In most states, a professional’s financial liability is not protected by typical business protections (i.e., the corporate veil), so firm assets and/or existing insurance policies are the only tools protecting your lawyers from personal financial ruin.
In our insurance brokerage firm, we spend many days and hours negotiating with insurance companies over the fine print points of every professional liability policy. And yes, they are important: Are you financially exposed to defense costs? What definitions and fine print are the best fits for your firm? Is that the best premium? All of these points consume our behind-the-scenes work to obtain the best insurance options for our clients.
But if the amount of insurance — the limit — is insufficient, the fine print won’t matter and having a good insurance policy (even a great one) will not adequately protect you. While there is no scientific method for selecting your limits, below are the various methods on how to calculate your limit. For most firms, one or two of the methods together make sound sense.
Average client: Purchase the amount of insurance that represents an amount near your average client exposure. Especially for a firm that is primarily litigation, this method can be used by taking your average case value. We assume that you will not commit malpractice on your largest cases, as you will be committing your best resources to that client matter. Some practice areas — such as SEC work, high-end trust and estates, and IP work — values need specific attention with this method of analysis. If you represent high-net-worth individuals, they tend to be litigious. But beware — not surprisingly, they are also litigious against their lawyers.
Per lawyer: The roughest calculation is $500,000 to $750,000 per lawyer. This means that a 20-lawyer firm should consider $10 to $15 million in coverage. This rule of thumb varies greatly by state and locality, but it is a good rough estimate.
Cynical approach: The firm should purchase the minimum amount of insurance so as not to be the defendant firm (in a multi-defendant professional situation) of having the “deepest pockets.” On the other hand, they shouldn’t purchase too little that plaintiff attorneys pursue personal assets. There is anecdotal and logical evidence for this approach, but it is especially important to constantly review these goals with your broker for specific advice to keep you abreast of the industry norms when it comes to insurance limits.
Purely financial: Unrelated to your practice areas of risk and your average client size, the firm conducts a purely financial analysis of the value of current revenues compared to the cost of the insurance. Regardless of the risk profile of your firm, the quotes are obtained for various limits and selected purely on the economics of the situation. For example, a highly profitable $25 million dollar firm might purchase $30 million to $50 million in limits as the cost of the insurance might only be $200,000 (a small amount for a highly profitable firm). A similarly sized law firm — but one that is less profitable with fee revenue of $10 million — might only purchase $10 million.
The best approach of all is to use a blended and educated approach to your limit selection. The discussion with your broker should be annual and should consider changes in your firm and changes in the insurance market. If your firm has grown or changed in practice mix, past limits might not be enough. In the past 10 years, excess insurance policies premiums have come down considerably. What made sense financially even a few years ago, no longer is a prudent financial decision.
Avoid rationalizing your decision making about limits to drive down the costs. There is a lot at stake with your professional liability. As with all important firm decisions, the analytical approach is the way to go when you decide your professional liability limits.