been mentioned, including that this change will increase the costs of conveyancing transactions and make the process longer. It seems clear from the disastrous experience of the last decade that poor lending decisions and cheap, poor-quality conveyancing contributed significantly to the problems not just of the PII market, but of the UK economy as a whole. Nonetheless, there is little evidence that this change will do anything but improve risk management, and ensure that the recklessness of the early 2000s does not re-occur. This should be welcomed by all concerned.
It should also be noted that insurance products which are fairly new to the UK, such as title protection products, are being developed in response to the problems of the conveyancing market. These provide innovative approaches and can supplement existing consumer protection approaches. The development of new products should be welcomed, as they provide flexibility to the profession, lenders and the public, as well as the competition that drives efficiency."
- Do you have any comments on the proposal to reduce the time a firm may be permitted to remain in the ARP to 6 months and the impacts identified? Are there any further consequential impacts of this change that you believe we should consider?
Please see Appendix 1and 2
We recommend that the firm should remain in the ARP for as short a time as possible; only long enough to get out or be merged, sold or shut down.
- Do you have any comments on the proposal to require detailed planning by firms in the ARP and the impacts identified? Are there any further consequential impacts of this change that you believe we should consider?
Please see Appendix 1
We believe that independent professionals, paid for by the firm and under the direction of the SRA should determine the outcome for firms in the ARP.
- Do you have any comments on the proposal to clarify the reporting requirements on qualifying insurers and the impacts identified? Are there any further consequential impacts of this change that you believe we should consider?
We are not in favour of insurers being required to report on firms other than to the extent that a firm is going into the ARP. Any more detail than this will jeopardise the integrity of the insurer/client relationship. This will cause firms to be ever more coy about what they tell insurers and this is counter-productive to openness and transparency.
It is imperative that the insurance industry does not become a surrogate regulator of the legal profession. There would be a serious and irrevocable breakdown of trust between solicitors and insurers and ultimately users of the legal profession if the insurance industry, in all its several and competitive parts, is seen as a “snitch” on its policyholders.
If the ARP were to be run in the manner originally intended that is all that is required for the SRA/Law Society to be put on notice that the insurance industry has unilaterally declared that a firm is uninsurable.
No amount of reporting will replace the fundamental need for active vigilance by the SRA of practicing firms. If a firm goes into the ARP that is warning enough for the SRA that a serious examination of the firm is required urgently by the regulators. What steps they take to shut down the firm or require a forceible transfer of its business to more competent firms is a matter to be discussed below but no amount of reporting will address the fundamental problem which is that if the insurance industry collectively cannot find a reasonable way to insure a firm then that firm should not continue unless it has been thoroughly investigated and re-engineered, which was the purpose of the ARP.
- Do you have any comments on whether we should permit a wider exclusion from the MTC such that cover is only required in respect of work done for ‘individuals’?
The majority of work done by solicitors is for individuals in their personal or family capacity and in their capacity as small businesses. Small businesses and SME are not in the same position as large corporations or institutions and for the purposes of consumer protection we would regard any separation of the client protection to be a retrograde step for all concerned. These matters are better dealt with by more articulate proposal form questions.
If the single renewal date is abolished then there will be more time for underwriters to underwrite and assess each proposal. This is to everyone's benefit.
- Do you have any suggestions on the definition of “individual client” that we should consider?
See 19 above This is matter of public policy.
- What impacts do you consider such a change would have?
We do not believe this is easily workable
- Do you have any comments on whether we should remove the role of the ARP as a provider of policies of qualifying insurance?
Please see Appendices 1 and 2
The ARP is not and should not be a stand-alone insurance company. In fact it need only be a premium collecting and claims payment facility operated by an ARP manager, holding no actual funds of its own by way of insurance.
It is facilitated by a coinsurance slip subscribed to by all of the participating QIs each underwriting the same percentage of any given risk and their previous year’s gross written premium (GWP) bears to the entire gross written premium for all the participating underwriters (circa £230 million).
When a firm goes into the ARP a premium is paid to the ARP managers who distribute that premium to all participating insurers in their respective proportions. In the event of claims payments being made and fees incurred the ARP manager carries out exactly the same function of apportionment, collection and payment.
This avoids any insurance fund being required at all.
