Legal Malpractice Insurance: Why Your Premium Doubles In The First Five Years

Legal Malpractice Insurance: Why Your Premium Doubles In The First Five Years

Many attorneys are surprised when, a year after buying their first malpractice insurance policy, their renewal pre-mium rises 20% – 30%, even though there was no material change in their practice, and they didn’t incur a claim. 

This post will explain why that hap-pens, not just at the first renewal, but also at the second, third, and fourth.

All legal malpractice and other professional liability policies are “claims-made”, whereby coverage is triggered by the filing of a claim against the insured lawyer or other profes-sional, i.e., the lawyer must have insurance in place on the date that the claim is made, for it to be eligible for coverage.

One of the least understood aspects of claims-made insurance policies is ‘step-rating’, which insurers implemented in recognition of the fact that there’s usually a lag of several years between the time an attorney commits an error and the time the client makes a claim. Step-rating allows insurers to match the premium they charge to the risk of a claim being made.

With step-rating, the premium is relatively in low the first year of a claims-made policy, i.e., an attorney’s first year with a firm, because there’s little risk that the attorney will incur a claim, i.e., handle a case and make an error and have the client file a claim all during the one-year policy period. This is true whether an attorney just passed the bar or has been practicing for decades with other firms.

After the first year, the premium increases in each of the next four years, to match the increasing risk that the attorney will incur a claim. This increased risk is due to the at-torney’s increasing “prior acts” exposure, which refers to malpractice claims that arise out of work done prior to the current policy period.

In an attorney’s first year with a firm, i.e., Year 1, there’s no prior acts exposure, because the attorney hasn’t done any work for the firm in past years that may result in a claim. Further, as noted, the work the attorney does during the first year is unlikely to result in a claim being filed during that year.

In Year 2, there’s a year of prior acts exposure from Year 1’s work; in Year 3, there’s two years of prior acts exposure, etc.

Step-rating increases stop after Year 5, because an attorney’s prior acts exposure stops increasing, as the statute of limitations tolls on cases from three and four years ago, which offsets the risk of a claim arising out of more recent cases. Thus, the overall risk of incurring a malpractice claim remains more or less constant after Year 5, and remains that way for as long as the attorney remains with the firm. That obviates the need – or justification – for further step-rating increases.

In other words, an attorney with, say, 30 years of prior acts exposure, has about the same malpractice claims risk as an attorney with six years of prior acts exposure, be-cause they have about the same probability of incurring a malpractice claim, i.e., very low, because few malpractice claims are filed 6 – 30 years after an attorney makes an error.

Here’s an example of step-rating:

Year 1 – 50%______________

Year 2 – 60%__________________________

Year 3 – 72%___________________________________

Year 4 – 86%___________________________________________

Year 5 – 100%_________________________________________________

Here, the Year 1 premium is 50% of the “ultimate” step-rating premium, i.e., a 50% dis-count, which is reduced each year as the attorney’s prior acts exposure increases. As noted, after five years, the prior acts exposure reaches equilibrium, and the attorney is considered to be “mature”, so the increases stop.

Note: each insurer uses different step-rating factors, which may differ from those shown above. Some insurers even spread the increases out over six or seven years. However, as a guideline, most insurers’ step-rating increases will cause an attorney’s premium to increase 2 – 3 times over the first 5 – 6 years that he/she works for a firm, independent of other factors that affect the premium, i.e., the policy limits and deductible, the firm’s  practice areas, revenues, claims history, etc., and macroeconomic factors, such as in-flation and interest rates. Also, keep in mind that most insurers calculate a premium for each of the firm’s attorneys and a premium for the firm, and blend them to get the final premium.

While step-rating applies to all attorneys, solo practitioners buying their first malpractice policy will especially notice the increases, particularly in the first three years (Steps 2 – 4), when the increases are larger and the base premium is smaller, but won’t be affected by them again after five years, i.e., once they’re considered to be “mature”.

Conversely, a multi-lawyer firm will experience a step-rating increase in its premium for each attorney who’s in year 2 – 5 with the firm. Therefore, if it adds new hires every  year, it’ll incur a step-rating increase every year, since barring a mass exodus of recent hires, at least one of its attorneys will always be in year 2 – 5 of his/her tenure with the firm. However, if most of the firm’s attorneys are “mature”, and thus not subject to a step-rating increase, then the step-rating increase it does incur may not be noticeable amid the other factors that affect the premium.

So, if you’re a solo practitioner, expect a 20% – 30% increase in your malpractice insur-ance premium in each of the first five or six consecutive years that you’re covered, solely due to step-rating, although as noted, your actual premium may increase more or less than that if your practice areas, policy limits, etc., change.

If you’re an owner of a multi-lawyer firm, expect a step-rating increase in your premium in any year in which your roster includes one or more attorneys who’ve been with the firm for less than six years, although it’s effect will be diluted by your “mature” attorneys, i.e., those who don’t receive a step-rating increase.

You can see a visual representation of step-rating in the diagram at the top of the page. The premium increases each year in years 2 – 5, as the prior acts exposure increases. 

