Claims information before merger options

by Alistair Sim

Risk issues to be considered when contemplating practice merger or acquisition and risk management issues to be considered before and after

The Journal, July 2003, page 36

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This article is mainly concerned with certain aspects of the due diligence appropriate to mergers or acquisitions of solicitors’ practices.

Before proceeding with a merger or acquisition, it must be prudent to make certain enquiries into the Master Policy claims record of the other practice (let’s call it Firm B). An indication from Firm B that they are currently receiving a Master Policy premium discount may be reassuring but might conceal an adverse claims history.  

Claims information is available either from Firm B or from Marsh as brokers to the Master Policy.  If Marsh are to provide the information, Firm B must expressly authorise them to disclose the information you require.  You are likely to want details of all matters intimated by Firm B (and any predecessor practices) over a period of at least five years (much longer if possible) and a note of Master Policy premium contributions in that period.  Perhaps you should also be asking Firm B to disclose particulars of its complaints record (not available from Marsh).

Due diligence

Firm B’s claims record will reveal the areas of work and types of (alleged) mistake which have given rise to intimation of Claims/Circumstances.  It may also identify the responsible partner and/or fee earner involved, the branch office concerned etc.

These enquiries might reveal, for instance, that a significant number of intimations arise out of the activities of one particular fee earner, department or office; that the firm is, or has been, involved in areas of work which are not otherwise apparent and which you regard as “high risk” or work which you would not wish to be conducted in the future.  Evidence of a claim involving embezzlement by a member of staff might put you on your guard about poor supervision of the cashroom or about Firm B’s recruitment procedures.

Your enquiries may disclose Firm B’s approach to claims prevention and risk management generally.  You might discern that problems in the past have arisen out of poor management, lack of supervision, “dabbling” in specialist areas etc.

Remember, however, that Master Policy records are limited in at least two respects.  These records will only reveal information about problems which have actually been intimated and, of course, they provide only a historic snapshot.  Claims and Circumstances are only intimated when problems actually arise and this may be years after the date of the alleged error or omission. Query how risk is being managed currently?

Premium rating implications

Under the present premium rating regulations, claims intimated to the Master Policy insurers are relevant to the level of the firm’s Master Policy premiums.  The basic premium (based on the numbers of partners and staff in the practice at 1 November) is adjusted by applying a discount or loading depending on the firm’s claims record measured by reference to an arithmetical loss ratio.  A penalty loading applies in the  case of firms whose loss ratio exceeds a particular threshold.  A discount applies to firms (with a Master Policy record of five years or more) which have a low claims or claims-free record.

If, after completing the due diligence exercise, the parties proceed with their merger or acquisition, the parties require to make an election as regards the basis of continuing protection under the Master Policy.  The parties must elect for either:

The “Continuation Basis”

The Master Policy records (claims and premiums) of the constituent practices are combined and carried forward.  On this basis, it is the merged practice’s continuing cover which provides indemnity in respect of claims emerging after the merger or acquisition whether the alleged error or omission occurred before or after the date of the merger or acquisition.

The “Cessation” or “Run-Off Basis”

The merged practice starts brand new Master Policy claims and premium contributions records and its premium rating position is unaffected by Claims and Circumstances arising from the constituent practices’ pre-merger/acquisition activities.  It is “Run-Off Cover” which provides continuing Master Policy protection for the past activities of the constituent practices as long as the Master Policy continues on its current basis.

There is a charge for the benefit of continuing Run-Off cover under the Master Policy if (i) based on the ceased practice’s record as at 1 November following cessation, a penalty loading would have been applied had the practice been continuing and renewing its own cover and/or (ii) the practice had not yet established a 5 year Master Policy record.  Otherwise, currently, there is no charge for the benefit of continuing Run-Off cover under the Master Policy.

Summary

• The principals of the firms concerned need to take account of various Master Policy implications.  These include future premium rating; assessment of Self-Insured Amount (excess) contributions in respect of past and future claims intimations; possible charges for Run-Off Cover; Professional Indemnity Insurance “top-up cover” requirements.
• The implications are too numerous and complex to be dealt with in this article and it is recommended that firms contemplating mergers or acquisitions should contact Marsh at an early stage.
• A material factor to be borne in mind in all of this is the fact that Professional Indemnity Insurance operates on a “claims made” basis which means that the cover which is relevant is the cover which is current at the date the claim is first intimated and not the cover current at the date of the alleged error or omission occurred.

Risk management issues following merger or acquisition

Case Study

Imagine your firm recently acquired an established practice in another town which will operate, with all its existing personnel, as a branch office of the enlarged practice.  As well as achieving other strategic objectives, this acquisition increases the firm’s strength in the commercial property area and brings entirely new capabilities in the areas of licensing and intellectual property.

The other practice hasn’t had the best claims record over the last few years and you have been charged with responsibility for addressing the problems that account for the poor claims experience and, at the same time, you aim to improve the risk profile of the branch office so that there are no further claims.

You have been asked to report back to next week’s partnership meeting with your action plan.  What are the matters that need to be addressed?   

There is clearly no definitively ‘correct answer’ here.  However, the principal elements of an effective action plan might include the following:

• Identify/quantify the problem – get hold of the files; list situations where mistakes have occurred, where remedial work has had to be done, where claims/complaints have been made. Ideally, tabulate this information in a format which makes it easier to analyse.

Analyse the information according to:

• type of transaction
• nature of the error

or omission

• underlying cause
• fee earner concerned
• potentially relevant aspects of the client – eg first time buyers; lenders
• Involve others in discussing this analysis – potentially include support staff as well as fee earners
• List/describe all agreed action points eg. changes in documentation (eg. missive clauses; new/amended terms of engagement; explanatory material distributed to clients); training; file reviews/audits; checklists; diarying arrangements; discontinue certain types of transaction?
• Prioritise and allocate responsibility for action points 
• Review success of implemented systems/procedures
• Rationalise styles and proformas 
• Rationalise diarying arrangements and maintain central diary
• Conduct an independent ‘audit’ of files
• Conduct a review of risk management systems and procedures and introduce changes as appropriate
• Involve branch office personnel in all firm-wide training sessions
• Integrate claims/complaints reporting processes
• Check out the ‘culture’ – establish readiness of new colleagues to share problems
  

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