Attorneys » An Insider's Look at Lawyers Professional Liability Insurance

I have found throughout my career in the lawyers professional liability (LPL) field that there are many elements underlying the pricing, underwriting and procurement of LPL insurance which most attorneys, unfortunately, do not fully understand. I have been blessed with the opportunity of both practicing law and working in the LPL industry. I firmly believe that if attorneys are armed with some "insider's knowledge", then they can make better decisions both in terms of how they procure their LPL insurance and how they can operate their law firm to become a more attractive risk to LPL underwriters.

Probably the biggest "black box" involved in LPL insurance is how a law firm's policy is rated. In other words, what is the mechanism by which an insurance company determines the premium to charge a law firm for their professional liability exposures. It is obvious that the insurer will charge more if a law firm wants higher limits or a lower deductible, but what drives the price at a more core level?

AOP Factors

One of the largest drivers of pricing in LPL insurance is what insider's call the "AOP Factor." AOP is a term used in LPL insurance that stands for "Area of Practice". Insurance companies know that certain AOPs generate more claims than others. But the everyday lawyer probably does not appreciate the dramatic impact that they AOP has on the pricing for the LPL insurance for his or her firm.

A simplified example will demonstrate this difference. Let's compare a ten attorney firm that performs 100% plaintiff personal injury work with another ten attorney firm that performs 100% defense work. Let's assume that both firms buy the same limits and deductible, and otherwise have in place similar risk management procedures within their firm:

	Plaintiff Firm	Defense Firm
Base Rate	$2,000.00	$2,000.00
AOP Factor	1.35	0.65
Premim per Attorney	$2,700	$1,300
Total Firm Premium	$27,000	$13,000

The base rate is multiplied by the AOP factor to arrive at the premium to be charged for each attorney in the firm. Note that the base rate (or starting point) for the pricing of the law firm is the same for both firms. As you can see, assuming all other factors being equal, the AOP factor has an enormous impact on the resulting premium charged for the firm. In this case, the differential shown between AOP factors for plaintiff personal injury firms and defense firms are typical of those used in the LPL industry. The specific AOP factors used by various insurers differ depending on each insurer's own view of how risky plaintiff firms are to insure versus defense firms.

What accounts for this substantial differential in AOP factors? In a word, claims. Plaintiff personal injury firms have consistently reported more claims on a per attorney basis than defense firms (what insiders call "higher frequency"). The other factor that insider's examine is the average value of each claim reported within an AOP (what insiders refer to as "severity"). Plaintiff personal injury firms have the potential to report high severity claims, but so do defense firms. Taken together, it is primarily the higher frequency of claims that come from a plaintiff personal injury law firm that drives the higher pricing rather than the potential severity of the claim.

As you might imagine, though, not all plaintiff personal injury firms and defense firms are created alike. One underwriting factor that many LPL insurers examine is the volume of cases that a law firm handles on a per attorney basis. If a personal injury law firm handles more than 50 cases per attorney per year, then a "red flag" is raised in the eyes of many LPL underwriters. They will then look at the average value of the cases being handled. If they are low in value (under $25,000 in case value), then higher case load volumes may be permissible based on the assumption that lower value cases translate into cases that are more routine in nature. However, if a law firm is handling more than 50 personal injury cases per attorney per year, and the value of the cases is significant, the LPL underwriter is often concerned. First, do the attorneys have enough time to give adequate attention to these more complex claims? Does the firm have systems in place that make sure that no statutes of limitations on any of these claims are being missed? While an increased workload for the law firm's associates may be preferable to increase revenues for the firm, it may spell trouble for an LPL insurer who is assuming the risk of claims in excess of the firm's deductible.

Routine versus Complex Matters

There is also a correlation between the complexity of the matters being handled by a law firm and the claims that result. In short, more complex cases/matters result in higher payouts by LPL insurers when something goes wrong. Typically, more complex matters involve higher amounts in dispute. They also are inherently more difficult to "get your arms around", which results in higher costs to the insurer when they hire outside counsel to defend the insured law firm. These claims take more time for outside counsel to understand, and sometimes specialized counsel is needed to properly comprehend and defend the claim.

As a result, many LPL underwriters prefer what they call "vanilla" risks. They view an ideal law firm as one that focuses on smaller, less complex risks all within the same AOP. If something goes wrong, then the resulting damages are typically not very severe. In addition, because of specialization, the firm has typically developed a long history of expertise and systems designed to handle the needs of that AOP.

