Trapped In An Insurance Defense Practice? Two Strategic Approaches

Dr. John W. Olmstead, Jr., MBA

Insurance defense practices are under siege. While these practices have always had to deal with low billing rates and unrealistic controls mandated by insurance companies, recent trends have reached levels that threaten the business relationship which has reached an all time low. The core element of the relationship, mutual trust, is in jeopardy. Many of our law firm clients have dropped insurance defense work entirely and have diversified into other practice areas. Insurance defense law firms must now jump through even more hoops to play in the insurance defense arena. For example:

• Many insurance companies are consolidating the work and using fewer law firms.
  
  
• Insurance companies are setting up their own lawyers to handle claims by hiring lawyers full time to represent policyholders.
  
  
• Some insurance companies are using staff counsel to handle as much as 50% of their cases.
• Strict guidelines established by insurance companies that dictate how the case is handled and managed by the attorney.
  
  
• Demands by insurance companies that attorneys provide services on a fixed fee basis.
• Some law firms are being forced to invest in expensive special case management and special billing software and hardware in order to be able to electronically interface with their insurance company client – only then to be told by the client that they have changed their mind and won’t be using the program. The law firm is left holding the bag.
  
  
• Law firms are being required to submit their bills to third party auditing firms retained by the insurance company to review and audit all their legal bills. In many cases these auditing firms make the final decision as to final payment. Often bills are arbitrarily reduced with little feedback or recourse to the law firms. Payment of bills are often held up for months. This has had a dramatic effect upon the cash flow of insurance defense firms that already must operate on razor thin profit margins.
  
  
• On-site audits conducted by third party auditing firms of bills and supporting documentation such as original timesheets, copies of vendor invoices supporting client advances, and actual case files. This week long visit will keep the law firm accounting staff busy full time just gathering documentation and responding to requests for additional information from the audit team. Actually, the accounting staff will have to begin the collection process a week before the actual visit as well as during the time of the visit itself. At the conclusion of the visit the law firm will be presented with a report of findings and may even be required to remit what the audit team considers excessive payments back to the client.

In The Beginning

In earlier times insurance defense firms had very close relationships with their insurance company clients. Many insurance defense law firm clients with whom this author has worked have advised that they used to consider themselves an extension of the insurance company’s claim office. In fact, many founding partners of these firms came from the insurance industry and worked in the claims offices of insurance companies. They attended law school at night and upon completion of law school eventually formed law firms and worked out arrangements with various insurance companies to handle their business. For many years the relationship was a good business partnership. The relationship provided the insurance company with discounted ongoing legal representation for their policyholders and the law firm with a steady flow of work. There were few restrictions levied by the insurance company as to case handling and billing. The law firm simply handled and managed the case and billed the client by the hour for services rendered with few questions asked.

Unique Nature of Insurance Defense Firms

Insurance defense firms face unique challenges that are quite different than those faced by other law firms. Unlike corporate litigation firms insurance lawyers must strike a balance between their duty to the insured and the insurance company. A three-sided relationship exists. Who is the client? While the insurance company pays the legal bills the lawyer has a independent professional responsibility to the policyholder. Often the interests of the insurance company and the policyholder are at odds and the lawyer is caught in the middle of a conflict situation. It is interesting to note that while insurance companies retain discounted services from insurance defense law firms for their policyholders, they retain different law firms charging premium billing rates for their representation when they themselves are involved in litigation. Typically silk stocking corporate litigation firms are used for this work.

Insurance defense firms face very constrained billing rates and flat fee arrangements imposed upon them by insurance companies. This author has seen very few billing rates over $100 per hour. The spread between junior associates and senior partners with many years of experience is often less then 30%. The founding fathers of many of the first generation insurance defense firms adhered to the following policies to achieve adequate profitability:

• Recruited quality middle of the class law school graduates from local law schools.
  
  
• Maximize financial leverage with high ratios of associates to partners. Ratios of four to one were typical. This was the primary area for profit margin.
  
  
• Attorneys worked hard. Both associates and partners worked evenings and weekends. Between 2000-2200 annual billable hours were typical.
  
  
• The road to partner was long. Many used the experience received at the law firm to prepare them for practice elsewhere and they moved on. Those who remained did not make partner until after ten years or so.
  
  
• Other expenses were also tightly controlled. Since the law firm typically did not see clients at their offices, they did not require offices in high rent districts. All other office expenses were tightly managed.

