Research Trends and Conclusions: Insurance & Reinsurance 2010
Tom Barnes -
In contrast to most of the rest of the financial world, the insurance industry has experienced a profitable past two years. The storm seasons in the US have been relatively benign, and overall there have been few (widely insured) catastrophes, either natural or man-made.
Insurance companies have been able to post strong results. Munich Re, one of the world’s largest reinsurers, posted a profit of €2.52 billion in 2009 and aims to produce similar results this year.
With the spectacular exception of AIG, the leading players in the industry have largely avoided the toxic products that caused such damage to their banking counterparts. Tighter regulation and overall toughening of standards were cited as having a beneficial effect, with underwriting discipline said to be much improved on past levels. While it isn’t all good news - the large portfolios of life insurance companies have been hit by recent market turmoil and investment returns have dropped off significantly – for the most part the insurance industry is enjoying a period of prosperity.
Areas of Activity
The expertise of the outside counsel selected in our publication covers a range of areas. The health of the insurance industry means those lawyers who focus on corporate and transactional work have fared better than their colleagues who draw their clients from other sectors. The signs are pointing to an increase in insurance M&A. Subject to stringent capitalisation requirements and with track records of conservative investment, insurance companies are attractive propositions to investors. Several of the sources we spoke to also indicated that a period of market consolidation is on the horizon, with clients flush with capital they wish to deploy both within the industry and further afield. High levels of post-acquisition restructuring work were also predicted.
On the other side of the coin, and as might be expected in an industry in relatively good shape, practitioners who specialise in insolvencies in the insurance sector are not as busy as their counterparts who focus on insolvencies in other sectors. The generally acknowledged improvements in industry regulation and instruments such as solvent schemes of arrangement in the UK have reduced the number of insurers going into full insolvency, and minimised the resultant legal work and attendant cost.
The directors & officers, errors & omissions and other professional lines market, is “absolutely red hot” in the words of one source, “like nothing I’ve ever experienced before” in the words of another. Rather than spending money on pursuing commercial disputes, lawyers reported a greater focus from clients on defending – and avoiding – claims regarding management decision-making. The increased focus on their actions that the global meltdown has brought has moved the issue up the corporate agenda. Companies are keen to ensure that their coverage is comprehensive, or to renegotiate existing terms, and insurers are more amenable to discussion.
The credit crunch and a multitude of high-profile company failures have also served to increase the focus on industry regulation, which has assumed a greater importance to both insurers and brokers. Lawyers in many jurisdictions are being called on to educate their clients on new governance and risk-management requirements. Chief among these is the European Union’s proposed Solvency II requirements.
Although not scheduled to come into effect until 2012, and with some details yet to be released, the new solvency regime for all EU insurers and reinsurers is already causing a “bow wave” of work for insurance lawyers across the continent. Outside counsel are being asked to advise on the forthcoming – more onerous – capital and governance requirements. This is no easy task, as there remains much to be finalised – in the words of one expert: “It will certainly affect our clients, but no-one is quite sure how.” The only point of certainty is that insurance companies are not entirely prepared and work will need to be done. Solvency II may also prompt higher levels of corporate activity. Larger clients have the time and money to do the modelling required to identify the impact it will have on their business, and this introspection has enabled some to spot duplication in their business and the opportunity for reconfiguration and consolidation. There is a gap appearing between the larger companies and their smaller competitors, who may lack the facilities to identify and prepare for the impending changes or the capacity to comply with the impending capital requirements and may be forced to merge with their larger competitors.
Disputes
The story from the disputes lawyers we canvassed was more mixed. Conventional wisdom suggests that tough times lead to more disputes: “Hard times mean more blame,” as one interviewee put it. But the nature of the insurance industry has mitigated against this. Belt-tightening across the board has made clients reluctant to expose themselves to the risk of trials and led to a greater emphasis on settlement. Cost was often cited as the deciding factor, although one private practice nominee noted that: “Lawyers haven’t done themselves any favours over the years. Overall they have been too expensive and found problems where the industry felt there were none.” Others noted that consolidation in the industry has resulted in fewer players left to come into conflict, and that those who remain are keen to preserve their long-term business relationships. “Clients don’t want to spend money on disputes that will only cause business problems for them in the future.” It was also noted that some types of suit have run their course. “There is no new asbestos,” and some areas that lawyers believed would generate many disputes did not live up to expectations.
However, set against these factors are several elements that may increase the demand for insurance dispute experts. An uptick in the professional lines market has already been noted, and other claims related to financial products and the credit crunch are said to be in the pipeline. Certain industries, such as shipping, continue to provide specialist firms with significant work, and insolvency disputes are also frequent, although as one lawyer notes: “That can hardly be classified as repeat business.” Some clients are forecasting more disputes, others note that the insurance market is traditionally cyclical and is due to return to more active levels.
Insurance disputes lawyers and their firms are also adapting to another shift in the market: the increased popularity of arbitration and other alternative dispute resolution methods. That said, there were reports of clients’ growing dissatisfaction with arbitration. Its traditional advantages – speed and relative low cost – have been eroded in recent years, but it continues to retain some specific advantages. Its confidentiality has always been attractive to clients, as has the lack of strictly binding precedents, and the option to have the case overseen by an industry expert eliminates the need to ‘educate’ a judge. Commercial pressures also combine to make other forms of dispute resolution attractive. Mediation, if successful, can use the commercial goodwill between two parties to find a settlement that not only satisfies each side but can also establish a protocol for disputes to come – an important consideration when the parties will be working together in the future. Clients are forced to explore every avenue to deal with disputes that arise, and to place the onus on their outside counsel to deal with them in the most efficient manner possible.
