Risk forecast: Predict your firm's professional liability claims potential

How can law firms effectively predict their potential for professional liability claims? Lessons can be drawn from the advanced data analysis used to measure the accuracy of the US presidential election polls.

During the last US presidential election, Nathan Silver, a well-regarded statistician who developed a means by which to statistically evaluate many different kinds of activity, used his technique to determine the accuracy of the national election polls.

Silver created algorithms designed to evaluate the pollsters and the polls themselves, their own proclivities or tendencies, the content of the questions asked, the tenor and 'leaning' of the questions, as well as a host of other issues which are equally important in determining the accuracy and objectivity of the polls.

The theory Silver propounded is that, by virtue of his analysis, he could perform an accurate forecast of the election results. He was 97 per cent correct in the previous presidential election.

The kinds of factors that Silver took into consideration when evaluating the accuracy (or bias) of polls can be extrapolated and brought to bear on ?the subject of professional liability ?claims in law firms.

A determination can be made as to whether or not a law firm may experience professional liability claims. Advanced data analysis, predictive modelling, computer-based data mining, web, text and risk analytics are just some of the areas which may be included in this kind of examination.

Claims forecasting background

To date, the prediction or forecasting of claims has been the focus of the efforts of the insurance underwriting community. Underwriters are those individuals who, given whatever information which may be available (including claims experience), are called upon to provide (or decline) insurance coverage.

The field of insurance is awash with statistics today. There is no shortage of numbers defining the accuracy or inaccuracy of the underwriter's skills (after the fact) and the concomitant costs and expenses attached to his ability or inability to forecast (which is really what he's doing) possible or probable results over the next 12 months (or whatever the term of the insurance coverage may be).

The forecast or prediction that is ?made is based particularly upon the ?body of information available over the previous 12 months, as well as on five ?or ten years of data. For each law firm, there is a track record.

Underwriters Lloyd's of London require a ten-year record of claims; domestic US insurers generally require only five. In both cases, however, the prognostication is largely (but not exclusively) based upon the record of professional liability insurance claims and the firm's associated need for the utilisation of its insurance coverage.

Law firms that have experienced professional liability claims within either the five or ten-year range are deemed problematic relative to new claims which may be filed in the next 12 or 24 months.

Conversely, law firms that have succeeded in avoiding these claims are considered a 'better risk'. The insurance premium may then go up or down, in part at least, in accordance with the level and number of claims the firm has experienced within that period of time.

There are of course other factors involved in creating or forecasting professional liability claims potential for ?a law firm. The practice area in which ?the law firm is involved, the region of a country, the economic environment in which the firm practices - all of these have an impact on the underwriter's assumptions as to the potential for ?(more) claims against the insured.

A niche law firm practicing in the real estate arena in a part of a country that is particularly hard hit by the economic downturn is therefore considered to be a poorer risk than, say, a general practice law firm practicing in the same region. This is chiefly due to the weakness in the real estate market and the losses individuals and companies may have suffered as a result of the overall economic patterns.

The forecast or prediction for professional liability claims by the general practice firm in those circumstances may therefore be given less statistical claims leverage than the niche firm, which is in what is deemed to be a relatively high-risk practice area. Notwithstanding its previous claims experience, the general practice firm is considered a better risk and therefore may well pay a lower premium for its insurance.

Analysing risk potential

Silver's analysis and algorithm breaks down the various elements of the subject involved, provides a numerical representation of those elements and seeks to bring greater precision to the field of prediction and forecasting.

Can the same thing be done in the field of professional liability for law firms? Setting aside the mere number of claims of a statistical average (the actuarial tables), let's see how it might work on a close-in basis and, in addition, in relation to the accepted idea that risk is the probability that a threat will exploit a vulnerability to cause harm to an asset, or R = f(T,V,A).

Absent any additional information other than that of the professional liability application for insurance, an underwriter's judgment is made on the merits of that application, as well as a variety of the other factors already discussed. Of course, some underwriters go far beyond the application in their assessment.

Just as a law firm needs to be extraordinarily careful about its new client intake and evaluate each client on the basis of as much information as it can gather (beyond that which the client may provide), an underwriter will carefully review the arena in which the firm is practicing. It will make an evaluation on other bases, such as an internet search of the firm and its principals, before it makes a decision as to whether or not to offer coverage, the limits of the coverage and at what price that coverage may be proffered.

In either case - the law firm evaluating a new client or an underwriter making an evaluation as to whether to offer coverage - the more information that can be gleaned, the more accurate the forecast of success or failure can be.