The Retroactive Date, which is the inception date of the first malpractice policy the firm  purchased and has renewed each year without interruption, never changes, but the prior acts exposure increases by one year each year the policy is renewed. As noted, that drives the premium increase in years 2 – 5. As also noted, step-rating increases stop after five years, because the risk of incurring a claim levels off, as the SOL tolls on older matters.

Your legal malpractice policy has a Retroactive Date for the firm, and for each attorney the firm subsequently hired. The Retroactive Date for the firm and every attorney who’s with it on the day it buys its first malpractice policy, is the inception date of that policy, as long as it renews it without interruption. For all attorneys hired after that, it’s their date of hire.

Your insurer uses these dates to calculate any applicable step-rating increase when it determines your firm’s renewal premium.

Keep in mind that if your firm switches malpractice insurers, it’ll lose all of its prior acts coverage, unless the new insurer offers it the same Retroactive Date that’s its prior insurer did. Insurers do this routinely, because otherwise firms wouldn’t switch insur-ers, but your firm needs to make sure that its new insurer does so.

Finally, consider increasing your firm’s policy limits as its Prior Acts exposure increases, i.e., when you renew your policy for Year 3. This is especially important if you chose a minimum limit policy in Year 1, as your firm will have ‘outgrown’ it by Year 3.  

Legal Malpractice Insurance: Avoid Gaps in Coverage

Legal Malpractice Insurance Coverage GapWe previously explained how a claims-made coverage gap can occur when a law firm switches insurers.

Another type of claims-made coverage gap can occur if attorneys are lax in re-porting a claim to their insurer.

This is due to the fact that the term “claims-made” is a misnomer, because most such policies are actually “claims-made and reported”, which means that the claim must be made against you during the current policy period, i.e., while you have a policy in effect with that insurer, and you must re-port the claim to your insurer during same policy period in which it was made, i.e., your current policy period.

This language from Aspen Insurance Company’s legal malpractice policy is typical:

I. INSURING AGREEMENTS
A.
Coverage

The Company will pay on behalf of the Insured all sums in excess of the deductible that the Insured shall become legally obligated to pay as damages and claim expenses as a result of a claim first made against the Insured and reported in writing to the Com-pany during the policy period…(emphasis added)

This means that if you had a policy in effect from, i.e., January 1, 2015 – January 1, 2016, received a claim on the December 31, 2015, and reported it to your insurer on January 2, 2016, the insurer could deny coverage, since you didn’t report the claim during the policy period in which you received it. That’s true even if you renewed your policy with that insurer.

Many insurers avoid this problem by allowing a grace period to report claims after the end of the policy period, usually 30 or 60 days. For example, here’s the language in CNA’s policy:

CONDITIONS
A. Notice

1. Notice of Claims

The Insured, as a condition precedent to the obligations of the Company under this Policy, shall as soon as reasonably possible after learning of a Claim give written notice to the Company during the policy period of such claim. The Company agrees that the Insured may have up to, but not to exceed, sixty (60) days after the Policy expiration to report a claim made against the Insured during the policy period if the reporting of such claim is as soon as reasonably possible. (Emphasis added)

The grace period applies whether or not you renew your policy.

Other insurers handle the problem by including a “continuous coverage” clause in their policy, which applies only to insureds that renew with the insurer:

if any Insured gives written notice of a Claim to the Company…during the Policy Period of any subsequent policy issued to the Named Insured as a result of continuous and un-interrupted coverage with the Company, any Claim subsequently made against any Insured shall be considered to have been first made during the Policy Period the In-sured first became aware of a Potential Claim”. (Emphasis added)

In other words, if you received a claim during your current policy period, you can report it without penalty during the next policy period, if you renewed your policy. However, these “continuous coverage” policies are often only issued to large law firms, which usually have a large deductible or self-insured retention.

So, if your policy is claims-made and reported, and has neither a grace period nor a con-tinuous coverage clause, your insurer could deny coverage if you report a claim even one day after the end of your policy period.

Further, the courts (properly) treat each policy like a self-contained unit, even if it’s been renewed for many years, and would likely affirm any denial of coverage based on a claim being reported after the policy in which it was received, even if it was just one day  late.

For example, in A.B.S. Clothing Collection, Inc. v. Home Ins. Co. (1995) 34 Cal.App.4th 1470, 1476-78 [41 Cal.Rptr.2d 1667], the court ruled that the renewal of an insurance policy is a separate and distinct contract from the prior policy, not a continuous contract, “unless there is clear and unambiguous language showing the parties intended to enter into one continuous contract.”  In other words, the courts won’t find that a continuously renewed policy is a ‘de facto’ continuous contract.

This clearly creates a potential gap in coverage for attorneys whose policy doesn’t have either a grace period or continuous coverage clause. However, insurers rarely, if rarely, exploit it, because denying coverage to a firm merely because it reported claim a day or two after the policy period ended, would make for terrible customer relations, and would generate “pushback” from brokers, because it exposes them to an E&O claim from their client.

That notwithstanding, the solution to avoiding a claims-reporting gap is to promptly re-port all claims or potential claims to your insurer,. However, sometimes a lawyer com-mits an error but believes that it can be fixed, or that the client won’t actually file a claim, and doesn’t report it to the insurer, because s/he’s afraid that doing so will increase their premium.