How Best to Serve Clients
The demands the insurance industry makes on its outside counsel are many and varied, and have been exacerbated by the pressures many firms are feeling as a result of the global slowdown. Across the board, relationships between clients and their firms are changing, and the nature of the work has altered. Transactional expertise has dropped down the agenda as advice on governance and regulation increase in importance. “Clients want to see more grey hair”, and are relying on lawyers with the depth of expertise and experience to guide them through challenging times. Creativity is also valued highly. Insurance litigators are being challenged to find alternative methods to resolve, settle or avoid disputes altogether. More and more of our sources related an increasing tendency for clients to reduce as far as possible the involvement of outside lawyers and to keep the less sophisticated work in house.
The issue of fee structures was brought to our attention time and again. Many of the lawyers in this book are being required to be proactive and creative in offering fee packages. Clients are exerting downward pressure and are keen to find alternatives to the hourly rate. The range of alternative methods mentioned to us is testament to the flexibility of the legal industry, with capped billing, flat fees, blended rates, two-tier structures and contingency fees all mentioned, the last reflecting a competitive environment where lawyers are being asked to take on some of the risk. Others reported a greater willingness from companies to try new lawyers. Firms are exploring ways to add value for their clients, with reports that extra services such as educational workshops and international updates are proving popular.
However, old habits die hard. While practitioners reported a high level of interest in alternative billing methods, many also cited reticence from clients to change established arrangements and scepticism about wide ranging changes in the future. While it is possible to build profit margins into fee quotes on transactional matters, disputes specialists noted that contingency fees can be difficult to implement when there is no clear definition of “success” and opinion can be divided over the desirability of a settlement or verdict. Others noted that due to the complexity of insurance and reinsurance matters clients are still inclined to opt for the best, rather than the cheapest. But even for the best lawyers in the business, acting for clients can be complex.
The Legal Market
There have been a large number of high-profile lateral moves and law firm mergers in recent years, with one side effect being an increase in conflicts. As the insurance market began to concentrate, the conflict situation became harder to manage and firms often found themselves on both sides. Many litigators based in large corporate firms found their situation untenable, the more work they did, the more work they were disqualified from. In the words of one, lawyers could end up in a situation where “there is no one you can sue.” Some insurance clients have a sophisticated attitude to outside counsel, and may overlook possible conflicts, but we also received reports that the generally less tolerant attitude of US clients is beginning to spread internationally.
Ultimately, this has led to the unwinding of the litigation practices in certain law firms, and the establishment of smaller disputes boutiques able to take instruction from previously barred clients. “If you are able to take cases that other firms can’t, that gives you a significant competitive advantage,” as one source puts it. The situation is illustrated by the lateral moves of many of the sector’s leading litigators in recent times, and exemplified in the 2009 formation of Chaffetz Lindsey LLP. The firm combines the disputes expertise of Peter Chaffetz and David Lindsey. The former was global head of litigation and a member of Clifford Chance’s management committee, and the latter led the firm’s international arbitration practice in the Americas. The new firm was formed to address two major issues: conflicts and costs. “Conflicts have always been a problem at large firms,” says the firm’s website, “That problem became dramatically worse following the economic downturn, as so many of the resulting disputes involved firm clients on both sides. We saw a need for a top-quality firm that did not have those conflicts.” The firm also addresses the cost pressures that are being experienced across the legal industry; “Even before the downturn, the large firm cost and fee structures made it difficult for clients to hire us on small to medium-sized cases. With low costs and no excess overhead, our new firm provides the value clients require.”
The pressure on billing levels and awkward conflict situations are two of the challenges facing the leading law firms in the market for insurance law advice. While the benefits of disputes boutiques are obvious, one of the clearest lessons for law firms coming out of the recent downturn is that those which are able to diversify their services have often been in a stronger position, while those that focus on a single area are left vulnerable if that sector, no matter how previously lucrative it may have been, dries up. And those who cannot diversify can find themselves in difficult positions. Our research saw evidence of firms looking to offer new insolvency, regulatory and corporate services and to broaden their practices and client bases, to fill the gaps. We have seen several firms building up their claims practices with some success, aiming to offer high volumes of work for lower overall rates.
For firms aiming to grow their market share, other challenges apply. The leading markets are very heavily regulated, and even the corporate work requires a high level of knowledge that is not easily acquired. Often familiarity with the industry and its precedents are of the greatest value, and “It is a really full understanding of the environment that makes the difference for the client.” It is difficult to build a practice organically; firms have to enter the market through lateral moves. Internationally the amount of work varies greatly, and local knowledge can often be indispensable, but while some countries support a thriving insurance bar, others are home to a small number of companies who keep their work in-house, and this can make the area a tricky proposition for international firms looking to incorporate the sector into their overall strategy.
Looking to the Future
In these difficult conditions, certain sectors offer hope for insurance lawyers and their clients. Climate change was repeatedly mentioned as an area that will create legal work, and nanotech was also cited as a potential candidate to fill the role of “the new asbestos”. Regulatory work will continue to climb up the agenda, and consolidation in markets around the world is widely expected: “The sector is ripe for another round of mergers.” Some believe that a surge in disputes is in the pipeline, and others note that insolvencies are also likely this year. Internationally opportunities remain in new markets such as Brazil and China, and the life insurance sector holds the potential for further growth – as one source notes: “Most people in the world aren’t covered.” Despite certain difficulties, insurance remains an essential product and continues to demand highly sophisticated legal counsel, such as the ones we list in this publication.