Why Defend the Indefensible?

According to the Insurance Information Institute (Fact Book 2005, page 130), defense costs and related cost-containment expenses (often referred to as allocated expenses specifically charged to individual claim files, as opposed to unallocated expenses, such as the cost of running the claim department or using outside adjusters) averaged 15.2 percent of incurred loss in all liability claims in 2003, a total of $19,232,739,000. This was an increase of more than $7 billion over the same costs in 2001. These ranged from 24.9 percent for general liability and 11.2 percent for commercial auto liability claims to 7.4 percent for private passenger auto liability claims. (Costs for commercial multi-peril, products and medical malpractice defense ranged from 46.7 percent to 37.5 percent, more than a third of the total incurred losses paid. Remember, incurred loss includes reserves, hence many of these claims are still pending.)

"According to Tillinghast, an actuarial consulting firm, the American civil liability (tort) system cost $233 billion in 2002, a $27.4 billion rise from the previous year," the I.I.I. reported. In 2002, the median award in a plaintiff's verdict was $30,000, down from $45,000 in 2000. "However," the institute noted, "insurers' defense costs as a percentage of incurred losses are going up."

The definition of "defense and cost containment expenses" was revised by the National Association of Insurance Commissioners in 1998 to improve consistency of reporting among insurers, according to the I.I.I. That definition includes "defense, litigation, and medical cost containment expenses [an independent medical examination, for example], litigation management and fees for appraisers, private investigators, hearing representatives, and fraud investigators," but significantly not the cost of the claim representative who is supposed to adjust the loss. Other costs, said the institute, include "engaging experts and fees for rehabilitation."

Elsewhere in the same book, the I.I.I. tells us that net private passenger auto liability insurance premiums written in 2003 were $89,284,322,000. If defense costs at $4.17 billion represent 7.4 percent of incurred losses, incurred loss must be $56.35 billion, with the remaining $32.93 billion going to run the insurance companies, pay the adjusters, and give some dividends to the shareholders.

The I.I.I. also tells us that up to 20 percent of the claim dollar is lost to fraud (see last month's column), so that means that, absent the $11.27 billion for fraud and the $4.17 billion for defense, only $40.91 billion actually goes to pay legitimate auto liability claimants, an amount representing 46 percent of the premium dollar. That's a pretty awful level of return on the premiums paid.

Adjusters Could Do Better

My friend with his headlight lawsuit probably already had spent between $15,000 and $25,000 on defense, experts, IMEs, and other trial preparation, and the trial would cost at least that much more to conduct. The whole claim could have been settled for far less, even if the chances of his winning had been better than 90 percent, which they were not. The adjuster had done many of the correct things. He had had an engineer examine the evidence, he had found and taken a statement from a witness, he had even checked to see how much daylight there was at the scene at the time of day. He had photos of the intersection, which showed the presence of street lights.

When I started asking some other questions, however, he hesitated. Had he visited the claimant's home and measured how far it was from there to the scene of the accident? The claimant was on his way to work, he knew, but did he park his car in a garage? On the street? In a carport? Did he back in, or back out? If it were dark at the scene of the accident, which itself was a questionable fact, it had to be just as dark when the claimant started his car. If he had parked on the street and had only driven a block, that is one thing; but if he had to back out of a garage, make a few turns on dark streets to reach the point where the accident occurred, then there was going to be far less likelihood that he had done so without turning on his headlights, despite what a witness said she saw.

Besides, where was she? What was her position in relationship to the insured and the claimant? A good plaintiff lawyer can easily make mincemeat of even a reasonably good witness. "Decades of litigation research clearly show that, next to honesty, the most important factor regarding witness credibility has to do with that person's likeability," wrote Robert Gordon, director of the Wilmington Institute, a trial and settlement science firm located in Texas, in the May 2005, issue of For the Defense (Defense Research Institute). "No other factor — including witness testimony — comes close for jurors, arbiters, and even judges."

How well had my friend's defense counsel prepared his witness? "Effective witness preparation is about how fallible human beings project themselves during the stressful experience of testifying," Gordon said.

And what type of car was it? In my car, if the switch is on automatic, the lights come on in the dark whether I turn them on or not. In some cars, the lights come on day or night, regardless of whether they are switched on. Was this the case with the claimant's vehicle? My friend did not know. Hopefully his expert did.

Coming away from my conversation with the suspicion that my friend would lose his case, I wondered whether the investigation he had put into the case had been sufficient to make that all-important litigation management decision whether to settle or defend. The state in which the accident had happened was one with modified comparative negligence. His insured had turned left in front of an on-coming vehicle that, technically, had the right-of-way; and but for the issue of headlights, perhaps a factor for liability comparison, the claim was clearly owed. I had even asked my friend if the situation would have been different if his insured had turned left in front of a child on a bicycle on his way to school in the pre-sunrise intersection. He had not considered that.

Had he tried negotiation? No, he had a good witness, he thought, and that was all he needed. Had he tried mediation? Nope. He was not sure what evidence the plaintiff had that would come bubbling out at trial. Hopefully, his attorney knew and was not holding back information from the adjuster. It was all or nothing, like the song from Oklahoma. "It's all, or nuttin', fer me."

What had defense counsel recommended? Now, I ask you, what is any lawyer going to recommend? Litigate! Defend! They are not in the settlement business; that is the adjuster's job. They will submit their bills, win or lose. The same is not true for the plaintiff's attorneys, who is only going to get paid if they either win or settle.

The Adjuster's Best Tool

"Many may question what imagination has to do with ethics," I wrote in Winning by the Rules: Ethics and Success in the Insurance Profession (National Underwriter Co., 2001). "It has a whole lot to do with it, from the marketing of insurance to the settlement of claims. The agent or broker must use his imagination to envision the various exposures an insurance applicant may encounter, and to find the appropriate treatment for those exposures. The risk manager must be imaginative when ferreting out hazards. The underwriter must use imagination to envision what the risk she sees on paper really represents. The claim representative must imagine himself as the damaged party in order to recognize various aspect of the loss and to envision which ones fall within the limits of the policy. True empathy requires imagination."

If my friend loses his case in court, perhaps it may be because he failed to imagine the scene. He was not an outside adjuster, and that makes claim investigation — and imagination — difficult. It is one thing to look at photographs; it is quite another to actually visit the scene.

When the liability industry is returning less than 50 percent (and in some coverage lines less than 20 percent) of the premiums paid by insureds to legitimate third-party claimants, it is a national scandal. Some day some Elliot Spitzer-like politician will latch onto this fact and begin our own trial by fire. Imagine it, because what we are doing now is indefensible.

Ken Brownlee, CPCU, is a former adjuster and risk manager, based in Atlanta. He now authors and edits claim adjusting textbooks.