PII Market Snapshot
The professional indemnity insurance market has shown improvement, but higher-risk practices still face challenges. Firms that produce a quality presentation and clearly articulate what sets them apart are viewed more favourably by insurers, says Brian Boehmer, partner at Lockton.
It has been a busy time of year at Lockton, with more than 50% of the legal practices in England and Wales that we represent renewing their professional indemnity insurance on 1 October with a number of additional practices seeking alternative coverage through us too.
The PII market has been showing some significant signs of improvement. With most insurers having an increased appetite for new business along with some new capacity entering the market, things have improved significantly for some. However, these conditions are sadly not universal.
Pockets of the legal profession t are still experiencing challenging PI Insurance market conditions, particularly practices with significant property exposure or other higher-risk practice areas with a modest fee income. In part, this is due to economic uncertainty. With the looming fear of a recession, which typically results in increased claim volumes, coupled with the fact that most insureds within each insurer’s portfolios have engaged in more conveyance work over the past 36 months, insurers are treading incredibly carefully. In respect to new business appetites, most insurers have imposed a ceiling/cap on the percentage of property work that they will consider which naturally reduces choice. Leading insurers openly seek to reduce property exposure and non-renew risks.
Having cyber insurance was imperative again for several insurers. Failure to have this specialist insurance resulted in the PII terms being loaded, or they simply would not offer terms.
Some other leading insurers adopted a different approach, wherein merely demonstrating cyber resilience was acceptable for them to provide a quote.
We will be reviewing our experience of this season in more detail. However, it has been evident that businesses that took the time to produce a quality presentation for insurers were viewed more favourably, making more options available to them on better terms. This statement goes for those practices that may fall into this higher-risk proactive area category, along with those that have a more desirable practice profile to insurers. Those that have taken the time to educate insurers about their practice, particularly articulating their approach to risk mitigation, have done better.
While there are similarities between practices undertaking the same areas of practice, each one will be unique. You will have different processes and procedures and you will have differing governance structures in place. I’m confident that everyone would appreciate being treated uniquely, especially when it leads to favourable outcomes. Therefore, I cannot emphasise enough how important it is to clearly articulate what sets you apart and to provide the underwriter with substantiating evidence for their records to validate their decisions.
We will produce a more detailed report on what has happened during the renewal season. In the meantime, for LPM readers renewing their policies in the spring of next year, we strongly recommend putting in the extra effort to create a high-quality submission for insurers, even if your practice profile is already favourable. Recent history has shown that this extra effort can yield significant benefits. For support and guidance, please do not hesitate to contact me or a member of the Lockton team.
Covering the bases
What will underwriters be most interested to learn about your firm this renewal season? Brian Boehmer, partner at PII specialist Lockton, offers insight into the state of the market.
The Spring renewal season is underway, and though there are signs of an improving professional indemnity insurance (PII) marketplace, law firms need to guard against complacency in the weeks ahead. Despite an increase of appetite, underwriters will remain cautious with a studious eye on the state of the economy. Brian Boehmer says: “History tells us that if we fall into a dark recession, which is a possibility, there will be an increase in claims activity, so insurers have to make sure to cover their costs.”
Flux and fluctuation
Inflation, too, is exerting its upward pressure on premiums, though Boehmer suggests that the risk exposures are increasing faster than the premiums are – as has been the case over the last two decades. He says: “If we look at figures from the Office of National Statistics, the average house price – a useful benchmark for asset values – has increased three and a half times since the open market began in 2000, which has a bearing on law firms’ risk. But insurance premiums have not increased at the same pace as the risk compound.”
The most substantial jump came in the wake of the pandemic, when the value of claims actually exceeded that of premiums collected – forcing insurers to implement steep pricing corrections across their portfolios. Rate increases won’t be nearly as high this renewal season, says Boehmer, who describes the current state of the PII market as being “in flux.”
Having corrected itself after the pandemic, the market is expected to benefit from new players and capacity this year, though unfortunately not in time to positively impact April renewals. The current PII landscape remains particularly challenging for certain segments of lower-income law firms that engage in high-risk work. “They have options, but not as many as practices with higher fee incomes, low-risk or diversified practice areas and a history of infrequent claims,” says Boehmer, who also notes a degree of regional bias – firms in the South typically deal with higher asset values and can consequently be less attractive propositions for underwriters due to the increased potential risk.