Further, many lawyers believe that if they maintain continuous coverage with the same insurer, they can report a claim in the policy period after they received it (within reason, i.e., a couple of days into the new period, if they received it in the last few days of the prior period).

However, as shown above, this isn’t true.

The safest action is to report all potential claims to your insurer right away. However, if you think you can resolve a potential claim without involving your insurer, then at least check your policy’s claim reporting requirements before you do so, i.e., determine if your insurer allows a grace period to report claims after the policy period ends. If so, then you can try to resolve the matter yourself, but make sure that if you can’t, you report it to your insurer before the grace period expires.

If your policy lacks a grace period, and you receive a potential claim near the end of your policy period, the prudent thing to do is to report it to your insurer before the end of your policy period. You can still try to resolve it with the client on your own, or even hope it just “goes away”, but be sure to protect yourself by reporting it before your policy expires.

Legal Malpractice Insurance: The Prior Acts Conundrum

Legal Malpractice Insurance: The Prior Acts Conundrum

All legal malpractice and other pro-fessional liability policies are “claims-made”, whereby coverage is trig-gered by the filing of a claim against the insured lawyer or other profes-sional, i.e., the lawyer must have in-surance in place on the date that the claim is made, for it to be eligible for coverage.

However, such policies are more ac-curately called “claims-made and re-ported”, which means that the claim must be made against you during the current policy period, i.e., while you have a policy in effect with that insurer, and you must report the claim to your insurer during same policy period in which it was made, i.e., your current policy period.

Further, with basic claims-made and reported coverage, the wrongful act underlying a claim must also have occurred during the current policy period.

Prior Acts Coverage

To be covered for claims arising out of wrongful acts that occurred prior to the current policy period, a firm must have Prior Acts coverage, a/k/a Retroactive coverage, which covers alleged malpractice committed before the current policy’s inception date.

Prior Acts coverage is essential, because malpractice claims generally aren’t filed until 1 – 4 several years after the alleged wrongdoing. Without it, the firm’s current policy – the one it has in place when it receives the claim – won’t provide coverage, since the wrongful acts that gave rise to the claim occurred before the inception date.

Every claims-made policy has a Prior Acts or Retroactive Date, which is usually on the Declarations (first) page of the policy. Insurers won’t provide prior acts coverage when a firm buys its first malpractice policy, so for that policy, the Prior Acts Date will be the same as the policy inception date. However, once a firm buys a policy and renews it without letting it lapse, its insurer will offer it prior acts coverage back to the inception date of its first policy, i.e., in the firm’s second year of coverage, it’ll have one year of prior acts coverage, in its third year, it’ll have two years of prior acts coverage, etc.

Then, if the firm is sued for work it did on or after the inception date of its first policy, and before the inception date of its current policy, and it reports the claim to its insurer during its current policy period, its Prior Acts coverage will obligate its insurer to protect it (sub-ject to policy exclusions, etc.)

Conversely, if a firm doesn’t renew its policy one year, then it’ll lose all of its Prior Acts coverage; the next policy it buys will cover any errors or omissions it commits only on or after the inception date. For example, if a firm was insured from Jan. 1, 2000 – January 1, 2016, but didn’t renew or buy Extended Reporting Period coverage, then starting at 12:01 AM on January 1, 2016, it would no longer be insured for claims arising out of er-rors or omissions it committed before then. Even if it bought coverage on Jan. 2, 2016, that policy would cover it only for any errors or omissions it commits between that date and Jan. 2, 2017.

Prior Acts Coverage Gaps

However, even if a firm has Prior Acts coverage, gaps can occur that will leave it unpro-tected if it incurs a claim.

This claim scenario that we discussed previously illustrates how a coverage gap is cre-ated if a firm switches insurers: the Great law firm bought a legal malpractice policy from Big Insurer effective January 1, 2012 – December 31, 2012, and renewed it for January 1, 2013 – December 31, 2013, and January 1, 2014 – December 31, 2014, but switched to Huge Insurer on January 1, 2015.

A Great lawyer represented client Smith from February 15, 2013 – May 1, 2014. On March 5, 2015, Smith notified the Great firm that he planned to sue it for malpractice. The firm reported the claim to Big Insurer on March 9, 2015.

Will Big Insurer provide coverage?

Previously, we presented three conditions that must be met for a claim to trigger cover-age under a claims-made policy:

1) The wrongful act(s) that gave rise to the claim must have occurred on or after the policy’s retroactive date – the date you began uninterrupted coverage with your insurer. 2) The claim must be made against you during the current policy period, i.e., while you have a policy in effect with that insurer.
3) You must report the claim to your insurer during same policy period in which it was made, i.e., your current policy period.

Let’s apply them to this scenario:

Condition #1: the wrongful act(s) that gave rise to the claim occurred between February 15, 2013 – May 1, 2014, the period of representation, which is after the policy’s retro-active date of January 1, 2012. Pass.
Condition #2: the claim was made on March 5, 2015, which was after the Great firm had terminated its coverage with Big Insurer. Fail.
Condition #3: The Great firm reported the claim to Big Insurer on March 9, 2015, which is after it had terminated its policy. Fail.

Can the Great firm obtain coverage by reporting the claim under the 60-day grace per-iod that most insurers allow after a claims-made policy is terminated? No, because this would’ve allowed it to report this claim by March 2, 2015, but it didn’t report it until March 9, 2015. Fail.

