Q: How does lawyer malpractice insurance work?
Professional liability insurance for lawyers does two things. First, it covers liability to clients for malpractice, meaning it provides funding to pay a settlement or judgment (indemnification). Second, it funds the defense of claims, meaning it pays the lawyers who represent the insured lawyer on the malpractice claim, and costs of litigation, including expert witness fees.
The policy provides a maximum stated amount of coverage (policy limits). Many insurance policies are "wasting policies." This is a policy in which the resources used to fund the defense of a lawsuit are subtracted from the policy limits available to pay a claim through settlement or after a judgment. For instance, under a wasting policy with limits of $1 million, if $250,000 is spent paying attorneys to defend the insured lawyer, and the plaintiff wins, there would be only $750,000 of insurance proceeds available to pay a $1 million judgment (the difference would need to be made up from the lawyer or law firm's own assets).
However, often even wasting policies provide an allowance for defense fees and costs before the policy starts to waste - for instance, $50,000.
Other policies extend this concept of allowance by providing separate indemnification and defense cost limits. For instance, the policy might provide $2 million in indemnity coverage and an additional $1 million in defense costs.
Some professional liability policies are "consent policies,” which provide that the insured attorney's consent is required for any decision to settle the claim (though such consent may not be "unreasonably withheld"). Sometimes this can be a game changer, depending on the personal dynamics of the case. An insurer might be willing to settle, but an attorney who has strong personal feelings about the case and his reputation might resist. Unless such resistance is deemed contractually "unreasonable" by the insurance company, this kind of obstinacy could hold up what might otherwise be a good settlement for the plaintiff. Often the situation is the reverse, whereby the client gives authority to settle within a particular amount (sometimes even for policy limits) but the insurer, under the guidance of defense counsel's appraisal of the case, may decide to gamble and go to trial.
The effective amount of coverage available to pay a claim may exceed the stated policy limits in situations where the insurance company unreasonably refuses to settle. Often plaintiff's counsel will make a written offer at or below policy limits, even if he or she does not expect that the offer will be accepted, in order to set up the insurance company for a claim by its insured for unreasonably failing to settle. (Failing to reasonably settle exposes the insured lawyer to liability if a later judgment exceeds the policy limit.) The intention is for the plaintiff to take assignment of the defendant lawyer's claim against his own insurance company for that excess, resulting in an effective expansion of resources available to pay the claim.