The requirement for solicitors to purchase and maintain professional indemnity insurance (PII) affects decisions that law firms and their partners* make in relation to succession planning and retirement.
Retiring – existing firm to continue
The Solicitors Regulation Authority (SRA) professional indemnity rules require that the continuing firm provides cover to former partners and, in the event of their death, their estate. Upon retiring, a partner therefore remains covered for any liabilities arising out of the firm’s private legal practice.
Should the firm subsequently close, it will be required to purchase six years’ run-off cover that meets the requirements of the Minimum Terms and Conditions for solicitors’ professional indemnity (MTC), which, of course, will provide cover in respect of any former partner, including liabilities incurred while they were in practice at predecessor firms to which the firm is a successor under the SRA Rules.
Currently, the MTC require that a firm purchases cover with a limit of indemnity of at least £2 million for sole practitioners and partnerships, and £3 million for incorporated practices and alternative business structures (ABS). Firms are free to purchase a higher limit; indeed, regulatory outcome 7.13 requires that firms make an assessment of what indemnity limit is appropriate for that practice, and purchases cover at that level.
Solicitors’ professional indemnity policies are written on a “claims made” basis, meaning it is the policy in force at the time that a claim is made (or circumstance first notified) that pays, not the policy in force at the time the work was done. For this reason, where the indemnity limit is in excess of the mandatory minimum, it would be prudent for the retiring partner to agree with the continuing firm that it will maintain an indemnity limit going forward that is no less that the level in place at retirement.
Many solicitors’ professional indemnity policies carry an excess, which in many cases, but not always, benefits from an aggregate cap. This limits the total amount of excesses to be paid in any one year. The continuing firm and retiring partner will need to agree whether or not the retiring partner will meet or contribute to any excess, in relation to any claims for which the retiring partner has a liability. The firm could opt to increase the excess in future, so it would be prudent for the retiring partner to agree a maximum amount with the firm.
Planned closure of the practice – requirements
Where a firm closes with no successor practice, SRA indemnity insurance rules require that the firm purchases six years’ run-off cover.
Further, the Participating Insurer Agreement (PIA) requires that the insurer on risk at the time a firm closes, provides six years’ run-off cover even if the firm is unable to meet the premium. However, this should not be considered as an option to dodge payment of premiums by firms or their partners. Non-payment of premium is a disciplinary matter and may affect the ability of the former partners of the closed firm to maintain a practicing certificate. Further, the participating insurer’s agreement requires insurers to notify the SRA where premiums have not been paid.
Where a partnership firm has not paid the premium due, insurers can (and certainly have in the past) sought recovery of outstanding premiums from the individual partners. Of course, many practices benefit from limited liability but this is not necessarily a protection, as some policies contain conditions agreeing that the principals of firms benefiting from limited liability, will be personally liable for outstanding premiums.
Run-off cover – scope
Run-off cover arranged must meet the MTC requirements for solicitors’ PII. The cover runs for six years from the expiry date of the policy currently in force at the time that the practice closes. If a firm closes after, for example, six months of the current policy period, in effect it will have a further six and a half years of cover.
As previously stated, the MTC require a firm to purchase cover with an indemnity limit of £2-3 million. Under the PIA, insurers are only required to provide cover that meets these minimum limits, so where a firm has a higher indemnity limit than this at closure, it might find that its run-off cover reduces to the minimum limit.
In theory there is no reason why a firm could not agree with its insurer(s) a higher limit than the required minimum. In practice, however, it is most unlikely that insurers will be prepared to offer higher limits.
Run-off cover – the costs and considerations
Typically, the premium for run-off cover is between 200% and 350% of the last annual premium. Insurers are required to state this figure in the policy schedule of the current policy. Where there is a material change in the risk since last renewal, some insurers maintain the right to amend the published rate for run-off cover. In theory, a practice could pay the run-off premium over a period of time, but, in practice most insurers would be reluctant to permit this, so a firm that is planning to close should assume that the premium for run-off cover will need to be paid in full.
