Throughout our decades worth of experience on both the claims handling and underwriting side of professional liability claims, we have learned that a spirit of cooperation between the carrier, the insured, and defense counsel is crucial to achieving better, quicker, and less expensive results. Whether in a soft or hard market, insurance costs tend to increase and only rise the longer claims are litigated.
Contrary to an insured’s desire to defend itself through trial, early resolution is usually in the best interests of all parties involved in litigation. While an insured may believe that fighting a claim to the end is the “right” choice, and their defense counsel is ready, willing, and able to litigate, the high defense costs associated with doing so only act as a disservice to insureds when seeking renewals, attempting to change carriers, or trying to add additional limits.
While this may seem axiomatic, the behaviors of the parties in the context of litigation can at times seem irrational. It is usually most cost effective for insureds and carriers to cooperate. Plaintiffs’ counsel, and plaintiffs themselves, also benefit from quick resolutions and are often willing to settle much lower in the beginning of litigation because they have invested less in the early stages as opposed to a case that is trial ready.
The perceived probability of loss, driven by legal action and corresponding settlement and defense expenses, is critical to the underwriting evaluation and assessment of risk. For underwriters, insureds with prior loss activity can be an indicator of risk management issues and the insured’s behavior on potential future claims. In today’s age of social inflation, legal expenses can erode self-insured retentions rapidly and expose directors’ and officers’ limits in short order. Accordingly, underwriting’s understanding of an insured’s proclivity to over-lawyer and reluctance to settle is paramount when assessing risk.
Unfortunately, exhaustion of the policy limits, excess and/or personal exposure, and underwriting implications are often overlooked by insureds faced with litigation, who instead favor of an overzealous, righteous attitude and choose counsel they feel will “fight the good fight” on their behalf. From our experience, the best intervention for this line of thinking is early and open communications with insureds regarding the following: the benefits of panel counsel (firms that exist on a list held by the insurance carrier as being pre-approved), the true definition of a “win,” whether extreme defense costs have been justified based on the outcome of past claims, and who is really paying the cost of over-lawyering.
The Benefits of Panel Counsel
At times, we have found that defense counsel can pose as a barrier to early resolution in a few different ways. One example is where insureds are convinced they need either independent counsel or counsel that is not associated with their insurance carrier in any way. The coverage argument in favor of allowing insureds to select independent counsel is that panel counsel firms are beholden to insurance carriers due to a steady workflow from the carriers. Due to the volume, panel firms can charge lower rates than they would normally charge. Since panel firms are supposedly beholden to the insurance carrier, the argument goes that, in the case where some causes of action are covered and some are potentially not covered, there is a line of cases in some jurisdictions giving the policyholder the right to select independent counsel. [See, e.g., Robert Usinger and Barry Temkin, “Conflicts of Interest and Choice of Counsel in Duty to Defend Insurance Policies: Should There Be Goldfarb Miranda Warnings?” (May 03, 2012)].
The theory behind these cases, and this argument, is that panel counsel will consciously or unconsciously direct the defense so that the uncovered causes of action remain in the case, but the covered causes of action are dismissed, leaving insureds without coverage and the insurer off the hook for the costs and loss. [See State Farm Mut. Auto. Ins. Co. v. Traver, 980 S.W.2d 625, 627 (Tex. 1998) (recognizing that an insured may rightfully refuse an insurer’s defense when the attorney hired by the insurer acts unethically and at the insurer’s directions, advances the insurer’s interests at the expense of the insured); See also 1 Allan D. Windt, “Insurance Claims and Disputes” § 4.20 at 369 (4th ed.2001)]. However, this argument presumes, among other things, that defense counsel will commit an unethical act and potentially risk disciplinary consequences (including a potential malpractice suit) to achieve this result; and that counsel, notwithstanding the facts and circumstances of a particular case, is capable of selectively getting certain causes of action dismissed and selectively keeping certain causes of action in the case. We have seen these arguments made even in the context of the carrier issuing any sort of reservation of rights letter where actual coverage limitations do not exist barring something very unexpected being discovered.
A more plausible, threatening scenario is where the insured quickly exhausts an eroding policy by overspending on their defense via over lawyering and is then left with exposure to their excess tower or, worse yet, personally exposed. Oftentimes, this scenario will play out as follows: First, the carrier, due to its ability to bargain for lower, volume rates, attempts to assign competent counsel at one-fifth the rate of a non-panel firm. In response, the insured rejects the suggestion and pushes for its choice of counsel, which almost certainly comes at a much higher hourly rate. Finally, by the eve of trial, the policy is more than half eroded and the settlement range is above the remaining limit. Noticeably absent from the commentary supporting the right to independent counsel is any assessment of the impact of using more costly counsel.
