Background:
In 2020, law firms faced a renewal cycle of rate increases and restricted capacity. Following years of historically low rates, insurers sought to recoup premium in an environment of increased frequency of severe losses. Self-insured retentions (SIR) and deductibles were also subject to increases in order to address growth of firms, increased severity levels of malpractice losses and higher costs of defending lawyers’ professional liability claims. In the first few months of 2021, underwriters continue to constrict primary capacity and execute more restrictive and disciplined appetite guidelines.
The following is our year-end 2020 review and 2021 forecast of the Lawyers’ Professional Liability (“LPL”) marketplace.
COVID-19
In April of 2020, many insurers expressed concerns regarding the impact of COVID-19 on claims frequency and severity. However, at the time of this polling, markets did not report a dramatic uptick in COVID-related claims. In fact, we found that the opposite was true. With court closures and reduced transactional work, many disputes were pushed toward an early resolution or were postponed pending reopening efforts. Underwriters report that claims resulted from the same high-risk areas identified prior to the outbreak of the pandemic. However, errors & omissions (E&O) claims take time to develop. COVID-related claims have yet to emerge. An uptick in claims arising out of the following scenarios remains:
- Transactions: The claim risk at this juncture is interrupted transactions in mergers and acquisitions (M&A), Real Estate and other complex commercial transactions. The shutdown caused re-evaluation of liquidity and financial resilience that resulted in decisions to withdraw from deals in progress. Failed deals often result in related legal malpractice claims
- Fee Disputes: Downturns frequently result in fee disputes. During difficult economic conditions like those caused by the pandemic shutdown, law firms struggle to maintain cash flow and clients fall behind in paying fees. Fee disputes are widely accepted as precursors of malpractice claims. An interesting point made by one of our LPL markets was that COVID has had the biggest impact on “blue collar” workers, which does not comprise the client base of many of our midsized to large law firm clients. Those firms with clients more heavily impacted by the shutdowns may experience more collection related issues and disputes
- Volume Increase Stress: Bankruptcy, Foreclosure, Labor & Employment and Intellectual Property practice areas typically ramp up quickly upon sudden economic downturns. Rapid increase in volume of work also results in off-cycle claims
- Trust & Estates: Stock market volatility will negatively impact the value of many trusts. Historically, significant fluctuations in the value of trust assets has resulted in legal malpractice claims against lawyers who have done work for the trustee or has served as the trustee. This is especially true as tax rules and regulations continue to fluctuate with changing federal administrations, which may result in allegations of poor estate planning
While markets are rightly concerned with the impact of COVID-19, they are more concerned with how COVID will influence the economy as a whole. Underwriters continue to resist comparisons to the great recession with respect to portfolio profitability and rate, but this could change if the economy fails to rebound as we transition to a post-COVID environment and a reduction of government stimuli.
Rate Adequacy
Our annual survey of select lawyers’ professional liability underwriters revealed continued general concern over frequency of severe LPL claims in the large, mid-size and small law firm segments. Similar to what the D&O and employment practices liability insurance (EPLI) market experienced in recent history, rate initiatives by select markets gained momentum in the LPL space in 2019, and this trend continued throughout 2020, with considerable success overall. In the first quarter of 2021, we confronted a similar environment; insurers are asserting that, generally, rates are still below levels needed to sustain profitability.
Rate increases in the range of 10% to 20% were realized among large law firms (200 lawyers and up) in 2020. In the large law space, many of the markets we polled noted high severity losses developing for the recent accident years of 2015, 2017, 2018 and 2019 and expressed concerns over mounting defense costs, which have increased exponentially over the past ten years. To address these concerns, underwriters have increased self-insured retentions to offset the cost of resolving claims. This holds true especially for larger firms that control defense strategy by maintaining coverage on an indemnity form and which tend to have greater potential to experience severe losses.
In the mid-sized and small-law space (1-199 lawyers), more abundant capacity and new entrants to the marketplace have allowed such firms to manage proposed rate increases. Nevertheless, underwriters have successfully achieved 2.5% to 7.5% rate increases in this segment. While rate increases in the mid-sized space are more manageable, excess capacity has become more expensive as excess insurers are also seeing a spike in severe losses that increasingly exceed primary limits.
Through the first quarter, 2021, LPL insurers did not change course but continued to execute rate initiatives and exercise underwriting discipline. Law firms renewing later in 2021 should anticipate another cycle of rate increases as underwriters contend that severe losses in the segment demand even further rate action. Underwriting discipline focused on avoiding and insulating insurers from risk profiles likely to generate severe loss will also be evident.
Claim Sources
Corporate, Securities, Tax, Commercial Transactions and Litigation practice areas continue as leading generators of severe losses for large and mid-size firms according to underwriters surveyed. Underwriters noted a recent resurgence of transactional and real estate Ponzi scheme cases, which tend to draw a number of law firms into a single, complex malpractice claim. Trusts & Estates (T&E) practices also generated an expectedly frequent level of severe claims. T&E claims have been more troublesome among small and mid-size firms, and we expect to see an increased frequency in such matters as the “baby boomer wealth transfer” continues to produce disputes. Underwriters in the U.S. and the U.K. are also monitoring a growing trend of Special Purpose Acquisition Company (SPAC) transactions. Concern regarding SPAC risk is rational at this juncture. However, this form of investment vehicle, with unique risks, has moved into the mainstream and underwriters appreciate the potential for malpractice or fraud allegations against lawyers in the event of a failed deal.
