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Demutualization. Now there’s a good word for hypnotists to use on their subjects — but only on the right ones. While repeatedly chanting the D-word will make most eyelids droop, its mere mention makes some folks drool. Here’s why. The process of transforming, or “demutualizing,” an insurance company from a mutual, or policyholder-owned, business to a publicly traded, shareholder-owned company, is complicated stuff. Insurers pay outside counsel hefty fees for help in overseeing these elaborate transformations. In 1999 and 2000 the Metropolitan Life Insurance Company paid some $30 million to the law firms that shepherded the company’s IPO. High legal bills are nothing new for the insurance industry. But what has changed over the last few years is the type of legal work these companies require. Demutualization became the rage, and trial lawyers found the life insurance industry a lucrative target for a variety of class action suits. As a result, the work handled by insurers’ primary outside counsel has shifted. And in many cases so have the firms handling these complex issues. In 1994 Corporate Counsel‘s sister publication, The American Lawyer, looked at the outside legal costs of life insurers and the law firms that got their business. For this article and the accompanying charts, we tallied the numbers again, this time for the year 2000. There were a number of noteworthy changes. The top 10 law firms raked in $136 million in life insurance billings in 2000, compared to $70 million in 1994 — almost a 100 percent increase. Which firms earned all that money? At the top of the list are Skadden, Arps, Slate, Meagher & Flom (which billed life insurers a gigantic $59.8 million in 2000), Sonnenschein Nath & Rosenthal ($19.4 million), and Proskauer Rose ($13 million). There are other significant changes. The roster of the top 10 highest-billing law firms changed over the last few years. Only four firms that appeared on our top 10 list in 1994 remained on the list six years later: New York’s Skadden; Chicago’s Sonnenschein; New York’s Debevoise & Plimpton; and Los Angeles-based Gibson, Dunn & Crutcher. Three Washington firms — Wiley, Rein & Fielding; Sutherland Asbill & Brennan; and Steptoe & Johnson — dropped out of the top 10 in 2000, while more New York heavyweights, such as Proskauer; LeBoeuf, Lamb, Greene & MacRae; and Dewey Ballantine joined the top ranks of firms with hefty revenues from the insurance industry. The change in firms’ popularity reflects both industry trends and law firm priorities. Some firms, such as Proskauer, aggressively pursued more business from the sector. “We’re consciously increasing the amount of work we do for insurance companies,” says the firm’s chief operating partner, Robert Kafin. He also points out that since 1994 fees have grown for some firms and dropped for others because of “convergence.” Insurance companies, he explains, have tried to cut legal costs by reducing the number of outside firms they use and picking one or two strong ones to serve as coordinating counsel, essentially managing and overseeing all aspects of a client’s legal needs. “This way we become part of the client’s risk management team rather than acting as just a hired gun,” Kafin says. OPENING THE CHECKBOOK On the other side of the ledger are the life insurance companies. Legal costs for the top 10 insurers rose from about $224 million in 1994 to $251 million in 2000. Last year the nation’s two largest insurers, MetLife and Prudential Insurance Company of America, accounted for nearly 70 percent of the top 10′s total billings, as compared to 45 percent in 1994. Those fees were largely a result of demutualization costs and litigation defense. Prudential, based in Newark, is in the midst of demutualizing, and spent some $87 million in legal fees in 2000, including millions at a few New York firms — Sullivan & Cromwell; Skadden; LeBoeuf; and Debevoise. While demutualizing is costly and complex, it can also bring in heaps of cash for life insurers. Beginning in the mid-1990s, federal regulatory changes let insurance companies branch into other businesses, including banking and other financial services. This development, say industry analysts, spurred a rush to Wall Street for funds to fuel this growth. Going public meant ready money. But the process isn’t easy. Life insurance IPOs are fundamentally different from standard public offerings. “In addition to the IPO, the company is reorganizing,” says Wolcott Dunham, a partner at Debevoise who has worked on more than a dozen demutualizations. “Demutualizations take longer than the average IPO because of the work needed to calculate the nature and value of the allocation to policyholders.” Demutualizations also take longer, says John Coates, a professor of securities law at Harvard Law School, because “the process lacks the owner-driven urgency of a typical IPO. There’s not a clear way to share the benefits of the stock offering. It should go to the policyholders, but they’re uninformed and dispersed, and generally don’t care.” Most people who hold insurance policies with a mutual company don’t even know they own part of that insurer, says Michael McNamara, who teaches the business of insurance at Washington State University. McNamara has a policy