Loading...

Future client financial protection arrangements – report on consultation responses and SRA conclusions

19 April 2011

Introduction

  • 1.1

    As part of the review of client financial protection arrangements, a consultation paper was issued on 6 December 2010 with a closing date of 28 February 2011. This paper summarises the key points emerging from the responses and sets out the SRA's conclusions. This document should be read in conjunction with the SRA's financial protection policy statement, which sets out the decisions reached by the SRA Board on changes to be made to these arrangements between October 2011 and October 2013, and the equality impact assessment on the planned changes.

  • 1.2

    A summary by number of the answers to the various questions posed is at Annex 1.

  • 1.3

    The number of responses received to this consultation paper was very considerable with 308 responses in total. It should be noted that one market participant wrote to its clients to encourage members of the profession to disagree with some of the proposals made (particularly the proposal to move away from a single renewal date). We believe that this has generated a number of responses on one issue in terms very similar to that advocated.

Overall approach

Q1: Objective and principles

  • 2.1

    The objectives and principles were supported by 100 respondents compared to 18 who were against them. Other respondents gave more ambiguous responses or provided general comments.

  • 2.2

    A number of those who objected to the principles or who expressed partial disagreement with them, objected to principle 3 (encouraging competition). The main area of concern was that this principle was interpreted as benefiting alternative business structures at the expense of traditional law firms.

  • 2.3

    Many respondents also believed that intervention by the SRA was not necessary and expressed concern regarding the amount of regulation surrounding insurance arrangements; some suggested that it was wrong for the SRA to intervene in respect of market forces in the insurance market.

Q2: Comments on future development of financial protection arrangements

  • 2.4

    There is a divergence in opinions among respondents regarding the future development of financial protection arrangements. Some see the value of additional flexibility being brought into insurance arrangements as a way to benefit the profession and as a way to increase the availability of cover and choice of insurer. They argued that the current inflexible arrangements were preventing some firms from being able to obtain cover.

  • 2.5

    Others see the value of maintaining a single approach for the sake of simplicity. They argue that greater variety will reduce certainty as to the details of insurance cover in different firms and some believed that flexibility would involve removing all regulatory requirements. They also see a danger in fragmenting the insurance requirements which some believe will lead to a reduction in availability of cover.

Q3: Comments on the wider regulatory issues

  • 2.6

    The great majority of respondents strongly supported the SRA taking a more rigorous and tough approach with the regulatory issues highlighted. A small number of firms raised concerns that this approach did not match with a movement towards outcomes-focused regulation which they perceived to be a reduction in regulation.

  • 2.7

    In general, many respondents agreed that there were firms in the profession that posed an unreasonably high level of risk and which should be closed down. They noted that good, high quality firms in the profession bear the cost of low quality or dishonest firms and that more rapid action was needed to close firms. Many argued that the fact that firms could not achieve open-market insurance cover was indicative that they should be closed down. Many respondents argued that the assigned risk pool (ARP) was a significant problem for the profession and that firms in the ARP with bad claims records and an unsatisfactory risk profile should be closed.

Conveyancing

  • 2.8

    Conveyancing was the topic most commonly commented on. Respondents believed that the SRA needs to take a tougher line on firms that conduct conveyancing. They supported the plan to investigate this area in more detail. Representatives of the black and minority ethnic (BME) sector indicated that more rigorous regulation of this sector would be to the advantage of BME firms by avoiding lenders taking actions based on factors such as size and turnover which they feel disproportionately affect BME firms.

  • 2.9

    Many respondents believed that large conveyancing firms were the cause of high claims and that reductions in pricing over time were linked to reductions in quality. However, it should be noted that the evidence of the ARP is that it is overwhelmingly small firms in the one-to-three partner range that are those unable to obtain open-market insurance and therefore generate claims against the ARP.

Post qualification experience (PQE)

  • 2.10

    Mixed responses were received on the length of time needed before individuals could set up new practices. Many agreed with the suggestion from insurers to move this to five years (or even longer) and expressed concern that the SRA had not previously taken action on this. They argued that allowing individuals to set up firms with only three years' experience creates risks for the sector. Others argued that raising the boundary beyond three years would simply be a barrier to new firms being set up, seeing this as a blunt instrument. They questioned the link between length of experience and risk.

Financial viability

  • 2.11

    Respondents who commented on financial viability were generally in favour of taking this into account. Many noted that if firms could not afford run-off cover then the cost of this was faced by the rest of the profession. Some did highlight the difficulties for firms seeking to close who are unable to because of the cost of run-off cover.

Qualified Lawyers Transfer Test (QLTT)

  • 2.12

    Respondents who commented on this generally agreed that the QLTT was not sufficiently robust arguing it was not a proper test of competency. Some believed the new QLTS was better.

BME Firms and the ARP

  • 2.13

    Respondents who commented on BME issues were in favour of ensuring that such firms did not face discrimination. Many who responded believed that difficulties faced by some BME firms were linked to the problems of the QLTT.

  • 2.14

    There were few individual respondents who were from the BME sector. Among those who did respond, some in the sector expressed concern that the current arrangements were unfair towards BME firms. Some therefore favoured a return to SIF since SIF guaranteed insurance for all firms. Representative groups in this sector expressed the concern that if the ARP was closed or the timescale available in the ARP shortened this would be particularly detrimental to BME firms.

Q4: Two-stage approach

  • 2.15

    The two-stage approach was supported by 48 respondents compared to 45 who were against it. Many of those who objected to the two-stage approach objected because they objected to the actual proposals rather than the two-stage approach itself. Nonetheless there were mixed responses with some respondents arguing that more time should be allowed for the first set of changes to be implemented while others believed that the second-stage changes should be brought in earlier than planned. Some respondents argued that it would be better to bring in all changes in one stage whereas others saw benefits in staggering changes, including over more than two stages. In general there was a preference to ensure that the proposals were the right proposals rather than concerns regarding the timing of those proposals being implemented.

  • 2.16

    Insurers were generally against the two-stage approach, arguing that changes needed to be made to the ARP at the earliest opportunity rather than delaying this, in order to maintain the viability of the open-market approach. There was also concern expressed that proposals which were delayed may not actually occur in practice with insurers seeking greater commitment to future change. Some also indicated that unintended consequences could arise in any transitional periods. Some insurers highlighted that confusion could be introduced by removing the single renewal date in advance of other changes being made.

