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For law firm managers, malpractice insurance is never a fun topic to ponder. And thanks to skyrocketing malpractice insurance costs, it’s become even less enjoyable. Law firms are now in the midst of what the insurance industry calls a “hard market.” In the last two years, most firms have seen their professional liability insurance rates go up by at least 50 percent. On average, full-service national firms now typically pay at least $3,500 per lawyer for malpractice insurance, and rates can go as high as $10,000 per lawyer, depending on factors such as the level of insurance a firm secures. This is some serious money: A firm with 700 lawyers, for example, will likely shell out at least $2.5 million annually to cover its malpractice risk. “We saw this cycle [of malpractice rate increases] in the ’80s, and we’re seeing it again,” says Brian Toohey, a Jones Day partner who oversees his 2,000-lawyer firm’s insurance needs. Unfortunately, firms cannot sidestep this hard market by merely maintaining a clean claims record. A firm with a history of malpractice verdicts and settlements against it will certainly pay more for insurance than a firm with no adverse verdicts, but both types of firms will still pay vastly more than they did in the past. That is because rate increases are largely due to broader market forces beyond firms’ control. In the mid- to late 1990s, malpractice carriers — competing vigorously for law firm business — undercharged for malpractice insurance. These rates did not cover the claims that carriers had to pay out on the policies, says a law firm specialist at a large insurance company, who asked not to be identified. Thus, carriers have had to play catch-up, charging higher premiums to recoup earlier losses. In addition, there are now fewer companies willing to underwrite malpractice insurance, further driving up rates. Still, law firms deserve some of the blame for higher insurance premiums. They are being hit with larger malpractice verdicts, and carriers have had to adjust premiums accordingly. “There are fewer claims against firms than in the past, but the claims are bigger,” says Snell & Wilmer chairman John Bouma, who is also chairman of the Attorneys’ Liability Assurance Society (ALAS), a mutual insurance company owned by major law firms. In the current post-Enron environment, firms worry that jurors will be more apt to punish professionals who are accused of wrongdoing and are thus eager to settle malpractice claims before trial, says one insurance executive. So what can firms do to keep professional liability costs under control? Certainly, they can steer clear of malpractice suits. There are other obvious solutions, such as buying less insurance coverage or assuming higher deductibles. But here are some other, less apparent tips: � Be choosy. Risk management starts at the beginning of a business relationship. The best way to avoid squaring off against a client in court is to pick good clients. Firms need to look closely into a prospective client’s past to see if it has been involved in litigation. Firms should ask, for example, whether a potential corporate client has previously been sued for defrauding investors. Such a client is more likely to get in trouble again and, more to the point, blame its legal troubles on its attorneys. “If a client wants to raise funds or to be involved in a venture with other people’s money,” says Bouma, “you need to get online and see whether it has securities fraud claims or securities law violations against it.” Once it has decided to take on a client, a firm should use great care in laying out the terms of the engagement. “Engagement letters should specifically outline the scope of services [the firm is to provide], so there is no misunderstanding later about what is expected,” says Stuart Pattison, vice president in charge of the law-firm division of CNA Financial Corporation. And after the firm has decided to sign up a client, the firm should not hesitate to reassess the client relationship. “Don’t hang onto clients who delay payment of their bills or complain a lot or want to limit how thorough your services are,” says Bouma. These sorts of clients, he says, are more likely to file malpractice claims. � Tinker with partner compensation. How a firm pays its partners wouldn’t seem to have any bearing on malpractice rates, but it does: Insurers like lockstep partnerships more than their eat-what-you-kill counterparts. Carriers worry that compensation schemes that emphasize rainmaking encourage partners to do whatever it takes to bring in new clients — no matter how unsavory those clients are. “Carriers prefer lockstep systems, but it is unrealistic to expect all firms to have that system,” says Guy Moffitt, a senior vice president with the insurance broker Marsh Inc. “If you have an eat-what-you-kill system,” he says, “you need to have adequate management control over the type of client that is brought in.” � Monitor risky assignments. James Jones, a director of Hildebrandt International, says that many firms are ill-equipped to deal with partners who are involved in risky matters. But firms must tightly manage risk, he says, if they want to ward off suits and keep insurance rates in check. As firms get larger and bring in more lateral partners, it is increasingly likely that there will be partners who are involved in offering esoteric, risky advice that their partners do not know about — or understand. For example, Jones says, if a firm partner is advising a company that is involved in complex financing arrangements, or offering advice on tax shelters, it is quite possible that most lawyers at the firm do not comprehend the work that the partner is performing. To keep better tabs on partners who push the envelope, practice-group managers need to institute an intake screening program that identifies risky clients and matters that deserve special scrutiny, says Jones, a former managing partner at Arnold & Porter. “Practice leaders also need to meet on a regular basis with partners in their area and understand the work that the partners are doing,” Jones says. “More than one lawyer in a practice should be knowledgeable about what is going on with a client’s business.” � Develop a sound disaster recovery plan. After the Sept. 11 terrorist attacks, many firms do not need to be reminded to prepare thoroughly for the unforeseen. But it’s worth remembering that emergency preparedness can affect insurance rates as well. Gary Beck, an insurance broker for AON Corp. who specializes in the legal market, says that firms must maintain off-site backups of their computer systems. Otherwise, he says, a computer crash could compromise a firm’s document management system, and the firm could lose sight of things such as a statute of limitations deadline. “I could tell you anecdotes from a fire or flood where four or five different law firms were locked out of their offices for five to six weeks,” Beck says. “Forget about the billable hours you lose — think of havoc with trial deadlines.” Carriers, he adds, offer lower rates to firms that carefully guard against such mistakes. � Adopt sound governance systems. Firms can never have too many systems in place to guard against technical missteps or ethical breaches. Pillsbury Winthrop general counsel Ronald Van Buskirk advises firms to draft professional responsibility manuals for their attorneys, form ethics committees that can respond to anonymous complaints from lawyers, and conduct internal audits to ensure that firms’ policies regarding conflicts of interest and electronic security procedures are being rigorously followed. Such audits “are familiar to corporate America, but few law firms do them,” Van Buskirk says. The current hard insurance market is not about to soften anytime soon. “It will get worse before it gets better,” says Marsh’s Moffitt. ALAS has announced that its 2004 malpractice rates will be 30 percent higher than 2003′s; it will be the third consecutive year of 30 percent increases. It’s distressing news, but Bouma offers this bit of perspective: Some ob-gyns pay as much as $275,000 per doctor for malpractice insurance. Tort reform, anyone?

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