ARP as an Insurer of Last Resort
The ARP should not be an insurer of last resort. It should be nothing more than an insurer of firms who are being investigated with a view either to being shut down or continuing and able to get insurance in the open market. There should be no question of an insurance that helps poor firms to stay in business, generating claims.
If the profession wishes to have an insurer of last resort it can only be the kind of compensation fund which it should provide for itself with a system similar to the FSCS where financial services firms pay a levy. There is no practical or principled reason why insurers in the market should provide this cover.
The ABI have made this point and we agree entirely. Uninsured firms should not be practicing at all but if they are it is the legal fraternities’ responsibility to pay claims emanating from them from a compensation fund. This should be entirely discretionary allowing the SRA to decide whether the merits of the case warrant compensation. It should not be based upon the minimum insurance terms, per se; these are liability based whereas a compensation is not so limited, it being discretion based.
Extension of time
If the single renewal date is scrapped we agree with ABI that it will relieve the pressure on firms and insurers and so make obtaining insurance a little easier. The ABI suggested a 3 month extension should provide a sufficient time to source cover.
If an ARP model was retained and a firm cannot get terms by the renewal date then it has to go into the ARP; it has to pay a premium and it has the opportunity to come out of the ARP as soon as it can demonstrate to the ARP manager that it has alternative insurance in the open market. If a claim has been made against the firm during its short time in the ARP then the full annual premium is earned. If no claim or notification has been made then a pro rata or short rate return of premium would be equitable. There must be some pain for the firm so that there is no incentive to go into the ARP.
When the firm is in the ARP the SRA/Law Society are notified and they can take any steps that they deem reasonable to look into the reasons for the firm being in the ARP and offer whatever help or solutions they wish to assist them in getting out of it.
This can include practical solutions of firms re-engineering and there are at least two specialist firms available to do this work.
What about the run-off costs of firms that fail to get out of the ARP and are closed down?
This is a question not just of insurance but practicalities. A firm that has outstanding business at the time that it closes down ought to pass that business to another competent practitioner. This is the best possible protection for the interests of the consumer/client. To do this would usually be achieved by insolvency practitioners. In the event of a firm wishing of its own volition to close down it would be available for discussions with other firms who might like the business and/or some of the staff. This is a facility that the Law Society could rearrange but even if it didn’t there are practitioners in the market ready willing and able to do this at the drop of a hat. By passing the work to another firm the liability arising from it could be added to the acquiring firm’s insurance and special arrangements for assessing and paying the premium would be available according to the circumstances. It is also possible for the SRA to consider a regulation that makes partners of firms ceasing in this manner to be personally liable for run-off insurance premium the non payment of which will result in legal action against them and removal of their practicing certificate for life.
The risk of such partners going beyond the seas and out of jurisdictional reach could be countered by a deposited bond or some other similar instrument.
The ARP should not continue to offer policies of qualifying insurance for any other reason. In the ABI response they say, “We support the abolition of the ARP in its entirety and its residual functions transferred to the compensation fund.”
The ARP should be a sensible practical and achievable function provided that it operates as described above and not as it operates today.
Alerting Consumer/Users to the Insured Status of Solicitors
We make a suggestion as to how this ought to be dealt with. Engagement letters are issued by solicitors and these can include a statement warranting that the firm is, and will continually be, insured in accordance with the SRA mandatory insurance regulations. A copy of the regulations is available on the SRA website for anyone to see.
The SRA will maintain on its website the name of every practicing firm and the date at which the LSRA most recently verified the existence of insurance. The verification process would be random and most firms would expect to be checked every two years or thereabouts. This will put the consumer on notice and they are free to make any enquiries they wish to obtain evidence of insurance. In practice most people would not do this but the opportunity would be there. For those firms that determinedly practice without insurance the only remedy is for the SRA to require evidence to be supplied randomly and at short notice. It is most likely that the SRA (and Law Society) will know from a variety of sources the firms where their efforts would be best focused.
We agree with the ABI that the only means of providing a guarantee of compensation for victims of firms who are deliberately not insured would be a compensation fund and this could be a levy from firms in the same way as for the client monies compensation fund. There seems no rationale for having two compensation funds, however; a the incidence of losses in this category is not high and with the appropriate measures should become lower.
- What impacts do you consider such a change would have?
We agree with ABI's view :-
"It is entirely likely, of course, that many firms will be forced to close down having not secured alternative insurance by the end of the three month period. This however, is not likely to be more than the number who would close anyway were the ARP to continue, as few firms exit the ARP after the first three months of its operation."