  • 2.17

    Other insurers and some brokers argued that the lack of consensus on how the ARP should be dealt with meant that a two-stage approach was inevitable.

Our response

  • 2.18

    We are pleased that respondents to the consultation paper have supported our objectives and principles in our approach to the review of financial protection arrangements. Over time we will seek to remove any unnecessary intervention in insurance markets while ensuring that regulatory minimums are clearly set out.

  • 2.19

    As set out, the review of financial protection arrangements also highlighted various weaknesses in the regulatory regime specifically with respect to the conveyancing process, the conditions in place when setting up a new firm and the financial viability of a small number of firms. The SRA will continue to make progress in taking a more rigorous approach in these issues.

  • 2.20

    The SRA will continue to work with representatives of the BME sector and insurers on the issue of disproportionate outcomes.

Maintenance of current arrangements

Q5: Use of the open market

  • 3.1

    Although it represents the maintenance of current arrangements, one of the key considerations during the course of the client financial protection review was whether the overall model used for the delivery of insurance was appropriate.

  • 3.2

    There was overwhelming support for the continued use of the open market. Among those who responded to this question, 128 were in favour of the open market with 10 against; a number of respondents gave ambiguous comments. Among those who were against the open market, the Solicitors Indemnity Fund (SIF) was favoured due to its mutual nature and the fact that it was obliged to insure all solicitors.

  • 3.3

    One area of concern raised regarding the open market was a view that insurance companies make arbitrary decisions regarding the firms that they will insure and that few insurers are willing to offer insurance to small firms.

  • 3.4

    Some, however, rejected the current open-market approach as not being sufficiently "open" and suggested that the SRA should move towards much more minimal requirements.

Q6: Qualifying Insurer's Agreement (QIA)

  • 3.5

    The maintenance of the QIA was supported by 122 respondents compared to 11 who were against its use. Of those against the QIA who gave reasons for their opposition, two were against it as they considered it to be an unnecessary intervention. Those who gave reasons for favouring it argued that it assists with the SRA's ability to ensure that certain criteria are met and that insurers report information to the SRA, others noted the benefits of having standardised contract terms to prevent clients needing to examine the detail of the provisions.

  • 3.6

    Insurers were split with respect to the QIA. Some argued it should be maintained due to the current mechanism for funding the ARP and also because it ensures standardisation in the terms of insurance contracts. Others argued it was unnecessary given that insurers are already strictly regulated by the FSA.

  • 3.7

    One key area of concern related to the insolvency clause related to the funding of the ARP. Currently if a Qualifying Insurer (QI) becomes insolvent, the other QIs would increase their share of the ARP funding cost. This provides firms in the ARP with greater protection than firms outside the ARP. It also means that individual insurers face risks associated to the insolvency of their competitors. Insurers highlighted this as unreasonable and that a similar clause does not exist in ARPs run by other professions.

Q7: Requiring additional criteria on insurers to be qualifying insurers

  • 3.8

    103 respondents agreed that there should be no additional requirements placed on insurers while 27 disagreed. Many of those who disagreed argued that credit ratings should be required with respondents commonly making reference to Quinn having lacked such a credit rating. These respondents argued that the simplicity of this does not detract from its value. Others who agreed that there should be no additional criteria stated that financial regulators were in a better position to check the quality of insurers than the SRA.

  • 3.9

    Insurers had mixed views with some arguing that insurers already faced high levels of regulation and others that credit ratings should be added since QIs face the risk of insolvency of their competitors.

Our response

  • 3.10

    As outlined in the consultation paper and as supported by the great majority of respondents we intend to retain the current open-market model for professional indemnity insurance (PII). At present we will retain the QIA and will not impose additional requirements on insurers before they can be qualifying insurers. As set out below we will, however, make some changes to the terms of the ARP funding related to insolvent insurers which will have the effect of placing firms in the ARP in a similar position to those outside the ARP if their insurer becomes insolvent rather than providing additional benefit to ARP firms which is currently the case.

Proposal 1: Remove the restriction of the single renewal date with effect from 1 October 2011

  • 4.1

    The proposal to remove the restriction of the single renewal date was, after Proposal 2 to permit the exclusion of claims by financial institutions from the minimum terms and conditions (MTC), the issue which provoked the second highest number of comments. Among the profession 51 respondents agreed that the single renewal date should be removed, while 147 disagreed. Of those that disagreed with the proposal there were a large number of firms that made reference to or directly quoted the advice of the market participant mentioned in the introduction. The Law Society is in favour of abolishing the single renewal date.

  • 4.2

    Brokers were split regarding their view on the single renewal date with some making similar arguments to those of the profession outlined below. Insurers all agreed with the proposed removal of the single renewal date.

  • 4.3

    Overall, 69 respondents were in favour of removing the single renewal date with 150 against.

  • 4.4

    Among those who were in favour of removing the restriction of a single renewal date, firms made the following arguments:

    • Introducing variable renewal dates would be beneficial for good firms as it will allow more time for insurers to underwrite each case and by encouraging better management, this will reduce premiums for well-run firms. More time to assess firms would mean that badly-run firms would be identified more quickly, would face higher prices and would find it more difficult to obtain cover. This would be to the advantage of the majority of the profession;
    • Variable renewal dates would give more flexibility for firms to arrange insurance at a time that was most convenient for the firm;
    • The single renewal date puts insurers and the profession under time pressure every September such that insurers do not have time to consider properly the risk profile of practices and firms do not have time to assess the choices which they have which some describe as placing the profession under unnecessary pressure;
    • The single renewal date creates volatility and a lack of predictability in pricing and firms believed that it created a "sellers' market" where premiums could be kept higher than otherwise would occur because insurers know that all firms have no choice but to renew by a fixed date;
    • They stated that the argument that firms were more likely to remember a single renewal date was poor, arguing instead that forgetting about the renewal date indicated poor practice management;
    • Other professions do not have single renewal dates and operate without difficulty; and
    • The single renewal date exacerbates problems related to the ARP problem by reducing choice in the run up to the renewal date, hence moving to a variable renewal date would reduce the number of firms entering the ARP.
  • 4.5

    Among the respondents who disagreed with the proposal, they made the following arguments:

