Legal Fees

Legal costs are a significant component of the Canadian property and casualty product. The p&c insurance marketplace represents approximately $40 billion in annual net earned premiums (NEP). The amount the insurance industries spent on legal services approached $ 1 billion ($971 million) in 2009. Therefore, legal services expenses accounts for three per cent of the industry net earned premiums. It should be kept in mind that the p&c industry operates on small margins. Assuming a similar growth trend on premiums and legal expenses as experienced over the last two to three years, it is projected that within the next four to five years, legal expenses will approach four per cent of NEP. Moreover, as a percentage of allocated loss adjustment expenses (ALAE), legal expenses in 2009 accounted for 50 per cent of all external adjusting expenses. Given the nature of the p&c business, legal costs will always remain a significant component of p&c insurance products. Nevertheless, litigation expenses are a major cost driver and a concern for p&c carriers.

Rising costs have therefore led to a number of initiatives aimed at slowing down the growth of legal services expenses. Top U.S. and U.K. law firms have, for example, spent billions annually on back office work, which is outsourced and off-shored to countries like India. Macro economic influences currently impacting the legal industry are similar the those factors which have already affected (and continue to affect) other professional service industries such as engineering, medicine, finance, etc. The United Kingdom is considering whether to allow law firms to become public entities and trade on the Stock Exchange. This will allow law firms the opportunity to raise capital for expansion into other countries and to invest significantly in information technology. Lord Denning must be turning in his grave — or maybe not? Entrepreneurship is transforming the legal service industry. Changes, as I see them, are transforming law from a practice focus to a business focus endeavour. Information technology has already commoditized many basic legal services. Today, anyone can log into the Internet to become an informed consumer of legal services and download forms and documentation to process simple legal services, e.g. wills, uncontested divorces and other similar transactions.

Alternative fee arrangements are another example affecting the legal service community as the p&c industry attempts to slow the growth of legal costs. Many claims organizations have developed alternative fee arrangement as a means of paying for certain commodity type of litigation. This model represents an alternative to the billable hour model. Depending on the insurer, an alternative fee structure covers all associated legal expenses bundled into a standardized fee for non-complex or commodity type litigation. In some cases, a combination of a bundled rate and billable hours model is used depending on the complexity of the litigation.

The $64,000 question is: Does this alternative fee arrangement model work?

In typical claims fashion, yes and no. Pardon the pun, but the jury is still out on the effectiveness of this type of cost containment initiative. The reason being is that at this point, it is difficult to assess the effectiveness of these types of arrangements. In the absence of objective quantifiable data to measure the value of legal work, insurers are, by default, developing alternative fee arrangements in the hope that they work. In fact, one can argue that alternate fee arrangements amounts to putting the proverbial cart before the horse. Well, what does this mean? Before we go off and expand the use of alternate fee options, it’s necessary to measure the value derived from the current model and from which, jointly with legal service firms, develop a comprehensive compensation model. First and foremost, this initiative requires developing metrics, aligning insurers and counsel goals, measuring results and ultimately, rewarding performance. This must come first.

That is to say, a successful performance management solution of legal firms requires measuring what matters in the litigation process from a insurer standpoint: i.e. quality of results, good case management, case planning, expense and budget management. Measuring these key activities is necessary in order to develop and implement a quality performance management system. Critical to the performance management process is continuous systematic audits and metric analysis to drive results. Metric analysis may include closed and pending caseloads, closing ratios and counsel costs per file, cycle times, file results and perhaps other variables. The data can then be used to analyze results of files within a particular firm and files amongst different firms. Tracking this type of data/information over periods of time will lead to certain litigation trends regarding staffing, expenses and results. The use of these metrics can also be used to develop scorecards for each lawyer and firm. As such, benchmarking will become key in assessing performance. Whether we are talking about alternate fee arrangements or the traditional billable hour’s model, without data, the ability to critique the effectiveness of any fee structure is impaired. Therefore, the benefits of performance managing legal services will allow insurers to objectively allocate to legal counsel whose quality value (as measured through metrics) exceeds the competition. This approach will help to identify issues with counsel and insurers that negatively impact litigation spend at all stages of the litigation process. Conversely, this approach will also help to identify top performers and best practices.

Overall, the key to measuring counsel and the litigation process is to develop, analyze and create measurable data. Simply put, you can’t manage what you can’t measure. Billable hours or alternate fee arrangements, at the very best, measure time not value. I’m certainly not advocating for the “Walmartization” of the legal services industry or that low cost provider is the way to go. On the contrary, I’m advocating through the use of data and metrics, to identify and reward high value providers. Thus, the goals of counsel and insurers can best be aligned through the use of incentive-based fee arrangements and metric driven compensation, which rewards performance, productivity, efficiency and cost control. By measuring what matters, the deployment of a comprehensive performance management system — utilizing audits and metric assessment — will improve litigation performance, and more effectively manage litigation spend. This, in turn, will also improve business relations between an insurer and counsel.

Rocco Neglia is the vice president of claims with The Economical Insurance Group.