Primary general casualty insurers are justifiably concerned with the costs of defending lawsuits against policyholders. Payments to defense attorneys are a measurable percentage of earned premiums, and next to the costs of staff claim personnel, legal fees are the largest segment of loss adjustment expense. The amount of defense costs is particularly significant since these expenses are related to a relatively small portion of total claims. Typically, 20 to 25% of an insurer’s claims are in litigation requiring the use of defense attorneys. The legal defense costs and percentages are even higher for insurers of professional liabilities.
Focusing on the amounts of paid expenses, insurers perpetually seek methods, approaches, and schemes to contain these costs. Litigation Management manuals and monitoring reports are published and updated by, in some companies, dedicated personnel. Spanning a half century, this article presents and assesses an inventory of favored approaches used by insurers. The observations and comments are based upon reviews of insurer claim files in the course of a career as a claim professional and a consultant retained by insurers. Suggestions are provided for the use of time tested practices which remove non-lawyer work from defense counsel to staff claim personnel.
Financial relationships: Tough to monitor
Staring at the amounts of paid and projected payments to defense counsel demonstrates the costly issue faced by executives. The amounts call for decisive action but often result in declaring a single condition or element as the cause of the problem. This narrow focus will drive monolithic strategies to address the cause of the problem.
Some insurers have decided that defense attorneys’ hourly rates are too high and have designed strategies to lower them. These strategies include the use of fixed-fee schedules in which attorneys agree to handle certain types of lawsuits, usually the less complex ones, for agreed-upon prices. A broader variation is the use of an annual retainer wherein a law firm agrees to handle a loosely defined number of lawsuits of all types in return for fixed monthly payments. Another approach is to simply shop around for the lowest hourly rate and to assign the work to the attorney with the lowest hourly rate; a cheap labor strategy.
It is difficult for an insurer to monitor the fixed fee or retainer contractual arrangements to determine whether they actually reduce defense costs. Also, for all of the financial arrangement strategies there is a potential loss of quality in terms of the level of defense services provided. This is an acute problem, given the duty of an insurer to defend and the duty the defense attorney has to his client, the policyholder. Cut-rate defenses can backfire into bad faith actions against the insurer and professional liability actions against the defense attorney.
The underlying reason why these strategies typically fail is the fallacy that the hourly rates charged by defense attorneys are too high. Nationwide, insurance defense attorneys charge about $130 per hour, with higher hourly rates often found in big cities. Actually, insurance defense rates are not high, compared with the hourly rates of most other legal practice areas such as work relating to the Securities and Exchange Commission, mergers and acquisitions, labor law, corporate litigation, real estate syndications and domestic litigation. Quite often, the hourly rates attorneys charge insurance companies for defense work are upwards of 40% lower than what they charge insurers for corporate work.
The use of staff employee defense attorneys is a fine extension of the do-it-yourself approach. The hourly cost of staff attorneys, including support staff and overhead, is approximately $80-$90. Therefore, companies enjoy a $40-$50 an hour savings for every hour of defense work shifted from an independent attorney to a staff attorney. This is an excellent method to lower defense costs, but its use is limited to those insurers who have sufficient geographic concentrations of lawsuits to keep a staff attorney busy. To be cost effective, there must be sufficient billable defense work to shift at least 1,900 hours per year from an independent counsel to a staff counsel.
The use of staff counsel can be undermined by hiring less experienced attorneys who cannot otherwise obtain employment in the market which charges $130 an hour for services. This error occurs as insurers seek to lower the hourly cost of staff counsel operations below a reasonable market value. Because of the difference in competencies, real or perceived, and potential conflict-of-interest considerations, staff attorneys often handle only the routine, less explosive cases. Given the necessary concentration of work, staff counsel can contribute to the reduction in overall defense costs. To work, however, staff attorneys must be competent and experienced to be an equivalent alternative to independent counsel.
A naïve approach, perhaps taken out of frustration, finds insurance companies forming advisory councils with defense attorneys or defense organizations to discuss and design plans to lower defense costs. This approach is doomed. Defense costs are expense to the insurers and revenue to the attorneys. Does anyone really believe that attorneys are interested in determining how they can earn less?