    • The current situation provides simplicity and transparency and enables the SRA to identify firms who have not obtained PII;
    • A single renewal date provides competitive pressure on insurers and therefore keeps premiums low, whereas removing it would lessen competition between insurers causing an increase in premiums;
    • A variable renewal date could leave some firms unable to obtain insurance because insurers might have a lack of capacity in some parts of the year, whereas the current approach is described by some as "fair" because all firms renew at the same time;
    • They were sceptical that firms who fall into the ARP temporarily do so because of the single renewal date, arguing that it was simply that they were disorganised and therefore they would continue to miss their renewal date if there were variable renewal dates;
    • They argued that there would be an additional layer of regulation and record keeping to keep track of individual firm's renewal dates;
    • Variable renewal dates would lead to insurers requiring more information and taking more time to underwrite on an individual firm basis; and
    • Some argued that firms would choose to have renewal dates linked to their end of year which would be burdensome at what is already a busy time of year.
  • 4.6

    A number of those who disagreed with the proposal instead favoured a move towards two renewal dates per year (others suggested four or twelve). Many firms that objected to the proposal nonetheless expressed concerns regarding the short period of time that they had to consider renewal terms from insurers.

  • 4.7

    A number of respondents cautioned that it would take some time before the benefits of moving away from the single renewal date were seen. Some brokers highlighted that the benefits of collective bargaining which they believed they brought for their clients would continue irrespective of the single renewal date.

  • 4.8

    Insurers also highlighted that the proposal would enable short term renewals of 30 or 60 days to consider notification of claims that arise in the run-up to renewal whereas the current arrangements may mean insurers are unwilling to offer insurance for 12 months. Insurers were also keen to ensure that the removal of the single renewal date would facilitate policies which were both shorter than and also longer than 12 months.

Our response

  • 4.9

    The single renewal date is an unnecessary restriction which causes difficulties for insurers and the profession alike during September. As noted earlier, one market participant wrote to its clients to encourage members of the profession to disagree with some of the proposals made (particularly the proposal to move away from a single renewal date) and we believe that this has generated many of the responses against the proposal to remove the single renewal date. We note that the Law Society (TLS) is in favour of removing the restriction.

  • 4.10

    We have decided to continue with the proposal to remove the requirement that all firms renew insurance at the same time. Removing the restriction does not mean that all firms will be required to renew insurance at a different time of year but rather that firms will have a choice when to renew.

  • 4.11

    Those firms that believe that an October renewal is in their interests can continue to renew in October; those brokers that believe this can continue to persuade their clients to renew at the same time as other clients. Those firms that would value the flexibility to move their renewal date to another part of the year would also be able to do so. Over time, the preferences of the profession along with any pricing benefits from spreading renewal over the year compared to any pricing benefits from renewing multiple firms at one time will determine the outcome.

  • 4.12

    Although we will continue with the proposal, we will not implement this change from October 2011. This is because of the package of other changes which we are proposing to introduce and we consider that it will be easier to implement the whole package by delaying the removal of the single renewal date until other parts of the package can also be implemented. We therefore intend to remove the single renewal date from October 2013.

Proposal 2: Remove claims by financial institutions from the compulsory MTC with effect from 1 October 2011

  • 5.1

    The proposal to remove claims by financial institutions from the compulsory MTC by way of permitted exclusion was the proposal which raised the greatest number of responses with many respondents choosing to respond to this issue alone.

Excluding financial institutions from compulsory MTC

  • 5.2

    Among solicitors and their representatives, 224 respondents opposed the proposed financial institution exclusion, while only 16 agreed with it. Representatives of the BME sector were against the proposal. Insurers were in favour of allowing the exclusion while brokers and financial institutions were against. In total, 236 respondents opposed the proposal and 25 supported it.

  • 5.3

    There were three main arguments which were commonly made by solicitors who disagreed with the proposal.

  • 5.4

    First, many firms argued that the proposal dealt with the symptoms of the problem and not the cause. They stated that the root cause of the difficulties lay in poor regulation of firms conducting conveyancing and that it would be better to improve regulation of firms and the conveyancing process rather than to address this issue through insurance provisions. Many firms also highlighted that TLS's Conveyancing Quality Scheme (CQS) was likely to be used by lenders to reduce the size of their panels and therefore that the market would already begin to address concerns about conveyancing through this channel. They argued this meant excluding financial institutions from insurance cover would not be necessary as a mechanism to deal with conveyancing claims.

  • 5.5

    Second, they argued that the proposal would lead to an increase in the cost of insurance for those who took out "additional cover". Firms argued that premiums are already based on the type of work carried out by individual firms and therefore insurers are capable of determining the extent of conveyancing conducted and pricing accordingly. Few respondents made reference to the inability of insurers to avoid cover where information is misrepresented which in practice means that insurers can not always identify the amount of conveyancing conducted and price accordingly.

  • 5.6

    Third, solicitors expressed considerable concern that firms would not all be able to obtain cover for financial institutions. A number of firms stated that similar cover had been withdrawn from the Irish market in the second year in which it had been possible to exclude cover for conveyancing activities. Linked to this was the observation that the proposal would place the decision regarding whether firms could conduct work for financial institutions with insurers rather than with the SRA (although insurers could simply refuse the firm altogether).

  • 5.7

    Additional arguments that were made against the proposal included:

    • preferences for only allowing firms with specific qualifications to conduct conveyancing to do so rather than blanket exclusions being permitted for financial institutions through insurance contracts;
    • preferences for any such exclusion to be limited to firms in the ARP alone;
    • concerns regarding the "claims made" nature of PII in which firms may have obtained cover in the year in which advice was given, but may no longer be able to obtain cover in subsequent years leaving them exposed to claims from financial institutions;
    • it would be difficult for members of the public to know whether a firm has cover for financial institutions or not. Therefore when looking to instruct a solicitor individuals might not be aware that separate lender representation could be required which could create confusion;
    • conveyancing transactions are linked to other types of law and failure to obtain cover for financial institutions could affect firms' ability to conduct matrimonial or probate work in which selling the family home may be required, personal injury cases where settlement money may need to be forwarded to banks as security for loans, use of powers of attorney etc;
    • it could make takeovers and successions less likely if there are differences in the cover between the acquired firm and the acquiring firm;
    • views that if firms were unable to obtain cover for financial institutions then they should not be in the market at all;
    • preferences for changing other terms related to misrepresentation such that insurers would not be required to cover claims where firms may deliberately misled insurers regarding conveyancing;
    • the observation that given financial institutions will insist on firms having cover then their incentive to assess the quality of the conveyancing will be unchanged from today and therefore that the exclusion does not achieve a great deal; and
    • the observation that not all fee earners will know the scope of PI and therefore that they could conduct work without cover.
  • 5.8

    In addition, financial institutions have informed the SRA that should such a proposal be implemented, they would have insufficient time to change their IT systems in order to capture information about whether or not solicitors had cover in place for financial institutions. Some of these firms expressed the view that if the change was implemented quickly they would be forced to move towards a very small panel of firms and, having done that, would be unlikely to reverse this decision once IT capabilities could be brought into place.