Conclusion: the claim isn’t covered under Great firm’s legal malpractice policy with Big Insurer.

It then reported the claim to its new carrier, Huge Insurer; will it provide coverage?

Let’s apply the three-condition test:

Condition #1: the wrongful act(s) that gave rise to the claim occurred between February 15, 2013 – May 1, 2014, the period of representation, which is before the Great firm’s policy’s retroactive date of January 1, 2015, its first date of coverage with Huge Insurer. Fail.

Conclusion: no coverage.

The Great firm thus has no coverage for this claim under either its prior or current pol-icy, so it will have to fund its defense and any monetary settlement out of its and/or its partners’ assets.

Avoiding Prior Acts Coverage Gaps

Here’s how the firm could have avoided this coverage gap:

I. Buy an Extended Reporting Period (ERP) endorsement from its former insurer (Big Insurer), which would allow it to report claims for 1 – 5 years or in perpetuity after ter-minating its coverage, depending on which option it buys.

The endorsement “applies only to claims first made against you and first reported to us on or after the policy termination date” – December 31, 2014 in this example – and “the claim (must arise out of) an act or omission occurring prior to the end of the Policy Per-iod”, – again, December 31, 2014 – and on or after the policy’s retroactive date – Janu-ary 1, 2012 in this example.

What would’ve happened if the Great firm had bought the ERP endorsement, even for one year?  Let’s apply the 3-condition test:

Condition #1: the wrongful act(s) that gave rise to the claim occurred between Febru-ary 15, 2013 – May 1, 2014, the period of representation, which is after the policy’s retro-active date of January 1, 2012. Pass.
Condition #2: the claim was made on March 5, 2015, after the Great firm’s policy ter-mination date of December 31, 2014, but the 1-year ERP extends the period in which the policy will cover claims made against it to January 1, 2015 – December 31, 2015. Pass.
Condition #3: The firm reported the claim to Big Insurer on March 9, 2015, which be-cause it bought the ERP, is within the allowable reporting period of January 1, 2015 – December 31, 2015. Pass.

Conclusion: assuming no policy exclusions, etc., apply, this claim is covered under the Great firm’s legal malpractice policy with Big Insurer.

However, ERP coverage is expensive, typically 125% of the annual premium for a one year ERP, rising to 300% for a perpetual ERP.

Also, whatever limit is left on the expiring policy carries over to the ERP. If/when that limit is exhausted by defense costs and indemnity payments made by Big Insurer to resolve malpractice claims, the Great firm will have no further coverage under that policy, even if it bought a multi-year ERP that still has years to go. In other words, buying an ERP doesn’t buy fresh policy limits.

Further, the Great firm would still have to buy a policy to cover it for any malpractice that it commits after 12/31/14.

II. Buy Prior Acts coverage from its new carrier, Huge Insurer, which resets the policy retroactive date to before the inception of coverage, i.e., back to when the Great firm first had continuous coverage, which is January 1, 2012, when it bought its first legal malpractice policy from Big Insurer.

This would be the retroactive date of its policy with Huge insurer, if it bought Prior Acts coverage; without Prior Acts coverage, the policy’s retroactive date would be the same as its inception date: January 1, 2015.

Now let’s apply the 3-condition test to the above claim scenario:
Condition #1: the wrongful act(s) that gave rise to the claim occurred between Febru-ary 15, 2013 – May 1, 2014, which is on or after the policy’s retroactive date of January 1, 2012. Pass.
Condition #2: the claim was made on March 5, 2015, during the current policy period of January 1, 2015 – December 31, 2015. Pass.
Condition #3: The firm reported the claim to Huge Insurer on March 9, 2015, which is during the same policy period in which it was made. Pass.

Conclusion: the Great law firm is covered for this claim is under its policy with Huge Insurer, subject to any policy exclusions, etc.

Further, Prior Acts coverage costs less than an ERP, and is generally the better choice for law firms that switch malpractice insurers.

Note: Insurers won’t provide Prior Acts coverage unless the insured attests that it’s un-aware of any pending claims against it, or of any incidents that could lead to a claim, i.e., an adverse outcome or a missed statute of limitations. If it is aware of a pending or po-tential claim, it must disclose that on its application, and the new insurer won’t cover it.

Thus, Huge Insurer would deny coverage for the above claim if client Smith had threat-ened to sue the Great firm for malpractice prior to 1/1/15, Great’s first day of coverage with Huge, or if the Great attorney who worked with Smith knew before that date that he/she had made an error that could result in Smith making a claim.

In either case, the Great firm should have immediately reported Smith’s threatened suit or the attorney’s error to Big Insurer, its malpractice insurer at the time.

Known v. Unknown Prior Acts

Keep in mind that even if you switch insurers and the new insurer gives you Prior Acts coverage back to the inception date of the first policy you ever purchased, it will cover only unknown prior wrongful acts, not known prior wrongful acts, i.e., those that a firm knew about before the inception date of its first policy with that insurer.

Every claims-made policy has a Prior Knowledge Condition, which excludes coverage for ‘known prior wrongful acts’.