More directly, the “cost of defense” settlement will reduce payments to independent counsel. The notion is to pay in loss an amount up to the expense cost of defending a threatened lawsuit. This can absolutely reduce legal expenses but it will certainly raise loss payments. A perversion of this concept is to assign a settlement value to virtually any asserted claim. In practice this does happen and subscribers will defend the concept as being financially prudent. Notes to claim files often describe the conclusion of a settlement negotiation as agreeing to pay an amount to avoid the cost of defense. Letters from defense counsel will also suggest a settlement amount to consider paying as the cost of defense. This is wrong since the insurer violates the insuring agreement to pay (only) those sums for which the policyholder is legally liable. It also fosters the notion that the insurer is an easy or liberal payer of claims; a perception that will bring demands to pay something for anything. The appeal of this approach should disappear with the presence and use of staff counsel.
In the mid 1990s, responding to pressure to lower legal defense costs, claim executives intensified and developed specific techniques directed toward lowering the billed amounts of defense counsel.
For decades, insurers have published general guidelines setting forth the duties and obligations of defense counsel selected to provide defenses to policyholders. This proper practice grew in scope in many unintended and often negative ways. Over time, the guidelines replaced a case specific letter of assignment provided by the staff claim handler to the selected defense counsel. (The recommended elements of a proper assignment letter are provided later in this article.) This was an initial step in reducing the affirmative role of insurer claim personnel in the management of litigated files. It fostered the concept of abandoning the file to defense counsel. Insurers recognized this as a bad practice but few focused on change. Actually, the use of guidelines is sound. It was the replacement of assignment letters and the often eventual removal of the role of the claim person that was bad. From defense counsel’s view, their primary duty was to the policyholder. With little or no direction from the claim person, counsel had no choice but to do what they were left to determine was necessary and in the best interest of the defendant policyholder. This evolved to counsel performing non lawyer work including taking the lead in gathering documents such as medical records; determining the need for and arranging for medical examinations; providing periodic status reports to the claim department; initiating the valuation of claims including recommendations for the amounts of case reserves; effectively deciding whether and when to try a case to verdict or to settle; conducting negotiations; and, essentially handling all aspects of the claim.
The unintended changes in the scope of the role of defense counsel described above resulted in a greater number of billed defense hours and higher defense charges per case. This began the use of general guidelines as a post billing hammer to adjust downward the number of hours charged. For example, if a billed item was not specifically included in the attorney’s responsibility as set forth in the guidelines, the billing charges were deducted and not paid. Often, the issue of whether the charged work was necessary to the defense of the policyholder and the fact that no one except the attorney elected to obtain the work was not addressed. This approach marked a deterioration of the working relationship between insurer staff claim handler and defense counsel. This is not a good thing.
To further manage litigation and defense costs, insurers properly required attorneys to provide budgets of estimated costs typically through discovery and exclusive of trial; a good management idea. In the wrong hands, the budget became the bar under which no management of the file by insurer staff was delivered. The budget also provided an opportunity to automatically rule out any charges that exceeded the budget. These cuts to bills overlooked the issue of necessary work as discussed in the preceding paragraph.
The success in actually and simply eliminating charges for work performed is moving the management of legal defense costs toward a health insurer model. The defense attorney (provider) submits an itemized bill for services; the insurer unilaterally compares and adjusts the charges against litigation management guidelines and pre-work estimated budgets (fee schedules); and, then sends a check in payment along with a marked and adjusted bill (EOB). This approach has not been seen to be successful in lowering defense costs. It has eroded the relationship between insurer and defense counsel.
Completing the back end approach is the creation of staff and vendor auditors of attorney bills. These auditors receive and scrutinize bills to identify variances to guidelines, budgets, and often subjective determinations of overcharges. The attorney then receives the lowered audited amount. Some vendors are paid on the basis of a percentage of savings. A vendor has confided that all attorneys intentionally over-bill. Perhaps this is a sign of “gaming” the system in expectation of bill reductions. An attorney remarked that the current adversarial relationship with insurer clients is prompting a move away from tort defense.
