Legal liability part three: top tips for shifting risk

With business comes risk. Most risks can be reduced or managed but very few
can be removed altogether. A firm can retain the risk and use internal controls
and capital to manage it. Or if it deems the risk too big, it can transfer all
or part of it to others.

Effective risk transfer removes the potential financial impact of a claim
from your balance sheet and puts it squarely onto someone else’s. Consultants
have several ways to do this.

Legal contract
In the previous articles in this series, I highlighted the importance
of having a contract in place between consultant and client which details what
services are expected and who will carry the can if things go wrong. This
contract should be the first line of defence, a place where consultants can lay
off some
of the risks they face.

It is increasingly common for consultants to cap their liability under a
contract by inserting a well-drafted clause. Take care in drafting such a clause
as the Unfair Contract Terms Act 1974 can be used to overrule punitive or unfair
limitations.

Captives
Captive insurance is relevant if your business’s insurance spend is well into
six figures. A captive is an insurance company that underwrites risks emanating
from its parent company.

For captive insurance to be worthwhile, the owner’s loss record must
outperform the market average. This is essentially because the captive can then
keep the surplus of premiums over claims for the business. The captive’s manager
can also reinsure catastrophic (or very large) potential risks to ensure they
are removed from the balance sheet.

Captives encourage good risk management, rather than a ‘who cares ­ the
insurers will pay’ attitude, and are often used by sophisticated businesses with
a very clear understanding of the nature of the risks they face.

Captives are often the domain of larger businesses that see them as more
cost-effective in the long term than taking the open market insurance route. But
in a ‘soft’ insurance market, where premium are falling, they may well prove to
be more expensive.

Mutuals
An insurance mutual is a commercial organisation owned by its members rather
than shareholders. Being part of a mutual does not lead to the complete transfer
of financial risk, as members remain responsible for the claims arising from all
the membership in a given time period.

A downside to mutual membership is that you can be held responsible for
claims incurred by other members, over which you have no control. Lack of
financial certainty is an added risk as you can receive cash calls or
contribution requests long after the time has elapsed.

Insurance policy
This is the most common form of risk transfer used by consultants, and
is ideally suited to a small or medium-sized firm as many policyholders share
the (sometimes huge) risks. The cost to the consultant is proportionate to the
size of the business.

The right broker

A good broker should always gather as much information about your needs and
expectations as possible so that they can provide the level of service and
policy coverage you need. They should also maintain strong relationships with a
range of insurance companies so that all relevant options can be explored.

An agent’s job is to provide the best possible coverage for their client for
the lowest premium. To achieve this, they should demonstrate knowledge of your
business and an understanding of your industry. They should have a proven track
record and a clear service ethic. Make sure they are in regular contact with
their clients and provide ongoing advice about the risk issues facing their
clients’ industries.

The right product
You and your broker should focus on the few insurance companies that deal with
management consultants as a distinct profession ­ for example, by specific
policy wording to provide cover for the diversity of activities within
management consultancy. Specialist wording protects the unique relationship a
professional has with their client and has features that don’t come with a
standard policy.

An example would be the mitigation of loss cover provided. Rather than basing
the cover on legal liability, which requires the insured’s clients to suffer a
loss and threaten legal action, this rectifies problems that can lead to claims
before the insured’s customer is even aware of them.

This will protect management consultants’ all-important customer
relationships and also their reputation. For the smaller consultant, it could
mean the survival of their business.

Once identified, risk can be minimised but very rarely removed altogether, so
the transfer of any unacceptable levels of risk is an essential element in
safeguarding the future of your business. Buying an insurance policy is
generally the best option for the small to medium-sized management consultant
and you should challenge your insurance broker to help you identify and remove
the key risks your business faces.

Gary Head is professions underwriting director at Hiscox. For more
information, go to www.hiscoxprofessions.co.uk