How much PII does a law firm need?

Are you tempted to reduce the limit of indemnity on your professional indemnity insurance (PII) to control your firm’s premium spend? Be aware of your regulatory obligations before you make a decision on this.

The issue

Law firms must have the compulsory primary £2m or £3m of cover required by the SRA’s Minimum Terms and Conditions (MTCs), but it is for firms to make their own decision as to the amount of excess layer cover (sometimes referred to as top-up cover) that they purchase.

Historically, excess layers have been very competitively priced, however an increase in the incidence of high-value claims hitting these layers has caused some insurers to remove their capacity from this area of the market and others have increased premiums by over 100%. This means that reducing the level of excess layer cover can now achieve a substantial reduction in a law firm’s overall premium spend.

As a result, many firms are pausing to reflect on the level of cover they really need. We urge caution on this issue and remind firms that if they are considering a change in their limit of indemnity, then they must be mindful of their regulatory obligations.

What are the rules?

The starting point is clause 3.1 of the SRA Indemnity Insurance Rules. It requires firms to

…take out and maintain professional indemnity insurance that provides adequate and appropriate cover in respect of current or past practice taking into account any alternative arrangements the body or its clients may make.

It is important to remember that your PII cover is written on a “claims made” basis with cover relating to the period when the claim is made, not when the work was performed. This is why the above rule refers to both current and past practice and both must be considered.

Assessing what is “adequate and appropriate”

While the SRA sets compulsory cover at a minimum of £2m for sole practitioners and partnerships and £3m for LLPs and other incorporated practices, this does not mean that such cover is “adequate and appropriate” for your firm. It could be, but this will depend on a range of issues and some firms will need significantly more cover in order to discharge their regulatory obligations.

The SRA have published a Practice Note on this issue that is available here. It is in the “must read” category for all those who are involved in purchasing the PII for law firms. Significantly, the note includes the following comment:

If a firm or individual can demonstrate to our satisfaction that they made an assessment, which includes consideration of any relevant factors listed in this guidance, and reached a reasonable and rational decision as to the appropriate level and wider terms of professional indemnity insurance cover, then we would not second guess that decision or take action for breach of this requirement.

It is therefore important that firms undertake a “reasonable and rational” assessment of the cover required and we recommend that this is done at each renewal. Care is required, as while it might be tempting to reduce your firm’s limit of indemnity to control the premium spend, claims inflation and the general increase in size of losses may mean you actually need to consider buying more cover.

Documenting your consideration of the issue and the decision-making process are key requirements to ensure that you can evidence your assessment to the SRA if called upon to do so.

Based on our experience as experts in solicitors’ PII, we recommend firms also consider the following issues:

• Your limit of indemnity needs to provide enough protection to cover both the claim and claimant costs. The latter can be considerable, particularly for any matters that proceed to a full defended hearing.  Seven-figure sums are not unheard of.  Be sure to take this element of the exposure into account when considering the level of cover you need.
• You need to consider whether you have agreed with any clients to maintain cover at a specific level. If you have, then you could find yourself in breach of contract by reducing the limit.  The consequences of this could outweigh the savings achieved. 
• Likewise, have you agreed with any former principals in the firm to maintain a certain level of cover? If you have, then you should consider contacting the individual(s) concerned to discuss the issue with a view to agreeing any proposed reduction in the limit.
• While the primary cover is written on an “each and every claim” basis, there is an aggregation provision which means that in certain situations insurers can treat a group of related claims as one claim, and subject to one limit. While the situations where this happens are rare, you need to consider if the work you undertake is more exposed to the risk of multiple claims that could be subject to an aggregation argument.  In this situation consideration should be given to a higher limit of indemnity.

Is limiting liability an answer?

Limiting (sometimes referred to as capping) liability at the point of client engagement can be a useful tool to control the limit of your exposure in the event of a claim, but again we urge caution with this approach. It can be difficult to get this right and you need to be confident that the limitation will be valid and enforceable if it is subsequently challenged.

The issue of limiting liability is discussed by the SRA in the Practice Note referred to above and we draw attention to the following extract in particular:

Any cap should [therefore]:

i.   be fair and reasonable in the particular circumstances of the client and
     the case;

ii.  reflect the balance of power and knowledge between the solicitors, REL
     or firm and that client; and 

iii. take into account the best interests of that client (SRA Principle 7); and must be communicated to the client in a way that they can understand the impact.

In addition to our requirements, the client will be protected by general consumer law which focuses on making sure that terms of any contract for service are not unfair.

We would therefore not expect to see caps put on liability to clients as a matter of routine.

For further discussion on the issue of limiting liability we would also recommend an article by Plexus Law that we published recently. It is available here. 

Dealing with a one-off high value case

Having considered the issue of “adequate and appropriate” insurance at the time of renewal and settled on the limit of indemnity that should be purchased, what happens if a client wants to instruct the firm in relation to a transaction where the value exceeds that limit?

Firms often contact us in this scenario to enquire whether it is possible to purchase a one-off policy or endorsement to cover this work. There is no market for a one-off policy to cover a particular transaction and as discussed above, given the “claims made” nature of PII cover, any increase in the limit of indemnity to cover the work will need to be repeated in successive years, until such time as you are satisfied that the limitation date for bringing any claim arising out of the work has passed. The cost of ongoing cover could quickly exceed the fees derived from completing the transaction.

A decision on whether to accept instructions in this scenario should be taken carefully and documented. Consider what the maximum loss might be. Is it the total value of the underlying transaction or asset, or is it something less than this. Be realistic in your assessment of this. Transparency with the client is also important and sometimes the right answer is to decline the instructions. The SRA’s Practice Note includes two case studies that might be a useful guide for firms dealing with this scenario (available here). 

We invite you to contact us if you have any questions or would like to discuss these issues further.