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National Competition Policy Review of the Legal Profession Act 1987
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11.1 The COAG Working Party Report stated in principle 9 that rules which required lawyers to obtain professional indemnity insurance only from insurers specified by Law Societies should be reviewed to establish whether they are in the public interest. New South Wales has supported the referral of this matter to the National Competition Council but the recommendations are still under consideration by the Commonwealth Government.
I. THE CURRENT SCHEME
11.2 Both solicitors and barristers are required to hold a professional indemnity insurance policy which has been approved by the Attorney General: sections 41 and 38R. The insurer is not specified by the Law Society or the Bar Council. However, all solicitors are required to contribute to the Solicitors' Mutual Indemnity Fund (SMIF) established under section 40. The purpose of SMIF is to pay the difference between an indemnity provided by an insurer to an individual solicitor and the amount of a claim made against the solicitor: section 44. SMIF is administered by the company under the Act. The company is LawCover, which is a wholly owned subsidiary of the Law Society.
11.3 The insurance policy which is currently in force has been negotiated with insurers by LawCover, and approved by the Attorney General. The Bar Council has negotiated a policy behalf of barristers. While there is nothing in the Act to prevent the Attorney general from approving another insurance policy, no formal applications for approval have been received from insurers in recent years.
11.4 SMIF was established in 1987 as a mutual fund because of difficulties encountered by solicitors in obtaining professional indemnity insurance. It has considerable reserves, which are beneficially owned by members of the Law Society.
11.5 Section 76 requires a solicitor (subject to some exceptions) to pay a contribution to the Fidelity Fund as a prerequisite to obtaining a practising certificate. The purpose of the Fidelity Fund is to compensate a person who suffers a loss as a result of a failure to account or a dishonest default: section 80.
II. EVALUATION
Compulsory professional indemnity insurance and fidelity fund cover
11.6 Lawyers are the only category of professional required to hold both professional indemnity insurance and fidelity cover. Clients obtain the benefit of protection against losses whether they are caused by negligence or wrongdoing. However, unlike members of other occupations, lawyers hold large amounts of trust funds as part of their practice and the risk of direct pecuniary loss may be greater.
11.7 Professional indemnity insurance and Fidelity Fund contributions are a significant business cost. In 1997/98 the average premium paid by a practitioner holding an unrestricted practising certificate was $12,000 for insurance and $800 for the Fidelity Fund. The cost of premiums and contributions may contribute to the marginal profitability of small practices.
11.8 Other providers of legal services, apart from registered conveyancers, do not have to hold insurance. Further, some legal services carry lower risks than others. For example, criminal law practitioners generate fewer claims than solicitors who work in the personal injury area. Little public benefit may be achieved by requiring low-risk practitioners to hold insurance and Fidelity Fund cover. Some clients might choose to instruct solicitors or barristers who did not hold insurance if the services were cheaper and fell into a low risk category.
11.9 However, a solicitor or barrister is permitted accept instructions in any area of work. A person who occasionally practises in a high risk area may be more likely to generate a claim than a solicitor or barrister who exclusively accepts instructions in that area of work. Moreover, if insurance and fidelity fund cover were optional a client might be unaware, or unable to verify, whether a practitioner held insurance.
Choice of funds and insurers
11.10 It is compulsory for solicitors to contribute to SMIF and the Fidelity Fund. The reason that the funds were established appears to have been that professional indemnity insurance and fidelity cover were not readily available from insurers and that a fund operated by the profession would work to the benefit of both members and clients, by ensuring that overheads were contained and that the public reputation of the profession was protected by the payment of claims. Compulsory contributions also ensured that the fund had a predictable source of income and could maintain adequate reserves.
11.11 However, professional indemnity insurance is now widely available and fidelity cover may also be arranged by insurers. This cover may be equivalent to that provided by the LawCover and the Fidelity Fund. The Law Society has indicated that it is exploring the possibility of the introduction of a competitive market for professional indemnity insurance.[1] In a deregulated market, many practitioners could expect to pay less for insurance. These cost savings could reduce the cost of legal services. However, there are a number of special features of legal practice that need to be addressed in considering whether other insurance policies should be approved.
