When clients attack

It would be interesting to know how Ernst & Young must have felt when, just over three years ago, Equitable Life’s claim against the Big Four firm landed on its doormat.

Apart from the obvious (‘call the lawyers’), the claim for £2.6bn, as it was then, must have prompted the thought: ‘Are we insured?’

The answer, almost certainly, is no. Claims of that magnitude cannot, for various reasons, be covered by conventional insurance.

But the trial currently taking place at the High Court, which may prove a landmark in auditor liability cases, does raise questions about accountancy firms and the way in which they are insured. How does their insurance, in so far as they have it, work? And do events like the Equitable claim, and perceptions that auditors are taking the rap for more and more corporate failures, push up the cost of insurance?

The Big Four probably do not carry commercial insurance for multi-billion pound claims like Equitable’s, believes Mark Hardinge, managing director of Aon professional risks, the market leading broker in the field.

For claims of that size, they are often self-insured by a number of means. One method is through captives, meaning they pay premiums into companies they own, often in favourable tax regimes.

If they have a claim, they may have enough to cover it in those captives. If they do not get a claim, the capital and surplus simply appreciates.

It would not be dissimilar to putting aside £1,000 a year for a gold ring worth £5,000. Initially, you would not be covered, but after five years you would.

The highest insured limit available in the commercial market place, is probably around $200m (£105m), Hardinge says. That is significantly less than the £2.05bn currently being claimed by Equitable.

So why can’t the Big Four get cover for those kinds of claims? Hardinge says that the market is just not big enough.

For significantly larger limits of several billion pounds, insurers could probably not accumulate a premium pool, he argues. There wouldn’t be enough premiums covering the occasional claims.

You would need a Big 25, he says, before you could have a significant community of insurers who could offer limits of this magnitude.

The insurer market works better for the firms who are lower down the food chain, he says.

The middle tier of accounting firms will probably tend to attract lower level claims because the business they transact is less complex and their clients are probably not as large.

Big Four firms also tend to have a higher frequency of claim so that their ‘insured attachment point,’ essentially similar to an ‘excess’, would need to be fairly high too.

Like many law firms, accounting firms may also elect not to cover themselves at too great a level, he says. Insurance contracts are discoverable at law, and large amounts of cover might lead plaintiffs to make larger claims.

So is cover becoming more expensive in the light of the liabilities accountants seem to be increasingly incurring? Not according to Hardinge, who describes the market as ‘stable’.

Sandra Neilson, senior vice-president of FINPRO, the financial and professional service practice of Marsh, the brokers, says that, excluding the Big Four (who are unique because of their size and scope of operations), the real cost has gone up over the last 15 years but has gone through ‘hard’ and ‘soft’ cycles in that period.

The general state of the economy has an effect on capacity, says FINPRO managing director Keith Tracey. As insurers capital bases become more secure, their capacity to write insurance increases.

In such circumstances, the market becomes more competitive, and insurers are willing to underwrite riskier business. In a ‘soft’ market the cost of insurance falls, and the availability of cover is likely to increase.

In 2004 the market stabilised as insurers results improved.

Neilson says that insurers for professional indemnity (again excluding the Big Four) include Lloyd’s and the London Market companies, for example, well-known names like Hiscox and Chubb.

In general, claims in the professional indemnity market were more difficult to statistically predict than, for example hurricanes, where a greater volume of statistical data exists for use in premium modelling.

And nothing, ultimately, could insure the likes of Ernst & Young against the reputational damage caused by losing a big case like Equitable, of course.

That is a big unknown for the Big Four firm, and it is difficult to estimate how losing, or the extent of any loss, might affect E&Y.

The firm itself remains upbeat about the case. It is coy about its insurance, for obvious reasons, but points out that it feels the question may prove irrelevant in any case.

It does not have cover for £2bn, but the figure is pie in the sky, anyway. It does not expect to lose and if it did the full damages claim would never be approved by the judge, it says.

Whether or not the judge will see it that way remains to be seen. But it might at least be said that the fact of the case itself and other multi-billion pound cases like it, raise an awkward question for Big Four firms as a whole ? how can they insure their futures in a litigious world?

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