What is defense cost erosion and how does it affect law firm coverage?

In most legal malpractice policies, defense costs are paid within the policy limits rather than in addition to them. This means that every dollar spent defending a claim reduces the amount of coverage available for a settlement or judgment. This structure is known as a wasting or eroding limits policy and is the industry standard for legal malpractice insurance, unlike commercial general liability policies which typically provide defense costs in addition to limits.

The practical impact of defense cost erosion can be significant. If you carry a $1 million per-claim limit and your defense generates $250,000 in attorney fees, expert witness costs, and other litigation expenses, only $750,000 remains available for indemnity. In complex malpractice claims that proceed through extensive discovery, motions, and trial preparation, defense costs can consume 30 to 50 percent of the policy limit before any settlement discussion occurs.

Some carriers offer defense costs outside of limits as a policy option, typically at a premium increase of 15 to 30 percent. This structure preserves the full stated limit for settlements and judgments while the carrier pays defense costs separately. For firms that handle high-risk practice areas or large-value matters, the additional premium for defense outside limits is often a worthwhile investment.

To manage defense cost erosion, work with your assigned defense counsel to develop a cost-effective defense strategy from the outset. Discuss litigation budgets, prioritize critical discovery over exhaustive document collection, and evaluate early resolution opportunities. Your carrier's claims professional can help balance aggressive defense with prudent cost management. If your firm regularly faces complex claims, factor defense cost erosion into your limit selection by purchasing limits that account for both expected defense costs and potential indemnity exposure.