with Equitable Life Assurance Society, and when it demutualized in 1991, he says, he got “what seemed like five pounds of mail from them every day. Most people will set that aside, and it comes as a surprise to them to find they have something valuable.” But some people are paying very close attention to the insurers. Prudential faces a number of lawsuits from policyholders claiming that the company’s proposed IPO will give shares to other policyholders who aren’t eligible to receive them. One suit on behalf of a group of Prudential policyholders was filed in New Jersey by lawyers at New York-based Milberg Weiss Bershad Hynes & Lerach. The demutualization plan “dilutes by about 11.8 percent the rights of participating policyholders,” says Brad Friedman, a Milberg Weiss partner. A Prudential spokesman, citing pending state review of its IPO plan, declined to comment. The company has said in statements that its plan is “fair and equitable” to all policyholders. WHERE THE MONEY IS One other significant factor drove the life insurance industry’s legal bills in the late 1990s. The sector saw a rise in class action law suits alleging a variety of misleading policy sales and claims payment practices. Those cases mushroomed over the last few years. In the mid-1990s, explains Alan Gilbert, a partner at Sonnenschein, a number of top plaintiffs’ lawyers saw the potential of wrongful sales practice cases. Mutual insurance companies have deep pockets, millions of customer-owners, and controversial sales practices. In other words, they’re perfect class action targets. Defending an insurer in a class action lawsuit is complex and costly. MetLife bestowed $44 million on Skadden in 2000 for managing the insurer’s class action litigation load. Prudential also reported steep legal costs. In 1994 the insurer posted legal fees of $64 million, much of it spent defending the company against class action litigation. Six years later Prudential was still fighting some of those suits and spent $30 million on litigation-related legal costs. Sonnenschein picked up $19 million defending Prudential in 2000, and at least a dozen other firms took in more than $1 million in fees last year for representing the insurer. A look at the legal bills of New York Life Insurance and Annuity Corp. reveals how much insurers’ legal bills can swing from year to year depending on litigation. In 1994 New York Life paid Debevoise $20 million to defend the company against a single class action suit and related state regulatory investigations. New York Life’s total legal fees that year hit $45 million. In contrast, the insurer’s overall legal bills for 2000 totaled just $18.3 million. “These cases are much more expensive to litigate than the routine, day-to-day cases,” says Sheila Davidson, general counsel of New York Life. “We’re very active in tort reform efforts for that reason — it’s not a very effective use of resources.” Trial lawyers continue to file new kinds of cases based on this litigation model. Currently, 18 life insurers are involved in “modal premium litigation,” primarily in New Mexico, but also in a handful of other states. Those cases allege that the insurers did not disclose that policyholders who paid their premiums monthly or quarterly paid a few dollars more than those who paid annually. Two other litigation trends surfaced recently and will likely take years and a lot of cash to run their course. Almost every major insurance company, says Sonnenschein’s Gilbert, now faces accusations of racially biased sales practices. Those cases charge that black policyholders paid higher costs and were sold policies inferior to the ones offered white customers. Many of the policies were sold in the 1940s and 1950s and are still in effect. MetLife has been sued in federal court in Manhattan over this matter, and most other major life insurers are in state litigation. Moreover, says Gilbert, state regulators are investigating the sales practices of dozens of other life insurers in this area. Those cases, say industry analysts, could cost the sector billions. Which means millions, at least, for the law firms involved on both sides. A new kind of litigation is also just starting to appear: unpaid death benefits cases. Many people, especially the poor, buy multiple life insurance policies — often for just several hundred or a few thousand dollars each. A small but growing number of suits demand that insurance companies search their records for additional policies that a deceased policyholder may have held, in addition to the one claimed. Right now, says Gilbert, state laws don’t require life insurers to conduct those searches. LOOKING FORWARD But that doesn’t mean insurers won’t have to pay to make their case. As long as the trial bar remains entrepreneurial, and companies can spin off shares for ready cash, legal fees for the industry will stay high — and law firms will stay happy. But demutualization can’t go on indefinitely. Eventually there won’t be many mutually owned insurance companies left. As for litigation? Well, that’s another story. Related charts: Outside Legal Costs Incurred by Life Insurance Companies How Legal Costs Compare at Selected Insurance Companies Law Firms With Largest Billings From Life Insurers in 2000

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