Run-off cover is often considered a barrier to a firm closing, so firms that are thinking of closing should plan to mitigate the cost of run-off cover, and consider the following steps:
- Ensure that professional indemnity premiums are as competitive as possible.
- Check what the rate for run-off cover is with the selected insurer. It may be better to pay a higher premium with another insurer if their rate for run-off is significantly better.
- The fee income of the firm affects the premium that it pays, so it might be worth considering scaling back the practice if the firm knows that it will close in the future.
- Move the renewal date to coincide with the closure date. Because the run-off period begins at the expiry of the current policy, if a firm closes after six months then in effect it will have cover for a further six and a half years. Now that there is no single renewal date, it might be possible for a firm to bring forward its renewal date (and possibly receive credit against run-off premium with the agreement of its insurer).
Given that plenty of insurers offer MTC cover, it might be assumed that there is a competitive market for run-off cover. The rules require cover to be provided by a participating insurer, but they do not make it compulsory for a firm to purchase cover from their current insurer. Unfortunately, run-off cover is universally unpopular among participating insurers, so it is most unlikely that a firm will find any insurer, other than its current insurer, willing to provide cover.
As has been widely reported, a number of insurers of PII have ceased trading in recent years. It is therefore vital to select a financially sound insurer – particularly because a firm purchasing run-off cover will rely on its insurer for a further six years.
Run-off cover – what happens after six years?
Any practice that has closed without a successor since 2000 currently benefits from further professional indemnity cover through the old Solicitors Indemnity Fund (SIF), for any claim made after the expiry of the six-year run-off cover provided by its original insurer. This arrangement expires in September 2020.
In March 2016, the SRA decided it was not prepared to extend this facility beyond the expiry date, because of concerns that the Solicitors Indemnity Fund (SIF) may have insufficient funds to cover the additional claims, and that extending the cover was contrary to its existing policy aims.
At the time, Paul Philip, SRA Chief Executive, said: “We consulted on reducing the amount of run-off cover because many see it as a barrier to closing down, and that’s still something we want to look at. Extending cover through SIF would be contrary to that aim and would be suggesting that six years’ run-off cover is not enough.”
The Law Society has tried to find an open-market solution to replace the cover provided by SIF and although no such facility has yet been launched, we understand that a solution is nearly ready to be formally announced. This solution is likely to extend the run-off on an annual rolling renewal basis. It may be possible to arrange cover on an individual basis, although insurers’ appetite to do this, and at what terms, is unclear.
Selling your practice to another firm
An alternative to closing a firm is to sell or otherwise dispose of the practice to another firm, which would become a successor practice. By default, a successor practice provides ongoing cover for the prior practice and its partners.
This option removes the requirement to purchase six years’ run-off cover and is clearly attractive to the acquired firm. However, a successor practice’s own insurance costs will be affected by the claims history and risk profile of the practice it is taking over – making it increasingly unattractive for a firm to take over another.
SRA recognised this issue and, in 2014, changed the rules so that a firm wishing to be acquired could elect to purchase run-off cover from its last insurer, which is obliged to provide the cover. In these circumstances, the acquiring practice would no longer be considered as successor to the firm being acquired. This has made it much easier for principals to sell their firm to another, although much of this benefit is offset by the premium needed to be paid for run-off cover.
While the last insurer must provide this elective run-off cover if so requested, it is only obliged to do so provided that the premium is paid in full, prior to the acquisition. If the premium is not paid in full, the acquiring practice becomes the successor practice by default. Further, the rules are not clear that the premium for elective run-off cover must be the same as that for standard run-off cover, and some insurers reserve the right to determine the premium for elective run-off cover at the point when the request for the cover is made.
Clearly the rules and considerations applying to ceasing practice are complicated and a range of outcomes are possible, most of which have significant financial implications. Like any major business decision, planning well in advance, and checking that plans remain viable, always repays the effort. Marsh JLT are here to help with insurance issues, and if you have any queries, get in touch with your normal Marsh JLT contact