- Do you have any comments on whether we should implement these restrictions on firms in the ARP?
We would agree with the ABI.
"Should the ARP continue to offer policies of qualifying insurance (we argue that it should not, and that it should be closed altogether) then we would agree with the restrictions as set out in paragraph 4.43."
- What impacts do you consider such a change would have?
We would agree with the ABI.
"This would assist in reducing the exposure of firms in the ARP, although SRA has not set out what would happen to claims connected to work done before the firm entered the ARP."
- Do you believe that we should change the way in which the ARP shortfall is funded? Please set out your reasons and any areas of agreement or disagreement with the analysis of the issues set out in this paper.
There is no justification in requiring insurers to pay any kind of losses for which they have received no premium. This is a counterproductive requirement of the legal profession to require of insurers.
It is only fair to adopt an FSCS model for solicitors. We are of the opinion that the shortfall of the ARP can be "run off” if the ARP is allowed to continue but under new terms and conditions, as we have described.
There are tried and tested run-off methodologies in the market that would accommodate this problem.
- In your view, what would be the impacts and the advantages and disadvantages of maintaining the current approach to funding the ARP shortfall?
We do not agree that it should be maintained. In its current form and mode of operation. See Appendix 1. It is not a fundable proposition in the long term and should therefore be changed as soon as practicable.
- In your view, what would be the impacts and the advantages and disadvantages of the two possible alternative approaches to funding the ARP shortfall set out in this paper?
An FSCS style levy on the legal profession is probably the most practical. Consideration would have to be given to the impact of another levy and we would like to be included in the discussion of this because it will impact the way brokers advise solicitors, generally about risk and insurance. Solicitors may see this as a higher cost burden but it is a successful model in the rest of the financial services sector and would help resolve the insurance premiums problems currently expensed.
We would also recommend considering a run-off financing approach proposed by the insurance market in much the same way as the Lloyd's Equitas scheme was devised to deal with its problem.
- Are there any other approaches to funding the ARP shortfall which you believe the SRA should consider?
See 28 above.
- Do you have any comments on whether we should permit the cancellation of policies for non-payment of premiums?
There is no commercial justification for requiring an insurer to remain on risk in the absence of a payment of premium. It happens nowhere else and should not be contemplated for solicitors. In the event that the premium is not paid this is a matter for the firm to be referred to the SRA. Non- payment of premium indicates the firm is in trouble and, by definition, is a justifiable reporting of a serious fact affecting the fundaments of regulation. Insurers should not be required to give any further information but the SRA have the opportunity of taking up the issue direct with the members/firm.
- Do you have any comments on whether we should permit the cancellation of policies for fraud or misrepresentation in proposal forms?
We agree with the ABI. The remedy against this is simply for notification to be given to SRA by the insurer in the event that they are contemplating cancellation for these reasons. However, the practical implications of this are more complex because it may only happen when it is discovered at the time of a claim. This would immediately put the payment of the claim in jeopardy and the compensation fund would have to take over. However, it would be sensible to consider an operating protocol between the insurer and the compensation fund to manage out the claim for a fee payable by the compensation fund thereby utilising the expertise available to the insurers and a consistency of approach that leaves the compensation fund with the opportunity of discretionary ultimate payment.
- Do you agree with our approach of having a single compensation fund which covers all regulated organisations, i.e. both traditional law firms and ABS?
We agree with ABI but would add the following. Considerable difficulties will arise if the interests of non-legal entities participating in ABS’s are mingled with the legal interests. This is a complex subject in itself, not much is known, yet, about the actual dynamics of ABSs and so it is not possible to give a fully considered opinion here.
- Do you have any comments on the interaction between the scope of cover provided by the MTC (i.e. with the proposed permitted exclusion of claims by financial institutions) and the compensation fund?
We believe the Compensation fund should be entirely discretionary and compensation based upon the facts put before the trustees/directors for the time being.
We conclude that a compensation fund run by lawyers will be entirely capable of determing compensation by reference to the terms of the MTC without actually enshringing the terms in the Compensation fund rules, per se.
- What are your views on the basis for assessing contributions to the compensation fund? Should we seek to establish a contributions formula that is more risk reflective and, if so, what approaches should we consider?
This will depend upon the outcome of how the ARP is to go forward and the scope of any new compensation fund, in the short and medium terms.
