Regulators forced to self-finance compensation funds

Nichols: LSB kept in the loop

Two of the smaller legal regulators are having to self-finance their compensation funds after their insurer stopped providing cover.

CILEx Regulation and IPReg – the Intellectual Property Regulation Board – are both consulting on the changes to their compensation arrangements following Royal Sun Alliance’s decision to pull out of the market.

The funds pay discretionary grants to people who have suffered financial loss because of a lawyer’s dishonesty or failure to account for client money where not covered by indemnity insurance – which is usually when there is not an innocent partner at the firm.

They became necessary for the two bodies once they started regulating entities – CILEx Regulation in 2017 and IPReg in 2014, but neither has had to pay out to date.

CILEx Regulation’s fund, which covers £6m in claims a year, is significantly larger than IPReg’s (£2.5m), reflecting the fact that its firms conduct higher-risk work such as conveyancing and probate.

In any case, those regulated by IPReg cannot hold more than £250,000 in client money without putting in place additional compensation arrangements that it has approved.

At present, individual claims against the CILEx Regulation fund are capped at £500,000 a year, and £2m for aggregated claims against a single firm.

An actuary commissioned by CILEx Regulation said the minimum requirements for a viable fund were £250,000 for the individual and aggregate caps, but the consultation said has decided in the short term to retain the £500,000 individual cap “to ensure that there is minimal disruption to consumer protection for individuals using CILEx Regulation regulated firms”.

But it plans to reduce the aggregate firm limit to £500,000 and an overall cap on the fund will be £1m for the next year.

Once the interim arrangements have been agreed, CILEx Regulation said it would then look to make “longer-term changes”, subject to further consultation.

Chief executive Carilyn Burman said the organisation had sufficient reserves to cover the proposals – in the event the fund is exhausted, its rules provide that no claims are paid.

She pointed out that CILEx Regulation only oversees 23 firms at the moment and “we know them all really well. We keep in close touch with all of them so have a really good idea of their position”.

IPReg’s consultation said it paid £25,000 plus insurance premium tax for its cover, with maximum payments of £25,000 per claim – which it intends to maintain – and £225,000 in the aggregate per practitioner, which it proposes to reduce to £100,000.

The fund itself will also be capped at £100,000. This, the consultation said, “gives it short term viability and enables flexibility to run it for the longer term without making changes if subsequent, more detailed risk modelling supports that approach”.

It added: “Without an insurance policy, existing benefit levels are not affordable given that IPReg’s annual fee income is approx. £1m.

“The existing limits per firm and per year seem excessive given the risk profile of the IP regulated sector. The new proposed limits per firm and per year are more realistic for a reasonably pessimistic, but not worst case, scenario.”

IPReg said it was “not aware of any events that are likely to lead to a claim in the compensation fund in the near future”. It used the same actuary as CILEx Regulation – John Birkenhead of HJC Actuarial Consulting – who noted that it knew its regulated community well.

In the unlikely event a claim arose soon after the fund was established, the consultation said, “if there were insufficient money in the fund to provide grants for allowed claims, IPReg is likely to fund the additional requirement from its reserves”.

The regulator said it too would move on to devise longer-term arrangements from 2023.

Mr Birkenhead concluded in each of his reports that it was “perfectly possible” that the respective funds would not see any claims during the period.

Chris Nichols, director of policy and regulation at the oversight regulator, the Legal Services Board, said: “CILEx Regulation and IPReg have both kept us informed of this issue, and we have been in contact as they develop responses that will maintain consumer protection. Any changes to their regulatory arrangements will need to be approved by the LSB.

“Looking beyond the immediate issue, we will be reviewing wider indemnity arrangements across the sector, as indicated in our strategy.

“This is likely to include consideration of compensation arrangements. We will be starting to scope this work shortly, which will be a significant focus into 2022/23.”

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