For any lawyer in search of a professional liability insurance policy, one of the top questions on their mind is, "how much is this going to cost me?"
As you begin receiving insurance quotes you may notice that not all policies are created equal, and neither are premiums. You may be wondering why quotes vary so much and what are the driving factors behind these varying rates.
If you have these questions, you're not alone. How premiums are established is one of the most misunderstood and least discussed aspect of professional liability insurance. In this article we hope to demystify professional liability insurance rates and shed some light on one of the largest rate drivers.
How Professional Liability Insurance Rates Are Determined
There are a number of factors considered by insurance companies in determining the premiums to charge for professional liability insurance, also referred to as rate making.
The process of establishing premium rates must ultimately lead to an insurance company’s ability to charge a premium sufficient to fund their commitment to pay losses in the future. So, you might wonder, how do you establish a premium, to fund unknown losses to be paid in the future?
The first step in developing insurance rates is to establish the exposure base to be used in calculating premiums. Exposure base provides a basis for the size of the entity being insured. For lawyer’s professional liability the primary exposure base is typically the number of attorneys, or head count of the firm. For other professions, like CPAs, insurance companies will typically use the firm’s annual revenue as a basis for establishing a premium.
Another factor in assessing exposure is the location of the firm. Lawyers rates can vary significantly state to state and reflect the insurance company’s assessment of the litigiousness and cost of handling losses in a given state. In many larger states there may also be rate relativities within the state reflecting exposure by county or rural vs. urban influences on the cost of losses paid.
A third factor in assessing exposure are the services provided by the firm also referred to as the firm’s area of practice. Similar to location driven relativities in rate making, the type of services provided also significantly impact your premium.
The following will look at how a law firm’s area of practice is evaluated by underwriters and used in determining the premium you pay for your policy.
How Insurance Companies Establish Premium Rate Factors for Areas of Practice
Practice area rates are established by underwriters based on historical claims data they have collected writing lawyer’s professional liability insurance. In analyzing claim data, consideration is given to the frequency and severity of losses expected to be paid evolving from the various practice areas.
Frequency is the anticipated number of claims that will be reported to the company. For the purposes of rate making, a company may develop a frequency rate per a fixed number of lawyers insured over the course of a year.
Examples of low frequency areas of practice include Alternative Dispute Resolution, Bankruptcy, Traffic/DUI work and most classes of defense work.
Examples of higher frequency areas of practice include Real Estate, Employment law and Personal Injury plaintiff work.
Severity is the expected size of a loss in a certain practice area or expected average size of a claim. For the purposes of this discussion we will look at severity from a small law firm perspective since client size has a significant impact on the magnitude of a claim. When looking at severity there are 2 components that contribute to the average size of a loss, defense expenses incurred by the company in defending their insured and actual damages ultimately paid to settle a loss. Combining both components results in an average incurred loss value and used as the claim severity factor.
Low severity areas of practice include Family Law, Criminal Law, Bankruptcy and most classes of defense work.
High severity areas of practice include personal injury plaintiff, real estate and wills, trust and estate work.
As mentioned earlier, defense costs can be a significant contributor to severity especially with more complex litigation matters more frequently seen in the high severity areas of practice.
Combining Frequency and Severity
Combining expected frequency and severity by area of practice creates relativity modifiers to be used in the rate making process resulting in different rates to be used for pricing practice areas.
As discussed earlier, family law and bankruptcy law both have low expected frequency and severity and will be rated at a discounted rate.
On the other end of the spectrum, personal injury plaintiff and real estate both have higher expected frequency and severity of loss and therefore will be rated at a higher rate.
How Legal Services Provided Impact Your Premium
Companies writing professional liability for lawyers will establish their own rating formulas including how they will differentiate by area of practice. As discussed earlier, the insurance company writing professional liability insurance must establish a rate to fund future losses. Rather then charging every firm the same premium, the company will vary their pricing using the area of practice relativities discussed above. The premium range can be significant depending on the firms practice mix.
As an example, a sole practitioner providing only criminal and defense related services and purchasing a $1,000,000 limit policy pays a premium of $1,500. If that same attorney specialized in real estate the premium will be closer to $4,000. Again, this is an illustration showing 2 hypothetical firms practicing only in areas at the low or high end of the area of practice range.
The most significant factor impacting what you pay for professional liability insurance are the services you provide. As you manage your practice areas or consider venturing into different services keep in mind that adding new services can impact your premium. It’s always a good idea to review your practice areas annually and report any changes to your insurance provider at renewal.
What Does This Mean For You?
Taking everything into consideration you can see that determining insurance premiums is a complex process that takes many factors into account. Practice area rates differ from carrier to carrier, but having a general understanding of how your areas of practice are viewed can help you better estimate your insurance premiums.
At Protexure we have experience in determining rate for all types of practice areas. For attorneys purchasing $1million/ $1million limits, we’ve seen customers pay as little as $1,000 per attorney and as much as $8,000 per attorney. However, many customers fall between ranges of $1,000-$2,000 for firms practicing in low risk areas and $3,000-$5,000 for firms practicing in high risk areas.