Why professional indemnity insurance is worth its weight in gold

Risk-conscious law practice managers need to be proactive in managing one of their most important practice assets, compulsory professional indemnity insurance, for the sake of their firms and their clients, writes Ronwyn North.

Do you take one of your most important practice assets for granted?

No, I don’t mean your people. I mean your professional indemnity insurance. The risk of a single, large, uninsured loss, or a string of smaller, uninsured losses, due to professional negligence should keep law practice principals and practice managers awake at night. However, if some recent conversations with practitioners are anything to go by, they are in dream land.

There is no doubt that professional indemnity insurance is a significant cost of doing business – until you need to cover a financial loss, in which case it is a jolly good investment. Australia has some of the best and cheapest  professional indemnity insurance schemes for lawyers on the planet, so I was taken aback to hear a group of practitioners bemoaning  that PI insurance is compulsory, too expensive and unfairly biased against practitioners in favour of undeserving clients. It soon became apparent that they had little understanding of their insurance arrangements, the factors that go into calculation of premiums and the potentially dire consequences they face if indemnity cover is inadequate or denied. To be fair, some of the practitioners were new to practice. Others, however, were principals who had set up or joined firms without giving much thought to the issue.

Humans are fallible

So let’s set the record straight before examining if your law practice is doing enough to get optimal value from its professional indemnity insurance.

It is true that compulsory PI insurance is, in essence, designed to protect clients from lawyers found to be negligent but who lack the means to compensate the client. However, the protection that such insurance also affords lawyers is undeniable. No matter how high the practice standards or how stringent the controls, the risk of human error can never be reduced to zero.

The business and personal assets of even the most careful and diligent lawyer are exposed to the risk of a claim; a claim that may be caused by others in the practice, rather than the lawyer himself or herself. In legal practice, big losses can be caused by simple oversights. In jurisdictions such as New Zealand and the United States, where insurance is voluntary, law practices do go out of business and lawyers do become bankrupt because they cannot pay out a claim. Yes, most responsible lawyers do carry insurance even when it is voluntary, but the reputation of the profession suffers every time one of the irresponsible few without insurance fails to do the right thing by the clients they have hurt.

Another advantage of compulsory insurance is that it provides the certainty of a large enough pool for insurance products to be viable and for premiums to be stable. Even with stable premiums, of course, it is true that insurance is a significant cost of doing business. For a sole practitioner working from home, it might be their biggest expense, and for other law practices it is likely to rank in the top five after salaries, rent and technology and communications costs. However, the Australian compulsory schemes are so well managed that premiums have stayed relatively stable over a number of years, despite an increase in the cost of claims.

Claims and counter claims

Premiums are affected by several factors, including the global economy and the investment returns of the insurer, the loss ratios of legal profession claims, and the risk profiles of individual law practices.

For law practices, their turnover, size, activities and claims history are key factors. If an underwriter has to pay a claim on behalf of a law practice, a higher premium for three to five years is to be expected while underwriters recoup some of their losses. So the fact that a firm is paying more in premiums is not the whole story. The story behind the numbers could be that the firm is enjoying greater success rather than having a poor claims experience.

As for the allegation that the system is biased against lawyers, in my experience this view is the result of an adversarial mindset and hurt professional pride on behalf of the lawyer. Lawyers involved in claims are, in most instances, not professional liability experts and may not be in touch with what the courts hold as professional standards. Some cases should be settled on a commercial or pragmatic basis, rather than firms risking a loss or creating an adverse precedent.

Lawyers spend a lot of their time trying to persuade clients to be objective, but it is difficult to be objective about ourselves. Insurers do run cases they think they can win and lawyers should trust the system to weed out unmeritorious claims.  At the same time, lawyers would do well to listen to advice about where they have gone wrong or left themselves exposed. For example, one insurer estimates that in almost 10 per cent of cases the lawyers are probably not negligent, but their files are in such a mess that they don’t have the records to prove it. In the absence of good records, the case will come down to the word of the lawyer versus the word of the client. Such cases are notoriously expensive to defend and unpredictable, so it is no wonder that settlement in such cases is often recommended.

I make no apology for defending compulsory insurance, the insurers and defence lawyers because I work with many of them and know how much they care for their insureds. Perhaps the group of practitioners who triggered this article have never had any claims and, therefore, have not experienced the relief of having someone in their corner to defend them. However, you don’t need to have had a claim to optimise the value of your insurance arrangements, so here are a few thoughts on how to do just that.

Factors to consider

Insurance is a risk-management tool whereby the risk of financial loss is transferred from the law practice to the underwriter. Insurance is a practice asset in that it is a contractual right to a cheque from someone else when you need it if certain conditions are met. Getting the most value from insurance arrangements requires a law practice to perform well in three interrelated areas:

• insurance cover and terms;
• making a claim; and
• loss prevention.

