What's behind large losses in law firms?
In a time of economic instability, a law firm that experiences a large loss may find itself in an especially difficult position.
In addition to having to ride the waves of the current business environment, the firm could also face higher insurance premiums following the loss, then find less competitive options for professional indemnity cover as a result.
Many law firms are feeling the pressure. Data from the Solicitors Regulation Authority (SRA) found that in the 12 months ending June 2023, 572 law firms had closed, while over roughly the same period, 383 firms had opened.
Although a sliver of the closures (17%) happened due to a merger or amalgamation, the majority of other closures occurred because the firms had ceased practising.
Mitigating large losses can help smooth the waters for firms.
Insurers, of course, also have a vested interest in helping their law firm clients anticipate their risks and take action to contain them – and the loss patterns they identify can say a lot about the exposures of a profession.
Loss patterns emerge from the data
Paul Smith, senior risk management consultant at Travelers Europe, studies data about losses in solicitor firms in an effort to identify such patterns, which hopefully shines a spotlight on where risk management can help.
Recently, Smith reviewed solicitors’ data between October 2000 and September 2023 to gather a significant data set of large loss claims, which the insurers defined as being over £250,000.
While that figure in 2001 would represent a much larger amount than in 2023 due to inflation, there are still some clear themes that emerged from the research.
1. Large losses are not limited to large firms
Large losses are persistent, becoming more costly, and happen for law firms of all sizes.
There have been a high number of claims for large losses in recent years and the total severity of those claims has been trending up.
While one might assume large firms are responsible for the largest losses, these claims tend to spread across all sizes of firm, not just the large or small firms.
The top five areas driving large losses in law firms appear consistently over time.
From 2001 to 2023, commercial work represented 30% of claims notifications and 50% of damages claimed. The remaining four areas included:
- commercial litigation
- commercial property
- residential property
- trust and probate
However, commercial work remains a clear outlier in the severity and frequency of its risks to firms.
2. Follow the trends
There are patterns in the kinds of errors that lead to claims for large loss.
Large loss cases tend to involve more failures of advice than in the overall book.
The most frequently notified errors pertain to retainer management failure. These errors are often very simple, such as not following instructions, taking the wrong step in a process, or missing a time limit.
Dishonesty has been on an upward trajectory since 2020 and involves a mix of methods, such as identity theft, fraudulent sellers, or the interception of payments and the changing of bank details.
3. Risk hotspots link to practice area
Mapping legal work areas onto errors reveals more specific risk management targets.
Commercial work presents the main challenge for firms looking to reduce errors in retainer management, drafting and advice as all three areas are claim hotspots.
Commercial property and commercial litigation generate claims in retainer management and advice.
In residential conveyancing, claims involving dishonesty (whether the dishonesty is by an employee or a third party) are a hotspot where firms could focus their attention.
Mitigating large losses
Given the data above, what can law firms do to manage and mitigate the risk that errors will generate claims for large losses? Targeting some types of error could potentially present faster results than others.Fatigue and pressure
Retainer management errors, for example, tend to be simple mistakes and the result of human error, such as distraction, in turn caused by stress, pressure or fatigue.
Where slips and lapses in procedure occur, firms should ask whether this is possibly a reflection of the firm’s culture as a whole and whether steps could be taken to address or improve the work environment.
While many firms have taken steps to support the mental wellbeing of their employees, recent research has found that these changes haven’t gone deep enough. Indeed, while nearly three-quarters of law firms report having initiatives in place to support employees’ mental health, in 2023 there a 24% increase in the number of people contacting LawCare, the mental health and wellbeing charity for legal professionals.
“Lawyers who are often tired and feel pressured to work are more likely to make mistakes,” Smith said.
“Poor sleep disrupts our circadian rhythms – the changes in our body functions over a 24-hour cycle, governed by exposure to lightness and darkness. That disruption can have adverse effects on our physical and mental health. It can set the stage for distraction, as well as affecting our decision-making ability. In extreme cases, it can warp an individual’s moral compass.”
Systems and supervision
The other error hotspots Smith identified may also have roots in the degree of physical support available to lawyers and the pressures this can generate for them. Lawyers tend to pride themselves on getting advice right, so if they are making advice errors, they may lack the support systems required to perform research and associated tasks properly.
Dishonesty claims tend to involve poor systems – particularly with regard to cyber security, or reduced awareness of the nature and scale of cyber threats – and can result when high work-related pressures combine with a lack of supervision.
“Law firms are inherently high-pressure environments and the pressures can present themselves in a range of forms,” Smith said.
“These pressures can – and do – lead to large losses, and the firms that take a step back to assess the reasons for those losses and make changes can strengthen their foundation against the economic headwinds that may debilitate other firms.”
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The information provided in this article is intended for use as a guideline and is not intended as, nor does it constitute, legal or professional advice. Travelers does not warrant that the information in this article constitutes a complete and finite list of each and every item or procedure related to the topics or issues referenced herein. Travelers does not warrant that adherence to, or compliance with, any recommendations, best practices, checklists, or guidelines will result in a particular outcome.