2017 The Law Society. All rights reserved.

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1 SRA publication 'Reflecting on Solicitors Professional Indemnity Insurance: market trends and analysis of historic claims data' The Law Society s response 7 March The Law Society. All rights reserved.

2 Introduction 1. The Law Society of England and Wales ('the Society') is the professional body for the solicitors profession in England and Wales, representing over 170,000 solicitors. The Society represents the profession to Parliament, government and regulatory bodies and has a public interest in the reform of the law. 2. We are providing a response to the SRA's publication 1 'Reflecting on Solicitors Professional Indemnity Insurance (PII): market trends and analysis of historic claims data' (October 2016). The SRA's accompanying news release 2 stated that the data pack is intended to provide a foundation for discussion on possible reforms to the regulatory arrangements for solicitors' PII. It is on this basis that the Society has chosen to comment. Data collection 3. PII is a complex market and gathering comprehensive data on claims against PII policies is difficult. Claims data is not held centrally, but by each separate insurer. We appreciate the SRA's efforts to gather data on PII claims to inform its regulatory approach. We also welcome the SRA's decision to make the analysis of the data publicly available to stimulate a discussion on what reforms to PII may be necessary or appropriate. 4. We understand that some insurers currently active in the solicitors' PII market supplied claims data covering the years There are some clear limitations to the dataset that need to be taken into account: The SRA estimates that the data covers 90% of insurers currently participating in the PII market. Many insurers who have exited the market in the period before 2014 (and in some cases become insolvent 3 ) will not have supplied their claims data and it may be expected that they carried the larger losses. It is therefore likely that that the true frequency and aggregate value of claims is greater and higher than the data pack suggests. The data pack does not include year-on-year comparisons of claim volumes and types of claim, although it is well known that types of claims change annually and claim patterns and volumes are tied to the state of the economy. The impact of cyber crime has not yet been properly evaluated. The dataset does not account for the increase in claims related to cyber crime post 2014, some of which have exceeded 1 million in value. 4 The recent Dreamvar case 5 has also raised concerns over growing identity fraud For example, Quinn, Lemma, Balva, ERIC and Enterprise will not have supplied claims data. This omission is not insignificant - when Quinn was declared insolvent, it was insuring approximately 30% of all solicitors' firms in England and Wales. 4 See, for example, 5 See / article 1

3 Insurers will not have categorised claims in the same way, which as a consequence may have led to inconsistencies in the way data has been aggregated. For example, a claim arising from the administration of an estate that involved the sale of a property, and advice on trusts and tax issues, could be classified differently from insurer to insurer. The data pack contains the SRA's interpretation of the data supplied by insurers to a third party. Without a better understanding of the underlying data and the methodology used to develop the data pack, it is hard to draw firm conclusions, nevertheless the representations we make in this document are on the basis of using the data as a baseline indicator of PII claims values and patterns. Basis for reform Reducing the cost of regulation 5. The SRA has stated that it intends to use the data pack to inform its development of proposals to reform the minimum terms and conditions of PII, as highlighted in the news release accompanying publication of the data pack. 6 The value of PII 6. The Society agrees that it is important to ensure that PII is affordable and proportionate for firms. Firms spend on average 4.8% of their annual turnover on PII. 7 The data pack shows that these costs are particularly high for sole practitioners and 2-4 partner firms, where the average cost of PII is 7% and 5.5% of firm turnover respectively This is borne out in LSB research from 2015, which reported that PII was perceived by SRA-regulated firms to be one of the highest cost areas of regulation However, while we acknowledge that PII costs can be perceived as high for some solicitors, the protections afforded by the minimum terms and conditions of PII (MTCs) are crucial to consumers and solicitors, as well as maintaining business confidence and supporting the wider public interest. Potential reforms Reduction in the minimum level of cover 9. The data pack notes that 98% of claims settled for less than 580,000, raising the possibility that the SRA may be inclined to revive its 2014 proposal to reduce the 6 "Securing an indemnity insurance policy is the single highest cost of regulation - with small firms particularly affected. The SRA wants to take a proportionate approach to setting minimum terms and conditions, making sure clients have the right level of protection in place without firms incurring additional expense that ultimately drives up costs, costs which are passed on to clients." 7 Law Society PII survey, p Data taken from the Law Society s PII survey, p LSB, The regulated communities views on the cost of regulation (March 2015), p.5. N.B. This statistic relates to the cost of regulation only, not of doing business generally. 2