Your Firm's Website

To further uncover these qualities in firm, more and more LPL underwriters are carefully examining the law firm's website. The typical law firm uses its website as one of its tools in securing new clients. As such, the law firm often touts its long experience in handling complex matters with high case values. The firm will emphasize its expertise in AOPs that are not typical of other law firms in its geographic area, hoping to distinguish itself in the local marketplace.

At the same time, savvy law firms (and/or their insurance brokers) have learned that LPL underwriters prefer to insure law firms that handle routine matters that do not involve a lot of complexity. As a result, the law firm's application for LPL insurance sometimes differs markedly from how the law firm has portrayed itself on their website. For numerous reasons, it is important for the law firm to portray itself accurately on its website. If an LPL underwriter has to question the law firm's insurance broker about the variance between the insurance application and what is contained on the firm's website, immediately a question arises in the LPL underwriter's mind as to the veracity of the application. The LPL underwriter begins to wonder, "Is the law firm just portraying itself as it believes I want to see it, or is it actually a realistic depiction of their practice?"

Beware of Misrepresentations

There are mechanisms in place that allow an insurer to be protected against misrepresentations in the law firm's application. In short, if a law firm inaccurately portrays itself in an application for insurance, and the underwriter's reliance upon that information was material in terms of their decision to underwrite the account, then any claim that resulted from matters misrepresented in the application can become grounds for denial of a claim in its entirety. As such, it is always better to fully disclose those items requested in the application, especially those related to pre-claim incidents that may reasonably lead to a claim. Many attorneys think that it is better to not report those incidents to their carriers or disclose them on an insurance application, thinking that it will result in higher premiums and/or less favorable terms. Although some insurers may react that way, it is my belief that most insurers will look upon over-disclosure favorably, especially if it is accompanied by meaningful remedial measures implemented by the firm as a result. LPL underwriters want to be left with the impression that that law firm cares about their risk management procedures, and that they do not view claims just as a cost of doing business.

Your Best Foot Forward

Attorneys must remember that an LPL underwriter is at a distinct disadvantage when trying to determine whether their law firm is a good risk to insure or not. It would be very different if the LPL underwriter could interview the attorneys at the firm face-to-face and actually inspect the office and the risk management procedures that are in place, but that is impractical. Therefore, the LPL underwriter must completely rely upon what is included in the insurance application.

This provides a great opportunity for a law firm to shine in the eyes of the LPL underwriter. If the firm takes the time to thoroughly answer all of the questions in the application, and offer amplified responses through the attachment of additional pages, then the LPL underwriter becomes more comfortable with the risk being assumed. In the absence of information, the underwriter naturally becomes more conservative. Therefore, over-disclosure is preferable, not only in protecting your firm against the potential of an insurer trying to deny a claim based on misrepresentation in the application, but also because it serves to increase the underwriter's comfort level in insuring the professional standards of all of your attorneys' work product.

At this point, it is important to note that something as simple as typing out your firm's application has a positive impact on how the underwriter views your risk. If the underwriter is able to easily read the application, and not guess at any of the firm's responses, it naturally flows into a better evaluation of your law firm.

Because of the unique nature of insuring the professional liability exposures of law firms, the LPL underwriter typically has a lot of discretion in terms of how they price a law firm's policy. It is not unusual for the underwriter to have discretionary pricing authority 25% higher or lower than the "manual rate." The manual rate is simply the premium that your law firm would be charged before the application of any subjective pricing credits or debits by the underwriter. This makes LPL insurance different from many other lines of insurance with which the attorneys may be familiar, such as their personal homeowners or auto coverage. These "personal lines" coverages are heavily regulated by state departments of insurance, so that if you receive a quote for your auto insurance from an insurer, it should be the same regardless of the underwriter pricing the account. Since LPL insurance is a specialized line of insurance, with difficult to predict claims loss patterns, state departments of insurance allow the underwriter to vary the price charged for the LPL policy depending on that underwriter's subjective assessment of the quality of your firm's risk management procedures, claims history, etc. It is this subjectivity that creates the opportunity for you to save money on your LPL insurance by portraying your firm in the best manner possible, and by implementing risk management procedures that are meaningful to an LPL underwriter, so that the credits can be applied on your firm's behalf and lower premiums can be realized.

