Legal Malpractice Insurance and Loss Prevention: A Comparative Analysis of Economic Institutions
UVA Law Faculty Affiliations
Legal malpractice is finally getting the recognition it deserves as an important institution for regulating lawyer behavior. Legal malpractice insurance is not-yet. Although scholars have begun to focus on the relationship between malpractice and legal ethics, the effect of malpractice insurance on this relationship has gone largely unexplored. And although legal and economic scholars have examined the theoretical underpinnings and practical uses and limitations of liability insurance generally, no one has yet tried to apply those insights to legal malpractice insurance.
This article attempts to remedy this deficiency and to spark debate over the current and proper role for legal malpractice insurance as an institution of lawyer regulation. My thesis is simple. Legal malpractice insurance, like other liability insurance, can further the deterrence goals of liability by improving the behavior of the insureds. This "loss prevention" function of legal malpractice insurance seems to be increasing in ways that the economics of insurance would predict. In fact, because of their comparative institutional advantages, legal malpractice insurers are increasingly serving as regulators of lawyer behavior and may be beginning to substitute for the firm and the bar in this role. Whether the trend is good or bad is a harder question, the answer to which depends, of course, on how effective this regulation is likely to be, what negative consequences it has, and what plausible alternatives are available.
I begin by offering some historical and institutional background. I then set forth an economic theory of legal malpractice insurance, comparing different insurance institutions. In particular, I try to articulate when market insurance is likely to be a relatively strong institution for shaping the behavior of insureds, and to argue that legal malpractice insurance fits this category. Initially, I make the simplifying assumptions that both lawyers and clients are, or can be treated as, individuals. Later, I relax the assumptions of individual clients and individual lawyers, and argue that the complexities introduced further support the argument that legal malpractice insurance may be a superior institution for regulating lawyer behavior.