Following are some questions to help you assess the performance of your law practice. Generally speaking, to what extent are you satisfied that your law practice:

• has PI insurance arrangements, cover and terms that are well matched to the needs and risk appetite of the firm, with a low likelihood of unexpected gaps in coverage or unstable premiums?
• will learn of adverse incidents quickly and handle incidents appropriately (not make the situation worse by a DIY fix) and that people know when, how and to whom to notify a claim or circumstance with little risk of denial of indemnity or falling foul of exclusions?
• is a good risk in the eyes of underwriters, not only because of a good claims history but because of a demonstrable commitment to loss prevention?

To gain a sharper view of your approach to PI insurance, to what extent are you satisfied that your law practice:

• ensures leaders and managers are well informed about professional liability issues and trends, and are capable of assessing liability exposure and articulating an appetite, or lack thereof, for high-risk activities and professional liability risk?
• regularly reviews the insurance needs of the firm to identify any risks of under-insurance; for example, from an increase in large or complex matters, or the emergence of new, uninsured risks?
• chooses insurers, particularly top-up insurers, based on their solid experience, reputation and product quality in relation to legal PI and not on the basis of price alone or relationships with clients in the insurance industry?
• ensures continuity of cover by handling renewals or renegotiations of PI insurance effectively and efficiently with proper and accurate disclosure, and having funds readily available to pay premiums on time?
• ensures principals, particularly new principals and senior staff, are well briefed about insurance arrangements such as exclusions from cover, obligations under the policy and behaviour that could undermine the chances of getting a cheque?
• has appropriate approval processes to respond to client queries about specifics of insurance arrangements or to agree to a client’s terms of engagement that have liability or indemnity implications?
• makes appropriate provision in the accounts for payment of the insurance excess in the event of a claim?
• has made an informed and sound decision on whether or not to join any Professional Standards Scheme available in your jurisdiction?

In relation to making a claim and being entitled to a cheque when you need it, to what extent are you satisfied that your law practice:

• has a policy and culture of ‘confession, not cover up’ and clearly communicates to all staff the range of incidents, not only claims that need to be reported internally?
• prompts ‘confession’ by requiring principals and senior staff to declare at least annually, but ideally more frequently, that they are not aware of claims or circumstances that could give rise to a claim?
• has nominated an appropriately knowledgeable and approachable ‘go to’ person to receive internal enquiries and incident reports about potential liability?
• does not commence proceedings to recover outstanding fees without a thorough assessment of the risk of a defence or counterclaim of negligence?
• takes a precautionary or conservative approach to notification of claims and circumstances that could give rise to a claim, including significant fee disputes, and ensures notifications are made promptly to both primary and top-up layer insurers?
• seeks the consent of underwriters before pursuing a mitigation strategy or undertaking repair work, admitting liability or incurring investigation or defence costs, all the while being mindful of duties of candour and avoidance of self-interest conflict with regard to the client who may have a claim?
• co-operates fully and constructively in the management of claim, including with defence lawyers appointed by the insurer, and in paying an excess promptly when required
• keeps principals (and affected others in the practice) appropriately informed about the management  and outcomes of claims and incidents?
• has a culture of supporting, not blaming, those involved in causing the claim.

While the main purpose of claims prevention activities is to protect clients, not insurers, insurers are increasingly taking the commitment to loss prevention into account in setting premiums and also making more loss-prevention resources available for law practices to use. Accordingly, to what extent are you satisfied that your law practice:

• does not mislead underwriters about the nature and extent of its loss-prevention activities?
• demonstrates an appropriate response to notifications of claims and circumstances such as investigation, analysis, reflection and remedial action?
• makes good use of loss-prevention resources that are available through the various compulsory insurers or top-up brokers?

It is worth noting that some terrific loss-prevention resources are available for downloading free of charge from the various websites of some of the compulsory scheme insurers. Anyone can access the resources of Lawcover (NSW), Legal Practitioners Liability Committee (Victoria) or Law Mutual (WA). Your people will need your firm’s member details to access the resources of Lexon (QL) and Law Claims (SA).

All in all, Australian lawyers would do well to look at the experience of lawyers overseas before they are too critical of their local schemes. They should stop taking insurance for granted and make it their mission to get the most value they can from their insurance and support the system that – when the chips are down – supports them.

Safe practice.

Ronwyn North is the managing director of Streeton Consulting and a qualified lawyer who specialises in consulting to the legal profession on practice management issues, including risk management. She can be contacted at rjnorth@streetonconsulting.com.au.