The RDR discussion paper seems quite critical of professional indemnity insurance and ventures to suggest there is some evidence that the PI market is not operating in a fully risk-based way. It also suggests some insurers do not consider the risk of individual firms in setting premiums.
I find this an extraordinary claim. The IFA sector is considered one of the most difficult classes of PI to write successfully and underwriters which have maintained a presence in the market throughout its turbulent history since regulation take risk assessment very seriously indeed. The length of an average IFA proposal form is a testament to that.
The PI market is cyclical and has periods of softness, as is the case presently. When capacity is washing round the market, less experienced underwriters do venture into this class. More experienced underwriters may occasionally scratch their heads at the recklessness or naivete of some of the new entrants but even they would not suggest that the underwriters are not trying to carry out any risk assessment at all.
However, there are limitations to what can be done by way of risk assessment for a proportionate cost. Not so very long ago when PI rates were double if not triple what they are today, underwriters could insist on risk surveys, with the cost being borne by the proposer or lost within a fat premium. By and large, those days are gone – at least for now – save for very big insured firms or distressed risks.
As the market reaches its bottom and cash sloshes around looking for something to do, even the poorest risks will find a home with the most desperate or naive underwriters. But the market will turn and at that point not only will rates for all insured firms start to go up but the weakest firms will run the real risk of becoming uninsurable.
The FSA appears to have a short memory. In 2002/03, PI rates were very hard indeed and there was a very restricted number of insurers prepared to write the class. Capacity restrictions on insurers also meant many IFAs could not find cover. A significant number of those IFAs did need driving out of the industry and figures from the Financial Services Compensation Scheme appear to support that.
Unfortunately, many good firms found themselves unable to get cover. Some were covered by an insurer which was fleeing the market and found established players giving priority to their own renewal books. The FSA begun signing waivers to get firms through the hard market but, in doing so, it threw a lifeline to some firms which the industry would have been better off without.
The PI market does to some extent police the market by driving out poor risks and at the peak of the market it can be very brutal. In the trough of the cycle as now, its effect is weak. In the ideal world, there should be a happy medium. However, to reach that, one would need to tame the insurance cycle and no one has worked out how that can be done.
Ultimately, the PI market is not there to police the IFA industry. The onus must be on the regulator to identify the bad apples and remove them from the market. As insurers, we have a small part to play and IFAs need to be concerned about their loss experience as the hard market will return.
Equally, insurers are looking to the regulator to identify and remove the worst offenders as it is very difficult to identify them from a few tick boxes on a proposal form and the average premium does not allow for the sort of in-depth risk analysis that would be required to identify the truly rotten risk.
The FSA has raised the issue of whether a business-written rather than claims-made basis of insurance would motivate insurers to carry out a better assessment of risk. Yes, it theoretically would but I cannot see any underwriter being prepared to write this class on a business-written basis. Premiums would be so enormous that it may well be possible to build in some extra risk assessment. However, it is a complete non-starter. No other UK profession is written on that basis and, with all due respect to IFAs, this would be the last profession where anyone would want to test a shift away from claims made.
To write on a business-written basis, you do not want to fear that 10 years later the regulator is suddenly going to decide that for the last 10 years the whole profession has been negligently misselling billions of pounds worth of policies which will belatedly need looking at.
In other jurisdictions that do have business-written insurance, there is normally a short discovery period of perhaps only five years.
The FSA has also had a dig at the PI market by suggesting there are terms within PI policies which tend to make it difficult in practice for firms to claim. The pension review did throw up some difficult issues for insurers. However, with the issue of blanket notification largely behind us – at least for now – my experience is that IFAs have little difficulty in claiming under their policies. Short of notifying the matter promptly as soon as you become aware of it and not agreeing to spend your insurer’s money without its prior consent, there really is not much more to it.
Ultimately, IFAs are underwriters’ clients. These underwriters care about their reputation, particularly where they have spent a long time building expertise and have every intention of being there in the hard market as well as the soft.