- If the purpose of the ARP was changed so that it no longer provided policies of qualifying insurance, do you believe that the ARP and Compensation Fund should be combined into a single fund?
Yes, it resolves the ARP problem
- Do you have any comments on the initial equality impact assessment?
We have no concerns about inequality in this matter.
- Do you have any comments on the draft SRA indemnity insurance rules 2011 or the draft Qualifying Insurers Agreement 2011?
Thank you for taking the time to consider our response. If you have any further queries please contact Graeme Trudgill, BIBA’s Head of Corporate Affairs for further information on 02073970218 or on firstname.lastname@example.org or Steve Foulsham, BIBA’s Technical Services Manager on 02073970234 or email@example.com or Peter Staddon, Head of Technical Services on 0207 397 0204 or firstname.lastname@example.org
Direct Tel: 020 7397 0201
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Section 5 of the CRA, the consultants say, “We note that the first purpose (of the ARP) represents one aspect of the primary objective of the financial protection arrangements more generally as set out in section 2.5 and the second purpose represents one aspect of principle 7, namely that the regulator should set the regulatory boundary. The SRA may also like to consider that it also addresses principle 8 – “the scheme should provide appropriate incentives for lawyers to undertake risk management by incorporating an element of polluter payers in to the scheme design”.
We say this because the ARP, in its original context was intended to facilitate the temporary accommodation of a firm unable to get insurance whilst the reasons for that untypical status were properly examined by the regulatory body. This is correctly referred to by CRA in its reference to the ICAEW methodology.
In our opinion the incentive to risk manage a firm should be such that admission to the ARP automatically triggers and investigation of the firm’s risk management profile.
At page 97 of the CRA report the consultants say, “Over the last ten indemnity years the loss ratio has averaged around 800%. Loss ratios of this kind would be inconceivable in the commercial market. It is also worth noting that this places the solicitor’s ARP in a different position to that of the ICAEW scheme, their premiums from firms in the ARP have usually been greater than claims costs."
CRA has correctly identified the costs to the ARP and the fact that it has served firms with less than five partners and in every year since 2004 the majority of the claims have related to negligent conveyancing. Furthermore, CRA report that, “historically more than half of the firms that successfully returned to the open market for 12 months subsequently ceased practicing or faced intervention”. And, at the end of 5.2.1, “In general the data does not support the position that a great proportion of firms in the ARP in recent years were "good’ firms". This is a point well made and raises the question whether, in general terms, it can be said that bad firms often conducting conveyancing are the root cause of the ARP’s problems.
(i) are closer to solicitor insureds than are the insurers.
(ii) recognise that small firms often carry out conveyancing because it is the easiest and generally more profitable work to do.
(iii) skills required for conveyancing are not at the top of the professional skills agenda and much of the work can be passed down to assistants who are often unqualified and unsupervised.
In our opinion there is nothing that the insurance industry can do to make some of these firms profitable to underwrite and there is a strong feeling that the SRA should take such action against some of these firms as either to remove them from practice or to require them to compulsorily change their practice methods and standards. We recognise that the latter is very difficult to achieve but at present these firms are known potential losses waiting to happen and the principles of insurance are fatally compromised by allowing this to go unchanged.
It can make no commercial sense whatsoever for these recognised sectors of the profession to carry on relying upon the ARP as an insurance of last resort in the knowledge that
(i) they can go into it, not come out of it and never have to account for the losses that they create by their negligence, before they enter or there afterwards;
(ii) they can wind up and walk away in the knowledge that the ARP will have to pay their losses;
(iii) they do not even have to pay any premium contribution in order to obtain the benefit of insurance cover.
In our opinion this is inequitable and discriminatory against the rest of the profession. Furthermore, as a community of brokers we regard this as a commercially imprudent requirement of the insurance market of qualifying insurers.
It is our experience and belief that for any scheme to be successful there must be a balance of risk and reward to the participating insurers. To require of insurers such terms that deny them the ordinary rights and remedies of insurance contracts and the reasonable controls with regard to moral hazard, selection of risk and withdrawal of cover is counterproductive to the majority of the solicitor and client beneficiaries of the mandatory scheme.
Having said that, we recognise the essential importance of consumer protection and that in return for guaranteed annual income to the insurance market (QI’s) it is not unreasonable to expect the QI’s to share a little more risk than would be normal in a facultative open market situation.