Here’s an example from Darwin National’s policy:

“…It is a condition precedent to coverage that the Wrongful Act upon which the Claim is based occurred…

  1. during the Policy Period; or
  2. on or after the Retroactive Date and prior to the Policy Period, provided that…prior to the inception date of the first policy issued by the Insurer if continuously renewed, no Insured had any basis (1) to believe that any Insured had breached a professional duty; or (2) to foresee that any such Wrongful Act or Related Act or Omission might reasonably be expected to be the basis of a Claim against any Insured;” (emphasis added)

Without such a policy provision, attorneys could remain uninsured until they committed a wrongful act, and then rush to buy a policy before their client filed a claim.

To prevent that, every malpractice insurer’s application requires a firm to disclose any known claim, or any known wrongful act that could lead to a claim. If the firm discloses a known claim or wrongful act, and later seeks coverage for it, the insurer can deny cov-erage under its policy’s Prior Knowledge Condition. If the firm doesn’t disclose it, and later seeks coverage for it, then the insurer can either deny coverage under the Prior Knowledge Condition, or seek to rescind the policy, due to material misrepresentation.

To protect your firm, report all actual and potential claims to your current insurer before the policy period ends, and you switch to the new insurer.

However, there’s no protection against a rogue partner who doesn’t disclose a potential claim. This creates a gap in coverage if the firm switches insurers, even if it gets full prior acts coverage from the new insurer.

We’ll illustrate using the above example, whereby the Great law firm bought three one-year legal malpractice policies from Big Insurer for January 1, 2012 – December 31, 2015, then switched to Huge Insurer on January 1, 2015.

A Great lawyer represented client Smith from February 15, 2013 – May 1, 2014. On October 4, 2014, Smith notified his Great lawyer that he planned to sue it for malprac-tice.

However, the attorney didn’t tell anyone at the firm about it, so it was never reported to Big Insurer before the firm’s last policy with it terminated on 12/31/14, and it wasn’t re-ported on the firm’s application to its new carrier, Huge Insurer.

On 4/1/15, Smith sued the Great firm, but Big Insurer denied coverage, since its policy with firm had expired on 12/31/14, and the firm didn’t renew. Huge Insurer denied cov-erage, even though the wrongful acts had occurred after the firm’s Prior Acts date of 1/1/12, because Smith’s attorney knew about the potential claim on 10/4/14, before the inception date of its first policy with Huge, which was 1/1/15, i.e., it was a known prior wrongful act, and was thus excluded by the policy’s Prior Knowledge Condition.

The firm would be covered if it had bought an ERP (‘tail’ coverage) from its former insurer, but as noted, that costs much more than buying prior acts coverage from the new insurer, so few firms do it.

That’s the Prior Acts conundrum: a gap in coverage can occur even if a firm has full Prior Acts coverage, if a rogue attorney hides a potential claim. 

Legal Malpractice Insurance: Claims-Made Coverage, Part 5 of 5: How It Affects Your Premium

legal malpractice insurance how claims-made coverage affects premiumYour firm’s malpractice premium de-pends on its attorney count, areas-of-practice (AOPs), claims history, geo-graphic location, etc., your chosen policy limit and deductible, your insur-er’s claims experience with the other law firms it insures and its lines of coverage it underwrites, its overhead, investment returns, etc.

Yet, independent of all of these, legal malpractice premiums reflect the fact that they’re underwritten on a claims-made basis, as discussed in our prior posts, rather than on an occurrence basis, as most lines of property-casualty insurance are.

The exposure under a new claims-made policy increases sharply each year, i.e., con-sider Lawyer Bill, who purchased a malpractice policy when he began practicing in 2000, and has had continuous coverage since then.

The risk that Bill will be sued for malpractice in his first year of practice is low, since he likely has few clients, and he would have to make a mistake, which would then have to be discovered, and cause damage, and result in a suit all within that year. 

However, in each subsequent year, Bill will likely have more clients and harder cases; he thus has more opportunity to make mistakes that injure his clients, and that they discover and sue him for.

Together, these factors increase his risk of being sued for malpractice each year. Insur-ers call this “increasing prior acts exposure”, with “prior acts” meaning those committed in previous policy years. For example, if Lawyer Bill started his practice on 1/1/2000, and bought a legal malpractice policy effective January 1, 2000 – December 31, 2001, he’ll have no prior acts exposure; if he renews it on January 1, 2001, then he – and his in-surer – will have one year of prior acts exposure: January 1, 2000 – December 31, 2000. Further, each year he renews the policy will add another year of prior acts exposure.

To accurately price this increasing exposure, insurers charge a lower premium in the first year of coverage, and apply “step-rate” factors in calculating the renewal premium each year, which result in higher premiums, independent of all other factors, i.e., changes in the firm’s attorney account, practice areas, etc., the insurer’s investment returns, etc.

Step-rate increases cease when the policy is deemed to have reached maturity, which for most attorneys is after five years of coverage, during which they cause a firm’s premium to approximately double.

After that, whether the firm’s attorneys have five years or 50 years of prior acts cover-age, it doesn’t affect the premium, because although their adding new clients, and thus new risks each year, their risk of being sued by former clients decreases as the statute of limitations from early cases tolls. Thus, the overall risk of a malpractice suit remains constant.