Many of the markets polled reported a consistent or decreasing frequency in the raw number of lawyers’ professional liability claims. However, the fairly consistent claim count was largely offset by loss severity. In 2020, multiple insurers reported experiencing losses that fully impacted large insurance towers and high excess placements.
Generally, in 2020 the root cause of claims varied widely and most frequently involve simple mistakes by lawyers. According to the underwriters surveyed, claim causes are similar to last year and include:
- Client acceptance issues – unworthy clients, conflicts of interest, poor or incomplete documentation engagement scope
- Simple drafting errors
- Failure to understand the law
- Failure to accurately document advice given
- Technology related errors – court generated notices caught in spam filters, errors in information input, IP maintenance payment notice caught in spam filter
- Errors calculating deadlines – unaware of jurisdictional differences of key dates, failure to discover the correct date of final decision
- Suing clients to collect fees
- Failure to supervise – young associates preparing and filing documents without requirement of quality review by a partner
- Poor client communication that resulted in misunderstanding of scope of engagement and expectations
- Failure to properly counsel a litigation client about the risk of going to trial, in writing
- Defense errors – trial strategy error, failure to call an expert, failure to make appropriate argument regarding damages, failure to settle case
- As a direct product of the COVID environment, conversations regarding potential errors or admonitions of guilt are memorialized in discoverable emails. Whereas, pre-COVID, such conversations were traditionally discussed verbally in the office
Underwriters continue to attribute these “causes” to an erosion of disciplined execution of basic risk management practices due to the pressure on lawyers to generate new clients and more revenue and a lack of oversight on work product. Consequently, the underwriting community is suggesting that law firms adopt a “back to basics” approach to risk management. Law firms must create a culture that fosters a stable environment for lawyers to grow their practices and establish sustainable careers. Additionally, the workplace dynamic has changed, and firms will need to focus on risk management with regard to a permanent remote workforce that will likely exist in the post-COVID era.
Conclusion
Overall, the U.S. property & casualty (P&C) industry is financially strong and well positioned to endure the economic turmoil caused by the COVID-19 pandemic. U.S. insurers have learned how to operate in an environment of artificially low interest rates, volatile capital markets and abundant capacity. Therefore, there is no reason to believe that current underwriting strategies will change dramatically as we start to emerge from the pandemic. Consequently, law firms renewing in 2021 will experience another cycle of rate increases, the extent of which will depend, in large part, on the size of firm.
Primary rate increase strategies will vary from one insurer to the next and depend on individual firm risk profile. Excluding a handful of primary markets, Insurers are typically only offering $5,000,000 in primary limits, which has resulted in upward rate pressure on excess layers. Efforts to manage limits exposed will continue through 2021 as will resulting upward rate pressure on excess layers. More attention will be dedicated to factors such as current rate per attorney, loss history, recent growth and size of firm, exposure to higher risk practice areas and risk management practices. Due to the limited number of insurers willing and able to compete for large firm primary placements, and the more abundant number of competitors for mid-size law firm business, what law firms should anticipate at renewal will depend largely on the size of firm.
Large Law Firm Segment: Large firms should once again prepare for rate increases in the 7.5% to 15% range on primary layers. Since fewer insurers are willing to deploy capital on large firm primary layers, less competition for such positions has emboldened insurers in this space to push rate. Insurers in this segment will likely seek to increase self-insured retentions perceived to be inadequate. Firms in this segment with adverse claims experience will struggle to avoid rate increases above the range noted above. Insurers will likely continue to deploy capacity more conservatively which will increase the cost of excess insurance and may challenge large towers of insurance to meet limit objectives.
Small-to-Midsized Law Firms: Law firms in this segment should anticipate rate increases in the 2.5% to 7.5% range and prepare to challenge any increase by leveraging more abundant capacity willing to compete for primary and excess layers. Some carriers may attempt to reduce primary capacity or move to a quota-share structure. Firms in this segment with adverse claims development will also face difficulty avoiding significant rate increases, as insurers seek to minimize exposure to severe losses. Coverage in this segment remains broad and competitive. Excess capacity is abundant, but firms can no longer expect flat renewals on excess layers.
Strategic and creative use of existing capacity, and new entrants to the space, must be exercised to offset insurers’ efforts. Firms should be prepared to show insurers how they avoid claims, especially high-dollar claims. In the period following the pandemic shutdown underwriters will seek to understand firms’ business operations. In particular, law firms should demonstrate financial strength, adequate supervision, proper intake and use of engagement letters, and robust risk management policies and procedures. As always, strong controls and risk management programs will place law firms in the best position maintain best available coverage and pricing in a hard market.
In the preparation of this report, we surveyed key LPL insurers regarding their portfolios, claims experience, rate initiatives and general emerging trends. We would like to thank the following insurers for their time, insights and contributions: Argo, AttPro, CNA, Everest, Huntersure, Markel, ProSight, Sompo and Swiss Re.
Lemme, a Division of EPIC
Lemme, a division of EPIC, (“Lemme”) has been providing specialized insurance brokerage and consulting services to the accounting and legal profession since 1998. Our experienced brokers work with clients to understand their business, assess needs, and develop solutions using our integrated approach to service. Lemme approaches each opportunity with integrity, transparency and full accountability to our clients. We are honored to have built long-term relationships with clients ranging in size from top national firms to large regional and local firms throughout the United States. In working with clients across the full spectrum of service offerings, specialty niches, and overall risk profiles, we gain valuable insights into claim trends, regulatory requirements and best practices we share with decision makers. Moreover, this knowledge gives us the ability to build enhanced policy wordings, program structures and risk management to achieve the best overall results for our clients.