  • 5.9

    Among those who favoured the ability to exclude cover for financial institutions, respondents typically highlighted that the exclusion would be fair as financial institutions are able to look after themselves. Some respondents stated that this would lower the cost of insurance for firms that did not work for financial institutions.

  • 5.10

    Financial institutions and their representatives who responded were all against the proposal. Some indicated that the proposal would lead to greater costs for consumers as it would increase the extent to which financial institutions appoint their own solicitor with these costs paid by the consumer. The increased cost of assessing whether or not firms had the appropriate cover was stated as likely to lead to smaller panels. They also highlighted concern about the timing of proposals expressing doubt that a database of firms with cover for financial institutions would be available in advance of October 2011. They also indicated that while financial institutions could assess whether cover was in place at the time that advice was given, they would not be in a position to assess whether cover in later years or run-off cover included cover for financial institutions at the time of any claim—brokers made similar observations on this issue. Some respondents indicated that variation in the MTC should be allowed for different types of work rather than for different types of client.

  • 5.11

    Insurers were generally in favour of the proposal arguing that additional flexibility of cover would be beneficial and financial institutions do not need regulatory protection. They noted that the benefits would be seen in better management of the next financial downturn rather than in the immediate aftermath of the recent downturn. Some insurers noted that if they were unwilling to offer financial institution cover to a firm, they thought it unlikely they would be willing to offer the more reduced cover.

  • 5.12

    Insurers indicated their willingness to offer cover for financial institutions. Some insurers indicated that the cover could have different terms associated to it compared to the rest of the MTC. Many highlighted the need to address the underlying regulatory issues to do with conveyancing.

Definition of financial institutions

  • 5.13

    The proposed definition of financial institutions was supported by 40 respondents compared to 72 who were against it. There were a number of respondents who gave comments regarding the question but where the comments were more ambiguous and respondents had mixed feelings about the definition.

  • 5.14

    Of those against the definition, the main argument made was that it was too wide in scope. Most respondents against the definition argued that if an exclusion was to be permitted it should be limited to work conducted in the course of conveyancing rather than any work conducted for financial institutions. In this regard they noted that some of the work which would be caught by the current definition included: undertakings with regard to inheritance tax, company and commercial matters, grant of easement and transfers of equity. One implication of this is that the current scope of the exclusion is such that many more firms would need to ensure they had financial institution cover than if the exclusion was limited to conveyancing. The benefits of any exclusion are somewhat smaller if most firms could not use it in practice.

Permitted exclusion from the MTC

  • 5.15

    The proposed implementation of the financial institution exclusion by way of a permitted exclusion was supported by 47 respondents compared to 67 who were against it.

  • 5.16

    The main reason why respondents are against this proposal was because they actually oppose the financial institution (FI) exclusion proposal. Other respondents in favour of the proposal stated that even though they do not support the FI exclusion, if it is to be implemented then it should be by way of a permitted exclusion.

Our response

  • 5.17

    The primary reason for proposing the ability to allow cover for financial institutions to be excluded which was that financial institutions are capable of looking after their own interests rather than needing regulatory protection. In addition, there was a very high level of claims by financial institutions in connection with conveyancing.

  • 5.18

    The exclusion was intended to make insurance policies more flexible for the profession. We note that the implication of rejecting the proposal is that some firms may be unable to obtain any insurance cover from the open market where they could have been able to obtain narrower insurance cover with the permitted exclusion; other firms may pay higher prices for their insurance than they otherwise would.

  • 5.19

    However, given the very strong feelings expressed by the profession, the concern by financial institutions regarding the time necessary to implement a change of this nature and the potential impact in terms of a sudden and extensive reduction in the size of lenders' panels (with a potential consequential impact on consumers), we have decided not to implement this change in October 2011.

  • 5.20

    As set out in the consultation paper and in the separate financial protection policy statement that is published alongside this response, the SRA intends to conduct further research and analysis into the regulation of the conveyancing process. This will include consideration of which parts of the process are most susceptible to negligence and fraud, whether there should be explicit authorisation to conduct conveyancing, whether the conveyancing process itself should be altered; or whether alternative approaches could be used to provide protection to clients.

  • 5.21

    We intend to complete this research in time to consider whether changes should be implemented at a later date after the transition to new ARP arrangements as set out in our policy statement.

Proposal 3 and other issues related to the ARP

  • 6.1

    Proposal 3 was to increase controls over the ARP included amending the ARP such that, with effect from 1 October 2011, firms can only be covered for six months as well as requiring that such firms must develop a plan to obtain open-market insurance or close. In addition to this proposal, the consultation paper also raised the possibility of changing the role of the ARP as a provider of policies of qualifying insurance either by ending this role altogether or by placing conditions on the work that can be undertaken while in the ARP such as by the SRA requiring the firm to not accept new instructions or to not hold client money.

  • 6.2

    The consultation paper raised a number of questions regarding the ARP and a large number of comments were received regarding the ARP.

Reduction of the ARP period to 6 months

  • 6.3

    Among the profession, 71 were in favour of reducing the time in the ARP (52 in favour of 6 months, 8 in favour of 3 months and 11 in favour of the ARP being closed altogether) while 41 were against reducing the time in the ARP. Once all respondents are included, 84 were in favour of reducing the time in the ARP and 49 against. Representatives of BME firms (who are disproportionately present in the ARP) were against this proposal arguing that there was insufficient evidence to support this step and viewing six months as insufficient time for firms to prepare to exit the ARP.

  • 6.4

    Insurers were in favour of reducing the period of time firms can spend in the ARP as being a step to reduce ARP liabilities, but argued more strongly for the complete closure of the ARP or, if its were to kept as a mechanism, the liability for funding the ARP shortfall transferred directly to the profession. Insurers argued that the ARP is distorting the market, reducing competition and increasing premiums for the whole profession.