For all practice types, one trend that is gathering momentum is co-insurance – where two insurers share the risk and reward of covering a particular firm. According to Boehmer, this is a popular option for insurers with growth ambitions – they can reach a wider share of the market while minimising their exposure, albeit at the cost of sharing the rewards. Given the historical correlation between recession and claims activity, this is a price many are willing to pay.
Movements like these might create a more active insurance market and give firms and brokers some negotiating power – provided they approach their applications with the necessary rigour. Underwriters will be putting practices under heavy scrutiny, particularly if the latter are subject to recessionary pressures.
Checks and balances
Boehmer expects that financial health will be in the spotlight, not just of firms but of their clients as well – if a firm’s clientele consists of businesses that are directly affected by ongoing geopolitical or economic circumstances, that significantly increases their risk profile.
Another concern for underwriters is sideways exposure. Boehmer says: “If there is a single mistake on a particular file – the error could end up being repeated every time the file is duplicated. Litigation and conveyancing are some examples of areas that are particularly vulnerable to sideways exposure, and insurers will be particularly vigilant about this.”
“Supervision and protocols more widely will be under scrutiny – insurers will be mindful about how workloads have been and continue to be managed amid high conveyancing volumes, as well as the health and wellbeing of associates during these periods. Cyber insurance policies are also a plus when it comes to PII, though these need to be supplemented with strong internal security measures such as multi-factor authentication to access systems and data – particularly in hybrid working models.”
And, continuing a trend from the October renewal season, some insurers are likely to introduce partner guarantees for firms that specialise in financial mis-selling. Boehmer says: “There are question marks around the moral intentions of some practices, and concerned insurers are asking for a partner or owner guarantee to protect themselves from any potential fallout and/or run-off exposure”
Best foot forward
It’s clear from the level of scrutiny that insurers are being very cautious about where to deploy their additional capital. As such, firms not only need to have stringent risk management strategies in place, they should also take control of the narrative being formed about their practice.
Boehmer says: “We can all agree that first impressions last – once an opinion is formed, it becomes very challenging to reverse. Underwriters have an appreciation of risk, but they are insurance professionals and not lawyers – they could possibly form an incorrect view of a firm, which would unnecessarily complicate negotiations.
“Firms can head this off by including in their application a complementary note – a brief document that clearly educates the insurer about their practice, complete with the type of work undertaken and the risk controls in place. Brevity is crucial – I can probably state on behalf of every underwriter in the market that they don’t want to see an office manual with every policy and procedure at a firm. But a concise, data-backed overview that can outline why a firm is less likely than direct peers to face a claim can help ensure that underwriters’ perception of the practice is based on fact.”
Boehmer equates a complementary note to a shop window, and lauds it as an opportunity for firms to proudly display their accomplishments. It can be a time and resource-intensive task to prepare such a presentation, but subsequently it just needs minor adjustments each year and can secure a positive outcome to one of the most important annual purchases made by law firms. The end goal is to have several insurers competing to cover a firm, which can certainly yield favourable terms.
Tripartite relationship
A crucial part of a broker’s role, says Boehmer, is to make sure that firms are putting their best foot forward. “We’re not postal workers – it’s our job to read and sense check complementary notes and give firms feedback when required. A good narrative can help us negotiate a good deal for our clients.”
And there is far more value on offer from brokers such as Lockton. Boehmer describes the tripartite relationship between firms, insurers and brokers. Firms might well benefit from having a direct line of communication with an insurer – they can understand exactly what is required of them to build a good application. But, equally, a direct relationship can become a hindrance if the two parties are not on the same page – in the event of a claim, for instance, if a firm isn’t happy with the strategy being adopted by the insurer. Or, if a big insurer with multiple clients moves in a direction that doesn’t suit an individual client.
“This is where an intermediary can use its leverage to change the dynamic and either challenge the insurer or reassure the client that other firms are going through similar difficulties. We can educate clients about how to minimise the impact of economic developments, while also offering access to a wider market, which puts them in a stronger negotiating position. As for our relationship with insurers, this extends beyond renewal periods – we have mid-term reviews with underwriters that can help us speed up the process of renewal when the time comes.”