While most cases do not go to trial, a very large number are litigated through to the eve of trial before settling on the courthouse steps. Sometimes, this is due to the actions of a stubborn or spiteful plaintiff, other times it is caused by clashing personalities of opposing counsel. No matter the cause, litigation up to the time of trial is a scenario that is very advantageous for defense counsel, as counsel gets to reap almost all the fees but does not have to run the risk of losing the trial.
We have found that panel firms are not as likely to lean into lengthy litigation and are more successful in obtaining early resolution than non-panel firms, as panel firms are motivated by the desire to continue getting cases from the carrier. If they do a good job on case X by achieving a less expensive, early settlement, they will likely get case Y. In short, the panel firms get less for the case, but get the next case. This same logic does not apply to non-panel firms, where the motivation is to accrue as much billable time as possible on one matter.
Both the insured and the carrier benefit from the panel counsel/carrier relationship because the panel firm is motivated to resolve the case quickly, resulting in cheaper resolutions, non-exhausted policy limits, and an insured with a much better track record to present to underwriting when it comes time for renewal.
Defining Winning
Employment claims provide a telling example of expense-run-wild and not usually to the benefit of the insured. Often, in employment cases, insureds insist on using the same firms they would use for class actions at astronomical rates compared to panel counsel. Employment stands out because there are many seasoned insurance defense litigators who may be the better choice based merely on experience and prior success in this area. But employment is not the only area; this phenomenon is common in less complex private company D&O claims as well. The losers in these scenarios are both the insurance carrier and the insured.
The True Cost of Over Lawyering
We have often been confronted with the argument, in various investigation claims and non-public company D&O claims, that the cost is justified because the results will provide justification. We have almost always been disappointed, however, and have been left with the belief that the insured probably could have attained the same poor result at half the cost since the exposure to fines and penalties (or therapeutics) or other types of loss is often minimal compared to the expense exposure.
Texas and Louisiana have developed tests to determine “reasonableness” of fees that include a results component, i.e., that the high cost of a particular law firm is at least partially reasonable due to the favorable result it obtained. [See Arthur Anderson & Co. v. Perry Equip. Corp & Rivet, 945 S.W.2d 812 (Tex. 1997)]. It is impossible to know the result at the initial phase and there is no way to know for certain if a less expensive firm could have obtained the same result at much less cost. But, at least these tests lend credence to the possibility that a good result may not have been obtained by a less expensive firm, and perhaps that a poor result could have been achieved by a much less expensive firm.
There are limits to the rates that carriers can be forced to pay for non-panel firms. Broadly speaking, the analysis relates to expenses being “reasonable and necessary,” which is common language on many non-duty-to-defend professional liability policies. Generally, judges have accepted the various arguments purported by insureds for these expenses and have instructed them to be paid, but insureds are both overpaying and over lawyering since “reasonable and necessary” is generally considerably higher than panel rates.
A recent example from the underwriting side is: Insurance Company A receives a new business submission for a longstanding private equity firm, based in New York, which manages and sponsors several private equity funds. The client is seeking a general partnership liability policy, inclusive of all the standard enhancements available in the current market.
In reviewing the risk, the underwriter becomes aware of prior loss activity. Allegations of breach of fiduciary duty, mismanagement, and negligence were made against three of the firm’s directors. The claim itself dragged on for three years, resulting in two annual extensions of the policy. In review of the claim details, several costly New York-based law firms were hired for the individual directors, and the insured denounced its insurance carrier’s plea to settle the case 14 months earlier. Their refusal to collaborate with the insurer ultimately resulted in ~$1.7 million in defense costs, while the settlement itself only totaled $1.1 million.
While the underwriter was able to get comfortable with the firm’s risk profile and fund performance, he had concerns with the private equity firm’s leadership and legal team. Based on the drawn-out lawsuit, as well as the exorbitant legal costs in relation to the settlement, the underwriter concluded that the insured and its counsel’s willingness to cooperate would be questionable if future legal challenges arose, presenting additional perceived risk. The evaluation culminated in a proposal that offered more restrictive coverage and higher self-insured retentions and pricing to build in a “challenging insured” premium.
Inflationary pressures loom large, and law firm hourly rates are no exception. The value in managing defense costs cannot be overstated. Insurance companies have the experience and data to predict the probable outcomes of cases, and the desire to get to a timely solution in a cost-efficient manner. These interests should be aligned with the insured. We do value outside legal expertise, but it is often overpriced. This overpaying and over lawyering ultimately lead to insureds paying more at their next renewal. Insurers have experience with thousands of cases compared to the insured, and it makes better sense to make use of this expertise to find a common solution. A renewal without a claim is one thing, but one with a claim that rips deep into a tower results in the insured looking at vastly different pricing on their next renewal.