11.12 Lawyers require insurance that provides cover after a person ceases to practise. A claim against a practitioner may not arise until several years after the service has been provided. However, many insurance policies apply only to claims made during their currency, rather than acts which occur while they are in force. At present, LawCover indemnifies practitioners after they have stopped practising without the need for them to continue to hold insurance ('run-off' cover). Similar terms would need to be offered by commercial insurers.
11.13 Another potential difficulty, related to run-off, is an insurer which ceases to operate. A client might be left without redress if the solicitor's insurer had collapsed or has ceased to operate.
11.14 The most difficult issue for a competitive insurance market is risk weighting. Limited risk weighting has been applied by LawCover to set levels of premiums for practitioners based on their claims history and the size of their practice. If commercial insurers were permitted to set premiums in a deregulated market, the premiums set for a number of practitioners could be expected to exclude them from practice.
11.15 Insurers would also have a right to refuse to insure bad risks. This could have beneficial effects, in that it may protect the public from incompetent practitioners. Practitioners would also be encouraged to adopt risk management strategies, because good management would be seen to have a direct impact on business costs. On the other hand, it might be argued that the disciplinary system exists to protect the public from unscrupulous or deficient practitioners and that insurance should not be an instrument of excluding solicitors from practice.
11.16 The Law Society has indicated that it would not be appropriate for LawCover to be used as a 'last resort' insurer. If the market were deregulated, LawCover would be treated in the same way as any other insurer. The fact that an insurer is owned by a representative body should not be a reason for it to be forced to accept all proposals for insurance.
11.17 An alternative to a deregulated insurance market would be a scheme where risk weighting by insurers is controlled to ensure that practitioners were not denied insurance. Insurers would be required to accept any proposal and there would be limits on the difference between the highest and lowest premiums. This is the model for compulsory third party motor vehicle insurance set out in the Motor Accidents Act 1988. Such schemes are based on the premise that all persons who are entitled to perform the activity insured against, should also be entitled to insurance at a reasonable cost. Of course, these schemes inevitably lead to cross subsidisation, and in the case of the legal profession, the cost savings achieved would probably be lower. Such a scheme might have limited attraction for the insurance industry, because of the disproportionate cost of bad practitioners.
11.18 A further issue is the manner in which potential insurers would be screened, and whether the number of participants in the market would need to be limited. It might be argued that any insurer which holds a licence under the relevant Commonwealth scheme for prudential supervision should be permitted to provide insurance, because it has satisfied the prudential guidelines set by that regulator. However, legal professional indemnity insurance may be regarded as having special features which would justify limits on the number of recognised policies and setting higher standards, such as capital adequacy and reinsurance, than applies to the insurance industry as a whole.
11.19 The market for professional indemnity insurance has been partially deregulated in the Australian Capital Territory and South Australia, with two insurers being approved in each jurisdiction. It appears that premiums are now considerably lower in each jurisdiction, although it is not yet clear whether lower premiums are sustainable in the long term. The Legal Practice Act 1996 (Vic) provides for insurers to be approved by the Legal Practice Board and contemplates a deregulated market.[2] However, other policies have not yet been approved.
QUESTIONS
A. Are the advantages of the insurance scheme and Fidelity Fund operated by the Law Society outweighed by the benefits to the public and the profession of deregulation?
B. Would a deregulated insurance market offer adequate protection to the public?
C. If a competitive market is established, should insurers be free to adopt risk weighting and to refuse cover?; Or:
D. Should there be limits on the price differentials between policies and an obligation on insurers to accept any proposal?
E. Should prudential standards be set for insurance companies offering professional indemnity insurance for lawyers, or should licensing by the Insurance and Superannuation Commission be sufficient?
F. Are there grounds for limiting the number of insurers permitted to enter the market?
Footnotes
[1] Law Society, 1997 Annual Report, vii.
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