Brokers offer expertise with a service mindset, which can be of tremendous support for firms at a time when the insurance market remains in a state of change and uncertainty. And to end on a positive note, Boehmer does see a more active, competitive PII market on the distant horizon.
Reforms to the period of taxation for sole traders, partnerships and LLPs
The way in which the tax basis period is calculated for the self-employed and partnerships is set to be reformed ahead of the implementation of Making Tax Digital (MTD) in April 2024, says Karen Hain, head of professional practices at MHA.
What are the current rules?
At present, unincorporated businesses are free to choose whatever accounting year-end they wish. These profits are then taxed according to the tax year in which the accounting year-end falls. For example, a business with a year-end of 30 September 2021 would be taxed on those profits in the tax year running from 6 April 2021 to 5 April 2022, with the tax payable on 31 January 2023.
HMRC believes that the current rules have created a complex system that is difficult to understand. When a business starts or a partner joins a partnership, the ‘opening year rules’ must be applied, this can create double taxation of some profits, called overlap profits.
Any profits that have been taxed twice on the commencement of trade can then be relieved in the year of cessation of the business or upon the partner leaving the partnership. HMRC has identified that these rules are often not correctly applied and records of any overlap profits can often be lost as the period between commencement and cessation of a business can be many years.
HMRC also believes that these rules can give an unfair advantage to larger businesses who often have accounting years that are non-coterminous with the tax year. Smaller businesses will commonly have a 31 March year-end for simplification purposes. If a business has an accounting period ending near the start of the tax year, this can give up to 21 months before tax is paid on those profits.
What are the changes?
HMRC will tax all unincorporated businesses and LLPs on a tax year basis regardless of the accounting year end. There is no requirement to change the accounting year end of the business, just the way profits are taxed.
For example, if a business has a 30 September 2023 year end the taxable profits would be calculated for the 2023/24 tax year by taking six months profits from the September 2023 year-end and six months profits from the September 2024 year-end. If the September 2024 accounts have not been prepared prior to the submission date of the 2023/24 tax return, provisional figures should be used and the tax return amended once the final figures are known.
That, however, would just seem to confuse matters, so we envisage that accounting year ends will change to 31 March, unless there is a strong commercial reason for a different year-end.
Will there be a transitional period?
HMRC has recognised that during the 2023/24 tax year, when the new rules are implemented, this could see taxpayers paying a significantly increased amount of tax as more than 12 months of profits may be brought into account. It will be possible to offset any overlap profits but, in many cases, these may be considerably lower than current year profits as they were created when the trade was commencing.
Where taxable profits exceed the current year’s profits, excess profits can be spread over five years.
This is demonstrated in the following example:
A sole trader has a year-end of 30 June. The profits to 30 June 2023 are £30,000 and for 30 June 2024 are £60,000. They have overlap profits brought forward of £5,000.
Taxable profits for 2023/24 are:
- 1 July 2021 to 30 June 2023 – 30,000
- 1 July 2022 to 31 March 2024 – 60,000 multiplied by 9/12 equals 45,000
- Less – overlap profits (5,000)
Taxable profits 2023/24: 70,000
As these profits exceed the current year profits of £30,000, the excess of £40,000 can be spread over five years. The minimum amount per year to be added is £8,000 (40,000/5). An election to spread the profits would therefore see 2023/24 taxable profits of £30,000 plus £8,000, equalling £38,000.
£8,000 would then need adding to the taxable profits for the subsequent four tax years. It is possible to accelerate the taxation of the spread profits, but they cannot be deferred.
Making tax digital for income tax
These proposals are seen as a forerunner to future reform, and MTD for income tax, which is due to be introduced from 1 April 2024 for sole trader and landlords and 1 April 2025 for partnerships. MTD sees all sole traders, partnerships, and landlords with turnover greater than £10,000 required to keep records digitally and submit quarterly updates to HMRC.
