On the face of it, it seems a simple equation; your firm hasn’t made any claims, and your work hasn’t changed since last year so surely your insurance premium should, at the very least, be the same. In an ideal world, intuitively, that’s what would happen, but unfortunately, we don’t live in an ideal world.
So what drives fluctuations in insurance premiums and why is the Professional Indemnity (PI) market particularly affected at the moment?
It’s over a decade since the last hard market for PI insurance, so that will be a distant, although lasting memory for the PI partner in the firm who lived through the experience. The profession is perceived to have enjoyed a period of relatively benign claims activity as there are no significant large market losses currently hitting the headlines. There are highly rated insurers signed up to the Solicitors Regulation Authority’s (SRA) Participating Insurers Agreement providing plenty of capacity over the last few years. So, logic would dictate that it’s steady as she goes. There are, however, market performance influences that need to be factored in.
Lloyd’s Performance Management Division (LPMD) has stated that non-US PI insurance is “one of the main drivers of its underperformance” and that PI is its “second worst performing class”1. LPMD has also identified that lawyers PI is a significant feature of this underperformance, so it’s not just about headline losses for the profession, attritional (e.g. routine, non-catastrophe) losses are taking their toll.
The Prudential Regulation Authority (PRA) which oversees the prudential regulation (financial strength/solvency) of general insurance companies licenced to carry out business in the UK has raised similar issues to the LPMD. The verdict is that this situation isn’t sustainable and Risk Adjusted Rate Change (RARC), the underlying adjustment in premiums simply allowing for changes in the exposure represented by individual policyholders, is not seen as enough to drive improvement in the market's performance2.
To compound pure underwriting losses, insurers, along with the rest of us, are having to deal with poor investment returns.
Premiums paid to insurers are available for investment until they are paid out in claims or released to the profit & loss account. The nature of certain risks, including PI, is such that it can take a long time for the full claims picture to become clear. Although claims payments are made gradually during the claims cycle, it does mean that insurers have a proportion, often significant, of the premiums received to invest.
Insurers are conservative investors; typically, they focus on the Money and Gilts (Government Bonds) markets. The past ten years have seen a significant reduction in the returns available. In July 2007 the Bank of England Base Rate was 5.75%. In January 2019 it was 0.75%3. It is a similar picture with Government Bonds. In January 2010 the interest payable on 2year and 10year bonds was 4.29% and 4.5% respectively4. In mid-January 2019, these rates fell to 0.80% and 1.35% respectively3. As investment returns reduce, insurers must focus on underwriting profit.
How market capacity works
Let’s turn to market capacity or the amount of insurance the market can supply. The cost and availability of capital drives market capacity. Easy access to cheap capital has increased the supply or availability of insurance which, in turn, has resulted in more competition between insurance companies, Lloyds Syndicates and other providers of insurance thereby reducing the cost of insurance and creating a classic soft or buyers market; something we have been experiencing since the end of 2003.
Poor underwriting results mean that capital is likely to withdraw from the market leading to a reduction in capacity or the supply of insurance. As capital and capacity withdraw, competition reduces and premiums increase creating the classic hard market. The resulting increased pricing, likely coupled with increased risk selectivity, will eventually improve insurers’ profitability which, in turn, will attract new capital, increasing capacity to the market and so the cycle begins again.
So, what are the implications for your PI insurance renewal? Your firm’s activities and loss performance will remain the main driver for determining how insurers view your firm, but there is likely to be increased scrutiny on how you manage your business. Do you have Lexcel accreditation? Can you demonstrate effective control of your risks? For example, do you carry out regular file reviews and have the results of the reviews feed into your operational and management controls? A firm that can demonstrate that it is well run should be a preferred risk and, therefore, benefit from a more competitive premium than one that can’t.
What should your firm do regarding the PI renewal?
A broker’s primary responsibility to the client is to develop a comprehensive understanding of the firm and present the risk to the underwriter in a comprehensive, logical and intelligible way. Brokers will go to great lengths to achieve the best possible terms for their clients, but they can only do this for those clients who help themselves by providing correctly completed proposal forms. It is not an exaggeration to say that the quality of a firm’s proposal form is a critical element in the underwriting submission as the implication drawn by an underwriter, when presented with poor quality or incomplete applications, are significant. You should, therefore, ensure that the proposal form:
- Has all of the questions completed.
- Can be easily read and understood.
- Has income splits by worktype that add up to 100%.
- Contains all requested information, such as:
- Up-to-date claims summaries from prior insurers.
- Supplementary forms and information.
- Report and accounts.
- Has been thoroughly checked to ensure that it, and any supporting documents, are clear and free from errors.
- Is signed and dated.
Getting the proposal form right first time can have a direct bearing on the terms offered, cost of the premium, or indeed whether terms are offered at all. Your proposal form and supporting documents are your shopfront. This is your opportunity to sell your firm to insurers and demonstrate to underwriters that your firm is one they want to insure. By carefully preparing your renewal submission, insurers will be encouraged take a more positive view of the risks posed by the firm and, in a hardening market, will help your broker achieve that most favourable terms available.
For further information on the issues covered above, contact Aon on 0371 4542 363 or visit or Solicitor Insurance page.
Lloyd’s, July 2018
Bloomberg, January 2019
Aon, “A Hard Market: Professional Indemnity Insurance - Implications for Design & Construct Contractors / Design & Manufacture Businesses” – December 2018