Professional Indemnity: be prepared

Accountants have benefitted from low professional indemnity insurance
premiums for years, but that might be about to change.

Partially as a result of the credit crunch and fall out from the US sub-prime
crisis that has had significant implications for the UK economy, accountants
should brace themselves as the PI insurance market could be about to experience
a shock to the system. Frequently, following economic shocks like the one we are
currently experiencing, there is a significant increase in the number of claims
against professionals.

The sub-prime crisis is causing a great deal of uncertainty in the financial
services market and accountants might well be considered prime scapegoat
material by certain companies and sectors whose margins and figures on the
bottom look set to take a hit.

Before focusing on PI for accountants, it might be instructive to compare
professional indemnity trends in other professional sectors. For example,
although the PI market for legal firms is at a similar state of the insurance
cycle as that for accountants, the same certainly cannot be said for the market
for mortgage brokers and IFAs.

A PI broker colleague of mine explained recently that due primarily to a
mixture of regulatory issues and the recent financial markets turmoil, a large
number of mortgage brokers were now unable to obtain PI insurance. The lucky
ones who did manage to obtain coverage were experiencing a huge spike in
premiums ­ in many cases a hike of over 100% and in some cases by as much as

No one is suggesting something similar is going to happen to accountants’ PI
rates, but one certainly has to question whether the market’s current low
premium levels are really sustainable for much longer.

As it currently stands, The PI market place is very healthy for accountants.
The insurance market goes through cycles and is currently experiencing what is
known in the insurance business as a ‘soft’ market. That means that for a number
of reasons ­ primarily because of the law of supply and demand and the intense
competition between insurers ­ PI insurance for accountants is low.

On guard

However, a number of observers and respected organisations are saying that
insurance premiums are unsustainably low and to be wary of a possible correction
that could lead to a sharp hardening (or spike) in rates.

In which case, now is the time to renew on a two-year fixed deal because if
you can obtain such a deal from an insurance broker, you might be able to
mitigate some of the exposure to higher premiums that may come with a rate

The risk is amplified because it is an unfortunate aspect of the soft/hard
rate cycle in insurance that soft markets tend to drift down quite gently
whereas a hard market usually experiences a rapid spike in rates that tend to
take firms by surprise.

The widely respected business intelligence and market research service
Datamonitor has also predicted that the market is expected to harden in 2008 or
2009 due to changes in competition and product penetration in the sector.

The report goes on to suggest two separate plausible scenarios in which
premiums go up. If premiums begin to harden in 2008 it is forecast that gross
written premiums (GWP) in the PI sector will grow to over £2.5bn by 2011. If the
market hardens in 2009, however, the forecast is GWP growth to ‘only’ £2.1bn ­
but still a 25% increase on the figures for 2006.

Meanwhile, the instability and volatility in the financial markets is
increasing. High levels of borrowing could land ‘a significant minority’ of
people in trouble in 2008, the
Financial Services
(FSA) has warned in a report issued recently. Its Financial Risk
Outlook report said that adverse market conditions were putting the business
models of some financial institutions under strain.

The report also warned that people may lose confidence in financial
regulators and market participants and consumers may lose confidence in
financial institutions and in the authorities’ ability to safeguard the
financial system. Consequently, the FSA expects that tighter economic conditions
will increase the amount of financial crime and fraud being uncovered.

One of the biggest risks for accountants is failure to pick up on a fraud
committed by a client’s employee with the potential that has for a professional
negligence claim and ensuing litigation.

Fraud indicators include false invoicing that leads to inflated turnover and
share price, acts which persuade lenders that a company turnover is higher,
theft by the finance director and/or his colleagues, and exaggerating the figure
for debtors to mask insolvency.

Every accountancy firm should be fully conversant with the money laundering
obligations on the profession.

The latest money laundering legislation further increases the exposure of
every profession and exposes individuals to criminal negligence claims as well
as civil liability actions.

The risk is not just limited to the Big Four either. Any accountancy firm
that fails to spot a fraud is at risk because, under current law, that practice
can be considered guilty of professional negligence with all the potential
liabilities and proportional losses suffered by the shareholder that entails.

It is certainly the case in PI insurance ­ which in many respects is no
different to other areas of our business ­ it can sometimes pay dividends to
build up a relationship with an insurer over time rather than enjoy the illicit
thrill of a ‘one night stand’ with an new entrant to the market.

Although new entrants offering the promise of lower premiums may be tempting
during a soft market, they frequently prove to be less than accommodating when
the market turns and the serious claims start to mount.

Things are looking up

For example if a PI insurer has underwritten a long-standing policyholder
with a good claims history they are much more likely to be less hostile when a
large claim comes in and it is time to renew the next year’s premium rate.

If we are towards the bottom of the market cycle (as most industry
commentators agree we are) it means that premiums are highly likely to start to
rise in the near future. On top of premium increases, we expect insurers to
adopt a more serious discipline in their underwriting approach. They will also
start to take a firm’s quality assurance procedures into account when
calculating premiums

If a firm’s, or a profession’s, claims experience is poor, it could also
result in a general lack of availability of insurance. Look no further than the
challenges faced by IFAs only five years ago in this respect and what is
happening to mortgage brokers today.

Mark Bracher works at Lockton International

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