4 minimum compulsory level of PII cover from the current 2 million / 3 million. The Society believes that even a substantial reduction in the level of cover would not lead to meaningful reductions in PII premiums, certainly not to the extent to justify the decreased protection for solicitors and their clients. Reduction in protection for consumers 10. The current minimum level of cover provides an appropriate level of protection for clients. The fact that the current protections are generally working well and consumers should not be expected to take on additional risks was corroborated by the response of the Legal Services Consumer Panel to the SRA's September 2014 call for evidence on client financial protection issues. 10 Reducing the minimum compulsory level of insurance would create a gap in consumer protection which disregards the need to maintain public trust and confidence in the solicitor profession. We support the judicial view that the solicitors profession is one in which the public must be able to place absolute trust We note with interest that the SRA draws out the 98th percentile figures throughout the data pack (e.g. that 98% of claims settled for less than 580,000). Insurance exists exactly for the purpose of protection against the worst case and unforeseen scenarios where the remaining 2% of claims fall. Using the figures provided, rudimentary calculations suggest that if the minimum level of cover was reduced to 580,000, there would be approximately 46 occasions per year where a firm's insurance would not cover the cost of a successful claim 12, amounting to 8% of payments by value ( 157 million) that would no longer be fully covered. 13 It is difficult to analyse the possible impact on consumers because the data pack does not provide statistics on the individual values of the 2% of claims that would not be covered in the event that cover was reduced to 580,000 (i.e. would a client on average be 50 out of pocket, or would there be life-changing 1.5m losses?). Clients would have limited chances of recovering the shortfall, relying on the firm having sufficient funds to cover the deficit, or suing the partners of the firm individually where possible s/client%20protection%20call%20for%20evidence%20september%202014%20final.pdf 11 That belief in the existing client financial protections was re-iterated by the Wolstenholmes sentencing judge's statement when he referred to the profession as: '...a business in which members of the public are entitled to place absolute trust'. Case No.2MA June According to data pack, 142,000 claims were notified over the 10 year period On average, there are therefore 14,200 notifications per year. If one in five notifications result in a claim, there are 2,840 insurance payouts per year. If cover was reduced to 580,000, 2% of these payouts would exceed the minimum level of compulsory insurance, i.e occasions. Removing the 19% of firms that have top-up insurance (according to the Law Society's PII survey, p.47), there would be 46 instances per year where a firm would be left with a shortfall. N.B. As discussed earlier, it is likely that the 580,000 figure is an extremely conservative starting point as claims against insurers that have gone insolvent were not included in the dataset. 13 From the data supplied in the data pack, 1,954m of total indemnity payments divided by a mean payment of 72,000 (slide 11) implies 27,146 payments, or 271 payments per percentile. Payments of 580k and almost 1m for the 98th and 99th percentile (slide 15) imply that on a conservative basis, reducing the minimum level of cover to 580,000 would leave around 157m of payments uncovered by PII, or around 8%. 3

5 12. The consequence of reducing the minimum level of cover is that clients' access to redress would be reduced if firms were not correctly incentivised to purchase top-up cover where necessary, and the reputation of the profession would come into disrepute as consumers discovered that their claim was not covered by the firm's insurance. The requirement on firms to assess and purchase the level of cover appropriate for the firm is not an effective consumer safeguard. As explained below, this regulatory outcome does not allow firms to purchase cover they cannot obtain or afford. In addition, difficulties in assessing exposure from possible related claims (which may or may not be treated in aggregate) will inevitably lead to instances of underinsurance. 13. The upshot of any reduction in the minimum level of cover may well be that astute consumers would take their future business to a larger firm where there may be more confidence of sufficient cover and a greater level of protection, hence removing work from smaller high street firms, reducing choice, access to justice and adversely affecting BAME solicitors. 14. Reducing the minimum level of cover would also raise the issue of what that new minimum should be. As mentioned above, the data pack does not include any yearon-year comparisons of claim volumes and types of claim, although we do know that types of claim change from year to year and claim patterns and volumes are tied to the state of the economy. If the minimum level of cover was reduced and the following year there was a spike in high value claims, this new minimum would no longer be appropriate. Any new minimum level would have to include a large enough margin of error to cater for changing claims patterns and potential rapid economic changes, as well as account for inflation. Reduction in protection for solicitors 15. The data pack shows that if the minimum level of protection was reduced to 580,000, 98% of claims would be met. However, the effect on a solicitors' firm and its partners in the remaining 2% of cases where the claim was not fully met by insurance, could be catastrophic. A claim of 2m, in the absence of top-up insurance, could lead to a shortfall of almost 1.5m. In some situations, high value uninsured risks could easily lead to firm insolvency and a reduction in competition and choice. Effect on premiums 16. All indications are that reducing the minimum level of cover to, say, 500,000, would have little effect on premiums, including for small firms for whom the SRA appears particularly keen to reduce regulatory costs. A 75% reduction in the minimum level of cover would lead to nowhere near a 75% reduction in the cost of premium. Premiums are assessed with reference to firm's turnover measured in cases and value, the insurer's premium rate, and the levels of risk associated with the type(s) of work undertaken by the firm. An underwriter knows the risks and the likely maximum potential losses, and prices its policies accordingly. The insurance market is already aware of the mean and median claim figures. It is widely known and understood that the majority of the exposure for solicitor firms sits within the first 500,000. This is corroborated by the SRA's own interpretation of the dataset, which shows that 98% of claims settled for less than 580,000. It is therefore unlikely that there would be any significant premium reduction for a firm taking out cover to a new minimum around the 500,000-1m mark. 4

