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What’s left of the crunched up PI?
It’s a time to be cautious as a slowing economy throws scrutiny on contracts and the spotlight on those who drafted them. But does an economic downturn really result in an increase in professional indemnity claims? Angela Priestley reports
After a hurricane, when those affected move to pick up the pieces of their broken homes, general insurance companies feel the sting. A natural spike in insurer statistics occurs and history writes itself as the mark becomes an identifiable record in the books, easily pinpointed on the timeline.
The impact on professional indemnity insurers of an economic downturn may seem comparable to the consequences of a major tsunami, earthquake or volcano on the general insurance market. The theory is thrown around legal circles often: A slowdown in the economy will see those most affected looking to pass the buck on to their advisors – leaving solicitors in the firing line.
The reality is, however, that there is little evidence in Australia to suggest claims against solicitors increase or decrease alongside the economic cycle. Theories are plenty, but a lack of evidence gives them little credibility.
The fire starter
At Aon Australia, Ross Castle in client research and development, says the insurer is anticipating an increase in claims activity in light of the subprime crisis in the United States. The claims they’re already seeing are class actions issued by investors and shareholders against directors, and other entities up the advisory chain.
The fallout from the US credit crunch has already hit Australia, with class actions launched against Centro, Allco Finance Group and MFS. It’s a dangerous time for any advisor but so far, Castle says none of these claims have targeted lawyers.
“A lot of them are simply involved in the documentation side, rather than the advisory side,” he says. “Where lawyers can be brought in is where they’re part of the reason for the non-performance or the failure, but I think that’s quite remote,” Castle says.
“Often the period between the so-called ‘mistake’ by a solicitor, and the time it takes to eventuate into a claim varies so much, that relating spikes in claims to ‘good’ and ‘bad’ economic times becomes unrealistic.”
A natural evolution
Michael Behm, principal of Verus Consulting, believes a change in the claims cycles is inevitable and only natural as the low claims era is expected to evolve. He suggests something like the US subprime market crisis – with its run-on effects on money, equity markets and people simply loosing out – as a potential catalyst to change this era. The claims cycle will continue to churn, but where some insurers pull-out as the movement heats up, the industry takes on a different look and feel.
“It could happen,” Behm says. “It really is all going to run on the back of how prosperous Australia can remain in the face of what’s happening globally.”
Whether or not the country can remain prosperous is uncertain – with inflation spiralling to new found heights and interest rates increasing, it seems many Australians are already feeling the pull. It’s a domino effect – from loss in consumer confidence, to spending slowing down and businesses failing and finally, to advisors being sued.
Ronwyn North, managing director at Streeton Consulting can’t see any definitive answers around the impact of economic cycles on the rate of claims against solicitors. She says the data is simply too mixed and in many cases, not being collected or effectively analysed.
“You talk to anybody and they tell you that lawyers get paid more in an economic downturn,” she says. “But that may or not be the case. We don’t have the definitive data because data is not being collected.”
So does the volume of work for solicitors go up or down during an economic downturn? On one hand, legal practitioners undertaking mergers and acquisitions work might find themselves with some additional free time. But on the other, insolvency work is running hot, increasing the distressed sale of companies and properties.
Acknowledging the change
The risk for law firms is that if they fail to see the economy shifting gears and consequently take action, then they will not have the right people and resources in place to fill the emerging gaps in work.
“When you go into it there are definitely different dynamics in the economic cycle,” says North. “But whether it’s an overall shift in the type of work and the types of mistakes rather than overall increase or decrease in work involved is a good question.”
The law firms affected, says North, are those that don’t plan ahead: “Unless lawyers have all their eggs in the one business, then a sensible law firm that’s paying attention to strategy will have a mix of work and skills that insulate them for the well-known cycles.”
Even the level of litigation is difficult to determine in line with the economic cycle. Conventional wisdom suggests that in a boom time there’s less litigation as organisations are not in need of chasing every dollar from an advisor who has done them wrong. On the flipside, organisations have more money to play with and therefore the resources to litigate.
North believes there could be one distinct factor behind the theory that claims against solicitors increase in a downturn. That is that the traditional work of some lawyers dries up, and they thereforemove to take on work they don’t necessarily have the expertise to do in order to account for the shortfall.
