It's Not What You Bill, It's What You're Paid

Over the past two decades, the monitoring of legal bills by insurance firms that are paying for outside counsel has become standard practice. Whether using in-house accounting staff or hiring a third party, insurers have put attorneys on notice about what they will pay for, and how work must be documented. In turn, attorneys who defend insurance cases have had to adjust the way they do business.

For attorneys, the change in attitude and practice hasn't always been easy. Insurance defense attorneys are, as one lawyer put it, “the most risk-averse, change-resistant segment of a risk-averse, change-resistant profession.”

As auditing became widespread, attorneys questioned both its legitimacy and utility. Court cases have tested the legality of sharing client information to facilitate audits. The ethics panel of the American Bar Association (ABA) has issued opinions about where to draw the line on auditing policies. In recent years, some insurers reduced their auditing after deciding that their real bottom line is the resolution of an insurance dispute, not savings on legal work. Yet all parties agree that billing review is now a permanent part of the landscape in insurance defense work, and it reinforces the need for insurance defense attorneys and the firms that hire them to communicate clearly about goals, expectations, and the parameters of work.

This special report looks at why the auditing of insurance defense bills began in the 1980s, how it peaked in the mid-1990s, and what attorneys, auditors, and insurers view as best practices today.

Stamping Out Egregious Billing

The insurance industry did not invent legal bill auditing, but major insurers quickly embraced the practice in the 1980s to address what they perceived to be an epidemic of improper billing. Indeed, according to articles in legal and insurance journals of the period, law firms were regularly charging their clients for donuts, videos, dry cleaning, and office air conditioning on weekends, in excess of overhead charges; earning 120% profit margins on photocopying; and submitting bills from attorneys who claimed 20-plus hours of work in a day.

“The situation is getting much better,” said Melinda Snipstead, founder of Advanced Auditing Services, Pasadena, CA. “We now see overhead treated properly, and all of these extra expenses are not being added.”

“The temptation for lawyers to over-bill has been diminished significantly because of third-party review of bills,” said Austin Anderson, an attorney and billing consultant with AndersonBoyer in Faline, MI.

In the early days, some auditors estimated that 15% to 20% of some types of legal bills could be eliminated, simply by challenging obvious mistakes and inappropriate charges. Usually, when charges were contested, the law firm and its client settled it quietly, and without damage to long-term relationships.

Occasionally, however, the disputes reached litigation. One case that went to trial in 1994 involved a two-man law firm that was defending a client of Fireman's Fund insurance. In 2 years, the firm billed Fireman's more than $535,000 for a case that typically settled for no more than $250,000 (and would have yielded a bill of $25,000 to $50,000). An arbitrator cut the law firm's fees to below $100,000. In another case in the early 1990s, a law firm that was defending 3000 asbestos cases billed Fireman's 0.2 hour of research on each case, or a total of 600 hours. When the firm could not document spending 600 hours on research, the bill was slashed.

Challenges to some fairly common billing practices even found support within the legal profession. The ABA's first billing opinion was issued in 1993 (No. 93-379), and it addressed the legitimacy of charging one client for time spent on a plane flight to a case, while charging another for work done on the flight:

Rather than looking to profit from the fortuity of coincidental scheduling, the desire to get work done rather than watch a movie [on an airplane], or the luck of being asked the identical question twice, the lawyer who has agreed to bill solely on the basis of time spent is obliged to pass the benefits of these economies on to the client … It goes without saying that a lawyer who has undertaken to bill on an hourly basis is never justified in charging a client for hours not actually expended.

With all of the momentum behind insurers at the time and a glut of new attorneys coming out of law schools, lawyers who relied on insurance defense work feared the worst. The “commoditization” of insurance defense work had been reached, according to some in the industry.

“In the early 1990s, a lot of lawyers were predicting the demise of insurance law firms,” said Michael Ford, partner in Quinlivan & Hughes (St. Cloud, MN), and a former president of the Minnesota Defense Lawyers Association and current chair of the Defense Practice Management Committee. “There has been consolidation, and some firms didn't survive. But most did, in one form or another.”

Ford and Anderson collaborated in 1992 to create a seminar for Minnesota defense lawyers about how to work with insurers. Continuing to present the seminar periodically since then, Ford said that the difference in lawyers' attitudes toward bill auditing today versus the early 1990s is “striking.” He elaborated, “There is almost a studied indifference to auditing, as compared to what seemed to be the end of the world a decade ago.”

