The demise of the ARP after 30 September 2013 and the prospect of new entrants to the solicitors’ professional indemnity market creates the possibility of more incidences of insurer insolvency. We look at the consequences for firms insured by those insurers.
No financial stability requirement for qualifying insurers
Although qualifying insurers entering the solicitors’ professional indemnity market will have to be transparent about their credit and financial strength ratings, neither the Solicitors Regulatory Authority (SRA) nor the Law Society vet, approve or regulate those insurers. They do not stipulate a minimum rating or even a requirement for a rating at all. It is for insured firms and their brokers to be satisfied of the financial stability of the insurer with which cover is to be placed.
Many new entrants to the solicitors’ market will be financially stable. But there will be an increased risk that it will now attract some, which are not, and which do not have a track record of underwriting solicitors’ PI insurance. The prospect of the insolvency of less financially stable insurers represents a significant risk to those insured with them. Last year, for example, saw the insolvency of Lemma Europe Insurance Company Limited, a qualifying insurer.
Consequences of a qualifying insurer’s insolvency
The financial and commercial consequences arising out of the insolvency of a qualifying insurer are potentially serious. Claims notified to the insolvent insurer – whether before or after the insolvency event – will remain covered by that insurer as any replacement cover will only meet claims going forward. However, it is unlikely that the insolvent insurer will be in a position to pay those claims or to pay them in full. The firm will, therefore, be responsible for the cost of defending the claims and for meeting any liabilities established against it. If, despite the insurer’s insolvency, there is the possibility of a full or partial indemnity being provided by it, there is also likely to be a lengthy delay before that indemnity is paid.
Firms insured with an insurer which becomes insolvent have only four weeks in which to find themselves alternative cover, which could be problematic in the event of claims. If they do not find replacement cover and continue to trade, they will have committed a regulatory breach.
Losing the protection of the ARP
Currently the ARP is the insurer of last resort for firms which have been unable to secure cover on renewal from qualifying insurers. But it also provides a refuge for firms which cannot find replacement cover if their qualifying insurer becomes insolvent. Significantly, it provides six years of run-off cover for those firms who, after entering the ARP, cannot find alternative insurance and, as a result, have to cease to practise. From 1 October 2013 that protection will no longer exist.
Financial Services Compensation Scheme
Firms which find themselves insured by an insolvent insurer or individuals who face exposure after their firm has ceased and whose policies are in run-off, may be eligible for compensation from the Financial Services Compensation Scheme (FSCS) in relation to claims liabilities they have. However, there are several restrictions upon eligibility for the scheme including those relating to scale of turnover and assets. Most significantly, compensation from the FSCS is limited to 90 per cent of the total amount claimed. Where a firm faces substantial or multiple claims the ten per cent shortfall could be significant.
Qualification no guarantee of quality
The Law Society and the SRA are very clear that an insurer’s status as a qualifying insurer is no guarantee of its financial stability. The availability of lower premiums which competition from new capacity might bring to the market may be initially attractive. But law firms and insurance brokers advising firms about their insurance arrangements need to be satisfied about the financial standing of their chosen insurer – otherwise, a short-term saving could lead to substantial costs in the long-term.