  • 6.5

    Among those who were against the reduction, many respondents stated that the change from two years to 12 months had only just been made and that time needed to be spent assessing the impact of this previous change before making further reductions in the time in the ARP. Others in favour of the reduction to six months considered that this was a sufficient period for any good firm to sort its difficulties out or for other firms to be closed in an orderly manner.

Detailed planning by ARP firms

  • 6.6

    Among the profession, 45 respondents were in favour of requiring ARP firms to undertake detailed planning of how they would exit the ARP while 11 were against this. Among those who were against it, respondents indicated that this could lead to "tick-box" regulation of these firms, that the planning would distract firms from getting on with serving their clients, or that it was an academic issue given that most firms in the ARP close anyway. Some objected on the grounds that not all firms in the ARP should be required to do this as not all firms in the ARP were high-risk firms, rather they were in the ARP due to misconceived rejections by insurers.

Closure of the ARP

  • 6.7

    The consultation paper raised a question as to whether the ARP should cease to offer policies of qualifying insurance in the future. Among the profession, 45 respondents were in favour of closing the ARP compared to 36 who disagreed with this option. Once all respondents are taken into account the figures are 55 for and 43 against. The insurers were strongly in favour of closing the ARP because of its distorting effect on the operation of the market and the fact that it results in increased premiums. Those who were in favour of closing the ARP made the following main comments:

    • The ARP leads well-run firms to subsidise the claims of poorly-run firms and the cost of the ARP is very significant for the rest of the profession;
    • Firms that cannot obtain insurance in the open market should not be in practice;
    • Firms in the ARP rarely exit the ARP to continue practising, the ARP does not rehabilitate firms and therefore should be closed;
    • Closing the ARP would force firms to close which, since they would be high-risk firms, would be to the benefit of the rest of the profession; and
    • Keeping the ARP makes entry by insurers less attractive, is a barrier to new entry and reduces competition, which in turn makes it more difficult for firms to obtain open-market insurance.
  • 6.8

    Those who were against closing the ARP made the following comments:

    • Without an ARP firms may be forced to close suddenly which would not be to the benefit of clients (although many respondents highlighted that having some form of policy extension similar to that suggested by TLS would assist in this);
    • Closing the ARP would place the insurers in the position to determine whether firms could continue to practice;
    • Some form of fallback mechanism was needed for firms who cannot obtain insurance because of unfair actions by insurers;
    • Closing the ARP would force firms to close which was seen as unreasonable; and
    • BME representatives highlighted the disproportionate number of BME firms in the ARP as a reason against closure.

Meeting claims against uninsured firms

  • 6.9

    Among the profession, 82 firms were in favour of retaining the role of the ARP to meet claims against uninsured firms while 35 disagreed. Of those who disagreed, 17 thought that the ARP should be scrapped altogether. Others who disagreed stated that the client should not expect full protection as this would not be the case in other professions and then clients would take more care about their choice of solicitor. Some preferred the idea that the previous insurer should pick up the risk from these firms.

Provision of run-off cover through the ARP

  • 6.10

    Among the profession, 80 firms were in favour of retaining run-off cover through the ARP while 37 were against.

  • 6.11

    Those in favour of retaining run-off cover often gave arguments in favour of run-off cover itself being required rather than run-off cover being delivered through the ARP. Some of those in favour of retaining run-off cover through the ARP suggested it should be delivered through the Compensation Fund. Others thought that the cover should be continued to be delivered through the ARP but with the principals of the firm facing the liability for claims. Many respondents favoured tighter requirements on the financial viability of firms to prevent costs of run-off falling onto the ARP.

  • 6.12

    Among the few who gave reasons for objecting, many objected to run-off cover itself arguing that the cost of this was a considerable burden for firms, especially small firms, and preferring to find an alternative way of providing run-off cover for all firms such as through either higher annual premiums or through a separately-provided fund. Some respondents thought firms should be obliged to plan for the cost of run-off so that they could afford it themselves. Others supported TLS's suggestion of requiring the last insurer to provide run-off cover.

Funding the ARP

  • 6.13

    The consultation paper sought views on whether to change the method of funding the ARP should it remain in place. The two options suggested were:

    • a direct levy on the profession, possibly collected and managed through a SIF mechanism (option one); or
    • a levy as a percentage of the insurance premium (option two).
  • 6.14

    Overall, among the profession, 61 favoured changing the way that the ARP was funded while 14 disagreed that there should be a change (two of these disagreed because they thought that the ARP should be scrapped). Many of those in favour of changing the funding mechanism indicated that it was unreasonable for insurers to fund the cost of the ARP where these firms, by definition, were firms that insurers were unwilling to insure. Many respondents recognised that the funding of the ARP was stopping insurers from entering the market which they described as being bad for the profession as a whole; hence they were in favour of altering the funding mechanism. Firms suggested that this was particularly detrimental to small firms.

  • 6.15

    Although firms were generally in favour of moving away from the current funding mechanism, there was a more mixed response regarding the method that should be used in the future. Among those who expressed an opinion, 14 favoured option 1 compared to six who favoured option 2 and 4 who stated that either would be acceptable. A further 18 expressed a preference for the proposal by TLS that the ARP should be replaced by the previous insurer taking responsibility for firms.

  • 6.16

    Other options suggested included merging the ARP with the Compensation Fund with the levies paid according to current Compensation Fund levies; extracting all monies from those in the ARP; requesting highly profitable members of the profession to pay; or basing it on the turnover of firms.

  • 6.17

    Insurers were all in favour of a direct levy on the profession if the ARP were to continue in its current form. Some believe that if Option 1 were implemented, the profession would have an incentive for greater self-regulation. They argued that a direct levy on the profession would be easier to be administer and would provide highly transparent costs which could accelerate self-regulation. If Option 2 was implemented, they generally believe it would be subject to the same market pressures as the current insurer-funded shortfall.

  • 6.18

    In terms of the current funding arrangements, as well as the general concern that funding via the profession introduced disincentives to compete for market shares, many insurers drew attention to two other issues:

    • The fact that Qualifying Insurers' ARP liabilities are scaled up in the event of insolvency of other Qualifying Insurers. Insurers objected to this because it meant that their liabilities depended on whether or not their competitors became insolvent. They also highlighted that it meant that firms in the ARP therefore had more protection than did firms insured through the open market; and
    • Concerns regarding the manipulation of market share information for apportioning the ARP cost between Qualifying Insurers. Insurers were concerned that some insurers and firms had sought to "get around" the rules which was to the disadvantage of those insurers that had not done this.