HMRC considers that moving to a tax year basis for taxing profits will reduce the number of submissions taxpayers may need to make. For example, a sole trader who is also a landlord may need to make quarterly submissions for both their business and rental profits. Rental income is currently taxed on a tax year basis. If the business was not taxed on a tax year basis, they may not be able to combine the two quarterly submissions, greatly increasing the admin burden for the taxpayer.
What next?
If you think that you will be affected by these proposals, please contact MHA and we would be delighted to discuss the pros and cons of changing your year-end and the best time to do this. If you already have a 31 March year-end, you should be unaffected by these proposals.
Payroll – out with the old, in with the new
As we move from one tax year to another, it is a good time to check the information held within payroll to ensure it is up to date. MHA’s head of professional services Karen Hain presents a checklist for firms to consider.
It’s time for law firms to take stock and perform data cleansing routines to reduce the extra work that generally rears itself at this time.
Potential areas for review and checks:
- Employee change of name or title? Have they married and wish to update their details on their records?
- Employee home addresses – there is always one who may have moved home and failed to alert HR or payroll and when their P60 is generated, this suddenly becomes important!
- Missing employee data – such as National Insurance (NI) numbers. Can these be found on documents sent to the employee from HMRC or tax code/student loan notifications send to the employer?
- Directors – have there been any new directorships in the tax year, or resignations? NI contributions may be affected within the tax year, and the start and end dates of the directorships are extremely important, ensuring enough has been paid.
In undertaking these checks now, payroll can be moved into the new tax year with the comfort that the data is correct from the beginning.
Payroll – what’s new for 2022/23?
As in previous years, there are changes to tax and NI contribution thresholds, national minimum wage and statutory payments. Here is a brief overview and quick reference guide:
Tax thresholds 2022-26
Employee personal tax allowance remains at £12,570.00, giving individuals a starting tax code of 1257L. Any further changes to tax codes will be informed by HMRC via P9 notice at the commencement of the tax year, or P6 throughout the tax year.
National Insurance thresholds and codes
There have been five new NI codes introduced in 2022/23, four of which relate to Freeport status. These are letters F (Freeport), I (Freeport – married women/widows reduced rate), L (Freeport Deferment) and S (Freeport State Pensioner).
The 5th new NI code is V, which can be used for Armed Forces veterans with as little as one day’s service, when they enter civilian life and begin work. It can only be used for the first year of employment, be that with one employer for the full 12 months, or several employers in that 12-month period.
One thing to note is that following the Spring statement in March 2022, the primary threshold (the level at which an employee will be subject to NICs) has increased and from Month 4/Week 14 of the tax year, will be the same threshold as the personal tax allowance.
National minimum wage
From 1 April 2022, the national minimum wage rates are increased as follows:
For employees above the age of 23, rates have increased by 6.6% to £9.50, while the 22-to-23 age bracket has seen a 9.8% increase to £9.18. Those aged 18 to 20 (inclusive) will experience an increase of 4.1% to £6.83, while 18-year-olds are set to receive £4.81 – an increase of 4.1%. And apprentices under 19 will receive an 11.9% increase to £4.81, while apprentices above the age of 19 see an increase of 11.9% to £4.81, for the first year of their apprenticeship only.
Statutory Payments
From Sunday 3rd April, the statutory weekly payments have changed. Sick pay will change to £99.35 per week, while maternity pay is 90% of an employee’s average weekly earnings for the first 6 weeks, followed by 33 weeks at £156.66 or, if this is lower, 90% of the average weekly earnings. Paternity pay is £156.66 for 2 weeks or, if this is lower, 90% of the average weekly earnings. Adoption pay is now 90% of employee’s average weekly earnings for the first 6 weeks, followed by 33 weeks at £156.66 or, if this is lower, 90% of the average weekly earnings. Shared parental pay is £156.66 for 2 weeks or, if this is lower, 90% of the average weekly earnings, while parental bereavement pay is now £156.66 or, if this is lower, 90% of the average weekly earnings.
The rate of recovery of statutory maternity, paternity, adoption, shared parental pay and bereavement pay from HMRC remains at 92% if Class 1 NIC’s are greater than £45,000. If less, then employers may claim 103%.
Student Loan threshold from 6 April 2022
- For plan one, the threshold will be £20,195 per year.
- For plan two, the threshold will remain at £27,295 per year.
