Dramatic Market Change Regarding Professional Liability Insurance
By Brian Ahern, RPLU, President of Ahern Insurance Brokerage

If you are like most law firms, 2003 and 2003 will be challenging years in respect to securing Professional Liability Insurance. The "new market" is similar to that of the mid 80s and has caused consolidation of carriers, poor loss history, declining investment income, reinsurance and limited capacity.

Over the past 12 months, nine insurance companies have left the California market. The diminishing supply of insurers has given law firms fewer options promulgating a less competitive environment. In addition, many of the insurance companies remaining have specific underwriting requirements such as number of claims, size of firm, etc. For smaller firms with claim activity, the options available are primarily hard to place facilities, which typically offer no prior acts coverage and limits of no more than $1 million. There are still over 20 insurance companies providing coverage in California but the aforementioned underwriting guidelines limit most firms to no more than five insurance companies to choose from.

Current market status can be described as, "a fluctuation in the insurance/reinsurance market characterized by an increase in the pricing level of insurance and reinsurance coverage."

During the soft market, which last took place 1988 to 2001, many carriers were forced to constantly lower premiums and provide broader coverage enhancements. This aggressive underwriting, which took shape in the mid 90s, is now rearing its ugly head as companies are in a better position to evaluate their losses due to the closing or maturing of claims that were filed three to five years ago. For many carriers, loss ratios of 125 percent to 250 percent and more have been commonplace. These numbers are compared to a "benchmark" or standard in the industry equaling approximately 90 percent -- including the company's operating costs.

The above losses often have been exacerbated by carriers' declining investment returns. For several years, carriers could take large gains from their bond and stock portfolio and use them to offset losses due to inadequate premium rates. Due to this fact, many companies have had to revert back to the true fundamentals of underwriting.

The role of reinsurance also has an impact on the rising costs of professional liability insurance, due to the fact that insurance companies insure part of the risk they underwrite by purchasing reinsurance. Although 9/11 did not have a direct impact on lawyers malpractice insurance, it did dramatically impact the reinsurance market. Most carriers renegotiated their reinsurance treaties in January or June of 2003 and have passed large price increases along to their insured. Additionally, subsequent losses that have impacted and will continue to impact the insurance industry such as the demise of companies like Enron will add significantly to the negative influences on reinsurance markets.

Law firms seeking liability insurance should also keep in mind that most carriers have capacity limits in terms of how much business they can write. With prices increasing and limited capacity available, carriers are reaching their maximum volume. As this starts to take place, carrier underwriters become even more selective and conservative in their underwriting.

What does the future hold? Predicting future insurance premiums is similar to predicting stock or home prices. It appears, however, that the hard market will be here until at least the remainder of 2003 and into 2003. Interestingly, pricing today is still lower for most firms than it was in 1985, which gives concern that we have not seen the end of rate increases. Most firms this year can expect a minimum increase of 25 to 40 percent. Additionally, firms with claim histories, high-risk areas of practice, i.e., plaintiff personal injury, securities, wills and estate planning, entertainment, patent and intellectual property, and/or below market rates due to multi-year policies or policies with carriers who have left the market, can expect increases well over 100 percent.

What can you do? Some recommendations are to:

Start your renewal process early. Make sure to give your agent 30 to 45 days to negotiate your risk.
Spend time on your application. Ensure your application and supplements are complete with a full description of any claims filed against you and/or your firm. Explain what your firm did to ensure these types of claims do not continue. If you or your firm practices in an area that is considered high risk, i.e., patent and copyright, but the work you and/or your firm does is litigation based, make sure your application states such.
Work with an agent who knows your business and specializes in professional liability insurance. This undoubtedly will save you and/or your firm time and frustration. Another suggestion is to ask your insurance broker how many carriers he/she represents as well as how many firms he/she insurers.

Focus on the big picture. A mistake that many firms make is focusing just on price - remember bad pricing is what got us into this mess. Look for a competitive product, but also take the time to review the policy and understand how the carrier handles claims. For example, does the carrier allow input with respect to defense counsel? If not, who is on its panel counsel?

Evaluate limits and deductibles, which means you need to evaluate your practice. Some questions to ask yourself are: What are your exposures in the event of a claim? Are your limits too low or too high? Can you take on a higher deductible to reduce your premium? A good rule of thumb for a deductible in a hard market is around $2,500 per lawyer.

Become educated. Law firms should take the time to understand how they can better manage their firms against the threat of malpractice. For larger firms, consider a risk management audit to ensure proper procedures are in place. Make a point of noting in your application the steps and processes the firm has taken to make your firm a better risk.

Take precautions in the event of a merger or lateral hire. Make sure to review the respective claim history of the firm or attorney before a decision is made. If the attorney and/or firm have past claims, understand how the association will affect your firm. Firms also need to find out how their practice areas will be perceived by their carrier.

Do not sue for fees. Law firm suits for fees generate a large number of malpractice claims. The reason for this is that once the suit is filed, the answer most often will include a defense and an affirmative counterclaim stating that the fee was not paid solely due to the fact that the attorney's performance was deficient. The counterclaim becomes for all practical purposes a malpractice claim against the law firm.

Sometimes the amount involved or the particular circumstances of representation may require a suit against a client for a fee. However, any decision to undertake any form of collection activity against a client is one, which should only be taken after you understand its hazards. A strong recommendation is to gain the advice of independent counsel and launch a lengthy and comprehensive review of the entire situation be made before collection activity is initiated.

It is estimated that approximately 10 percent of all malpractice claims originate as counterclaims to suits for fees, and approximately 50 percent of all suits for fees generate malpractice counterclaims. Pursuant to these statistics, carriers are now looking very closely at a firm's approach to this issue and in many cases are declining to provide terms for firms who sue for fees.

The outlook for the next 18 months appears to be bleak, it is inevitable that carriers that are on the sidelines now will find the increased rates very attractive. When this does happen, we will find ourselves back in a soft market, characterized by increased competition in which prices are depressed, and is usually attributed to excess capacity (more sellers than buyers) and/or high interest rates. The soft market is estimated to occur in 2004. Until then, law firms can expect prices to either steadily increase and/or remain higher than they have been in the immediate past.

Although many firms have seen rates increase from 25 to 40 percent, it is not uncommon for rate increases to be as high as 200 percent as the underwriting community considers California to be one of the highest risk states with respect to malpractice. In fact, one in six attorneys are sued every year. Therefore despite the increase in rates, most firms are electing to continually purchase professional liability insurance, eagerly awaiting the return of soft market conditions.