TLS proposals

  • 6.19

    Following the SRA's review of client financial protection arrangements and the publication of the consultation paper, TLS made proposals for an alternative approach related to the ARP. TLS proposed:

    • the closure of the ARP to new entry other than the role of providing cover for uninsured firms,
    • an Extended Renewal Period lasting a minimum of three months in which firms can either obtain insurance elsewhere or plan for orderly merger, succession or shut-down,
    • a notice period of six months of an insurers' intention to not renew a policy (which can include the three-month Extended Renewal Period),
    • the premium for the three-month Extended Renewal Period to be charged at the same pro-rata amount as for the existing policy in place,
    • the ability to place firms into the Extended Renewal Period in the case of fraud, misrepresentation or material non-disclosure, and
    • a requirement that insurers take on the six-year run-off risk for firms they were previously insuring.
  • 6.20

    A number of respondents made reference to TLS proposals in their responses to various questions in the consultation paper.

Our response

  • 6.21

    A number of potential changes have been suggested by TLS and other stakeholders regarding the approach to be taken in relation to the ARP. In the light of comments received through the consultation process and continued discussions with key stakeholders, we have decided to revise our approach to the ARP. Not all of these issues were included in the consultation paper and we have therefore decided that we will set out our long-term plans for the ARP, including transition arrangements, in a separate document (see the SRA's separate financial protection policy statement) with further consultation on the detail of the arrangements as necessary.

Medium term

  • 6.22

    Our approach, which will take effect from 1 October 2013, is as follows:

    • The ARP will close to new entrants;
    • Following the expiry of a policy of Qualifying Insurance:
      • a firm has a grace period of up to 30 days to obtain cover and backdate it to have effect as from the expiry of the previous policy – the "Qualifying Period Extension";
      • on the expiry of the 30 days, if the firm has not obtained Qualifying Insurance:
        • it must cease accepting any new instructions and run-off all existing instructions in an orderly manner by no later than 3 months following the expiry of its last policy of Qualifying Insurance;
        • the SRA shall have powers (and will be expected) to supervise the orderly wind-down, take steps to restrict the firm from accepting any new instructions and, if necessary, transfer of business to another firm within the 3 months period;
        • the last Qualifying Insurer of record retains the risk for claims arising from the work of the firm during its 3 months winding down period; and
        • as is currently the case, the last Qualifying Insurer of record retains the risk for a 6 year run-off period after the expiry of the last policy of Qualifying Insurance. This run-off policy will also provide cover (to the same date) for any claim arising from work performed by the firm in the 3 month period after policy expiration.
  • 6.23

    In respect of closing the ARP to new entrants, we note that more than half of the profession who gave clear comments on this issue were in favour of closing the ARP and many in the profession expressed frustration that firms were being sustained in business when they should be closed down.

  • 6.24

    One of the main concerns expressed regarding the closure of the ARP was that this could lead to firms suddenly having to close down because they were temporarily unable to obtain insurance from qualifying insurance. The proposal to have a Qualifying Period Extension helps to deal with this concern as it introduces additional time for firms to seek appropriate cover if they have been unable to do so in advance of renewal. It should be noted that this does not prevent insurers and firms from freely choosing to extend policies for short periods of time. Rather, the Qualifying Period Extension is aimed at ensuring that firms have an extra 30 days to obtain insurance should their existing insurer determine that it is unwilling to continue offering insurance to them.

  • 6.25

    We will also ensure that information channels are put in place between insurers and the SRA to ensure in order to ensure that there is clarity as to whether a firm is operating under the Qualifying Period Extension during which time we anticipate increased regulatory attention. Firms which enter the Intervention Period will face considerable regulatory attention with a view to firms being closed down in an orderly fashion.

  • 6.26

    The final element of the long term proposal is that insurers will be required to automatically take on run-off cover for any firms that they insure if those firms cannot obtain alternative insurance and enter the Qualifying Period Extension and the Intervention Period. This is an extension of the requirement that insurers take on run-off cover for firms that close down during the policy year as is currently the case.

  • 6.27

    The intention of this proposal is that it would prevent the re-emergence of the current situation where firms end up with qualifying insurance provided by the ARP and then enter run-off also through the ARP. This would also improve the incentives for insurers to report information to the SRA regarding any poor behaviour of firms because the current insurer would inevitably bear the run-off risk of the firm and therefore has an incentive to limit the cost of this through rapid reporting of any failures by the firm.

  • 6.28

    Some respondents to the consultation paper suggest that this proposal may lead to an increase in premiums for some firms compared to the absence of this requirement.

Short term – changes from October 2011

  • 6.29

    As well as the changes which we set out for the longer term, while the ARP continues to operate we will make the following changes:

    • The maximum time a firm may obtain Qualifying Insurance from the ARP will be reduced to six months from 1 October 2011,
    • ARP firms will be required to plan for either obtaining open-market insurance or closing in an orderly manner,
    • Changes will be made to remove the scaling up of a Qualifying Insurer's ARP liabilities in the event of insolvency of one of them (bringing the ARP funding in line with what would happen if insolvency arose in the open market), and
    • The criteria for apportioning the ARP cost between Qualifying Insurers will, if deemed necessary following the current review of declared premiums for the 2010/11 indemnity year, be revised in order to enhance clarity and transparency.
  • 6.30

    The proposal to shorten the time in the ARP from 12 months to 6 months was supported by the majority of respondents who commented on this issue and we will implement this from 1 October 2011. This will further reduce the costs of claims against firms in the ARP, create a greater focus for ARP firms either to close in an orderly fashion or take the steps necessary to address the issues which prevented them from obtaining insurance and be consistent with the transition to the new arrangements applying from October 2013. In addition, it will be important to ensure that, when October 2013 is reached no firms remain in the ARP. This is more likely to be the case if entry into the ARP is permitted for 12 months rather than 6 as it is relatively common for ARP firms to seek waivers of the ARP rules to extend their period within the ARP. In addition, reducing the number of firms in the ARP at any point in time will enable the SRA to concentrate available resources to address the regulatory issue that arise with many ARP firms.

