A changing legal landscape

The landscape for law firms specialising in reinsurance is changing. Some of the areas that have traditionally delivered healthy pots of fees to law firms, such as large contractual disputes, have fallen by the wayside. Although new areas of legal expertise are emerging, a gap is forcing law firms across the board to diversify and seek new ways to compete on fees to retain clients.

A big reason for this is simply that the industry has become more professional than ever. Contracts are no longer drafted quickly and without forethought (never mind the old ‘back of a beermat’ days at Lloyd’s) but properly drafted by lawyers experienced in the nature of disputes. And on top of this, many reinsurers no longer have the stomach for costly long-winded court battles.

“The reinsurance sector has become steadily less active in terms of big legal disputes over the past five or six years,” says John Nonna, partner at US law firm Patton Boggs specialising in dispute resolution, arbitration and litigation for the reinsurance industry. “There are fewer large disputes these days.”

He says this is for two reasons: “First, companies are a lot more careful with their contract language. In the past, there was simply less legal oversight in the drafting of contracts. Second, in this difficult economic climate, reinsurers are less willing to go to court, with all the associated costs and time that involves. They are more willing to settle and establish an ongoing business relationship with the other party.”

Nonna says there are still some legacy issues from things such as historic asbestos business generating work, and some disputes on property contracts. And despite a drop in the total value of deals in recent years, the mergers & acquisitions market has remained healthy in terms of numbers of deals. “These can often generate disputes usually around the way in which certain things were disclosed to the buyer,” he says.

Good news for buyers

These days the trend is very much towards arbitration and getting things right contractually first time around. This has led to more competition among lawyers that specialise in reinsurance dispute resolution and a reduction of fees—something that is good news for clients.

“Clients have certainly benefited as fees have been squeezed or law firms have had to explore new types of fee arrangements with clients,” Nonna says. “We have been sensitive to that. We have lowered fees and looked at doing flat fees, for instance. We have also looked to diversify and seek clients elsewhere (see part 2 of this feature in the next issue).

“We have become much more sensitive to clients’ demands and needs and we try to be as efficient as we can.”

Patton Boggs also looks to help clients in other ways. It holds regular free seminars on topics such as contract wording and common causes of disputes, for example. Nonna’s colleague Larry Schiffer held two talks in Lloyd’s for the Lloyd’s Market Association in April—one called Facultative Reinsurance Certificates in an MRC Environment and one called Adventures in Contract Wording: The Effect of Ambiguous Contract Language.

David Kendall, partner at Edwards Wildman Palmer UK, agrees that fees have been squeezed in what is an increasingly competitive market. And he identifies another reason that fee income among law firms specialising in reinsurance is under pressure: “many insurers and reinsurers have invested more heavily in in-house legal staff in recent years”.

“In the US and the UK, insurance law firms have been impacted by an increase in the level of in-house legal staffing by many insurers, a reduction in the number of re/insurance disputes, and pressure on fee levels as insurers look to cut costs,” he says.

“As a result, firms that provide ‘commodity’ services in relation to low value, high volume claims have had to become more efficient to remain profitable. Firms that provide advice on complex coverage or compliance issues, or act on transactions, have broadened their offering so that clients can look to them for help on cross-border disputes or transactions arising from the many jurisdictions in which re/insurers operate.”

Michael Mendelowitz, partner at Norton Rose based in the UK, agrees that the market is very competitive for law firms and lawyers specialising in reinsurance at the moment. But as well as the workload contracting, he believes one reason for this has been a recent period of consolidation among law firms with quality insurance and reinsurance teams, especially in the UK market.

“There have been some big ticket mergers in the insurance law sector but also a raft of deals between smaller and mid-size firms,” he says. “That has meant that competition has become concentrated in what is already a difficult market for lawyers. One of the consequences has been downward pressure on fees.

“All firms are trying to improve their profits. They can’t charge more so they are looking to cut costs and improve their margins in other ways. This situation has possibly been exacerbated by US law firms targeting the London market.”

He says that on the reinsurance side specifically some firms appear to have succeeded in retaining their biggest clients while others are struggling in the present environment.

“It is a very patchy market,” Mendelowitz says. “Some firms are busy while others are scratching around. Reinsurance dispute work is almost dead in the water. There are very few major cases around arising out of current or recent underwriting, but there are some resulting from legacy business or companies in run-off where management is being very careful—sometimes to the point of refusal in principle—about what they pay out. There is also work coming out of professional indemnity and directors’ & officers’ policies because of the problems that have emerged in the financial services sector.”

Intense competition

Nick DiGiovanni leads the reinsurance and insurance litigation groups in law firm Locke Lord. He says competition between firms in the US is as intense as it has ever been, particularly in the areas of coverage litigation. The slowdown in reinsurance litigation and arbitration occurred between 2009 and 2012. Since then, it has become more of a buyer’s market with price competition among firms and rate pressures from clients.

