How to choose the right level of professional indemnity insurance cover
Nicola Anthony, risk manager, vice president, at Lockton and Alex Heelas-Jorgensen, account executive at Lockton, explore the risk and regulatory factors for law firms to consider when selecting the best-suited level of professional indemnity insurance cover
Choosing the right level of professional indemnity insurance (PII) isn’t always easy. Without an appropriate limit of indemnity, claims can expose your business to a catastrophic loss. In the case of a partnership (with unlimited liability), this may leave individual partners assets exposed.
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
For regulated law firms in England and Wales, the solicitors’ minimum terms and conditions mandate a minimum standard of coverage by virtue of a policy wording. Meanwhile, the Solicitors Regulation Authority’s (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 (for example, any legal services firm, such as a partnership, LLP, or limited company, that has been formally authorised by the SRA).
Certain firms may require higher levels of cover. However, as per SRA rule 3.1, a firm’s level of cover must be “adequate and appropriate.” The precise level of cover that qualifies under these terms will depend upon your individual business and its circumstances.
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
Your transaction sizes, as well as the volume of client funds that you hold, are key factors when deciding on an appropriate level of cover for you or your firm.
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, claimant-friendly environment is driving up the cost of claims, a trend known as social inflation. Widely felt economic pressure is encouraging clients to apply greater scrutiny to the work performed by their advisors. If even a minor discrepancy is discovered, a 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 also deepening 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 five years ago may not be adequate for claims maturing now, or for claims that settle in the future.
Risk appetite
Higher limits give your firm 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, and many may prefer a lower limit and discourage risk-taking behaviour.
Ultimately, your appetite will be determined by 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, effectively limiting your liability can give both you and your client and clear indication of the amount of compensation that might be available if things go wrong. But such clauses must be drafted carefully to be effective. If restrictions are too onerous, they could be deemed unenforceable.
Need to amend your limit?
Increases to your limit of indemnity can generally be made at any point during your policy period. 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.
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.
