Picking the right insurance coverage for your firm

Attorneys should not wait until a claim has been filed against them to check the scope and limitations of their legal malpractice insurance policy - by then, it may be too late. Coverage is fixed in place by the policy with conditions, limitations and exclusions, and an attorney could be facing a claim that is excluded from coverage.

The best time to review a legal malpractice policy is during the immediate two months before renewal, especially in today's competitive insurance market. There is no substitute for professional help in choosing the best malpractice coverage at the most affordable price.

Here are some basic questions every law practice should consider in deciding which malpractice policy to buy.

What are the right policy limits?

When law practices carry insurance they do not end up using, it may seem too expensive, especially when the premium is due. On the other hand, when a claim comes in, it rarely seems like the available policy limits are enough.

Striking the balance involves consideration of the type of practice (such as plaintiff's personal injury, bankruptcy, IP, etc.); the practice's locale (whether urban, suburban, or rural); the size of the practice (be it solo, two to 10 attorneys, or more); and the amount involved in a typical representation (both in fees received and exposure to clients).

In addition, not every policy limit is the same. For example, some policy limits are "self-consuming" or "burning" limits. This means the costs to defend a malpractice claim reduce the available policy limits the same way a settlement or payment of a judgment does. See Powerine Oil Co. Inc. v. Superior Court (Central Nat'l Ins. Co.), 37 Cal. 4th 377, 402 (2005). So, if an attorney has a $1 million policy limit, but $200,000 is spent defending the claim, then the limit is down to $800,000.

For some practices, like residential real estate, this type of policy may make sense. If a residential real estate attorney misses a tax lien in a title search, the cost of defending such a claim may not be that expensive because the defense is not likely to be very fact-intensive.

On the other hand, for plaintiff's personal injury lawyers or IP practitioners, the costs of defending a legal malpractice claim are routinely high. In these cases, claimants must win the "case within the case" to prove any alleged mistake actually caused damage. This translates into higher litigation costs.

There is also the difference between an aggregate limit and a per-claim limit. The per-claim limit is the most an insurer will pay for any one claim. The aggregate limit is the most the insurer will pay for all of the claims, but never more for any one claim of the per-claim limit.

So, if the policy has a $100,000 per-claim limit and a $300,000 aggregate limit, the most the insurer will pay for any one claim is $100,000. The most the insurer will pay for all of the claims during the policy is $300,000 - but never more than $100,000 for any one claim.

If the law practice involves a practice area that faces a high severity but a low frequency of risks (such as securities and corporate transactions), then the practice may consider whether it is sufficient for the per-claim limit to be the same as the aggregate. Practices with higher frequency of malpractice claims but lower severity, like criminal defense and domestic relations, could consider a lower per-claim limit.

What is the retroactive date?

Under California law, three dates generally dictate the boundaries of malpractice coverage. First is the date after which an act, the professional negligence, must occur in order to be covered. That is the retroactive date. See Merrill & Seeley Inc. v. Admiral Ins. Co., 225 Cal. App. 3d 624, 630 (1990). If the alleged negligent act occurs before the retroactive date, the resulting legal malpractice claim is usually not covered even if the claim is made during the legal malpractice policy. The best rule of thumb is to consider a retroactive date at least six years or longer before the inception date to encompass all claims made within an applicable statute of limitation.

Second, there is the date after which a claim usually must be made to be covered. This is the inception date, when the policy begins. If the claim is made before the inception date, it is usually not covered. For coverage, the alleged conduct must occur after the retroactive date and the claim must be made after the inception date. Typically, these are different dates.

Some policies have a retroactive inception date. This often means that for coverage to exist, the alleged negligent act must occur after the policy begins and the claim must be made before the policy ends.

Third, there is the date before which a claim must be made. This is the expiration date. It is when the policy ends. For law practices changing insurers, there is the option of an extended reporting period. This extension allows a law practice more time to report an incident.

Claims-made policies may contain an automatic extended reporting period applicable to claims "first made and reported during a period of 60 days prior to the policy term ending." See World Health and Educ. Foundation v. Carolina Cas. Ins. Co., 612 F. Supp. 2d 1089, 1095 (N.D. Cal. 2009). The automatic extended reporting period provision applies if the insurance company or the insured cancels or refuses to renew the policy. Id. at 1095 n.2.

Basically, to be covered, four things have to line up. The act must be after the retroactive date; the claim must be first made after the policy begins; the claim must be made before the policy ends; and the claim must be timely reported, in most cases before the policy ends.

Attorneys have an obligation to timely notify the insurer - typically, when the attorney gains "first knowledge" of a problem. Waiting until there is an actual lawsuit or demand letter could be too late.

The duty to notify begins from the application process and extends until the policy ends. For example, a typical question in an application for legal malpractice insurance is: "Are you after reasonable inquiry aware of any circumstance that might give rise to a claim?"

An accurate response is important. Law firms should survey their attorneys and inquire if any attorney is aware of any circumstance that might result in a claim. If so, the safer course is to do two things: answer "yes" and identify the circumstance; and, report the circumstance under the expiring policy.

Lawyers who answer "no" and fail to notify their existing insurer run the risk of no coverage under either the expiring policy or the new policy. Under the California Insurance Code, a policyholder must disclose facts material to the insurance contract. California Insurance Code §331 allows an insurer to rescind a policy based on a policyholder's material misrepresentation in its application that affected the insurer's decision to underwrite the risk. Even unintentional material misrepresentations in an insurance application can void a policy. See Thompson v. Occidental Life Insurance Company of California, 9 Cal. 3d 904, 916 (1973); Barrerra v. State Farm Mutual Auto Insurance Co., 71 Cal. 2d 659, 665 (1969).

Is the insurance company financially sound?

The good news is there are many choices for insurance companies from whom coverage may be purchased. Unfortunately, however, it is not as simple as just selecting the cheapest rate or the broadest coverage. If an insurance company is not around to deliver on its promises, the fact that it charges less is of little comfort.

In considering a new insurer, it is recommended that attorneys check the financial rating of the insurance company using established services like A.M. Best or Moody's. Another important consideration is the size of the company. Size can enable companies to better weather soft and hard markets and still be around when needed most.

When making a decision about which legal malpractice policy to purchase, consider the whole package. For example, some policies provide a defense to bar complaints as well as legal malpractice claims. Others permit an insured to pick their own attorney to defend. Some offer employment liability claim coverage. The best way to learn of how much more is available is to just ask.

In addition to possible coverage additions, carefully review the exclusions. Both the type and wordings of exclusions vary significantly among legal malpractice policies. For example, some policies exclude coverage for all claims of fraud, while others narrowly exclude intentional fraud only after final adjudication.

Legal malpractice insurance is very important. Treat it that way now. Tomorrow could be too late.