DiGiovanni cites a number of factors for this change. He says the economic recession affected virtually all industries, and the insurance industry was not immune. Insurance companies went through a ‘belt-tightening’ phase, putting more pressure on fees. In turn, this forced some large firms with high fee structures to conclude that their insurance/reinsurance practice was not profitable enough, and they exited the sector.

While this could have lessened competition, in fact it meant that the specialist lawyers from those firms simply joined smaller firms with lower rate structures, or set up their own practices.

“Mid-level firms with lower fee structures perceived that to be an opportunity to be more competitive, and this combined with the perception among some insurers that portions of the insurance/reinsurance practice area had become more commoditised, resulted in clients retaining firms that had not previously been involved in this practice area,” DiGiovanni explains.

“Another factor is that there has been no industry-wide meltdown, such as we saw with the Unicover dispute, where the stakes were high, as was the number of insurers involved.”

He identifies several interrelated reasons for the lower workload. Some of the big disputes such as workers’ compensation carve-out problems have been resolved while others, such as asbestos claims, have slowed and become more predictable.

“At the same time, economic issues have caused clients to become more cost-sensitive than they were several years ago,” he says. In addition, many companies have experienced favourable underwriting results (leaving aside the catastrophes of late 2012), reducing their incentives to litigate. These factors have combined to make clients more inclined to settle or avoid disputes than they were several years ago.

“The London insurance and reinsurance market is awash with capital—it has been a safe haven for capital investors, originally as a hedge, but increasingly as a principal investment strategy as the global bond market returns remain weak on low interest rates,” DiGiovanni explains.

“This coincides with one of the more prolonged soft markets—perhaps because of, rather than despite, this extra capital—with the accompanying reduction in the number of disputed claims. Tie in the increased sophistication of insurers’ own claims departments and the need to reduce expenses (again because of the reduction in investment returns in the bond markets), and there is a ‘perfect storm’ of reduced work for insurance/reinsurance law firms. This increases competition, strengthens the buyer’s market of legal services, and reduces legal spend.”

The 2013 upturn

DiGiovanni says he has noticed an uptick in work in 2013, primarily due to the large number of large loss catastrophes in 2011 and 2012. “This will likely result in an increase in competition for this new work, but I should add that the market is becoming a more sophisticated consumer of legal services and recognises the advantages of quality and experience which in many respects diminishes the perceived advantage of competing simply on the basis of fees,” he says.

He says that on the regulatory and transactional side of the practice, the competition is also strong, but healthy. “There are only a handful of firms in the US with credible and substantial practices in these areas,” he says. “The regulatory and transactional side, particularly in the healthcare-related industries will remain a robust market. Again, while many seek to compete, the market will continue to recognise that quality and experience remain the top criteria.”

“Clients have certainly benefited as fees have been squeezed or law firms have had to explore new types of fee arrangements with clients."

On the litigation side, financial lines, catastrophe-related property/business interruption and ‘large loss’ engineering and energy sectors are relatively active and promise to be busy claims sectors. Also, litigation against aircraft lessors remains an active area because of the ease with which plaintiffs can secure jurisdiction over these largely US-based companies, he notes.

On the transactional side, health insurance/reinsurance transactions are extremely active, primarily as a result of the industry’s response to the new federal healthcare legislation. In this regard, market conduct examinations of life and health companies by state insurance departments are on the rise, while market conduct examinations of the P&C companies have dropped proportionately.

Change on the way

Others agree that there is some light at the end of the tunnel. According to Nonna, the status quo could be changing. He predicts that although contracts are so good these days that disputes over working are uncommon, there may be more instances of disputes over new and emerging risks or claims from unexpected sources not necessarily catered for in policy wordings.

“When you consider the uncertainty around things like climate changes and severe weather events, and the new risks the industry is grappling with such as cyber risks, there will always be a strong chance of disputes around some of these areas,” Nonna says.

“This could even cause an uptick in reinsurance disputes in the future. It won’t be the contract wordings that will be problematic or anything ambiguous on that side of things, it will simply be that claims will emerge that will be unusual and which it may have been impossible to predict when drafting that contract.”

Nonna says he is also seeing a lot more work on the structured contract side of the business, on which he works side by side with corporate finance lawyers.

“Then you have the insurance-linked securities and industry loss warranties markets growing, and an increased need for multi-year and multi-peril contracts which can contain sophisticated mechanisms such as premium changes based on losses, etc. And the M&A market is also ticking over. Although the value of deals is lower the overall number of deals remains healthy.”

Overall, it seems the industry has become a lot better at avoiding disputes and a combination of this and economic conditions have made it a buyer’s market when it comes to legal services in the reinsurance industry. This has forced law firms to respond. In the next issue we will explore the strategies some have adopted to secure work in new markets and on new product lines.