So you have risk management – what do PI insurers make of it?

The current world economic turmoil is causing wide-ranging problems for businesses. Here in the UK we are firmly in recession and comparisons are being drawn to the early 1990s. Well-known high street retailers are in liquidation, the property market has fallen dramatically in value and repossessions are increasing. Business confidence is critically low and increasing levels of unemployment are putting additional pressures on government. Where only a year ago we witnessed interest rate rises to fight inflation, rates are now down to 1.5 per cent (at the time of writing this article) and, for the first time in history, there is speculation that rates could fall as low as 0 per cent! Where once we talked of millions, we now talk of billions, particularly in relation to bank bailouts, and indeed trillions when we talk about the growing national debt.

All businesses have to adjust to this new world order and, as solicitors are intrinsically involved in most business activities, firms face considerable challenges. After many

years of rising fee income, many firms are seeing reductions in income and those that were heavily dependent on the property market have seen dramatic changes. All firms now have to manage their costs even more carefully. The recession also brings many risks to light and presents new risks that many people will not have experienced before. It is at times like these that all firms need to take a fresh look at their cost of risk, how risk is managed, retained or transferred and, just as importantly, how they present this information to their insurers.

For most firms, the professional indemnity (PI) insurance premium is the third largest single expenditure. After salaries and office costs, the PI premium is often next on the list. With the additional risks associated with a recession, and the related hardening of the insurance market, this overhead is only likely to increase further. Insurers will also in all probability require firms to retain more risk than in previous years. Considering these and many other important factors, it is surprising to see that many firms are not presenting information relating to their risk management systems, procedures and culture in a way that will obtain the maximum benefit possible. Although insurers’ rates are driven by actuaries, underwriters do have considerable discretion and how the individual underwriter feels about the risk can have a significant impact on the premium paid.

We recognise that risk management has improved in recent years, but what do your insurers feel are the key areas? We have conducted a number of interviews with leading insurers and highlight a number of areas for consideration.

What do insurers expect from a top-20 law firm?

It would be easy to expect that all firms within the top 20 would have excellent systems and procedures, and a good risk management culture. Insurers’ experience has shown that this is not always the case. This tends to show up in the first instance in their claims record. Insurers pay credence to the root causes of claims as well as the actual merit of the claims being made.

Insurers certainly expect to see those with senior responsibility and authority being associated with the risk management role. In recent years, there has been a trend towards senior partners or managing partners taking on this position once they have stepped down from their previous responsibilities; the challenges being faced certainly call for an experienced eye and there are many reasons why this is a positive trend. In other firms, the role of chief risk officer (CRO) is performed by experienced risk management and insurance professionals. Whatever the structure, insurers expect to see clear risk identification and detailed action plans for managing performance and demonstrating continuous improvement.

Two key areas of concern for insurers in this sector of the profession are first, how overseas offices are managed, and second, how firms ensure that rainmakers and/or mavericks are subject to the same rigorous controls as other members of the team. Many of the larger claims come from these two areas and insurers are increasingly focused on them. They expect to see clear evidence of the systems and controls in place and how firms ensure consistent compliance with these procedures. These are also the two areas that can cause the greatest reputational damage.

What do insurers expect from a top-200 law firm?

Insurers understand that medium-sized firms will not necessarily have the same resources as a top-20 firm, but still expect to see strictly controlled management practices. There are many firms where the individuals responsible for risk management maintain a fee-earning role, and in some cases this can be a distinct benefit. Insurers do, however, want to see sufficient resource dedicated to risk management that is separate from fee-earning. They want to see clear management responsibility, consistent procedures, contract terms and case management protocols.

In recent years, there has been consolidation within this sector of the profession. Many firms have merged or acquired other firms in order to achieve their business objectives. Mergers and acquisitions do bring with them a variety of risk issues that are sometimes difficult to identify and control. The transitional period of bringing two firms together will always prove to be an issue and the integration of two potentially different cultures is an area that is certainly difficult to manage. There are also heightened risks regarding new conflicts of interest and potential differences in operating and case management systems. Preventing the ‘I’ve always done it this way and I’m not changing now’ attitude that can prevail may prove a challenge for the merger project team. How this is achieved is of great interest to insurers.

Other areas of concern include work and client selection. Insurers expect firms to have strict criteria for the type of work accepted and similar controls and procedures for client selection. Insurers continue to receive claims notifications from firms that have taken on work where they do not have the relevant experience to perform the work to the standards expected.

Training and development plans also need to be demonstrated, particularly where there has been an element of redeployment.

Negotiating renewal with insurers

In 2008, after a number of years of ‘soft’ market conditions (where solicitors had a wide choice of options and rates were reducing) the market turned. Many small firms were used to leaving negotiations late in an attempt to get a last minute deal as insurers fought for business – in September 2008 this was a high-risk strategy. In many sectors of the market, insurers retracted as time went on. Most firms that left it to the last minute either struggled to obtain cover or found rates had increased substantially.