It could easily be argued that offering professional liability insurance coverage before the complete analysis of a law firm is made prejudices the estimation of the prediction or forecast for potential claims. Setting that aside, however, the question becomes: Are there elements of a law firm's practice management environment which, evaluated in a different manner and statistically weighted by an established algorithm, may act to increase the potential for accuracy in the forecast or prediction of potential claims?

The important role that statistics play in decision-making is abundantly clear. Let's look at some subject examples as well as some 'intangibles' which are of real assistance in evaluating risk in a law firm practice environment.

Figure 1 provides a list of the most important aspects of practice management inside a professional law practice. Each category is given a certain number of base points relative to an assigned objective value and how it factors into the operation of a subject firm. A law practice which handles the issues well gets a full points total; fewer points by degree are awarded for deficiencies.

Generally speaking, a law firm that scores 75 to 80 points in total might be considered a good risk. Less than 75 points would have to be considered an average risk and, below that, a poorer ?risk. Conversely, a firm which scores 80 ?or more points would have to be considered an above-average risk and/?or a very good risk.

Thus, a firm which has a good set of operating principles, management in place, a well orchestrated and managed conflicts determination system and good communications would be a more desirable risk to insure.

Let's take this one step further. If we provide for a weighted analysis based upon law firms that have suffered professional liability claims, the result is even more striking. We sampled a hundred law firms and over 600 claims. The findings of that analysis make it clear that not all of the ten elements enumerated in Figure 1 carry the same weight.

That analysis, which was fairly consistent with earlier American Bar Association findings, gives an even more detailed description of the critical elements in managing a law practice. Those findings, in fact, describe circumstances in which a law firm may escape professional liability claims by the proper operation of only four out of the ten elements. Professional liability claims, then, are still concentrated on these four basic elements:

• calendaring systems;

• conflicts of interest determinations;

• new client evaluation (matter acceptance principles and ?operation); and

• good communication.

This means that, even if a firm is not particularly well managed, its financials are not handled as they might be, there is not much planning and its technology standards are below par, it can still be a good risk.

Set upon those assumptions, with those four elements being given additional weight, an analysis can be made of the likelihood of a law firm suffering professional liability claims in the manner shown in Figure 2.

Based upon these weighted standards, in order to be considered a good risk, a law firm that handles its calendaring, conflicts, case acceptance and has good communication can do without much else. Indeed, many law firms do just that when their management structure is not particularly effective, their technology is middling at best, there is really no planning whatsoever and their finances are managed by the 'seat of their pants'.

The joker in the deck, of course, is the question of how to make that determination using only the methodology of the professional liability insurance application form. This is not an easy task. Such forms are regularly filled out by a legal secretary, an associate, a junior partner or administrator in the firm.

For the most part, applications are almost always filled out in the same manner, with a high degree of 'fudging' (to be polite) and often great inaccuracy. The distinction has to be made at the point at which the claims are analysed on the basis of the aforementioned categories.

It follows, then, that a professional liability claim involving the calendaring system of a law firm becomes a serious issue. Likewise, a professional liability claim which appears to grow from any of the other three categories deemed most significant has to be considered in the same manner and given appropriate (additional) weight.

This means that, in evaluating a law firm's claims history, more emphasis might well be given to claims involving the top four highlighted categories. Notwithstanding the fact that the pound or dollar amount may be considerably higher or substantially lower, the analysis of whether or not to provide coverage, the level of premium and other elements of insurance will therefore be more dependent upon the category of the claim for the purposes of forecasting and predicting the firm's future claims potential.

Claims which fall outside of these four categories may very well be more expensive, but that may not necessarily mean that it is more likely to have additional experience of that or other types of claims.

Conversely, claims which do fall within the top four categories, whether they are less or more expensive to cover, could be a good deal more accurately predictive of whether or not the firm will have claims in future. The dollar amounts, though evocative of the overall stance of the insurer, do not of themselves serve the purpose of predicting additional claims.

Preventing claims

Weighting certain professional liability claims on the basis of particular categories is a more accurate way of projecting the potential for additional claims in future. The more focus and emphasis the firm can give to the top four categories, do them well and operate them consistently at the highest level of quality, the safer and more secure the firm will be.

In fact, one could do far worse that to review the firm's internal operations from the standpoint of predictive analysis. The firm's inability to manage the top four categories at the highest level (inclusive of all of the partners, associates and staff) is generally predictive of a higher potential for professional liability claims against it.

Either way, the failure to understand the bases upon which claims analysis is made makes the managing partner more subject to the whims of chance and less able to prepare for the possibility of future claims.

Thomas Berman has been advising law firms on practice management and professional liability issues for over 20 years (www.bermanassociates.net)