What occurred is that law firms adapted their business practices to meet the expectations and guidelines that insurers created.

Accommodation went both ways, as insurers “realized that you get what you pay for,” said Linda Klein, managing partner with Atlanta-based Gambrell & Stolz and the chair of the ABA's Tort Trial and Insurance Practice Section. “Insurers found that maybe they could save 4% or 5% on their legal bills, but that the outcome of the cases was unchanged. And it's the outcome where the big bucks are.”

Intrusion into the Legal Process

Not only did audits potentially affect livelihoods, some legal scholars saw a more harmful impact: intrusion upon the legal process, or violation of the basic tenets of the attorney-client relationship.

“Auditing started with a look at issues such as whether a firm had internal conflicts of interest, or if a partner was doing work that an associate could do,” said Klein, past president of the State Bar of Georgia. “Then insurers started telling firms how many lawyers they would need at trial and how long a deposition should take.”

When auditing reached the point of dictating to attorneys how long they could spend on elements of a particular case, many attorneys felt that a line had been crossed. Attorneys were further angered by the fact that many of the overseers were non-lawyers ' a familiar cry that is raised by critics of health maintenance organizations and their health care gatekeepers.

Insurance companies argued that because they had thousands of similar cases across the country (asbestos or car accidents, for example), they had enough information in their databases to accurately estimate the time needed to handle fairly routine actions. Many other industries were developing “best practices” models, and insurance companies saw no reason why that type of systemic review could not be applied to the legal profession as guidelines. Moreover, insurance companies allowed attorneys to request permission to invest more time in a particular case if circumstances warranted it.

Conflicts over this probably peaked in the mid-1990s, when it was estimated that three-fourths of the bill auditing was done in the insurance field.

Then along came a decision by the Montana Supreme Court in April 2000. In In the Matter of the Rules of Professional Conduct and Insurer Imposed Billing Rules and Procedures, 2 P.3d 806 (Mont. 2000), attorneys successfully challenged the notion that insurers could delve into every aspect of their billing practices.

The court found that insurance audits and guidelines violated the rules of professional conduct in several major ways. The conditions limited or directed the scope and extent of the representation of the insured, and they potentially undermined an attorney's ability to exercise independent judgment. The court also found that attorneys might be violating client confidentiality if they submitted “detailed descriptions of professional services to outside persons or entities without first obtaining the informed consent of his or her client”; in other words, if they gave third-party auditors the information they needed to do an audit. (See Case Brief, page 6.)

In 2001, the ABA issued an ethics opinion (ABA Formal Opinion 01-421) that came to similar conclusions. The ABA stated, “A lawyer must not permit compliance with 'guidelines' and other directives of an insurer relating to the lawyer's services to impair materially the lawyer's independent professional judgment in representing an insured.” The ABA said that disclosure of confidential information to the insurance firm was permitted if it was deemed to be in the client's interest, but disclosure to third parties was prohibited. Adhering to an insurer's guidelines did not absolve lawyers from the obligation to provide the insured with his or her best independent professional judgment.

“Basically, the ABA opinion and the Montana decision said that auditing of bills cannot be done in a way such that a lawyer's independent professional judgment is impaired, or client confidentiality is waived without his consent,” said Klein.

Several state bar associations followed up on the ABA's ethics opinion with similar statements. To some degree, the pendulum swung back toward the middle.

Impact on Legal Counsel

Today, insurers and their legal counsel seem to have reached a workable compromise. “Insurance firms that regularly audit their bills are very pleased with their relationships with their legal counsel,” said Julie Brompster, founder of Accountability Services, in New York. “Insurers that don't monitor their bills can still be hit with some nasty surprises.”

“Auditing has greatly reduced honest mistakes in billing, partly because it helped to propel firms to use computerized billing systems,” said John Toothman, founder of The Devil's Advocate (Alexandria, VA), one of the oldest auditing firms in the business. “Computerized systems are very effective at catching certain types of problems.”

Simply making sure that counsel knows that its bills will be reviewed is probably beneficial for all parties, added Snipstead. “Often, it's just a matter of law firms preparing their bills better … so that we can understand what they did and what their bills are for,” she said.