Insurers were extremely nervous about conveyancing exposure following the deterioration of the property market and historical claims patterns during the last property cycle. There was also a greater emphasis on identifying those firms that might be a source of mortgage fraud. For these firms, it was all the more important to demonstrate a good attitude to risk management.

We asked insurers how firms can demonstrate a good attitude to risk. Jon Davies, assistant general manager at Travelers Professional Risks Limited responded: “Without a face-to-face meeting it is difficult. A covering letter from a managing partner or practice manager covering the key aspects of risk management is much more influential than a copy of the firm’s practice manual. At the end of the day, claims experience is the proof. Certainly an explanation of how claims came about and the steps taken to learn from this is critical if there have been any.”

Of course, it would be impossible for insurers to meet all firms. For the larger firms, however, meeting insurers with your broker can be of benefit. This meeting is, however, not without its dangers and it is important to ensure that time is devoted to preparing for this meeting. Your broker should be able to provide considerable assistance in alerting you to any particular underwriter’s concerns and the information they would like you to provide. The old adage that ‘you never get a second chance to make a first impression’ rings very true in this regard.

For those that rely on a proposal form alone, it is vital that all the relevant information is provided. We currently act for nearly 2,500 solicitors’ practices and have seen the proposal forms for many more. I would estimate that approximately 60 per cent of the proposals that we see require further information or simply have not been completed correctly. Providing full details is an absolute necessity.

One common question asked of us is ‘does Lexcel accreditation help?’ Jon Davies’ answer to this was: “Yes. It proves a direction of travel which, if borne out by the claims experience can be important to pricing. That said, there are some firms who have paid an external consultant to help them obtain accreditation and it has little impact on the quality of the firm. It usually becomes quickly identifiable when we visit a firm whether Lexcel (or any other accreditation) is a tick-box marketing exercise or a vehicle for continual improvement.”

Risks associated with the recession

There are a number of risks associated with a recession. These include:

Banks looking to recover losses related to sub-prime mortgages;
Liquidators looking to recover insolvency losses;
Fraud/dishonesty being uncovered by the recession and the associated risk of damage to reputation;
Client loss;
Bad debts/billing;
Diversifying/reallocation of resources; and,
Lack of revenue resulting in firms taking on dubious work.

Many individuals within the profession and the insurance industry will have no experience of trading through a recession. This is a time for the experienced to provide the help and guidance required by the less experienced to ensure firms trade through this difficult period.

Now is the time to be acutely aware of the ‘enterprise risks’. Cash strapped clients are more likely to question bills and just as likely to make a complaint. Pursuing clients for unpaid bills is increasingly likely to result in a counter claim. It is vitally important that fee-earners and the finance department work closely together. Any file where there is a significant outstanding bill should be reviewed to ensure the work undertaken is properly documented before taking a firm stance. Pursuing a bill where a file is inadequate can lead to greater problems and it may well be more sensible to negotiate the outstanding fee rather than aggressively seek full payment.

Additionally, this is a time when the actions of overworked solicitors during the boom years may come to light. It is advisable to identify and audit areas of the business that may be at risk before any problems are identified by clients. In the current economic climate, clients are far less likely to be tolerant of mistakes or, for that matter, poor service.

Ten top tips for 2009

If you haven’t implemented a risk register – implement one. If you have one already, ensure it is updated. Risks are ever-changing and as new threats or opportunities arise, these need to be carefully assessed;
File reviews – using your risk register you can focus immediate attention on the areas most at risk and review files and procedures. While standards and procedures exist, these are often aspirational and the reality can be somewhat different.;
Finance – billing clients regularly helps to keep bad debt risk to a minimum. Cash flow is king for any business and having outstanding bills growing in size will create a potential time bomb;
Make sure your engagement letters are comprehensive, clear and used on all matters;
Make sure your procedures for meeting the anti-money laundering regulations are followed;
Ensure that any staff being redeployed to other areas are properly trained and supervised, or you may be creating a bigger problem than you are solving;
Ensure that there is a focus on staff motivation. Keep a watching eye and provide help and support where required;
Ensure that solicitors remember to notify anything they think may give rise to a claim. Staff can become nervous of doing so when others have recently been made redundant or consultation periods are in place;
Due diligence – ensure that, if your firm is in merger or acquisition discussions, you fully review successor issues and perform adequate due diligence in respect of risk and insurance issues. Your broker should be able to assist; and,
Get good advice – this is not the time for a novice or a generalist. Using a specialist PI insurance broker will increase the chances of obtaining the optimum blend of protection and pricing.

2009 will undoubtedly present many challenges. The economy is widely reported to remain in recession throughout 2009 and the burden of repaying the national debt will no doubt present issues for the next decade. Managing the immediate risks and ensuring cost effective risk transfer via insurance will need careful consideration and preparation. Firms that can demonstrate to insurers clear, consistent risk management procedures and maintain a good claims record through these difficult times will surely benefit when they renew their PI insurance.

Colin Taylor is a director, Lexcel consultant and head of risk management at Prime Professions. He can be contact on 020 7173 2100 or ctaylor@primeprofessions.co.uk