Legal Malpractice Insurance: Claims-Made Coverage, Part 4 of 5: Avoiding Gaps

Legal Malpractice Insurance Avoiding Claims Made Coverage GapsLast time, we saw how switching malpractice in-surers can create a gap in a law firm’s coverage, when a claim scenario such this arises:

I. The Great law firm bought a legal malpractice policy from Big Insurer effective January 1, 2012 – December 31, 2012, and renewed it for January 1, 2013 – December 31, 2013, and January 1, 2014 – December 31, 2014, but switched to Huge Insurer on January 1, 2015.

II. A Great lawyer represented client Smith from February 15, 2013 – May 1, 2014. On March 5, 2015, Smith notified the Great firm that he planned to sue it for malpractice. The firm reported the claim to Big Insurer on March 9, 2015, and then to Huge Insurer.

Both insurers denied coverage: Big Insurer, because the claim was reported to it after its policy with the Great firm had expired (December 31, 2014), as had the 60-day grace period to report claims after the policy expiration date (March 2, 2015), and Huge Insur-er, because the wrongful acts occurred before its policy with the Great firm had begun.

How could the Great firm have avoided this gap?

I. Buy an Extended Reporting Period (ERP) endorsement from its former insurer (Big Insurer), which would allow it to report claims for 1 – 5 years or in perpetuity after ter-minating its coverage, depending on which option it buys.

The endorsement “applies only to claims first made against you and first reported to us on or after the policy termination date”December 31, 2014 in this example – and “the claim (must arise out of) an act or omission occurring prior to the end of the Policy Per-iod”, – again, December 31, 2014 – and on or after the policy’s retroactive date – January 1, 2012 in this example.

What would’ve happened if the Great firm had bought the ERP endorsement, even for one year?  Let’s apply the 3-condition test:

Condition #1: the wrongful act(s) that gave rise to the claim occurred between February 15, 2013 – May 1, 2014, the period of representation, which is after the policy’s retro-active date of January 1, 2012. Pass.
Condition #2: the claim was made on March 5, 2015, after the Great firm’s policy term-ination date of December 31, 2014, but the 1-year ERP extends the period in which claims can be made against it to January 1, 2015 – December 31, 2015. Pass.
Condition #3: The firm reported the claim to Big Insurer on March 9, 2015, which be-cause it bought the ERP, is within the allowable reporting period of January 1, 2015 – December 31, 2015. Pass.

Conclusion: assuming no policy exclusions, etc., apply, this claim is covered under the Great firm’s legal malpractice policy with Big Insurer.

However, ERP coverage is expensive, typically 125% of the annual premium for a one year ERP, rising to 300% for a perpetual ERP.

Also, whatever limit is left on the expiring policy carries over to the ERP. If/when that limit is exhausted by defense costs and indemnity payments made by Big Insurer to resolve malpractice claims, the Great firm will have no further coverage under that policy, even if it bought a multi-year ERP that still has years to go. In other words, buying an ERP doesn’t buy fresh policy limits. 

Further, the Great firm would still have to buy a policy to cover it for any malpractice that it commits after 12/31/14.

II. Buy Prior Acts coverage from its new insurer, i.e., Huge Insurer, which resets the policy retroactive date to before the inception of coverage, i.e., back to when the Great firm first had continuous coverage, which is January 1, 2012, when it bought its first legal malpractice policy from Big Insurer.

This would be the retroactive date of its policy with Huge insurer, if it bought Prior Acts coverage; otherwise, it would be the same as the policy inception date of January 1, 2015, i.e., it would have no retroactive coverage.

Now let’s apply the 3-condition test to the above claim scenario:
Condition #1: the wrongful act(s) that gave rise to the claim occurred between February 15, 201 – May 1, 2014, which is on or after the policy’s retroactive date of January 1, 2012. Pass.
Condition #2: the claim was made on March 5, 2015, during the current policy period of January 1, 2015 – December 31, 2015. Pass.
Condition #3: The firm reported the claim to Huge Insurer on March 9, 2015, which is during the same policy period in which it was made. Pass.

Conclusion: the Great law firm is covered for this claim is under its policy with Huge Insurer, subject to any policy exclusions, etc.

Further, Prior Acts coverage costs less than an ERP, and is generally the better choice for law firms that switch malpractice insurers.

Note: Insurers won’t provide Prior Acts coverage unless the insured attests that it’s unaware of any pending claims against it, or of any incidents that could lead to a claim, i.e., an adverse outcome or a missed statute of limitations. If it is aware of a pending or potential claim, it must disclose that on its application, and the new insurer won’t cover it.

Thus, Huge Insurer would deny coverage for the above claim if client Smith had threat-ened to sue the Great firm for malpractice prior to 1/1/15, Great’s first day of coverage with Huge, or if the Great attorney who worked with Smith knew before that date that he/she had made an error that could result in Smith making a claim.

In either case, the Great firm should have immediately reported Smith’s threatened or potential suit to Big Insurer, its malpractice insurer at the time.

Legal Malpractice Insurance: Claims-Made Coverage, Part 3 of 5: Gaps

Legal Malpractice Insurance Claims-Made Coverage GapsPreviously, we discussed how claims– made policies differ from occurrence policies, and the conditions that must be satisfied to trigger coverage under a claims-made policy, which is what all legal malpractice policies are. 