With a track record of a decade or more, insurance companies have been able to assess when and how much to audit, and how to make auditing more effective and less intrusive. For example, guidelines are more effective than strict rules. Insurance firms also learned that squeezing a firm on its billing rate (for “commoditized” services) and then squeezing the firm on its hours would truly put the firm in a financial bind. Some long-term relationships were badly damaged by overly aggressive billing crackdowns, until insurers took a look at the bigger picture: the quality of the representation they were receiving. “Insurance firms learned that you can have the best litigation management in the world, but you can't make up for choosing the wrong law firm,” said Toothman.

Third-party auditors have learned to work with attorneys, rather than to antagonize them. Although the credentials of auditors were challenged by law firms, the truth is that most auditing firms are founded by former practicing attorneys and have many attorneys on staff. [The four auditing firms quoted in this article were started by attorneys.]

Yet, some large insurers have significantly reduced their auditing effort, or dropped third-party auditing after finding it was not cost effective. “We believe in auditing, but it is not the answer to all of our cost-containment issues,” said a representative of one insurance firm.

While this raises the question of the independence of the auditor when billing disputes arise, the procedures for resolving a billing dispute are themselves fairly routine today. “Bills do get rejected, and might seem as if it's frivolous,” said the insurance firm representative. “But it's not very difficult to appeal the rejection and to get paid. You just have to stay on top of your system.”

Some auditors have changed their approach, too. Accountability Services, for example, does not prescribe the time for a deposition, as it might have in the past. In return, the company expects the law firm to work within the time limits that it has self-identified (See related article, page 1.)

The growth of law firm management consultants has been another factor that has helped to ease some of the confusion about billing. Consultants, who are familiar with billing issues, can teach firms how to work within the parameters set by their clients. “We regularly help firms modify their practices,” said Ford. “Law firms have learned that cost is one component that does matter to their client, and it's in the law firm's best interest to organize its practice so that its client gets the most bang for its legal buck.”

Time restrictions for depositions and research have forced attorneys “to work smarter,” Anderson said. Computerized information databases have made attorneys more efficient, too.

Even the way that insurance cases are handled may be reducing the tension between insurance companies and their legal counsel. Ford said that alternative dispute resolution (ADR) of personal injury cases has changed the dynamics of insurance cases for the better. “ADR has been tremendously successful in Minnesota,” said Ford. “We see a lot of cases being mediated. From an insurance company's point of view, mediating a case before trial is a great way to avoid a lot of depositions for the defense. Same with arbitration. And if they feel that the mediation or arbitration is not going well, then trial is still an option.”

However, the benefit of arbitration with respect to keeping down legal bills is certainly an open question. Toothman said that the open-ended discovery rules for many arbitrations “can result in bills that are as high or higher than in litigation.”

Alternative fee structures, such as flat fees, were a popular experiment in the insurance defense business a few years ago. To some extent, they were a fad in the late-1990s that fell out of favor when their promised benefits did not materialize. “Flat fees have their place in some types of litigation,” said Toothman, who is co-author of a book about legal bills, Legal Fees: Tools & Management.

Snipstead suggests that value-based billing ' charging for a work product, not for hours ' also has a place in the insurance defense business. “It might not be easy to come up with the exact figure in the early stages of litigation,” she said, “but it is not hard to come up with a reasonable cap on expenses, and a plan to discuss the case if costs are coming close to that cap. This would focus effort on the case, rather than the bill.”

Conclusion

The legal profession is always in flux, and it's not surprising that auditing of legal bills continues to change. Tensions remain ' particularly the requirement by some insurers that law firms submit all bills through specialized billing software that they must purchase from the developer.

Yet insurers and law firms have generally reached agreement on how to process the majority of routine insurance cases that do not expose insurers to huge levels of financial risk. One lesson that law firms must remember is that from an insurer's perspective, each case is not win-at-all costs. “The insurer has a bottom-line objective, and the attorney must put in a level of effort and billable time that is consistent with the actual risk we face,” said a representative of one insurance firm.

Consensus seems to be that the guidelines developed by insurance firms are generally workable, and that they are based on legitimate data about how lawyers settle and litigate cases in the real world. Lawyers have learned to work within those guidelines, and to understand that they need to communicate with their clients when circumstances indicate that a greater investment is needed.