Accordingly, if it is the SRA’s intention to retain the ARP then it must revert to its originally intended status and operational dynamics (see Appendix 2) and that it ceases to be an insurance of last resort.
Rather, it should become only a temporary place of respite and reflection for firms who have no choice other than to go into the ARP in order to remain practicing and who then undertake, contractually with the insurers and the SRA to exert their own efforts under supervisory SRA direction to either wind up, sell, merge or get back to an ordinarily insurable status.
Non- Applied Firms
CRA report at 5.4 – client protection from non-applied firms – that this is likened to the Motor Insurance Bureau which exists to compensate the victims of uninsured and untraced motorists.
In our opinion the ARP is not and should never be an emulation of the Motor Insurance Bureau. If firms do not comply with insurance regulations we can see no reason why the insurance industry should pick up the bill. If the SRA conclude that it is in the public interest that claims arising from these firms should be compensated then we recommend that this should be by a separate compensation fund and that, at most, insurers might be asked to reinsure a compensation fund.
In our view there is no case for transferring this risk to the insurance industry in whole or in part. The remedy is for the SRA to implement a more rigorous audit of insurance coverage targeted particularly at the section of the profession that it suspects is non compliant and to take immediate and conclusive measures to stop such firms trading. Ideally assets should be seized as security against claims emanating from such firms.
Compensation schemes are, by definition, different from schemes of insurance of liability and we recommend that insurance and compensation remains entirely distinct and separate at all time. In our experience they are incompatible bedfellows. However, reinsurance protection is available for compensation schemes under certain circumstances, as already alluded to above.
Short Term Covers
At paragraph 5.3 on page 106 of CRA report consultants say, “It is worth noting that having an ARP to provide a role of offering short-term temporary cover is highly unusual in insurance markets.”
Whilst we entirely agree with this comment the ARP was designed for the ICAEW, originally, to provide a temporary haven for insurance whilst independent third party experts examined the reason for them not being able to get insurance. Therefore we do not regard the role of offering temporary cover as anything other than highly beneficial to solicitors in England and Wales.
At 5.5 – insurer of last resort due to misalignment of incentives – we agree with CRA’s conclusion that insurers have an incentive not to report poorly performing firms for fear of being required to give them run-off cover. In our view it is unreasonable to require insurers to give run-off cover for poorly performing firms for the following reasons.
Insurance is about fortuity of loss. That fortuity is significantly reduced, if not eliminated, by knowing in advance that the firm is poorly performing. The risk burden to insurers is therefore disproportionate and can only be paid for by increasing costs to the well performing firms, and without them actually knowing that this is happening. We regard this as imprudent and unfair.
We can see no justification for run-off cover being required at all, for no additional premium. We commented above that insurers benefitting from annual income from a mandatory scheme ought to be able to offer a little more in the way of protection. However, we feel that this is a step too far because the consequences of paying for run-off in the current circumstances are disproportionate to the insurer’s risk and therefore threaten to destabilise an otherwise reasonably stable QI insurance market.
Where does the run-off insurance premium come from? In every other kind of PI insurance this has to be funded by the firm and it is a requirement to maintain it. The RICS recommend six years but have an absolute requirement of two years. In our opinion six years is an appropriate length of time for consumer protection purposes and we would recommend that the SRA make this a requirement and consider asking the market to find a means of advanced funding for this insurance (which is possible) in and therefore transferring the risk and liability back to the firms as is proper and commercially prudent.
5.6 – Orderly rundown – we do not believe there is any merit in immediately closing down firms that go into the ARP. It would be fraught with commercial and political problems and generally not in the interests of the profession or consumers. Rather, we would recommend that independent third party intervention is part of the ARP rehabilitation process and that this paid for by the firm. If they are unable to pay for it then their options are the same as for any other commercial entity and the SRA could authorise the orderly transfer of their work to other firms. It is possible that "consideration" could pass in this situation to offset the costs of SRA overseeing the transition.
5.10.1 – payment by firms in the ARP. Our view on this is:-
that firms should pay a premium when in the ARP and if they do not do so then insurers should not be liable for any claims. This should pass to a compensation fund, as mentioned above.
The premium payable by the firm when entering the ARP should be
- Sufficient to cause pain
- Not so much as to jeopardise rehabilitation/reconstruction of the firm
- Based upon an independent assessment of affordability having regard to assets and cash flow.