6 17. Evidence that altering the limit would not have any significant impact on premium comes from the 2005/6 renewal. In 2005, the limit of cover doubled from 1m to 2m. The impact of this was negligible with the total market premium that year only moving by 0.45%. 14 Similarly, when the SRA consulted in 2014 on reducing the minimum level of cover to 500,000, insurer respondents agreed that reducing limits would not reduce the risk to insurers to such an extent that the cost of cover would reduce pro rata to the limit reduction. Rather, the premium reductions across the board were unlikely to be in excess of 5-10%. Given that there has been no change to the PII regime since 2014 (besides alterations to the MTCs to reflect the Insurance Act 2015), there is no reason to believe that insurers' views on this matter will have changed since Anecdotally, the Society s recent conversations with a number of insurers and brokers support this assertion. Effect on top-up cover 18. A lower compulsory limit of indemnity would boost the top-up market, as many firms would wish to insure themselves beyond the new minimum. However, reducing the baseline level of compulsory cover could lead to a corresponding increase in the price of top-up insurance, and/or affect firms' ability to obtain top-up cover on MTCs. Conclusion on minimum level of cover 19. In light of the reasoning set out above, the Society maintains that reducing the minimum level of cover would be misguided, allowing firms to opt for lower levels of insurance cover would: increase the risk exposure of firms and their clients to unnecessary and avoidable levels; create an uncertain and potentially more costly market for top-up cover; allow trust in the legal system to be eroded by unmet claims; and lead to no substantial reduction in the cost of regulation to firms, or the cost of legal services for consumers, via lower PII premiums. Other issues raised by the data pack 20. We have set out below some initial reflections on other issues raised by the data pack. Innovation in insurance products 21. The SRA's accompanying analysis to the data pack suggests that prescriptive coverage via the MTCs is preventing innovation in insurance products for emerging risks. We assume that the SRA is referring to risks such as theft of money from firms client accounts via scams. However, the profession and consumers benefit from this insurance cover being part and parcel of the MTCs and therefore face reduced regulatory burdens and costs of purchasing separate insurance elsewhere. Indeed, there is no guarantee that insurance to cover certain risks would be available to law firms (or if so, at affordable prices), if no longer covered by the MTCs. While insurance products to cover certain aspects of cyber risks are still 14 SRA/Zurich.pdf 5

7 evolving, it seems sensible for these emerging risks to continue to be covered by the MTCs. 22. Before any reduction in the MTCs is proposed, it would be critical to show that insurance would be available to cover the risks no longer covered by the MTCs. Run off cover 23. The data pack includes run off claim figures from the Solicitors Indemnity Fund, showing that 35% of claims by number, and 39% claims by value, arise after the first three years in run off. We believe these figures provide sufficient evidence of the risk of long-tail run off claims emerging to prevent the SRA proposing to reduce the requirement for compulsory run off cover below the current six years. 24. The Society would welcome further discussions with the SRA on this matter. 6

8 Annex 1 Source: Law Society Group Management Information If the total number of solicitor firms in England and Wales are split into four equally sized groups according to firms size (measured by annual turnover), the smallest group (quarter) of firms earns only 0.7% of all solicitor revenue from residential and commercial property work. Corresponding percentages are shown for all other areas of solicitor work (excluding residential and commercial property). The chart therefore shows that the smallest groups of solicitor firms account for larger shares of revenue from residential and commercial property work than they do for other areas of work. 7

9 Excluding top 50 firms: Source: Law Society Group Management Information As above, but excludes the top 50 firms which account for approximately 35% of all income and many of which are global firms specialising in corporate work. 8