Over the past two decades, the monitoring of legal bills by insurance firms that are paying for outside counsel has become standard practice. Whether using in-house accounting staff or hiring a third party, insurers have put attorneys on notice about what they will pay for, and how work must be documented. In turn, attorneys who defend insurance cases have had to adjust the way they do business.

For attorneys, the change in attitude and practice hasn't always been easy. Insurance defense attorneys are, as one lawyer put it, “the most risk-averse, change-resistant segment of a risk-averse, change-resistant profession.”

As auditing became widespread, attorneys questioned both its legitimacy and utility. Court cases have tested the legality of sharing client information to facilitate audits. The ethics panel of the American Bar Association (ABA) has issued opinions about where to draw the line on auditing policies. In recent years, some insurers reduced their auditing after deciding that their real bottom line is the resolution of an insurance dispute, not savings on legal work. Yet all parties agree that billing review is now a permanent part of the landscape in insurance defense work, and it reinforces the need for insurance defense attorneys and the firms that hire them to communicate clearly about goals, expectations, and the parameters of work.

This special report looks at why the auditing of insurance defense bills began in the 1980s, how it peaked in the mid-1990s, and what attorneys, auditors, and insurers view as best practices today.

Stamping Out Egregious Billing

The insurance industry did not invent legal bill auditing, but major insurers quickly embraced the practice in the 1980s to address what they perceived to be an epidemic of improper billing. Indeed, according to articles in legal and insurance journals of the period, law firms were regularly charging their clients for donuts, videos, dry cleaning, and office air conditioning on weekends, in excess of overhead charges; earning 120% profit margins on photocopying; and submitting bills from attorneys who claimed 20-plus hours of work in a day.

“The situation is getting much better,” said Melinda Snipstead, founder of Advanced Auditing Services, Pasadena, CA. “We now see overhead treated properly, and all of these extra expenses are not being added.”

“The temptation for lawyers to over-bill has been diminished significantly because of third-party review of bills,” said Austin Anderson, an attorney and billing consultant with AndersonBoyer in Faline, MI.

In the early days, some auditors estimated that 15% to 20% of some types of legal bills could be eliminated, simply by challenging obvious mistakes and inappropriate charges. Usually, when charges were contested, the law firm and its client settled it quietly, and without damage to long-term relationships.

Occasionally, however, the disputes reached litigation. One case that went to trial in 1994 involved a two-man law firm that was defending a client of Fireman's Fund insurance. In 2 years, the firm billed Fireman's more than $535,000 for a case that typically settled for no more than $250,000 (and would have yielded a bill of $25,000 to $50,000). An arbitrator cut the law firm's fees to below $100,000. In another case in the early 1990s, a law firm that was defending 3000 asbestos cases billed Fireman's 0.2 hour of research on each case, or a total of 600 hours. When the firm could not document spending 600 hours on research, the bill was slashed.

Challenges to some fairly common billing practices even found support within the legal profession. The ABA's first billing opinion was issued in 1993 (No. 93-379), and it addressed the legitimacy of charging one client for time spent on a plane flight to a case, while charging another for work done on the flight:

Rather than looking to profit from the fortuity of coincidental scheduling, the desire to get work done rather than watch a movie [on an airplane], or the luck of being asked the identical question twice, the lawyer who has agreed to bill solely on the basis of time spent is obliged to pass the benefits of these economies on to the client … It goes without saying that a lawyer who has undertaken to bill on an hourly basis is never justified in charging a client for hours not actually expended.

With all of the momentum behind insurers at the time and a glut of new attorneys coming out of law schools, lawyers who relied on insurance defense work feared the worst. The “commoditization” of insurance defense work had been reached, according to some in the industry.

“In the early 1990s, a lot of lawyers were predicting the demise of insurance law firms,” said Michael Ford, partner in Quinlivan & Hughes (St. Cloud, MN), and a former president of the Minnesota Defense Lawyers Association and current chair of the Defense Practice Management Committee. “There has been consolidation, and some firms didn't survive. But most did, in one form or another.”

Ford and Anderson collaborated in 1992 to create a seminar for Minnesota defense lawyers about how to work with insurers. Continuing to present the seminar periodically since then, Ford said that the difference in lawyers' attitudes toward bill auditing today versus the early 1990s is “striking.” He elaborated, “There is almost a studied indifference to auditing, as compared to what seemed to be the end of the world a decade ago.”

