When evaluating the exposure of you or your firm to professional negligence claims, a key consideration is the level of Professional Indemnity Insurance (PII) that you hold. Without an appropriate limit of indemnity, claims can expose the business to a catastrophic loss. In the case of a partnership (with unlimited liability), this may leave individual partners assets exposed.
But choosing the right level of cover isn’t always easy. And as claims become more frequent and expensive, many buyers are considering whether to adjust their limit of indemnity.
Below, we explore the key factors likely to influence your decision – from the type of transactions you undertake, to how much risk you’re willing to retain:
SRA Indemnity Insurance Rules
Your limit of indemnity is the maximum amount insurers will pay out for one or multiple claims, subject to the nature of your policy.
As a starting point, regulated law firms in England and Wales must confirm with must comply with the solicitors’ minimum terms and conditions (opens a new window) (MTCs). The MTCs mandate a minimum standard of coverage by virtue of a policy wording, while the SRA Indemnity Insurance Rules enforce requirements to carry a minimum limit of indemnity of:
£2 million for any one claim; or
£3 million any one claim for a Relevant Recognised Body (e.g. any legal services firm, such as a partnership, LLP, or limited company, that has been formally authorised by the Solicitors Regulation Authority (SRA)).
Beyond the minimum limit that must be held, certain firms may require higher levels of cover. As per rule 3.1 of the SRA Indemnity Insurance Rules, a firm’s level of cover must be ‘adequate and appropriate’. The level of cover that qualifies under these terms will differ from one solicitor or firm to the next depending upon the individual business and their circumstances. Further guidance to help firms understand whether their insurance is adequate and appropriate is available via the SRA (opens a new window).
Breaching these indemnity regulations can result in regulatory action against you or your firm. In severe cases, your business may even be forced to close. As explained in the guidance, the SRA expects to see that firms have made a ‘reasonable and rational’ assessment of the level of professional indemnity cover they require.
In the case of offshore law firms, SRA regulations may not apply. However, appropriate and adequate insurance remains an important consideration.
Transaction sizes and client requirements
A key factor when deciding on an appropriate level of cover for you or your firm is the size of transactions that you choose to take on as well as the subsequent level of clients’ funds that your business holds.
Firms will often choose limits multiples higher than their largest transaction values, as this can help to protect the business in the event of a major loss or aggregation of claims. Clients may also require you to hold a certain limit of indemnity, which generally will reflect the size of the transaction they are instructing you on.
Certain areas of legal work, such as high-value conveyancing or tax advice, typically see both a higher volume and severity of claims. If undergoing a merger, acquisition or taking on lateral hires, firms should consider if this will change their exposure profile, both going forward and in terms of any past liabilities that will be subsumed by the continuing entity.
Inflationary effects
An increasingly litigious and claimant friendly environment is driving up the cost of claims, a trend known as social inflation. Social inflation is driven by societal shifts and changes in the outcomes of litigation. In addition to this, there is widely felt economic pressure, with individuals and businesses are applying greater scrutiny to the work done by their advisors. The failure of a large commercial transaction, for example, may lead a client to undertake a re-review of relevant documentation. If even a minor discrepancy is discovered, the client may seek to place blame on their lawyers and recoup some of their losses via a claim.
Broader inflationary pressures – including a higher cost of living, and larger asset and estate values – are increasing transaction values. This, in turn, is leading to deeper potential losses. The cost of defending claims has also risen significantly, with cases taking a long time to settle and panel law firm rates increasing.
As a result, what was an adequate limit 5 years ago may not be adequate for claims maturing now. And crucially, what is an adequate limit for claims maturing now may not be high enough for claims that settle in the future.
Risk appetite
Your appetite for risk, or that of your firm, should be one of the most significant factors impacting the level of indemnity you choose to purchase. Higher limits will give your firm a greater level of cover and therefore greater flexibility to pursue work which has a high value, risk of error, or likelihood of claims aggregation. But not all firms will opt for a higher limit, with others preferring a lower limit and more risk-averse behaviour.
Ultimately, a determining factor for any firms’ appetite will be how much you are willing to spend on PII. The more risk averse may look to capitalise on soft market conditions by purchasing higher limits. Some larger firms may buy as much cover as is available in the market.
For all firms, it remains important to limit liability (opens a new window), to give both you and your client and clear indication of the amount of compensation that might be available if things go wrong. But while limiting liability is good risk management practice, such clauses must be drafted carefully to be effective. And if restrictions are too onerous, they could be deemed unenforceable – leaving liability unrestricted.
Need to amend your limit?
Increases to your limit of indemnity can generally be made at any point during your policy period. Additional limits are almost always priced at a lower per-million cost than primary insurance, or more exposed lower excess layers.
Given the ‘claims-made’ nature of PII, once a limit has been increased for a specific exposure, it is prudent to retain at least this level of cover for several years after the transaction is complete to protect against claims brought against your firm.
Our specialists can advise you on the availability of higher limits and provide limit and claims benchmarking services to compare your exposure against peer firms.
To better understand your risk, prepare for your upcoming renewal, or for more in-depth advice around limits, reach out to a member of our team.
