All law firms must have professional indemnity insurance. This is, according to the Law Society, becoming hard to come by as insurers look to offer cover only to firms they conclude are well placed to succeed in what is a very competitive market place.
The level of cover required is determined by two factors. The first is that firms established as an unincorporated practice (a partnership or sole practitioner) must have a minimum of £2m of cover for each claim, whereas firms established as an incorporated practice (a limited liability partnership or a limited liability company) must have a minimum cover of £3m for each claim. The second, however, relates to risk and client requirements. If you envisage undertaking work where the potential loss exceeds the minimum level of cover then it is highly advisable to obtain top up cover to a level commensurate with that risk. Some savvy clients will enquire as to your level of cover and may not be willing to instruct you if they deem it to be insufficient.
You may think that obtaining £3m of cover would be substantially more expensive than £2m and thus starting as a partnership or a sole practitioner might be more economical. This is not however the case. Insurers price on the basis of risk and the cost of insurance is determined by the type of work to be undertaken, the anticipated turnover of the firm, the number of offices and staff and how compliant insurers perceive the firm will be.
The Law Society authorises those insurers that are permitted to offer law firm professional indemnity cover but the list of “participating insurers” is relatively small. The list ranges from ‘A rated’ insurers to those which are unrated. There have been some widely publicised issues regarding professional indemnity insurers, for example firms insured by the Latvian insurer Balva found themselves without cover only a few weeks before renewal when Balva pulled out of the market and subsequently went into administration. It is highly advisable therefore to seek the advice of an insurance broker in good time.
While there are some insurers who will not insure sole practitioners and small firms, most will offer suitable cover to ‘risks’ (that is how insurers see law firms) they understand. The bulk of the insurance market for small firms is domestic property and consumer related and insurers can offer reasonably quick turnarounds and competitive quotes. Anecdotally, insurers do struggle to offer cover to small firms doing ‘complex work’. For example in the insurance proposal form you will be asked questions like; ‘will you advise on contracts governed by foreign laws’, ‘will you act for listed plc clients’, ‘will you act for foreign clients’? If you are planning to answer these in the affirmative, then you can expect your insurers to require further information before they are happy to offer cover to your new firm; generally only larger firms with tightly controlled internal risk processes and good claims histories would answer these questions in the affirmative.
According to Stephen Levey, a solicitor and a Director of the legal insurance broker, St Giles, “firms should ensure they receive their proposal forms in good time. For example we send our forms out to clients in June for an October renewal, giving our clients ample opportunity to get it completed and returned to us. The insurance proposal form is an important document and firms cannot practice without insurance. Firms should also cultivate a relationship with their insurer; not just speak to them at renewal. St Giles, for example, offers a full risk management service throughout the year and actively works with clients to reduce risk and therefore insurance premium.”
Insurance cover is one of the most significant costs to a firm. For an average firm with a good spread of work and with no claims it can expect a premium in the region of 3% to 6% of anticipated turnover, property sees the most claims and thus leads to the highest insurance premiums. Each insurer has its own way of pricing insurance and each proposal is different, but a new two partner firm should budget something in the region of £20,000 for its insurance.
The cost of insurance does not end there. So that clients are not prejudiced by the closure of their law firm, the Law Society requires that all firms (that do not merge with another firm) purchase run off cover before they cease trading. This would typically cost between 2.5 to 4 times the annual premium as at the date of closure and is payable in a lump sum before the firm closes. So assuming the premium at the time of a firm’s closure is £20,000 then the cost of run off could be as much as £80,000 (but a good compliance regime and claims history should yield a much lower figure). Alternatively, if the firm merges with another firm then the new firm would become the successor practice and by doing this take on all residual liability. In this scenario run off cover would not be required, however few firms are happy to accept such risk and usually require the firm they are seeking to merge with to acquire run off insurance in any event.
There is an alternative solution if you seek all the flexibility and freedom of setting up your own law firm but wish to avoid the investment inherent in setting up.