What occurred is that law firms adapted their business practices to meet the expectations and guidelines that insurers created.

Accommodation went both ways, as insurers “realized that you get what you pay for,” said Linda Klein, managing partner with Atlanta-based Gambrell & Stolz and the chair of the ABA's Tort Trial and Insurance Practice Section. “Insurers found that maybe they could save 4% or 5% on their legal bills, but that the outcome of the cases was unchanged. And it's the outcome where the big bucks are.”

Intrusion into the Legal Process

Not only did audits potentially affect livelihoods, some legal scholars saw a more harmful impact: intrusion upon the legal process, or violation of the basic tenets of the attorney-client relationship.

“Auditing started with a look at issues such as whether a firm had internal conflicts of interest, or if a partner was doing work that an associate could do,” said Klein, past president of the State Bar of Georgia. “Then insurers started telling firms how many lawyers they would need at trial and how long a deposition should take.”

When auditing reached the point of dictating to attorneys how long they could spend on elements of a particular case, many attorneys felt that a line had been crossed. Attorneys were further angered by the fact that many of the overseers were non-lawyers ' a familiar cry that is raised by critics of health maintenance organizations and their health care gatekeepers.

Insurance companies argued that because they had thousands of similar cases across the country (asbestos or car accidents, for example), they had enough information in their databases to accurately estimate the time needed to handle fairly routine actions. Many other industries were developing “best practices” models, and insurance companies saw no reason why that type of systemic review could not be applied to the legal profession as guidelines. Moreover, insurance companies allowed attorneys to request permission to invest more time in a particular case if circumstances warranted it.

Conflicts over this probably peaked in the mid-1990s, when it was estimated that three-fourths of the bill auditing was done in the insurance field.

Then along came a decision by the Montana Supreme Court in April 2000. In In the Matter of the Rules of Professional Conduct and Insurer Imposed Billing Rules and Procedures, 2 P.3d 806 (Mont. 2000), attorneys successfully challenged the notion that insurers could delve into every aspect of their billing practices.

The court found that insurance audits and guidelines violated the rules of professional conduct in several major ways. The conditions limited or directed the scope and extent of the representation of the insured, and they potentially undermined an attorney's ability to exercise independent judgment. The court also found that attorneys might be violating client confidentiality if they submitted “detailed descriptions of professional services to outside persons or entities without first obtaining the informed consent of his or her client”; in other words, if they gave third-party auditors the information they needed to do an audit. (See Case Brief, page 6.)

In 2001, the ABA issued an ethics opinion (ABA Formal Opinion 01-421) that came to similar conclusions. The ABA stated, “A lawyer must not permit compliance with 'guidelines' and other directives of an insurer relating to the lawyer's services to impair materially the lawyer's independent professional judgment in representing an insured.” The ABA said that disclosure of confidential information to the insurance firm was permitted if it was deemed to be in the client's interest, but disclosure to third parties was prohibited. Adhering to an insurer's guidelines did not absolve lawyers from the obligation to provide the insured with his or her best independent professional judgment.

“Basically, the ABA opinion and the Montana decision said that auditing of bills cannot be done in a way such that a lawyer's independent professional judgment is impaired, or client confidentiality is waived without his consent,” said Klein.

Several state bar associations followed up on the ABA's ethics opinion with similar statements. To some degree, the pendulum swung back toward the middle.

Impact on Legal Counsel

Today, insurers and their legal counsel seem to have reached a workable compromise. “Insurance firms that regularly audit their bills are very pleased with their relationships with their legal counsel,” said Julie Brompster, founder of Accountability Services, in New York. “Insurers that don't monitor their bills can still be hit with some nasty surprises.”

“Auditing has greatly reduced honest mistakes in billing, partly because it helped to propel firms to use computerized billing systems,” said John Toothman, founder of The Devil's Advocate (Alexandria, VA), one of the oldest auditing firms in the business. “Computerized systems are very effective at catching certain types of problems.”

Simply making sure that counsel knows that its bills will be reviewed is probably beneficial for all parties, added Snipstead. “Often, it's just a matter of law firms preparing their bills better … so that we can understand what they did and what their bills are for,” she said.

