The Butterfly Effect, and Other Factors Affecting Your LPL Rates, |
By Dan Klauss, Aon Law Firm Solutions
With apologies to experts in Chaos Theory, the wild swings of the last 10 years or so of the Lawyers Professional Liability (LPL) market can leave you wondering if maybe there's something to that whole "butterfly" analogy. Seriously, though, last September, some LPL underwriters were opining that the dramatic hurricane losses would firm up the LPL market in 2006. Long story short: that hasn't happened, and the LPL market continues to get healthier. New insurers with credible programs are entering the fray—so your rates are actually likely to come down somewhat (unless you've had claims issues or you have one of the "red-flag" areas of practice). That's not to suggest it couldn't have played out that way: serious losses in other lines of insurance legitimately can have a profound effect on LPL rates, as we saw in the aftermath of 9/11. So what are the factors that affect LPL rates?
LPL Claims experience: This factor is the most fundamental in determining whether LPL insurance is profitable, and LPL insurers continue to point to defense cost inflation and a rise in the number of high-profile, high-value "catastrophic" LPL claims as reasons why rates shouldn't come down significantly. What really unnerves the underwriting community, however, is what claims are coming: what's the next Savings & Loan crisis? Corporate governance and tax shelters are the recent problems, but what's on the horizon? E-discovery? It is this unknown factor that scares insurers away from LPL, and causes those who do write it to try and build "buffers" into their pricing to account for it.
Investment income: Much of the last soft market was subsidized by insurers' ability to invest premiums in fixed income and equity investments, thus creating another source of revenue. If the stock market remains strong, insurers will want to write more business to take advantage of it— and pressure to write more business means pressure to lower premiums. Rising interest rates exert similar forces on insurers: they devalue the insurers' existing fixed income investments, putting pressure on them to write premiums to make new fixed income investments to take advantage of the higher interest rates.
Cost of capital: Capital tends to flow towards lines of insurance where the best return can be obtained. For instance, in the immediate aftermath of a Katrina, capital will be sucked from other lines of insurance to write Catastrophe insurance in anticipation of big rate increases in that class. This means LPL underwriters have to justify to management why capital should still be allocated to LPL—and they typically do that by promising higher profits (i.e., higher rates). Conversely, when other lines of insurance perform poorly, capital will flow towards LPL.
Competition in LPL: Established LPL insurers say they have the best sense of what pricing should be because they've paid the losses. New entrants typically have to compete (to some degree) on price to lure business away from established players, who then have to respond with price cuts, etc.
Your Claims: This is probably the biggest influence on premiums, so putting it bluntly, have as few paid claims as possible. Here's where you can have some influence:
Decide how low your deductible really needs to be. Low deductibles seem great, but if insurers are paying out even small amounts of money on your policy every year or two because of them, this will cost you in the long run. Instead, choose a deductible that's high enough to capture as many of the "nuisance" claims as possible, but still low enough that you can afford to pay one or two—or three— in any given fiscal year. (A note of caution: aggregate deductibles give you some protection against multiple claims hitting all at once, but remember that the aggregate applies to a policy year; claims heat up at their own pace, and it's common to have claims from different policy years become active in the same fiscal year of the firm—and then an aggregate deductible won't be much help.)
Similarly, decide whether you need "bells and whistles" like First Dollar Defense. It sounds great to have defense coverage that isn't subject to a deductible, but in this litigious era, mid-sized and larger firms should consider foregoing this type of coverage.
Your Areas of Practice: Before bringing in a new area of practice, ask your broker for input on how the area is viewed, so you can better assess the true costs of the acquisition. Intellectual Property, Securities, Plaintiff and Entertainment are some examples of areas that can result in a) higher rates, and b) some insurers refusing to quote you at all—limiting your ability to generate competition for your business. If you're already in those "red flag" areas, find out what specific concerns your insurers have and try to address them.
Your Application: In completing your annual insurance application, especially the Risk Management section, try and get a sense of what answer the insurer wants. If the honest answer to a question is "no" when you think they want "yes", try to explain why the answer is "no" (or if there isn't a good explanation, consider changing your firm's procedures). An example: an application asks the firm a) if there is a management committee, and b) how often it meets. The truthful answer is "no" and "N/A", but this is a firm with only 4 equity partners, all working within 50 feet of each other. No formal committee, no formal meeting schedule—but daily interaction between the firm's decision-makers, which is all the insurer wants. Similarly, if you've had claims, learn from them—and convey that fact in the application. The idea is to avoid a declination from an underwriter (which is difficult to undo once you get one). Consult with your broker about what "red flag" issues are raised by your application, and address them before the application gets submitted to insurers.
Your Website: If it overstates your firm's capabilities in various areas—an extreme example, Biotech IP—be prepared to answer insurers' questions about it.
Competition: Choose a good broker (one who has access to a good cross-section of markets, and can analyze the strengths and weaknesses of competing proposals) to try and generate "competitive leverage" for you. Remember, though, that LPL coverage is in no way standardized, so you'll be relying on your broker to report on policy coverage differences (e.g., some policies contain a conflict of interest exclusion), financial strength and intangibles (claims-paying reputation, credibility, commitment to the LPL market, etc.). Price is important, but lower premiums aren't worth it if your claim ends up being denied because of gutted coverage.
You could dwell on all the things that could go wrong—why, it's enough to give you butterflies (sorry)—but with any luck, current trends will continue and the market will stay healthy enough to suppress rates, but not so soft as to chase insurers out of the LPL business.