  • 6.31

    The reduction in the period for which a firm is entitled to continue to operate in the ARP is also likely to benefit consumers. About 50 per cent of firms in the ARP are categorised by the SRA as being high-risk with the remaining firms categorised as medium/low-risk. Reducing the period for which ARP firms can automatically continue to provide services to the public is a clear mechanism to address this particular risk.

  • 6.32

    Making this change does not reduce the client protection provided by the ARP as it will still enable firms up to one month's temporary cover with subsequently obtained open-market insurance being backdated (something done by some 190 firms following the October 2010 renewal) and ensure that firms are not forced into rapid and disorderly closure.

  • 6.33

    Our equality impact assessment (EIA) addresses the issue of the impact on BME firms of a reduction in the period of time a firm may spend in the ARP (as well as the decision to replace the ARP in 2013). BME firms are disproportionately over-represented in the ARP compared to white firms. This issue has been considered carefully as set out in the EIA. However, the SRA's view is that this decision is proportionate and justified both as a measure to be implemented in October 2011 and as being consistent with the transition to the new arrangements for October 2013. It is important to note that small firms, a category in which BME firms are also over-represented, have a very limited choice of insurer within the current market. This step (together with the others we have set out) is critically important not only to maintaining a viable open-market system but also to encouraging new entrants and increasing competition for firms' insurance business—including that of small firms. The majority of BME firms do not rely on the ARP for insurance but the open-market and, therefore, improvements in the availability and cost of open-market insurance, particularly to small firms, will benefit BME firms generally.

  • 6.34

    In addition, we note the comments from the profession regarding the firms that fall into the ARP for a short period of time and the implications this may have for the quality of these firms' practice management standards. From October 2011, we therefore anticipate investigating all firms that enter the ARP for a short period as well as the more intensive approach that we will take for firms that remain in the ARP beyond the period of temporary cover.

Proposal 4: Clarifying obligations on insurers to provide information to the SRA

  • 7.1

    The majority of respondents from the profession agreed that insurers should be required to provide information to the SRA regarding misrepresentation or failure to pay premiums. A small number of respondents, however, raised cautions that the interpretation of whether information had in fact been misrepresented means that firms should have the opportunity to respond to this position.

  • 7.2

    Insurers, however, had more mixed views regarding the proposal. A number of insurers argued that the change would have little impact since the SRA already monitors the activities of almost all the reported firms. In respect of information related to paying premiums, some insurers thought this would have little effect since most insurers insist on cash before cover because they are unable to avoid cover for non-payment of premiums (although they cannot do this for run-off). With respect to fraud and misrepresentation, insurers stated that clear guidance would be need as to when suspicions should be transmitted to the SRA and warned that insurers did not always have proposal forms where insurance has been written through brokers using binding authorities.

  • 7.3

    Most insurers expressed frustration that where insurers have passed on information to the SRA there was insufficient regulatory action in response as well as concern that the SRA does not share information with insurers. More generally, insurers indicated that they should not take on the role of the regulator.

Our response

  • 7.4

    We will be making one small change to the QIA for 2011/12 to clarify reporting requirements. In addition we will continue to work with insurers to improve information flows.

Possible future changes

Further extension of permitted exclusion to limit cover only to individuals

  • 8.1

    Among the profession, 118 respondents were against the proposal to enable a permitted exclusion for all clients other than individuals and only 13 were in favour. Those who agreed with the proposal argued that commercial clients did not need regulatory protection.

  • 8.2

    Among those who disagreed, some thought that permitted exclusions should be based on the work type rather than the client type (with this linked to regulatory permissions in many cases). Others that the exclusion should be limited to large corporates rather than going as far as suggested by the Ombudsman definition of individuals.

  • 8.3

    Those who objected did so for similar reasons to those given regarding the exclusion of financial institutions. In particular, many respondents were concerned that they would be unable to obtain insurance cover for clients where permitted exclusions were possible. Some saw the proposal as unnecessarily complicated. It was also noted by many respondents that most solicitors act for firms outside the scope of the "individual" definition and would therefore require full client coverage, many firms also noted that it was common to act for small business owners on a range of issues some of which could fall inside the definition of work for individual clients and some of which would fall outside. They also challenged the assumption that non-individual clients would always be in a better position to assess the quality of the solicitor than individual clients would be (although some used the same argument to suggest that since individual clients can assess quality other clients can as well).

Our response

  • 8.4

    We will be considering this issue further but do not intend to make any changes in this area before we have completed the ARP transition programme in 2013/14.

Cancellation of policies for non-payment of premiums

  • 8.5

    The proposed permit of cancellation of policies for non-payment of premiums was supported by 86 respondents compared to 27 who were against it.

  • 8.6

    Those in favour of the proposal argued that law firms should not have undue protection against insurers and that the proposal was simply standard commercial practice. Many expressed concern that the current arrangements meant that those firms that pay premiums subsidise those that do not. Many also stated that firms that did not pay premiums should be shut down immediately (although some noted the need to give firms time to pay in case this was an administrative error) and respondents believed that this would be to the advantage of the profession as a whole. Others, while agreeing with the proposal, thought it would not make much difference as they believed that insurers already required upfront payment.

  • 8.7

    Some of the respondents who oppose the proposal think that it is a good idea in theory, but impractical. Furthermore they believe this could damage the clients' interests and the reputation of the profession and could increase the number of firms that would be placed into the ARP. In general, however, these firms believed that failure to pay premiums should lead to SRA investigations of the firms.

  • 8.8

    We will consider this issue further in the context of the arrangements we are putting in place for the replacement of the ARP.

Cancellation of policies for fraud or misrepresentation in proposals

  • 8.9

    The proposal to permit cancellation of policies for fraud or misrepresentation was supported by 68 respondents compared to 22 who were against it.

  • 8.10

    One of the issues raised by some respondents is that there should be a different treatment for fraud, for which they agree with the policy cancellation, and misrepresentation, for which they think the cancellation, should not be allowed. Some other respondents state that only innocent misrepresentation should not lead to policy cancellation. In general there was more concern regarding making changes related to misrepresentation than making changes with respect to fraud. A number of respondents were concerned that the present arrangements mean that good firms pay for deliberate misrepresentation and fraud by bad firms. Respondents were also in favour of regulatory investigation of these firms.

  • 8.11

    As for the respondents against the proposal, they think that this measure, by removing protection, could have an adverse impact on clients, and could be abused by insurers who would seek to repudiate more claims. It is in their opinion that insurers should counterclaim against the insured. Some others think that this should primarily be a matter of professional misconduct requiring action by the regulator.