- For postgraduate loans, the threshold will remain at £21,000.
- For plan four – the threshold will be £25,375 per year
Employment Allowance
In the spring statement in March 2022, the Chancellor increased this allowance to £5,000. Eligibility rules apply.
Health & Social Care Levy
The introduction of a temporary increase in National Insurance of 1.25% for employees, self-employed and employers has come into force from 6 April 2022, and will affect NI Contributions in the following brackets – Class 1, Class 1A, Class 1B, Class 4
Earnings above the Primary Threshold, £823 for April, May and June and thereafter, £1048, till the end of the 2022/23 tax year will be calculated at 13.25%/3.25% (employees), 10.25%/3.25% (self-employed) and 15.05% (employers). The increased NI Contributions can be offset against the employment allowance in 2022/23 tax year.
HMRC have requested that employers display the following message on employee payslips for the whole of the 2022/23 tax year:
1.25% increase in NICs funds NHS, health and social care.
Any benefits given in the tax year 2021/22 and processed in 2022/23 will not be affected by the increase. However, this will change in the subsequent tax year. From 2023/24, a new tax levy will be introduced to support UK health and social care bodies and NI Contributions will revert to the 2021/22 rates. Further details will be released in respect of how this will interact with the Employment Allowance. Employees over the state pension age will pay a health and social care levy tax of 1.25% and employers will continue to pay 15.05%.
Statutory redundancy pay
The maximum weekly threshold for England, Scotland and Wales is set at £571. The maximum weekly threshold for Northern Ireland is set at £594.
To discuss any of the matters raised in this blog please contact our MHA UK.
What a changing tax framework means for your business
Changes to National Insurance rates and basis periods are set to impact individuals and businesses alike – MHA’s SRA specialist director, Robert Blech, goes into the details.
Following the huge impact of the pandemic, it is clear that monies need to be recouped, and inevitably some of it will unfortunately fall on the taxpayer.
With some tax changes already in place, some proposed, and a new Spring Statement announced for this coming March, what do law firms need to be mindful of? And, what will the impact be on the practice and its owners?
National Insurance changes
There will be a 1.25% increase in all National Insurance (NI) rates from 5 April 2022. From 5 April 2023, NI rates will return to previous levels and this extra tax will be collected as a new Health and Social Care Levy. This levy, unlike NI, will also be paid by state pensioners who are still working. In line with this, there will also be a 1.25% increase in dividend tax from 5 April 2022, taking rates to 8.75% for basic rate taxpayers, 33.75% for higher rate taxpayers and 39.35% for additional rate taxpayers. The £2,000 dividend allowance will still be in place.
A rise in NI means that the cost of employing staff goes up, which affects cash flow – especially for law firms where this is already tight. The result of such an increase may lead to employees asking for a rise to offset the fall in pay.
If a law firm is a sole trader/partnership or LLP, personal tax will also increase due to the NI change. If trading as a limited company, income tax on dividends will detrimentally impact dividends received. For example, a dividend of £10,000 will attract £125 in extra tax. Taking into consideration payments on account, where tax is paid in advance based on the previous year’s liability, this amount will likely be higher.
For further information on this, as well as other tax planning tips, please see MHA’s Year End Tax Planning Guide. The publication is for individuals and businesses and summarises some key tax and financial planning tips which must be actioned prior to 5 April 2022.
Basis period reforms
Additionally, there are proposed changes to the tax basis period from 2024-25 with a transition year from 2023-24 for sole practitioners, partnerships and LLPs. Under this reform a business’s profit or loss for a tax year will be that which occurs in the actual tax year itself, irrespective of the accounting year end date. Under the current regime, the tax is based on the profit attributable for the accounts period end, which falls in the relevant tax year. For this reason, many law firms have year ends of 30 April, which in effect defers most of the profits until the next tax period. To illustrate this, an LLP’s profits with a year end of 30 April 2022 will fall into the 2022-23 tax year. However, under the proposals (if applicable now) in the 2022-23 tax year, all profits from 6 April 2022 to 5 April 2023 would be taxable. The reason for the transition year is to catch up with periods that have not yet been taxed. Therefore, in 2023-24, there will be a catch up if a law firm has a year end not in line with the tax year, which if 30 April can be significant.
