Professional indemnity insurance (“PII”) cover for solicitors is notoriously forgiving to policyholders on the issue of non-disclosure.
In general, insurance contracts are subject to the wording of s18(2) of the Marine Insurance Act 1906, which permits insurers to avoid cover if the policyholder fails to make a disclosure before the contract is concluded that “would influence the judgment of a prudent insurer in fixing the premium, or determining whether he will take the risk.” Whilst this amounts to so-called "material non-disclosure", insurers do not in fact have to show that had they been provided the information in question they would have declined the risk or even offered different terms. It is sufficient to demonstrate that a prudent insurer (i.e. a hypothetical insurer) would have considered it relevant. As such, statutory law is unforgiving towards policyholders yet it allows insurers’ underwriting policies and practices to escape individual scrutiny.
In the case of solicitors, the Law Society protects its members from the sometimes harsh consequences of this rule. Insurers authorised by the Law Society to issue policies must first agree to provide cover which complies with the Law Society’s minimum terms and conditions. These minimum terms prohibit insurers from avoiding or repudiating the insurance “on any grounds whatsoever including, without limitation, non-disclosure or misrepresentation, whether fraudulent or not.”
However, whilst this clause is intended to afford protection to solicitors in any given policy year and guarantees that any persons who successfully claim against the firm will actually receive the monetary remedy they are rewarded (up to the indemnity limit), the recent upheavals in the PII market may mean that claimants, policyholders and insurers are less protected than is currently believed.
Solicitors’ indemnity insurance: A possible black hole in coverage
The PII market for solicitors is now ferociously competitive. Since the move from a mutual Solicitors’ Indemnity Fund to commercial placement of insurance in 1999, competition has had a radical effect on the premia paid by solicitors. In 1999, 9,000 firms of solicitors collectively paid £255m (£375m in today’s money) for cover. The 2012 round of underwriting saw a total sum of £239m paid across 11,000 solicitors’ firms. On average therefore, firms’ premia have fallen by nearly 50% in real terms over the course of fourteen years.
Simultaneously, the Law Society’s minimum terms have increased the indemnity limit from £1m to £2m.
This competition has created real difficulty for some PII insurers, particularly those underwriting smaller firms, has. In 2010, Quinn Direct Insurance Ltd went into administration, followed in 2012 by Lemma Europe Insurance Company Ltd. More recently, Balva (who in 2012/13 underwrote 6.8% of firms) lost its ability to write policies within the UK as it was incapable of fulfilling the levels of provisions and capital required for its business volumes.
The effect of these market moves has been an increase in the number of solicitors switching insurance providers. In particular, approximately 15% of solicitors’ firms have been insured by at least one of Quinn, Lemma or Balva, and therefore have previously accepted policies with insurers who are no longer trading and/or solvent. Ordinarily, this would not matter, as such legacy insurers are no longer on risk. However, the Law Society’s minimum terms contain a provision that ameliorates the effect of the non-avoidance rule set out above that only functions where off-risk insurers remain trading.
Clause 6.1 of the Law Society’s minimum terms contains the so-called "passing back" clause, which permits exclusion of:
“Any claim in respect of which the insured is entitled to be indemnified… under a professional indemnity insurance contract for a period earlier than the period of insurance, whether by reason of notification of circumstances… under the earlier contract or otherwise.”
In other words, if a solicitor notifies a claim or circumstance to its insurer in year 2 that was or ought to have been notified in year 1, the year 2 insurer can avoid cover pursuant to clause 6.1 and instead the previous year’s insurer will be required to indemnify the claim.
However, this process breaks down where the previous insurer is no longer trading. Where does this leave the parties to the year 2 policy?
A literal reading of the phrase “is entitled to be indemnified” would suggest that the clause is concerned with the contractual terms of the previous year’s policy (ie whether the claim falls for cover pursuant to those terms) but not with the commercial reality, ie whether in fact a solicitor can obtain a worthwhile indemnity from its previous insurer. If this is so, solicitor policyholders are now at an increased risk of finding themselves in a coverage black hole, such that they can no longer afford to be sanguine about late notification and their disclosure obligations. This would have implications both for the firm itself, its regulatory obligations and for claimants who may be unable to enforce judgment against solicitors.
If an alternate reading of the phrase “is entitled to be indemnified” is adopted, whereby the overriding policy is to protect both claimants and solicitors, the on-risk insurer may be unable to rely upon the pass back clause. If so, the insurers currently in the market will face a greater risk from insureds with this legacy. This risk may create a negative cycle if more insurers cease trading, as more solicitors will have gaps in their passing back provision, thereby increasing the risk on insurers who remain in the market. This may in turn drive more insurers from the market.
Clause 6.1 has as yet not been the subject of judicial interpretation, but the chance of future litigation is undoubtedly increasing given the number of firms potentially affected. The narrower reading of the above phrase fits more naturally with the word “entitled”, which in the ordinary sense means a "right to receive something" rather than "in fact can receive something", and so appears to be a more attractive construction of the phrase. If so, the risk on insurers would not be ramped up, but a secondary market would necessarily appear whereby solicitors seek to insure against the risk of their former insurers becoming insolvent and being unable to pick up a passed back claim.
Until the position is clarified, insurers are at risk of an increase in the number of claims they have to indemnify, solicitors are at risk of being uninsured for claims that fall within clause 6.1, and claimants may discover that they have no effective remedy against a defendant firm of solicitors.