We also mentioned how attorneys’ lack of understanding of how claims-made cov-erage works can cause a gap in their malpractice insurance, i.e., a denial of coverage for a claim, which would require them to fund their defense of the claim out-of-pocket.

There are two gaps to be aware of: claim-reporting, which we discuss in this post, and  switching legal malpractice insurers, which we’ll discuss today.

Law firms switch insurers often, sometimes because their incumbent insurer provided poor service or mishandled a claim, but usually because the new insurer offered better terms.

This claim scenario will illustrate how a coverage gap is created: the Great law firm bought a legal malpractice policy from Big Insurer effective January 1, 2012 – December 31, 2012, and renewed it for January 1, 2013 – December 31, 2013, and January 1, 2014 – December 31, 2014, but switched to Huge Insurer on January 1, 2015. A Great lawyer represented client Smith from February 15, 2013 – May 1, 2014, but didn’t do a great job: on March 5, 2015, Smith notified the Great firm that he planned to sue it for mal-practice. The firm reported the claim to Big Insurer on March 9, 2015; will Big Insurer provide coverage?

Previously, we presented three conditions that must be met for a claim to trigger cover-age under a claims-made policy.

Let’s apply them to this scenario:

Condition #1: the wrongful act(s) that gave rise to the claim occurred between February 15, 2013 – May 1, 2014, the period of representation, which is after the policy’s retro-active date of January 1, 2012. Pass.
Condition #2: the claim was made on March 5, 2015, which was after the Great firm had terminated its coverage with Big Insurer. Fail.
Condition #3: The Great firm reported the claim to Big Insurer on March 9, 2015, which is after it had terminated its policy. Fail.

Can the Great firm obtain coverage by reporting the claim under the 60-day grace per-iod that most insurers allow after a claims-made policy is terminated? No, because this would’ve allowed it to report this claim by March 2, 2015, but it didn’t report it until March 9, 2015. Fail.

Conclusion: the claim isn’t covered under Great firm’s legal malpractice policy with Big Insurer.

It then reported the claim to its new carrier, Huge Insurer; will it provide coverage? Let’s apply the three-condition test:
Condition #1: the wrongful act(s) that gave rise to the claim occurred between February 15, 2013 – May 1, 2014, the period of representation, which is before the Great firm’s policy’s retroactive date of January 1, 2015, its first date of coverage with Huge Insurer. Fail.

Conclusion: no coverage.

The Great firm thus has no coverage for this claim under either its prior or current pol-icy, so it will have to fund its defense and any monetary settlement out of its and/or its partners’ assets.

Next time, we’ll examine how it could’ve avoided this.

Legal Malpractice Insurance: Claims-Made Coverage, Part 2 of 5: Triggers

Legal Malpractice Insurance Claims-Made Coverage Triggers

In our last post, we discussed how legal malpractice and other professional liability policies are underwritten on a claims-made basis, and how such policies differ from occurrence policies.

Today, we’ll analyze the different conditions that must be met for a claim to trigger cov-erage under an occurrence and claims-made policy.

Occurrence v. Claims-Made Coverage Trigger
Occurrence coverage is triggered (activated) based on when the incident that led to the claim took place; if you had a policy in effect on that date, then it will be triggered no mat-ter when the claim is made, even if it’s years later.

Claims-made coverage is triggered primarily by the act of reporting a claim to your in-surer; you must have a policy in effect on that date in order to have coverage.

However, that is only one of three conditions that must be met for your coverage to be triggered:

1) The wrongful act(s) that gave rise to the claim must have occurred on or after the policy’s retroactive date – the date you began uninterrupted coverage with your insurer.
2) The claim must be made against you during the current policy period, i.e., while you have a policy in effect with that insurer.
3) You must report the claim to your insurer during same policy period in which it was made, i.e., your current policy period.

Thus, subject to its definitions and exclusions, a claims-made policy covers claims for wrongful acts that occurred on or after the date you began uninterrupted coverage with your insurer, and that are made against you and reported by you to your insurer during the current policy period.

Example:
Attorney Doe bought his first malpractice policy for the period of January 1, 2013 – December 31, 2013, and renewed it for January 1, 2014 – December 31, 2014, and January 1, 2014 – December 31, 2015.

On May 1, 2014, he missed a statute of limitations deadline for client Smith. On April 1, 2015, Smith notified Doe that he was going to sue him for malpractice. Doe reported the claim to his malpractice insurer on April 15, 2015. Assuming no policy exclusions, etc., apply, will his coverage be triggered?

Condition #1: The wrongful act that gave rise to the claim occurred on May 1, 2014, which is after the policy’s retroactive date of January 1, 2013, the first date of Attorney Doe’s uninterrupted coverage with his insurer. Pass.
Condition #2: the claim was made on April 1, 2015, which is during the current policy period of January 1, 2015-December 31, 2015. Pass.
Condition #3: Doe reported the claim to his insurer on April 15, 2015, which is during the same policy period in which it was made. Pass.

Conclusion: the claim triggers Doe’s legal malpractice policy.

To review, a claims-made policy covers claims that are made against you and reported by you to your insurer during the current policy period, for acts you committed on or after the date you began uninterrupted coverage with that insurer.