Crunching the numbers
LawCover attempted to find a correlation between the economic cycle and spikes in claims against solicitors through an extensive study commissioned to a NSW university back in 2004. Paul McGahen CEO of LawCover sums this work up fairly easily: “We weren’t able to establish any definite links through that study. There were no conclusions, no demonstrable indicators.”
The idea of the study was to attempt to analyse LawCover data to match up claims over a 15 year period against economic upturns and downturns. The answers were clear: While the industry expected to see correlations, the conclusions did not find them. McGahen says this time round LawCover is certainly analysing their incoming claims at the moment, but have not noted any particular trends as yet. “We certainly haven’t seen an increase in claims that we would identify as being because of say, increasing interest rates and business failures,” he says.
If they were to see an increase, McGahen believes it would be later down the track, in six to 12 months as a lag effect catches up with the market, and that any claims will depend on the types of problems triggered. “If you have very large corporate claims and lawyers are giving decent advice, perhaps they will finish up suing their accountants or their merchant bankers rather than their lawyers!”
Like many insurers in the space, LawCover says its claims have been stable over the last four to five years – and considerably down on levels from the mid- to late-1990s. Meanwhile the Queensland-based Lexon Insurance also notes stability from the last five years or so – with property on the top of the list followed by personal insurance – and finds no correlation between the economic cycle of this period and rates of claims.
Reflecting on Lexon data, David Durham, legal risk counsel at Lexon believes different claims arise from different periods of an economic cycle but overall, conclusions can not be drawn on the rate of claims.
“The underlying factors which drive claims remain the same irrespective of the economic conditions,” he says. Listing examples, Durham asks, “What processes do I have in place to ensure that the required steps in the legal process are addressed? Am I communicating effectively with my client?”
Calm before the storm?
Miranda Milne, CEO of the Victorian-based Legal Practitioners Liability Committee (LPLC) says it’s too early to tell if claims to LPLC have or will spike with the current economic mood. But Milne maintains claims have been stable for the last 13–14 years. “We’ve been seeing a declining frequency in claims,” she says. “The state of decline has been the case for the last four years.”
Looking a couple of months forward to the end of the financial year, Milne believes they may actually see the lowest number of claims and notifications since the 1980s. She says a buoyant economy has assisted these records, with asset prices stable or growing, particularly in the property space.
However the economy is turning and asset stability is moving in the process. In the past, Milne says the last time LPLC saw a spike in claims was a result of the property crash in the late-1980s/early-1990s. It was a combination of inflated property prices and increasing interest rates – particularly in the commercial property space, with prices falling by as much as 50 per cent. A pessimist crystal gazer may feel we’re heading for a similar period now but this of course remains to be seen.
“This time round there has been a clear slowdown, in consumer spending for example,” Milne says. “But the interest rates are nothing like they were back in the early-1990s and you’re not seeing that situation just yet. I don’t know that we will have it because I think if property prices do fall off, it won’t be as dramatic as last time.”
But with any fall in property prices comes buyers scrutinising their contracts and in some cases, looking for ways out of them. Contract documentation comes under scrutiny along with the lawyers who drafted them. LPLC has been busy ringing the warning bells, calling solicitors to realise the economy is running hot, and to be cautious of contract documentation.
So does Milne believe a slowing economy provides a hotbed for claims against solicitors? “I don’t think it’s a coincidence,” she says. “Where you have rising or stable asset prices you don’t have people looking for a way to escape their options.”
At Lexon, Durham maintains they do not necessarily anticipate an increase in claims along with the current global situation. “If there is anything we can be certain about it’s that a credit squeeze will affect some types of legal services more than others and the majority of our insured firms are unlikely to be directly involved in matters immediately arising from the credit crunch,” he says.
Whether or not the economic cycle impacts rates of claims against solicitors remains to be seen, but one thing already clear is the potential for effective risk management to counteract the hazard. Since the notable spike in claims from the early-1990s, insurers have treated risk management as a centrepiece to their efforts, and the work has paid off. Does an economic downturn influence a rise in claims against solicitors? With a risk strategy on the frontline as the number one defence, there’s no need to find out.
23-Apr-2008
Related Tags
risk , insurance , professional indemnity
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