Although there are many risk management procedures that are important to LPL underwriters, it is worth mentioning a few of them. First of all, many claims result from alleged conflicts of interest. A classic problem is when the founders of a new business comes to a law firm to get incorporated. Technically, there are multiple clients in this situation, i.e. each of the founders and the corporation itself. The firm with good risk management procedures would document in writing the existence of this potential conflict of interest, the option for each of the separate parties to obtain their own counsel, and document in writing if the founders and the corporation itself decided to waive the conflict. If this is not documented in writing, then this could be the basis of a claim against the firm in case a dispute arises amongst the founders. This is just one example of the broader conflict of interest issues. At the very least, the law firm should have a solid system for checking for potential conflicts of interest, not only when the firm is taking on a new client, but also when taking on new matters for existing clients.

Another is the consistent use of engagement letters. Ideally, the LPL underwriter wants to see that a firm uses engagement letters 100% of the time. The engagement letter serves to guides the expectations of the client, and in particular, define the scope of the engagement. Claims sometimes result when a client is damaged by its failure to comply with a new law or regulatory requirement. They claim that you, as their lawyer, should have informed them of the new requirement (even though it was beyond the scope of the original engagement). Although the insurer can many times be able to successfully defend such claims, it still costs the insurer money to defend your firm against these allegations, which drives up insurance costs and sullies your firm's particular insurance history.

Lastly, it is highly advisable to avoid suing your clients for unpaid legal bills. When an LPL underwriter sees that a firm has three or more fee suits in the past three years, it usually is a glaring "red flag". In fact, many underwriters view that any suits for fees are a cause for great concern. When a firm has to sue their client for unpaid legal bills, something is definitely wrong. The firm may have poor client selection. The firm may not have been responsive to the client, i.e. poor communication skills. The firm may not have good billing systems in place. There are a host of potential explanations for why a firm is suing their client, and almost all of them are negative. Even worse, when a law firm sues their client for fees, the client often counterclaims for legal malpractice. This counterclaim triggers the firm's policy, and thus defense costs for the insurer start to accumulate. Any suits for fees should be carefully explained by the law firm on their application, because they are a particular sore spot for many LPL insurers.

If your firm has implemented good conflicts check systems, engagement letter usage, and a policy against suing its clients for fees, then an underwriter can give substantial credits to your policy. However, it is important that this is communicated effectively to the underwriter. "Checking the boxes" on the application may or may not result in credits, but if you go the extra mile, and describe your systems in depth through additional disclosure, it is more likely that the underwriter will apply these subjective credits on your behalf. Again, it is important to realize that you are trying to impress a person that you are an above-average risk. Your answers in the application are not fed into a computer with the final price being automatically determined. Just like you try to impress potential clients, you should "put your best foot forward" to impress the underwriter.

Insurance is Unique

For almost every other product in our economy, the provider of that product knows their "cost of goods sold" before the product is sold. If a widget costs $1 to make, then the provider will charge something higher than $1 in the marketplace in order to generate a profit. Insurance is different. The provider of insurance does not know its "cost of good sold" until after the product (the insurance policy) is sold. In the case of LPL, that cost is sometimes not known for many years after the policy is issued. Therefore, it is vitally important for an LPL underwriter to carefully select those law firms that are likely to perform well in terms of low or no losses. LPL underwriters know that claims are a normal part of running a law firm. That is why law firms buy insurance. However, it is the LPL underwriter's job as a gatekeeper to make sure that the firms that are included in the insurer's book of business perform well. To the extent that the underwriter's risk selection is good, then the insurer can lower its rate in the future to gain marketshare.

Successful Underwriting

Some insurers do not take the time to distinguish between law firms as mentioned above. For example, they classify all plaintiff personal injury firms the same, whether they work on routine "fender benders", or if they work on more complex matters, such as medical malpractice, wrongful death, or class action plaintiff work. To the extent that a carrier charges the same rate for firms with differing risk profiles, the more likely that carrier will accumulate law firms with high risk exposures in its book of business. Other carriers that choose not to be as competitive on law firms doing plaintiff medical malpractice work will not win those accounts, and they will instead migrate over time to the carrier that does not make such distinction. Over time, this accumulation of riskier firms will result in higher pricing for all firms in that carrier's book of business. That is why it is important for a law firm to choose an insurer that carefully underwrites each law firm, no matter whether it is a solo attorney or a 100+ attorney firm.

