Survival of the Financial Fittest

Directing and controlling allocated legal expense in troubled economic times.

July 16, 2012 Photo
Managing profitability through hard and soft markets causes carriers to fluctuate between their operations and investment portfolio. What happens, however, when markets collapse or implode and operations are under siege from relentless catastrophes?

This article is an exploration of the root causes (versus symptoms, such as asbestos, environmental, construction defect, class actions, shareholder lawsuits, medical malpractice lawsuits, etc.) and effects of legal system expense, which is a significant economic driver of insurance industry allocated adjustment expense. It will also provide insight and suggestions designed to bring about purposeful action toward desired objectives based on actual case reviews.

With the loss of financial flexibility, carriers must focus their attention on cost or expense in order to manage their operating margins toward maximum profitability.

To begin to understand why there never seems to be a plateau or lessening (there will never be an end) of allocated legal expense, we need to examine what it is that keeps broadening as well as changing the law, requiring constant coverage opinions examining what seems to be, and quite often is, the same set of facts and ever-expanding theories of liability requiring the ubiquitous defense under a reservation of rights. Does this sound familiar?

Like the first musket fired at the bridge at Lexington and Concord, Bates v. State Bar of Arizona is the equivalent of the legal expense shot heard around the world. It, too, signaled the beginning of a revolution in legal allocated loss adjustment expense that has increased exponentially ever since. The Bates case represented a sea change regarding how lawyers solicited business, ushering in the era of billboards and nonstop television commercialization—all of which ultimately translated into billions of dollars in legal expense for the insurance industry over the next 35 years.

Systemic Drivers

Laws do not change by themselves. Accepting this premise, we then divert our attention to core external forces of change, which include law schools, lawyers, courts, and the legislature. This limited list is a force majeure within the realm of legal expense. Beginning with law schools, not only are they designed to ensure a constant supply of attorneys, they also provide a breeding ground for variations on any given legal theme, thereby laying the foundation for a constant state of fluctuation and uncertainty, or clear self-perpetuation.

Next, we find the lawyers who through aggressive and creative billing practices (to be discussed in greater detail) appear to be able to establish continuous income streams even on the most routine cases.

The courts present a somewhat more volatile expense exposure due to the potential escalation of costs involved in the subsequent appeal process following an adverse judgment or verdict—in terms of both the immediate case-specific economic impact and the bigger-picture industry impact of potentially resultant harmful law.

The last group, lawmakers in Congress, have and continue to prove time and again a bias for, as well as support of, the trial lawyers association, which is well organized and heavily financed.

What is the result of the above external root causes? As of 2009, the U.S. tort system cost $248.1 billion. Since 1950, growth in tort costs has exceeded growth in GDP by an average of approximately two percentage points.

Consider the magnitude of the escalation of costs in the following table. No other area of allocated expense reflects the escalation of unbridled cost more than legal expense.

No surprises so far. This is the business environment within which the insurance industry must operate. The question facing claims departments is how best to mitigate this element of expense. As the numbers in the above table suggest, this is big business where survival of the intellectually fittest prevails.

Determine a Course of Action

In order to succeed, organizations need to predetermine a course of action; develop policies; set procedures; allocate resources; establish priorities and sequence; time action steps; decide how and when to achieve goals; and discern where the present course will lead. What should this look like or contain?

Let’s begin with the architecture of effective allocated legal expense mitigation. Do nothing until the question of expected outcome has been answered. Absent a clearly defined outcome, any and all activity related to construction of litigation expense containment will be a wasteful expenditure of corporate resources. Questions to consider include: What do you need to build, and how do you go about doing it? How is the operation set up? Does it promote or complicate?

Next, effective legal expense mitigation must set out written processes and procedures designed to produce an expected outcome. For example, create efficiency in the initial screening process by minimizing layers of unnecessary or redundant decision making. Prioritize coverage analysis, making it the first and most important element in the workflow. Avoid delays. Review the pleadings, conduct an assessment, and make a decision (e.g., settle or defend) as to how and when to achieve the intended result. This last step is often ignored or overlooked. However, without establishing a clear action strategy at the outset, the carrier creates the potential for aimless activity, or what some refer to as “drift.” In other words, you end up going where the tide takes you instead of charting your own course and taking decisive navigation action to reach your destination.

As you progress, keep in mind that most, if not all, process and procedure failures occur as a result of errors or omissions in execution as people carrying out the tasks do so in a manner that doesn’t meet performance standards. Questions to consider may include: Is performance being assessed regularly? Are the current measurements appropriate?

A recent audit found a long-standing case involving property damage which had progressed to the appellate court level. “We won!” exclaimed the email from an elated defense attorney in response to a favorable appellate court ruling following seven years of protracted litigation. Upon further review of the file, it was determined that the original settlement demand was $40,000. The final defense bill (which was split between multiple carriers) totaled $260,000. The case had, in fact, been abandoned to defense counsel after a succession of staffing turnovers. In this situation, nobody won.

Direction begins and ends with clear and continuous communication designed to bring about purposeful action toward desired objectives and to ensure understanding. This applies to the policyholder/defendant, defense attorney and claim handler. For example, cases presenting with material or potential coverage–related issues need a clear and comprehensive reservation of rights as close to the outset as practicable.

Next, the referral letter to defense counsel must be equally clear and concise. What should it say? What does it need to do? At a minimum, the referral letter, which sets the direction and tone of the defense, should detail the known issues as well as immediate and future handling expectations. The importance of prompt, initial evaluation by defense counsel cannot be over emphasized. Likewise, requesting a prompt and accurate budget helps insure timely communication of financial exposure to the organization as well as economic case analysis.