The impact of this on cash flows may be material and, therefore, planning should begin on mitigating the potential impact of this now. Professional advice should be sought, and discussions had at management level.
Conclusion
It is important that law firms are aware of the proposed changes to the basis periods, and the impact this will have on the practice and the owners. If you would like assistance with any of the points raised above, or other tax planning issues, then please contact our national team.
Year end tax planning tips for you and your practice
Tax planning season has arrived, and law firms have a lot to think about before the end of the financial year. MHA’s head of professional services, Karen Hain, presents a guide to tax planning for 2022.
As we approach the end of the tax year, now is the time to review your tax affairs to ensure that you have taken advantage of all reliefs available, and have considered some planning opportunities to help reduce your tax liabilities.
The MHA national tax team has worked together to create our annual Year End Tax Planning Guide, which provides key tax and financial planning tips that must be actioned prior to 5 April 2022. Some of the themes include:
Corporation tax: New measures
In the March 2021 Budget, the Chancellor announced measures to encourage investment and help struggling businesses. In our guide we look at some of the measures announced, including The Super Deduction, accelerated relief for Special Rate Asset expenditure, extended loss carry back relief and the Annual Investment Allowance. To benefit from these changes, legal firms need to think carefully about when they spend money on capital assets and what they spend it on.
Inheritance tax: Food for thought
There are a number of reliefs and exemptions for inheritance tax, and some are worthy of annual consideration, while there is a lot to be considered when it comes to longer term inheritance tax planning as well.
The Health & Social Care Levy: How will it affect your practice?
On 7 September 2021, the government announced the introduction of a new tax called The Health and Social Care Levy to support the UK health and social care bodies, following the impact of the Coronavirus pandemic. This will likely have implications for both employee and employer national insurance contributions.
Capital gains tax: Use your annual exemption – or lose it!
The annual exemption for 2021/22 is £12,300, and will remain at that level up to and including the 2025/26 tax year. This is a ‘use it or lose it’ exemption – it cannot be carried forward to future years. It therefore makes sense to crystalise gains each year to the extent of the annual allowance.
Pensions: Structure your assets to make the best use of reliefs and allowances
If the total of all your pension funds is likely to be at or near £1m by the time you retire, you should seek urgent advice. A look at current pension rules could reveal some options to consider.
More tax changes ahead!
Last year, the government set out its thoughts on modernising the tax system over the next 10 years – with a focus on going fully digital and working closer to real time. Kate Arnott from MHA summarises what this could mean for professional practices.
Basis periods
The proposed reform of basis periods seeks to end the calculation and use of overlap, which will result in income being taxed at the relevant point in the tax year. It also proposes that for periods after April 2023, income should be apportioned to the actual period in which it arises.
The proposal brings to light two considerations for those not using 31 March as the year-end – the use of overlap, and – for partnerships – the allocation of proportional profit at partner level.
This is potentially the most significant change for legal practice sole traders and partnerships. Experts at MHA have considered these proposals in detail and have set out some key considerations and planning points to be aware of.
Fiscal year end
The Office for Tax Simplification is exploring the potential for moving the end of the tax year, focusing on two specific dates – 31 March and 31 December:
31 March. As both the end of a quarter and the nearest month to the current tax year end, this is also when the UK government makes up its own accounts to, and by, reference to which corporation tax rates apply. The difference of five days (from 5 April to 31 March) is unlikely to cause an issue for most businesses.
31 December. Moving the year end to 31 December would result in a shortening of the tax year by three months and five days and would bring it in line with many major tax regimes. While potentially an advantage for individuals and companies based in multiple jurisdictions, it will cause issues during the transition year for those not currently using this date.
Making tax digital (MTD)
The introduction of MTD for individuals has been pushed back to April 2024, when there will be a shift from annual to quarterly reporting. With the general direction towards reducing the gap between profits being generated and tax being paid, we wouldn’t be surprised to see the acceleration of tax payments from half-yearly (payments on account and balancing payments) to quarterly (and balancing payment) in the future.
The corporate reporting regime will not be mandated before 2026. Read more about new tax proposals and their implications here.