Sometimes law firms will be bristle at the amount of information that LPL underwriters ask in the form of supplemental applications and requests for additional information. Instead of viewing these requests for additional information as merely another burden to bear, it likely means that the underwriter is taking their job as a gatekeeper seriously, and is often a sign that the insurer is a serious long term player in the LPL marketplace. That is not to say that some LPL underwriters request additional information just because "the underwriting manual says so". Your insurance broker should be able to identify those insurers that are careful in their underwriting, and that only request additional information if the underwriter truly needs such information instead of just "papering the file".

The Insurance Market

Some law firms may notice that the premium for their LPL insurance seems to change without corresponding changes within their own practice. That is because pricing for LPL insurance should be viewed at both a micro and macro level. Most of the discussion so far has been on the micro level, i.e. what can be done to affect pricing for your law firm in particular. However, there are macroeconomic factors that affect pricing for LPL insurance. In general, we have been in a "soft" insurance market cycle for several years now. A "soft market" is characterized by the ready availability of insurance on favorable terms and conditions. A "hard market" is just the opposite, i.e. it is characterized by higher premiums, higher deductibles, lower limits, and tighter terms and conditions being offered by LPL insurers.

Several factors go into whether an insurance market is "soft" or "hard". The first and most important is claims activity. When the economy is good, it has a positive effect on LPL claims. There are fewer deals "going bad", so there is less likelihood that the lawyer will be pulled into an adverse situation. In addition, even if there is malpractice, the losses resulting from such claim are mitigated to the extent that the economy has buoyed the client's financial situation. Conversely, when the economy is suffering, higher frequency and severity in LPL claims has historically followed.

The second predominant factor is the interest rate environment. Insurers make an appreciable amount of their profit from the "float" on the insurance premium they take in, i.e. the interest they earn on the premium between the time they collect it from the law firm and the time that it is ultimately paid out on claims. If there are high interest rates, insurers can charge less premium because they make more money on the float. Conversely, in a low interest rate environment, insurers have to charge higher rates to make up for the loss of interest income. LPL insurance is particularly sensitive to the interest rate environment because the float period between the time the premium is collected and when the claim is paid is longer than most other lines of insurance. Insiders refer to LPL as having a "long tail" for its claims, meaning that it often takes many years for LPL claims to be resolved.

The third predominant factor is the amount of capacity, or surplus, in the marketplace. Over the past few years, insurers have been flush with a lot of capacity. Even with the large insurance losses due to Hurricanes Katrina and Ike, the insurance marketplace has been able to replenish their surplus very quickly on Wall Street. To the extent that insurers are not able to replenish their surplus after large losses drives insurance pricing up. In addition, to the extent that insurers lose money due to bad investments, this decrease in surplus will also drive insurance pricing up.

As one can see, the current economic conditions are pointing towards the coming of another hard market. The current economic conditions are some of the worst on record. Anecdotally, many insurers and brokers are reporting a marked increase in claims, particularly those related to the real estate AOPs. To combat the economic malaise, the federal reserve has lowered interest rates to historic lows. That greatly decreases the amount of float income for LPL insurers. Lastly, insurers' surplus has decreased due to the values of their portfolios falling with the overall stock market. This last effect has been mitigated somewhat due to the fact that most insurers are prohibited from having too much invested into the stock market. Nonetheless, it is apparent that macroeconomic forces are all moving in the same direction, and it is possible, if not likely, that a "hard market" for LPL insurance will emerge in the next year or two. The longer these underlying conditions exist without a corresponding increase in premiums, the harder the "snap back" there will be in pricing and terms when the market finally does correct. It is similar to what was seen on Wall Street and the subprime mortgage problem. It was only when some Wall Street institutions started to fail that the whole stock market began collapsing. When enough pressure builds in the insurance market, these "snap backs" often occur when there are large insurance events, such as Hurricane Katrina and 9/11, that take out large quantities of surplus in terms of claims payments all at once.

In general, the best way to look at the insurance market and how it affects the pricing for your firm is to think of the macro economic conditions as defining the upper and lower levels of pricing for your firm's insurance, and then your firm's micro factors defining where you land within those pricing levels. If you focus on those factors that are within your control, then you will always do better relative to your competition regardless of prevailing market conditions.

Hopefully, this discussion has given you some insight into how LPL insurance is underwritten and priced, and how you can better position your firm at your next renewal to obtain the best deal possible for your firm's LPL insurance.