(Credit: ImageFlow/Shutterstock.com)

Law firms continue to raise their rates, which helped offset a drop in demand for legal services that appears to be worsening, according to a report released Monday by Thomson Reuters’ Peer Monitor.

Demand fell by an average of 1.1 percent in the third quarter of 2016 after falling 0.9 percent in the second quarter, the report said. The decline in demand over the last six months comes after more than two years of steadily increasing demand, according to Peer Monitor.

Because the drop in demand is measured as hours billed, some of the decline could reflect a move away from the billable hour toward alternative fee arrangements, such as contingency fees.

“More work being brought in house and increased competition from places such as legal process outsourcing” are also contributing to the decline, said Leonard Lee, an analyst at Peer Monitor.

The report also found that expenses have hit their highest levels in at least four years. The rising costs of technology, marketing, recruiting and staff compensation lifted law firms’ expenses by an average of more than 4 percent in the third quarter, Peer Monitor said.

Attorney head count grew 1.2 percent, which may have contributed to both the rise in expenses and a decline in productivity, something that Peer Monitor defines as average hours billed per attorney. Productivity has been declining steadily in the last three years, according to Peer Monitor, dropping a sharp 2.5 percent during the last quarter, said its latest report.

Not all practice areas are feeling the drop in demand equally. Patent prosecution and corporate departments saw demand rise 1.3 percent and 0.5 percent, respectively, last quarter. Litigation dropped 1.9 percent in the third quarter and is down 1.4 percent from last year. Demand for bankruptcy, labor and employment, real estate and tax work each fell by more than 1.5 percent and are down compared to this same time in 2015.

One metric that continues to rise in the legal industry is rates. Firms increased their rates by an average of 3.1 percent in the third quarter, while cash collections were up 2.3 percent. While increasing rates can help firms grow their revenue even as they bill fewer hours and expenses rise, an earlier Peer Monitor report found that firms that grew their rates at a slower pace also saw an increase in hours billed.

The Peer Monitor report concluded that 2016 has been volatile for law firms.

“Barring a sharp reversal in the fourth quarter, 2016 could very well be on course to see the first down year in demand since 2013,” the report said.

Citi Private Bank’s law firm group has also registered a volatile year. The financial services giant reported what it called a surprising 1.8 percent growth in demand during the first quarter of 2016, followed by almost flat demand in the second quarter.

In August, the bank forecast “low single-digit profit growth” for 2016.