  • 8.12

    We will consider this issue further in the context of the arrangements we are putting in place for the replacement of the ARP.

Compensation Fund

Q32: Single Compensation Fund

  • 8.13

    The proposed single Compensation Fund for covering all regulated organisations was supported by 71 respondents compared to 40 who were against it.

  • 8.14

    The main reason that respondents are against the single compensation fund report is that since the Compensation Fund has been fuelled by the contributions of traditional law firms, ABSs should not be allowed to benefit from these contributions, but should rather pay into their own separate Compensation Fund. These respondents state that by creating a single compensation fund, the SRA would allow ABSs to free ride on the efforts and contributions of solicitors firms.

Q33: Interaction between the scope of cover through the MTC and the Single Compensation Fund

  • 8.15

    The respondents to this question seem to be mainly concerned by the fact that the Compensation Fund will be used to protect financial institutions, even though such organisations will not be protected by MTC (assuming that the financial institution exclusion was permitted). They argue that if financial institutions were protected by the single Compensation Fund the burden of financing such losses will merely move away from insurers and the ARP to the Compensation Fund. It is their opinion that a single Compensation Fund will exacerbate the concerns of the financial institutions in dealing with smaller firms and will consequently lead those firms to be excluded from the conveyancing market. This will have the effect of reducing consumer choice and driving more firms out of business.

  • 8.16

    Another concern relates to the different nature of the two funds: the cover provided by the MTC should be for civil claims, whereas the cover provided by the compensation fund should be for dishonesty.

  • 8.17

    Alternatively it was suggested that insurers should have an aggregate cap on claims by financial institutions, rather than having a single Compensation Fund with an aggregate limit on its liability and, therefore, a cap on the number of claims that can be made on it.

Q34: Views on the basis for assessing contributions to the Compensation Fund

  • 8.18

    77 respondents expressed views on the basis for assessing the contributions to the Compensation Fund.

  • 8.19

    Many respondents state that the contributions to the Compensation Fund should be based on risk reflective criteria. Others are concerned that the proposed contribution methodology might be too difficult and complex to be achieved without adding more bureaucracy and consequently more administrative costs. Some other respondents are concerned that this measure will imply that conveyancing firms will pay more.

  • 8.20

    Some respondents proposed alternative approaches to the contribution methodology. The proposal that is support by the greatest number of respondents is the approach adopted for TLS payments, i.e. that contributions should be set as a percentage of turnover. Other suggestions are to link the contributions to the size and type of business; gross premium income in previous years; the number of claims; to make contributions on a basis similar to that used to calculate the fee for the SRA; and to link contributions to the number of partners within the practice.

Q35: Single fund

  • 8.21

    It should be noted that this question is only relevant if the purpose of the ARP was not changed and that it continued to provide policies of Qualifying Insurance. Given this change, there were 44 respondents who believe that the ARP and the Compensation Fund should be combined into a single fund while 41 respondents opposed the proposal of a single fund.

  • 8.22

    Some objected to the proposal because the ARP and the Compensation Fund have different purposes and therefore should not be combined. Others fear that the value of a single fund may be insufficient to meet claims.

Our response

  • 8.23

    As set out in the separate policy statement we will be giving further consideration to a number of issues concerning the Compensation Fund during 2011/12.

Equality impact

  • 9.1

    Only 20 respondents commented on the initial equality impact assessment and among them there is a divergence in opinions regarding the impact of the proposed changes. All of the comments on equality issues were considered in the drafting of the final EIA which is published alongside this response.

  • 9.2

    Respondents who believe the changes would have a negative impact are mainly concerned that the financial institution exclusion will affect disproportionately the small firms. They believe that the PII premiums are unlikely to reduce in the early years following 2011. On the contrary, for firms with a financial institution's exposure, the overall premiums are likely to increase, as they will need to buy additional cover.

  • 9.3

    Another concern relates to the two-stage approach as it may make it more difficult for small firms, BME, female and sole practitioners to obtain insurance due to the period of uncertainty regarding the SRA's approach to the ARP.

  • 9.4

    Among the 5 respondents who see the impact of the proposed changes as positive, 3 respondents believe the changes would make the market more innovative and by removing barriers to entry, more competitive. Therefore the enhanced competition would improve equality by lowering prices and by making insurance more accessible.

  • 9.5

    Regarding the single renewal date removal, a respondent believes that if a sufficient spread of variable renewal dates is achieved, then there may be a positive impact on small firms and indirectly on BME firms. However, if there is not a sufficient spread of variable renewal dates then it is possible that firms will continue to be disadvantaged.

  • 9.6

    Concerns raised in relation to equality issues flowing from decisions on the ARP have been referred to in the relevant sections earlier in this paper and are addressed at length in the EIA published alongside this paper.

  • 9.7

    Nine respondents said that there is more work to be done on the equality impact, in particular concerning entry requirements to allow solicitors to practice. A respondent believes that a full equality impact assessment, as opposed to an initial assessment, and an extensive consultation with the groups likely to be affected by the current proposals are necessary.

Annex 1

Summary of overall results

The table below sets out a summary of the main responses by whether respondents agreed or disagreed with the main proposals.

 

Yes

No

Question 1: Agree with Objectives and Principles

100

18

Question 4: Agree with two-stage approach

48

45

Question 5: Maintain open market

128

10

Question 6: Maintain QIA

122

11

Question 7: No additional criteria for QI

103

27

Question 8: Maintain ARP for claims against uninsured firms

93

41

Question 9: Maintain ARP for run-off cover

89

44

Question 10: Maintain current approach to setting premiums

76

48

Question 11: Remove single renewal date

69

150

Question 12: Agree with FI exclusion

25

236

Question 13: Agree with definition of FI

40

72

Question 14: FI as permitted exclusion from the MTC

47

67

Question 16: Agree with ARP to 6 months

84

49

Question 17: Require detailed plan from firms in the ARP

54

14

Question 18: Agree with reporting

56

19

Question 19: Cover restricted to individuals

20

131

Question 22: Remove ARP as provider of QI

55

43

Question 26: Change ARP funding

79

17

Question 30: Permit cancellation for non-payment of premiums

86

27

Question 31: Permit cancellation for fraud or misrepresentation

68

22

Question 32: Single compensation fund (law firms and ABS)

71

40

Question 35: Single fund (ARP and CF)

44

41