With a track record of a decade or more, insurance companies have been able to assess when and how much to audit, and how to make auditing more effective and less intrusive. For example, guidelines are more effective than strict rules. Insurance firms also learned that squeezing a firm on its billing rate (for “commoditized” services) and then squeezing the firm on its hours would truly put the firm in a financial bind. Some long-term relationships were badly damaged by overly aggressive billing crackdowns, until insurers took a look at the bigger picture: the quality of the representation they were receiving. “Insurance firms learned that you can have the best litigation management in the world, but you can't make up for choosing the wrong law firm,” said Toothman.

Third-party auditors have learned to work with attorneys, rather than to antagonize them. Although the credentials of auditors were challenged by law firms, the truth is that most auditing firms are founded by former practicing attorneys and have many attorneys on staff. [The four auditing firms quoted in this article were started by attorneys.]

Yet, some large insurers have significantly reduced their auditing effort, or dropped third-party auditing after finding it was not cost effective. “We believe in auditing, but it is not the answer to all of our cost-containment issues,” said a representative of one insurance firm.

While this raises the question of the independence of the auditor when billing disputes arise, the procedures for resolving a billing dispute are themselves fairly routine today. “Bills do get rejected, and might seem as if it's frivolous,” said the insurance firm representative. “But it's not very difficult to appeal the rejection and to get paid. You just have to stay on top of your system.”

Some auditors have changed their approach, too. Accountability Services, for example, does not prescribe the time for a deposition, as it might have in the past. In return, the company expects the law firm to work within the time limits that it has self-identified (See related article, page 1.)

The growth of law firm management consultants has been another factor that has helped to ease some of the confusion about billing. Consultants, who are familiar with billing issues, can teach firms how to work within the parameters set by their clients. “We regularly help firms modify their practices,” said Ford. “Law firms have learned that cost is one component that does matter to their client, and it's in the law firm's best interest to organize its practice so that its client gets the most bang for its legal buck.”

Time restrictions for depositions and research have forced attorneys “to work smarter,” Anderson said. Computerized information databases have made attorneys more efficient, too.

Even the way that insurance cases are handled may be reducing the tension between insurance companies and their legal counsel. Ford said that alternative dispute resolution (ADR) of personal injury cases has changed the dynamics of insurance cases for the better. “ADR has been tremendously successful in Minnesota,” said Ford. “We see a lot of cases being mediated. From an insurance company's point of view, mediating a case before trial is a great way to avoid a lot of depositions for the defense. Same with arbitration. And if they feel that the mediation or arbitration is not going well, then trial is still an option.”

However, the benefit of arbitration with respect to keeping down legal bills is certainly an open question. Toothman said that the open-ended discovery rules for many arbitrations “can result in bills that are as high or higher than in litigation.”

Alternative fee structures, such as flat fees, were a popular experiment in the insurance defense business a few years ago. To some extent, they were a fad in the late-1990s that fell out of favor when their promised benefits did not materialize. “Flat fees have their place in some types of litigation,” said Toothman, who is co-author of a book about legal bills, Legal Fees: Tools & Management.

Snipstead suggests that value-based billing ' charging for a work product, not for hours ' also has a place in the insurance defense business. “It might not be easy to come up with the exact figure in the early stages of litigation,” she said, “but it is not hard to come up with a reasonable cap on expenses, and a plan to discuss the case if costs are coming close to that cap. This would focus effort on the case, rather than the bill.”

Conclusion

The legal profession is always in flux, and it's not surprising that auditing of legal bills continues to change. Tensions remain ' particularly the requirement by some insurers that law firms submit all bills through specialized billing software that they must purchase from the developer.

Yet insurers and law firms have generally reached agreement on how to process the majority of routine insurance cases that do not expose insurers to huge levels of financial risk. One lesson that law firms must remember is that from an insurer's perspective, each case is not win-at-all costs. “The insurer has a bottom-line objective, and the attorney must put in a level of effort and billable time that is consistent with the actual risk we face,” said a representative of one insurance firm.

Consensus seems to be that the guidelines developed by insurance firms are generally workable, and that they are based on legitimate data about how lawyers settle and litigate cases in the real world. Lawyers have learned to work within those guidelines, and to understand that they need to communicate with their clients when circumstances indicate that a greater investment is needed.