What can be done?
There is no magic bullet or quick fix to contain legal defense costs, and the so–called litigious society is not going away. Insurers will continue to be buyers of expert services and, in the case of litigation, those services are provided principally by independent tort defense lawyers. Therefore, the guiding principle for insurers should be to hire lawyers to do only the work that requires a lawyer’s services and not to ask them to do work that could be done by claim people. This means minimizing the need for lawyers in the first place by working to control the numbers of lawsuits filed against policyholders. This also means working to adjudicate matters by using alternative dispute resolution forums such as binding arbitration.
The control of defense costs begins before the suit is filed. The handling of claims should be directed, to the extent practical, toward limiting the numbers of lawsuits to those claims where the loss amount demanded is greater than the insurer is willing to pay. Lawsuits filed because the insurer has been slow in investigating or negotiating often result in unnecessary defense costs and should be avoided. Of course, this excludes cases where the lawsuit constitutes the first notice of a matter.
As a quick test, claim management personnel should review the claim file upon the receipt of a lawsuit to determine whether the claim adjuster has been responsive to the claimant or his attorney. If it is a case in which the insurer would pay some amount to settle, has this been communicated or has an offer been made? Based upon independent studies, a conservative finding is that 5 to 10% of all lawsuits – and their resulting expenses – were probably unnecessary. This first test identifies the need for training and, perhaps changes in the supervision process such that claim personnel exercise greater contact and communication with third parties or their attorneys to eliminate the filing of potentially avoidable litigations. Of more direct and immediate consequence, the claim personnel can request an extension of time to file and answer to permit an evaluation of the claim and perhaps a successful settlement. In the latter case, a successful and justified negotiation means eliminating the need to retain counsel and the avoidance of legal expenses. Any extension of time must be confirmed in writing from the plaintiff’s counsel.
Alternative dispute resolution/arbitration
Working to reduce the potential of lawsuits to fair differences means a claim reaches the point where there is an impasse between the amount demanded and the amount the insurer is willing to pay. At this point, the matter requires adjudication. There are two courses available to the parties. An alternative to the filing of a lawsuit is the selection of an arbitration forum to apply for binding arbitration. The American Arbitration Association is an example of an organization which is equipped to facilitate arbitration. Arbitrations require the consent of both parties. Arbitrations are typically decided by a three member panel of arbitrators. Each side appoints one panelist and the two selected arbitrators agree upon the third member, the umpire. Arbitrations typically produce lower legal fees and are decided in a much shorter time. An insurer is missing the opportunity for reducing legal expenses if it has not attempted arbitration.
Assignment to counsel
Another critical point in managing legal expenses occurs when an unavoidable lawsuit is initially assigned to defense counsel. The initial assignment is the first opportunity the insurer has to direct the work of attorneys, and it often sets the stage for the insurer-attorney relationship over the course of the litigation.
Insurers typically assign work to attorneys through the use of a letter of transmittal. The extent and quality of assignment letters vary greatly from insurer to insurer. At one extreme, the letter consists of a few brief sentences typically telling the attorney to file an appearance and do whatever is necessary.
This type of letter does not restrict, define or limit the attorney’s activities, nor does it provide the insurer’s assessment of the claim and plan for future activity. As a result, it invariably produces a multiple-page letter of first impression from the attorney in which the attorney reviews the file which he has just received from the insurer. There is no benefit to pay someone to tell you what you already know. These “feedback” letters conservatively cost between one and two hours of attorney time charges, or from $130 to $260 for every suit assigned.
The assignment letter
Insurers who effectively manage and control litigation use a very detailed, case specific letter of assignment which tells the attorney how to proceed instead of leaving the assignment open-ended and undirected. Following are some guidelines regarding the specific points that should be included in the insurer’s initial assignment letter:
Coverage. Identify the coverages and limits of liability of the policy involved in the case. Discuss any coverage questions or state affirmatively that there are no coverage issues.
Identification of plaintiffs and defendants. Review the relationships of all parties to the litigation and identify any additional parties to be joined.
