The professional indemnity insurance market is in crisis. Many firms are without cover and many have non-compliant cover.
The rules regarding professional indemnity insurance are very stringent. They are contained within chapter 13 of the Interim Prudential Sourcebook for Investment Businesses.
The rules are very clear in that any firm with a market capitalisation under £50m requires professional indemnity insurance.
The insurance rules have recently been relaxed by the FSA in a direct acknowledgement of the “hard market”.
What is very clear is that no amount of relaxation will entice underwriters back into the market at present.
The relaxation, which started on November 1, 2002 will expire on June 30, 2003. In that time, eight months of renewals will have passed.
It is very likely that firms will have to cease trading in their current form and accept consolidation. The other viable alternative is a network.
What is clear is that many firms have taken an ostrich type of approach on the basis that it will not happen to them.
I have advised firms with no pension review, no FSAVC review, no zeros and no endowments which have been rejected for doing “risky business” – in their case, drawdown.
The market does not have enough competition. You can hardly blame the insurers for wanting to move out of the market. In many cases, vast losses have been made, leaving positions economically unviable.
The first port of call has to be a further relaxation in the rules.
The European legislation is not going to allow firms to run without PI. The need to have a layer of PI will remain. The balance between policies which have such high excesses and low aggregate cover means that the market is out of kilter.
Having £25,000 excesses on endowment claims means that they are uninsured in the majority of cases.
The FSA have indicated its willingness to review the whole position. This means that a consultation will be needed in order to settle upon firm proposals.
My suggestions are:
Increase the level of the capital adequacy requirement substantially for directly authorised firms.
Settle the level of capital adequacy for appointed representative at a similar level to their directly authorised counterparts.
Allow the creation of authorised captive insurance companies to carry elements of market risk.
Make public the level of capital adequacy for each firm.
Make public the level of professional indemnity for each firm.
Allow firms to insure by product clusters
Insist on basic qualifications for specialist areas, such as G80 for long-term care business.
Allow costs awards against lay complainants in Financial Ombudsman Service cases.
It is crucial that the market for PI knows it is dealing with firm which have the resources to trade their way through problems. The “ambulance-chasing” culture has led to rafts of spurious and unfounded claims against advisers.
The advisers are stuck as they are contractually obligated to notify claims to insurers. The insurers are nervous and so the cycle of declined firms continues.
The market should be allowed to cater for risk management at all layers.
Self-insurance is not the key for smaller firms. The use of a mutual fund is the key. Mutual fund models have a historic precedent, not all of it good. The Solicitors Indemnity Fund closed due to its financial state. Even now in run-off, solicitors pay a levy to clear the deficit. The idea of a mutual fund for thousands of one-person operations makes the ideal lack viability.
The market for captive insurance in the financial services industry has potential. Currently, the FSA has not allowed the use of captive insurers.
Rule 13.1.6. G (1) requires firms to insure with any insurer authorised to transact professional indemnity insurance in the UK. Captive insurance is usually found in offshore tax havens and are therefore going to be prevented under the current rules.
I am surprised that IFA firms are not allowed to go to the European market for insurance, particularly as the free movement of goods and services would suggest that this possible.
The future for the whole financial services sector is the ability to accept higher capital adequacy and lower-risk insurance. The balance has to protect the consumer while at the same time making the market attractive to insurers.
The FSA, which has a statutory responsibility in this regard, will have a tough time in preventing hundreds of firms going to the wall if it does not act very quickly. The need for each and every firm to prepare their PI for renewal is vital. Solid information based upon sound risk management is key.
Gareth Fatchett is chief executive of ProAct Legal Solicitors.