Increasing the premium of the expiring year by between 50% and 100% would usually be affordable albeit a considerable strain. The ICAEW uses this method and the RICS adopts a similar standard although through a different methodology.
CRA goes on to say, “One potential improvement to the scheme would therefore be to bring in better underwriting skills…”. We think this is unrealistic. Underwriters have the skills they have and those do not include financial accounting and measurement. This is why we recommend that it should be the prerogative of an independent accountants in conjunction with underwriters rather than left to underwriters alone.
5.10.1 – Payment by Firms in the ARP – We broadly agreed with CRA report in this section. We entirely agree with recommendation 5.10.2 that if firms do not pay their premiums they should not receive insurance cover.
5.10.3 – moreover we agree with CRA’s suggestion, “The fact that large numbers of firms do not pay their premiums raises questions about the financial
viability of firms”. We agree that this suggests regulatory failure and we would urge the SRA to take steps towards ensuring that firms have sufficient resources both to pay premiums and to enter run-off if this is necessary.
The ARP was originally conceived in the early 1980s (by CT Bowring) for the Institutes of Chartered Accounts in England, Wales, Ireland and Scotland. RICS followed the methodology shortly afterwards. The ICAEW ARP and the RICS ARP are still operating after 25 years almost exactly as they were originally intended.
The ARP adopted much more recently by the Law Society scheme did not follow that structure that, in our opinion has led to the current untenable position of the ARP with it shortfall. This should not be overlooked.
What was the Genesis of the Original ARP?
In the early 1980s the ICAEW was under immense pressure from Government to follow the lead of the Law Society and impose mandatory PI insurance on its members. At the time the “big five” international accounts refused to contemplate a mandatory scheme applying to them and this gave the ICAEW a headache in knowing how to satisfy government requirements. They recognised that they couldn’t impose mandatory insurance on their profession, as the Law Society had done, because whereas the Law Society had an Act of Parliament whereby they could impose mandatory insurance status, the ICAEW did not have an equivalent and would be required to get a majority vote of members in order to bring it into being.
It was evident at that time that it would be impossible to persuade the members of ICAEW to vote for mandatory insurance and CT Bowring, who were the official brokers to the ICAEW at the time, were charged by its client (ICAEW) to find another solution.
This became the ICAEW compulsory (as distinct from mandatory) insurance scheme whereby it was a requirement that every chartered accountant would be required to have PI insurance based upon a minimum standard policy wording and underwritten by known and recognised insurers.
Self insured Excess
This scheme also included a clever device to bring the big five accountants within the regulations. Its purpose was to bring the Big 5 within the regulations but to allow them to take self insured excess that would take tem beyond the minimum sum insured requirements.
It was agreed with the ICAEW that every equity partner of every firm of chartered accountants was “good for” £20,000 personally, of their own money. This figure was used to calculate a maximum self-insured excess for the firm. E.g. four partners could carry £80,000 each and every claim, excess. At the time the majority of firms would buy £250,000 indemnity or £500,000 indemnity and these were the kind of limits imposed by the ICAEW as the maximum insurance required by the firm having regard to a multiplier of its gross fees which I recall was 1½ times and/or 3 times the largest single fee in the year preceding the year of insurance.
This put compulsory insurance beyond the actual need of the very largest firms simply by applying the multiplier for sums insured and excess so they exceeded the minimum insurance requirements.
The RICS adopted a similar approach a couple of years later.
The ARP was a by-product of the compulsory insurance concept. Its purpose was to prevent the insurance industry from summarily putting firms of accountants out of business simply by refusing to offer insurance, often at the last minute, based upon underwriting preferences or prejudices.
For example, a small firm of accountants who had experienced a loss by fraud (alleged fraud) that was notified less than a week before renewal of their insurance was denied insurance for the further future year and was therefore immediately in breach of the insurance regulations and could not continue in business. It only took one occasion for it to be recognised that there had to be a safety net for firms to prevent this unfair treatment.
The ARP concept was that if eight leading insurers (there were only eight at the time) all declined to offer insurance to the firm (and this included offering insurance at commercially unaffordable rates – which was in itself carefully defined) then the risk of the firm would be shared rateably/proportionately by all the qualifying/approved insurers in the UK PI market under a specially placed insurance contract called, the assigned risks pool. The risk was assigned to the pool and this is what happened next:-