Once that policy period ends, you’ll have no further coverage under that policy, either for claims that you don’t yet know about, i.e., those that’ll be made in the future, or those that you do know about, but didn’t report to the insurer during the policy period*.

This is how insurers achieve what Fischer called “greater actuarial certainty” that they’re not “on the hook” for any claims that are made after an insured’s policy period ends: they don’t cover them.  

However, if you renew your policy, you’ll be covered for claims that are made against you and reported by you during that policy period; further, at the start of the new policy period, most insurers will allow you to report claims that were made against you at the end of the prior policy period, but that you haven’t yet reported.

In contrast, an occurrence policy covers claims based on when the underlying wrongful act(s) took place, which in this example is May 1, 2014. Thus, if legal malpractice cov-erage was still underwritten on an occurrence basis, and Attorney Doe had such a policy in effect on that date, then it would respond to Smith’s claim no matter when he made it.

Now, we’ll analyze a more complex example:
Attorney Doe bought a malpractice policy for the period of January 1, 2013 – December 31, 2013, and renewed it for January 1, 2014 – December 31, 2014, but didn’t renew it for 2015. She represented client Smith from February 1st, 2013 – December 15, 2013. On December 28, 2014, Smith notified Doe that he was going to sue her for malpractice. Doe reported the claim to her malpractice insurer on January 5, 2015. Assuming no pol-icy exclusions, etc., apply, will his coverage be triggered?

Let’s apply the three-condition test:
Condition #1: The wrongful acts that gave rise to the claim occurred during the period of representation, from February 1st, 2013 – December 15, 2013, which is after the pol-icy’s retroactive date of January 1, 2013, the first date of Attorney Doe’s uninterrupted coverage with her insurer. Pass.
Condition #2: the claim was made on December 28, 2014, during the then current pol-icy period of January 1, 2014 – December 31, 2014. Pass.
Condition #3: Attorney Doe reported the claim to her insurer on January 5, 2015, after the end of the policy period in which it was made (January 1, 2014 – December 31, 2014). Further, Doe didn’t renew her policy, so she didn’t have a policy in force with that insurer when she reported the claim. Therefore, this condition hasn’t been satisfied, and the insurer could deny coverage. However, most insurers allow a grace period, i.e., “We will provide 60 days after the policy termination date for you to report any claims to us (for) professional services (that were) rendered prior to the end of the policy period”. Here, the policy termination date is December 31, 2014, so Doe has until March 2, 2015 to report this claim. Pass.

Conclusion: the claim triggers Doe’s legal malpractice policy.

Our next post will explain how a claims-made policy can cause a gap in your coverage, i.e., a denial of coverage for a claim, which could put your assets at risk if you’re sued.

*We’ll discuss exceptions to this in a future post.

Legal Malpractice Insurance: Claims-Made Coverage, Part 1 of 5: vs. Occurrence Coverage

Legal Malpractice Insurance Claims Made v OccurrenceFor decades, all property-casualty insurance polices were occurrence policies, which cover claims that arise out of incidents that happen during the policy period, regardless of when the claims are made. For example, if your auto pol-icy runs from January 1, 2016 – December 31, 2016, and you rear-end another car dur-ing this period, you’ll be covered if the other driver sues you, evens if it’s not until years later, long after your policy has expired.

Most property-casualty insurance policies – i.e., auto and homeowner’s, general liability and workers compensation, – are still underwritten as occurrence policies; however, ac-cording to Fred Fischer’s “A Review of the Modern Claims Made Form”, insurers con-cluded that the occurrence policy was inadequate for professional liability insurance, i.e., medical and legal malpractice policies, because unlike a driver who’s rear-ended or a homeowner who sustains a fire, “rarely are clients immediately aware of a (profession-al’s) wrongful or erroneous actions… because (they) seldom cause immediate injury… (they) may not manifest in client injury until long after”.

As a result, when professional liability insurers were deciding what premium to charge a doctor, lawyer, etc., who had applied for a policy, they had to forecast a) the likelihood that one or more of the doctor or lawyer’s clients would discover an injury and file a claim against him or her after the policy had expired, and b) the costs they would incur to re-solve such claim(s); their forecasts were usually inaccurate, so the premium they had charged often failed to properly reflect the risk they had assumed by providing coverage.

In other words, they were paying out too much money to resolve claims relative to the premiums they had charged, and were therefore either losing money or not earning enough profit.

Insurers’ desire for “greater actuarial certainty” that no claims would be made after an insured’s policy period ended was a key factor in the search for alternatives to the oc-currence policy. This search culminated in the development of the claims-made policy in 1964; by 1976, “claims-made policies and the number of carriers offering them flour-ished”.

Today, all professional liability insurance policies are claims-made, although they’re more accurately called “claims-made and reported” (see next post).

However, despite its widespread use, the claims-made policy still confuses many pro-fessionals, including attorneys, who think that once they buy it, they’re covered forever. This can result in their being denied coverage for a claim because they didn’t comply with their claims-made policy’s strict claim-reporting requirements, or cause a gap in their coverage if they change insurers or jobs, which will put their personal assets at risk if they’re then sued for malpractice.

We’ll explain these claim reporting requirements – and how to avoid coverage gaps – in future posts.