All too often, files cases are referred to defense counsel with a one- or two-line cover note stating “new assignment.” Nothing signals abandonment and the potential for increased allocated legal expense more than the uninformed transmission of lawsuits to defense attorneys. Take the time to invest in the case right at the beginning by providing defense counsel with your thoughts and insights concerning the allegations. This practice also establishes a level of authority and direction between counsel and the claim handler.

Regardless of the line of business involved, no case in litigation should go beyond 90 days without documented activity including follow-up with defense counsel. How often is more appropriately determined by case specifics, such as severity, complexity, and discovery. Ensuring progress toward objectives includes ongoing evaluation of the case litigation plan as new information becomes available. Ascertain the extent of any deviation, and adjust the plan to remain focused on the goal. Control ensures that the case is directed to conclusion versus reactive to events and that a proper balance between defense counsel and claim staff activities and decision making occurs throughout the life of the file.

Legal bill review—why and how? Legal bills can tell a great deal about performance execution, oversight and the relationship between defense counsel and the claim staff. For example, the amount and type of work being performed by defense counsel provides insight into potential abandonment of direction and control of the case to them by the claim handler. Do not let legal billing invoices go unchecked (trust but validate). A line-by-line review of each invoice is strongly recommended regardless of the firm involved. Following a series of audits, which included litigation handling, certain billing patterns began to emerge.

Serial Billing

A recent legal bill review found one firm averaging 147 billing entries per month, per file, with spikes as high as 174 entries. Excessive even by California standards! Another legal bill review determined defense counsel was attending inconsequential motion hearings and depositions of non-material witnesses. A deposition transcript was ordered and reviewed reflecting no participation or involvement whatsoever by defense counsel in the deposition. The audit determined attendance at these activities was for billing purposes only. Both firms were removed from active defense panel listings.

Stealth Billing

Review of an aged litigation inventory reflected a number of rate increases throughout the life of a number of files being handled by one particular firm. Over a period of three years, the firm had raised rates without announcement or approval of the carrier. Every entry on every invoice had been billed at partner or senior partner rates regardless of the task or activity. Another defense firm touting its low hourly rate was found to be billing a high number of hours at full partner rates where associates or paralegals would have sufficed. Another example involved the managing partner of a defense firm taking boxes of files to his vacation retreat where he would arbitrarily charge his fee for services across all files as if he had performed work on them. This, in conjunction with a firm-wide systematic billing scheme designed to maximize each invoice, led to an investigation and in-person meeting with each of the firm’s partners at which time a confidential settlement was reached.

Rogue Billing

Defense counsel unilaterally retained the services of an expert without notifying or otherwise seeking approval from the carrier. In fact, the carrier was unaware of the situation until a bill in excess of 540% of defense counsel’s authority was submitted many months after the case had been closed. In another case, the defense attorney summarily rejected substantive technical input from the carrier’s representative and proceeded on a costly path to trial at which point his entire case was deconstructed.

Adjusting staff involved in litigation handling need to constantly monitor and, where or when appropriate, question defense counsel’s actions.

What’s on the Horizon?

Issues having a direct impact on allocated legal expense range from deregulation of the practice of law to law school campus recruitment to non-lawyer ownership stakes in law firms.

Questions in corner offices and boardrooms have begun to surface asking if there is an excess supply of lawyers. Discussions exploring the potential of deregulation and entry by new firms (e.g., consultants, accountants, etc.) offering legal services at lower prices have ensued. In response, a majority within the legal community are advocating for new limits on entry into the legal profession. Why is this important to the insurance industry? More restrictive licensing limits competition and raises the cost of legal services. The U.S. Senate Judiciary Committee is currently investigating the matter.

In direct response to the economy, companies are once again directing their attention toward internalizing legal resources. Companies are no longer willing to pay high hourly rates charged by outside firms for work performed by associates. Some companies have begun to hire law school graduates to work on entry-level litigation-related matters while developing their skills over time.

In yet another direct reaction to the economy, companies have begun to employ the use of reverse auctions to negotiate legal services. This form of competitive bidding pits multiple law firms against one another—the purpose of which is to drive the cost of services down. Expect to see this area of cost containment gain significant traction.

Litigation is currently underway challenging regulatory prohibition against non-lawyers holding ownership stakes in law firms. The potential influence that venture capitalists may have on firms in placing profits ahead of client interests is a significant consideration.

The financial pressure and uncertainty of the economy will continue to take its toll for the foreseeable future. One example is the San Francisco Superior Court, which plans to close 25 of 63 courtrooms and 14 of 17 civil trial departments this year as well as lay off 40% of its workforce. The result from the insurance industry’s perspective is that cases filed in this jurisdiction will remain open longer, creating the potential for increased allocated legal expense.

San Francisco is not alone by any means. This unfortunate financial scenario is playing out in a number of jurisdictions across the country. As a deep-pocket target, the insurance industry needs to communicate and execute clearly and decisively now more than ever.   

Paul Swank is principal of Swank Consulting Services and a former claims executive with a multi-line background. He has been a CLM Fellow since 2011 and can be reached at,

                    U.S. Tort Costs

Year  (Billions)

1950                         $ 1.8

1960                         5.4

1970                         13.9

1980                        42.7

1990                        130.2

2000                       179.1

2001                       205.4

2002                       232.9

2003                       245.7

2004                      260.3

2005                       261.4

2006                      246.9

2007    252.0

About The Authors
Paul Swank

Paul Swank is principal of Swank Consulting Services and a former claims executive with a multi-line background. He has been a CLM Fellow since 2011 and can be reached at,  

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