Identify the insured defendant. Specify the defendant(s) for whom a defense is owed. If the defendant is other than a named insured, explain the basis for coverage and defense.
Facts. Review the facts of the claim, including physical evidence, official records, witnesses’ versions of what happened and the position of the plaintiffs and defendants.
Damages. Outline the claimed damages and provide an assessment as to the accepted damages.
Current evaluation. Give the insurer’s evaluation of liability and damages, including potential claims for indemnity or contribution.
What the insurer will do. List any additional activities planned by the company, including additional investigation to be obtained and a timetable plan for disposition.
What defense counsel will do. In addition to filing an Appearance and Answer, list the items of requested Discovery. Request that the attorney simply acknowledge receipt of the assignment and limit any further comments to only those parts of the assignment letter which the attorney disagrees with or finds deficient.
Request an estimate of defense fees and expenses. Require the attorney to submit a budget of expected future costs. This will allow the claim supervisor to compare his own expectations as to defense costs to those of defense counsel. A wide variance signals the need for discussion with counsel. The defense attorney’s budget should be compared to actual costs as the case moves forward. The budget should be updated over time.
This type of letter supports the goal to manage legal expenses. It also ensures that the file supervisor has performed an up-to-date assessment of the claim and has a clear plan for the future handling of the case. Both purposes served by the letter should ultimately produce financial benefits.
Lawyer and non-lawyer work
After the initial transmittal of the suit, the level of legal expenses is related directly to the amount of work performed by the defense attorney, which should be limited to only those activities which require the services of an attorney. These typically include the preparation and filing of pleadings and interrogatories, appearance at trials and motions and the taking or defense of depositions. The insurer should recommend or approve all affirmative depositions. As noted earlier, defense attorneys should not perform work which can be done by adjusters, such as ordering and obtaining items in investigation and conducting negotiations. Insurers can review their closed suit files and paid attorney bills to determine the extent of work performed by attorneys that could have been performed by staff claim personnel. By identifying line item time charges for work not requiring an attorney, the insurer can develop an estimate of the amount of money paid to lawyers for performing work not requiring a lawyer.
Estimating the savings
Step 1. To estimate potential savings on attorneys’ fees, first estimate the number of avoidable lawsuits each year and multiply that by the historical average defense cost per closed litigated claim.
Step 2. Figure what can be saved by writing comprehensive assignment letters and thus avoiding long attorney “feedback” letters by multiplying the number of lawsuits per year times the average hourly cost of attorneys. (This assumes that the attorney spends only one hour on the response letter.)
Step 3. Take the average estimated number of hours of work per lawsuit that was unnecessarily completed by a lawyer and multiply that by the average hourly attorney fee. If no improvement is needed in an area, enter zero and consider this to be unique, extraordinary, and illusionary.
The sum of these three figures provides an estimate of the money to be saved by eliminating unnecessary litigation and attorneys’ fees. Studies have shown that unnecessary attorney activities (step 3) average five to twelve hours of charges per case. At $130 an hour, this adds $650 – $1,560 to the cost of defense for the insurer for each case. Alternatively, insurers can probably skip the process of reviewing files and estimating potential savings on defense costs. Savings are possible for every company. Carriers that adopt the policy of providing prompt evaluation and responsive communications to third parties, sending explicit letters of assignment and not paying lawyers to do work which can be done by staff or other non lawyer parties will find that the dollar savings are there.
Jim Cerone is an independent consultant to the insurance industry, former Executive Vice President of the Travelers Property Casualty Corporation and former President of the technical services division of their claim organization. Prior to joining Travelers, Mr. Cerone served as Senior Consultant and Equity Principal of Milliman & Robertson, Inc. (M&R). At M&R, he founded and directed the claims management consulting practice, specializing in consulting with management on a wide range of strategic and organizational issues. His background also includes service as Vice Presidents and Consultants with Tillinghast, Nelson & Warren, Inc.; Kramer Capital Consultants; and senior executive positions with three other U.S. insurers; Commercial Union, John Hancock, and American Reserve. In these positions, he was responsible for organizational design, acquisitions, automation, training and education, and the general management of large scale claim operations.