Many of the lessons of the founding fathers of these first generation insurance defense firms have been lost in transition to second generation firms. Many second generation insurance defense firms have tried to spruce up their image in an effort to emulate the corporate silk stocking firms. They have:

1. moved into high cost A or B office space,
2. invested heavily in technology without modifying work processes, methodologies, or practices,
3. lost financial leverage by promoting too many associates to partner,
4. failed to maintain the same level of client communication and understanding that the founding fathers displayed,
5. failed to manage and control office expenses,
6. failed to maintain 2000-2200 annual billable hour production quotas, and
7. neglected marketing and business development activities which could have resulted in higher levels of work.

The present state of the insurance defense practice presents numerous challenges to the law firm. These challenges simply cannot be ignored – they will have to be faced head-on. The solutions are complex and will require time to sort through. While solutions can come in different varieties, they will take the form of one of two general strategic approaches.

Reinvent The Practice – Stay In The Game

For many firms the appropriate strategy may be to stay in the game. These will be firms that have a well-established reputation in insurance defense, where insurance defense represents a major source of their revenue, and where adequate leverage and profitability and leverage exist. These firms will not be firms that dabble in insurance work. These firms will be committed to this practice area and will focus on it exclusively. They will be innovative client-market driven firms that blend contemporary approaches with the lessons learned from the founding fathers.

While it is too early to foresee the actual particulars, some of the following actions will be required to reinvent the practice and stay in the game:

• Get leverage back on track. Tough decisions will be required here. High priced senior associates will have to be let go. Unproductive partners will also have to leave. Paralegals should be hired. Ratios need to get back to 4 to 1.
  
  
• Partnership admission criteria will become more demanding. Time required to make partner will be lengthened.
  
  
• Compensation will be based upon performance.
• Billable hour quotas will be enforced.
  
  
• Expenses will be tightly controlled.
  
  
• Flat fees and other forms of alternative billing will be commonplace.
  
  
• Unique out-of-the-box solutions will be designed to provide tailored services to meet client needs and differentiate the firm from competitors. The firm will no longer wait for the insurance company to take the lead. The firm will take the lead and provide clients will a menu of service solutions.
  
  
• Technology will be employed to the fullest extent to reengineer work processes. It will not be used just for technology sake or to keep up with the corporate litigation law firms. When technology is employed old outdated practices and processes will be eliminated.
  
  
• Standardized practices and procedures will be developed and used throughout the firm wherever possible.
  
  
• Client focus groups, insurance company councils, and other forums will be formed to open up channels of communications with clients in order to mend the tarnished client relationship and reestablish a business partnership. Innovative insurance defense firms will take active leadership roles in this endeavor.
  
  
• Aggressive marketing and business development strategies and plans will be implemented in order to maintain appropriate growth rates and profitability. Relationships with unprofitable clients will be terminated. Marketing with be done as a team approach as opposed to being a function done at the individual lawyer level.
  
  
• Both firm and individual personal marketing plans will be commonplace.

Exit Or Diversify The Practice

This strategy will be appropriate for firms that desire to get out of insurance defense work entirely or that desire to reduce their dependence on insurance defense work by diversifying the practice. In this way the mix of the practice can be altered. This strategy will not be easy. It will be a rough road and will take time.

Insurance defense attorneys typically do not have the expertise, experience, or the client contacts in other practice areas such as corporate business. Another factor is perceived image. The business community often views insurance defense firms as second rate firms. Often the law firm has in essence branded itself as an insurance defense firm. This can be a difficult obstacle to overcome. Client law firms with whom this author has worked have found that it can take five years or longer to accomplish such objectives.

Specific tactics will depend upon the firm’s size and the amount of insurance defense work in the practice mix. One of the first steps is for insurance defense firms to try to leverage their litigation experience in order to obtain the defense work from self-insured corporations and general corporate representation. In some instances it may be possible to pick up some of the general corporate representation of insurance companies. This will be a tough road.

Larger firms will require some new blood in the firm with expertise, experience, and a book of business in the desired practice areas. This will require insurance defense firms to consider merger or acquisition. Smaller firms may be able to accomplish these objectives completely internally or with lateral partner acquisitions. Both large and small firms should begin extensive programs of continuing education in desired practice areas. Firm and personal marketing plans should place strong emphasis on creating new business relationships as well.

Much work needs to be done by management of insurance defense firms. The process will take time, hard work, and dedication regardless of the strategic options chosen. Now is the time to get started.

Dr. John W. Olmstead, Jr., MBA, is a Certified Professional Consultant to Management and the president of Olmstead & Associates, Legal Management Consultants, St. Louis, MO. The firm provides organizational performance, management, leadership development, and marketing advisory services to law and other professional service firms. He is the Editor-in-Chief of The Lawyers Competitive Edge: The Journal of Law Office Economics and Management, West Group. He may be contacted by e-mail at jolmstead@olmsteadassoc.com.

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