Coping with the potential October PII Rule Changes
Following its consultation earlier in the year, the SRA has now announced its plans to make changes to rules relating to the minimum terms for PII cover, residual balances and compensation fund eligibility, despite reservations expressed by many – including the Law Society.
The SRA claim that the changes to its regulatory requirements will make them more proportionate and targeted and so reduce the cost and burden of regulation and that in doing so they will:
- remove unnecessary regulatory barriers and restrictions to enable increased competition, innovation and growth to serve the consumers of legal services better,
- reduce unnecessary regulatory burdens and cost on regulated firms, and
- ensure that regulation is properly targeted and proportionate for all solicitors and regulated businesses, particularly small businesses.
Many, including the Law Society, do not agree and, certainly in the case of changes to the compulsory level of PII, will be asking the LSB to block the proposed changes.
The SRA claim in their press release about the changes that “The majority of responses to our consultations agreed with our aim of reducing the burden of regulation.” Unfortunately this is not something that is easily verified since the section dealing with consultations simply indicates that, in relation to the outcome from them, “analysis of responses in progress”.
Action and Reaction
Part of the problem with the proposed changes is, as Newton so clearly explained in his Third Law of Motion, that “for every action, there is an equal and opposite reaction”. If the SRA acts to reduce the burden of regulatory requirements then there will inevitable be those who, no longer able to rely upon the safeguards which those regulations brought, will simply react in such a way that any benefit derived from the easing of the burden will be lost in the detriment of reduced willingness to instruct.
That particularly applies to the reduction in the level of PII.
The Law Society commented in a press release in June that:
“The lending institutions have already made clear that if the removal of client protections proposals go ahead, lenders will act swiftly to minimise their exposure to risk. This could mean a substantial reduction in the number of firms which act on their panels and introducing greater controls on those they retain or even moving work away from ‘high street’ firms”.
Meanwhile, those within the insurance industry have indicated that the changes would not even necessarily reduce the cost of PII. A prevalent viewpoint is that since the most significant risk for insurers lies within the lower bands of insurance cover the costs of cover, especially for those firms deemed to be high risk firms will continue to be high.
In any event, the change in the regulation is not as clear cut as a reduction to £500,000. What the proposed change actually provides is to reduce the minimum level of compulsory cover per claim to £500,000, but also, at the same time to place a new compulsory outcome in the Code of Conduct to require firms to assess and purchase an appropriate level of insurance cover.
In other words swapping regulatory certainty for an uncertain system where firms have to predict the level of cover they will need and potentially run the risk of regulatory sanction if the SRA do not feel that they have exercised that decision in a manner which addresses the risks within the firm.
If the changes are introduced in October 2014, as the SRA plan, then this does not give firms adequate time to be able to assess in any adequate and objective way what their PII requirements are and to then make an informed decision. In particular, it does not give them the opportunity to find out whether, in real terms, they will be better or worse off if they elect for a reduced amount.
Objections to the SRA’s plans have come from many sources.
James Dalton, the Head of Liability Insurance at the Association of British Insurers said:
“Reducing the minimum level of PII cover for solicitors does not change the risk profile of the firm and only increases the risks to consumers if things go wrong. Consumers will end up paying the price because the SRA thinks solicitors should save money rather than protect consumers. The SRA is misguided in thinking that lowering the limit will lead to a meaningful reduction in premiums for small firms.
“The SRA has not made a final decision on whether consumers who are failed by a lower PII limit will be able to make a claim from the compensation fund. If they can, this will result in an increased levy on those firms who make prudent and sensible arrangements for their own PII cover.
“The Legal Services Board needs to ask itself whether the SRA’s proposals are a good outcome either for the legal profession or, more importantly, the profession’s customers.”
Whilst the Nationwide Building Society has said that all 4,300 firms on its panel must maintain a minimum cover of £2m as at present. Their view is that they do not support the changes which they believe will reduce the level of regulatory protection provided to their customers, and have stated that they “hope the Legal Services Board will reject these proposals.”
A point for many firms to bear in mind is that even if the LSB does not reject the proposals many mortgage lenders will follow the Nationwide and insist upon solicitors having higher cover than £500,000 if they are carrying out conveyancing work.
The Council of Mortgage Lenders, in their response to the SRA consultation (www.cml.org.uk/cml/filegrab/180614-sra-consultation-pii-reducing-mtc.pdf?ref=9038) have also come out against the proposals, stating that they believe that:
- there will be a range of unintended and undesirable consequences on the conveyancing market, with a disproportionate impact on small firms;
- the SRA should first concentrate on tackling the causes of PI claims and focus on high risk areas such as conveyancing;
- there is no robust evidence to support the anticipated benefits of lower costs to small firms by way of lower PII costs;
- the proposals will make solicitors a less attractive option for clients where they have access to other professionals who offer them greater protection; and
- the proposed timeframe for change is incredibly short and does not give the market time to react and prepare. Lenders would need at least 18 months to prepare for these changes.
Firms should be aware of these viewpoints when considering whether to reduce their level of cover.
Assessing the firm’s PII needs
So what factors should firms be considering when looking at the level of PII cover they should take in the coming years? There are firms who will undoubtedly benefit from lower premiums – especially those operating in very low-risk areas of work or where the level of potential financial claim against them is likely to be low. Others, however, in higher risk areas, may however, succeed in reducing their premiums but only by exposing themselves to potentially costly uninsured risk.
For this reason, firms have to give careful and realistic thought to what exactly is their level of potential exposure to risk and, having ascertained that, decide whether any saving they may achieve in reduced premiums – bearing in mind that they may not see a great reduction if they are in a high risk area of work – is worth the increased risk of uninsured claims arising.
Clearly the firm will need to give careful thought to the type of work that it undertakes, the value of the transactions that are involved and the likely level of any loss that a client could incur should the firm be negligent. This could include looking at the value of properties if the firm undertakes conveyancing or the potential level of loss as a result of bad advice if the firm provides financial advice of any sort.
Also relevant is the extent to which the firm is able to manage those who undertake work, the extent to which the firm could be vulnerable to “rogue elements” within the firm and the firm’s ability to manage the risks which arise.
Next, the firm needs to consider the nature of the client’s for whom it acts and in particular the likely attitude of those clients to the proposed level of cover – for example we have seen above how lenders can be looking for firms to maintain higher levels of cover.
Consideration should also be given to the extent to which the firm is willing to take on unfamiliar areas of law or whether there is a risk from undertaking pro bono work, or work for charities and other non-commercial advice services.
The firm needs also to look at some of the wider risks than purely the work it undertakes, for example cyber risks from new technologies, such as digital document storage and electronic filing, and risks to the integrity of the firm through issues such as natural disasters or terrorism. Here it would be wise to have, and consider the contents of, risk and business continuity plans.
These are only some of the factors that firms will need to consider. However, from as pragmatic perspective, perhaps the most effective way forward is to ask the question if the claim by the SRA is correct and a reduction in premium of around 5% can be achieved by reducing cover from £2m/£3m to £500,000, is this sufficient justification for the increased risk? Furthermore, since cover is on a “claims made” basis – that is to say that the cover a firm has is for the time at which a claim arises and not the time of the act or omission leading to the claim – then firms could find themselves inadequately insured in relation to work carried out in previous years when the firm would have had a higher level of cover.
Whatever decision the firm reaches, it must be based upon sound logic and not be one which is plucked from the air or taken for no reason other than that it might result in a lower premium.
For a comprehensive note on many of the aspects of PII, see the Law Society’s PII Practice Note – www.lawsociety.org.uk/advice/practice-notes/professional-indemnity-insurance/