Heightened Risk

The first of April this year was a landmark day in the calendar for personal injury firms, with the introduction of wide reaching change in the claimant personal injury market, beyond anything experienced before.

Unlike Lord Woolf’s Access to Justice reforms, which provided massive opportunity for personal injury specialists, April’s changes created challenges to the economic model. The reforms mean that only the most efficient firms will be able to operate profitably in the sector, and the rest must quickly wake up and face reality instead of sitting in denial, hoping they won’t be affected.

Lessons from Scotland

With regards to remuneration per matter, the situation is now not dissimilar to the judicial scale charges structure that has existed in Scotland for decades. While the scale charges in Scotland remained static, the value in personal injury was eroded over a long period of time. With the axe that fell on 1 April, the value in England and Wales has been dramatically reduced overnight. The probability of a similar outcome is highly likely.

When considering the financial rewards available for performing the work, while there was a time when most firms in Scotland handled claimant personal injury work, today that has fallen to around 20 firms, and eight of these carry out some 80% of the work. South of the border, just as the erosion in value happened overnight, so the consolidation of firms operating in personal injury in England and Wales is likely to happen much faster than it did in Scotland, once the cash still flowing from pre-1 April retainers runs out. What’s more, with the ban on the payment of referral fees in April, a further complication was introduced which fundamentally changed the landscape with respect to how firms attract work in the first place.

Today, the number of firms estimated to be exposed to claimant personal injury work is in excess of 4,000. But – based on the Scottish experience and adjusting the figures according to population – a rough and ready calculation suggests that in the not too distant future, less than 100 firms will be handling 80% of claimant personal injury work in England and Wales.

Areas of risk

Setting marketing challenges aside, quite simply, if firms do not innovate to attract new work, their time in the sector is limited. They must tackle key areas such as the risk management of work performed on a speculative basis, their cost base, their systems of financial and internal control and, finally, the availability of working capital.

Managing risk associated with performing work speculatively on a Conditional Fee Agreement (CFA) has been a steep learning curve for the legal profession since the introduction of Access to Justice in 2000. Those that have done it well have been extremely profitable and cash rich in the last decade. But the majority of firms have enjoyed profitability despite poor risk and financial management, simply as a result of the attractive levels of remuneration for the work performed in the standard personal injury areas of road traffic accidents, employment liability and public liability.

Putting that into numbers, before the introduction of the RTA portal and its fixed fees, firms in England and Wales enjoyed average remuneration per matter of £2,800.

Using the previous activity and extrapolating forward using the new fixed fee levels, the consensus is that this £2,800 will dramatically drop to a figure in the region of £750 per matter. Looking at a snap shot of ten cases, under the previous fees regime, only winning three cases out of ten would still generate revenue of £8,400. But today, that revenue cannot be achieved; even winning ten out of ten cases would result in just £7,500 of revenue, plus a potential contribution from the claimant by way of a deduction from damages.

No firm will admit to only winning three out of ten cases, and there is no doubt the profession is no longer as naive about the quality of the information presented to them at the outset of a given matter. That said, it is only those with short memories that have forgotten how many firms faced a challenge from the after-the-event insurers for the inadequate vetting following the demise of The Accident Group.

Reducing cost base

Firms that believe dramatically improving risk management is the answer, or even straightforward, are wrong. Those that do not already have an iron grip on this have fallen far behind the leading firms, and the new economic environment does not lend itself to playing catch up. Significant financial investment is needed to restructure the cost base, de-skill where possible, and drive in controls and efficiencies via a robust use of IT.

But while moving to a process-driven environment and reducing the cost of labour is essential if profitability is to be achieved, care must be taken to avoid under settling cases and exposing the firm to professional negligence. Robust systems of internal control are therefore a fundamental requirement, and making sure that staff at management level have the right skill set to handle more complex matters when identified must underpin any systems implemented.

Sound financial and operational management information is already one of the factors that separate the truly successful firms from those that have done well in the last decade. The new environment demands this level of management information, and businesses now need to formulate a clear strategy for the future if wasting the existing asset is to be avoided. In general this comes with scale, although there are exceptions, as the necessary skill sets are expensive, and generally not the product or outcome of legal training alone. In general, sole proprietor and small partnership businesses will find this difficult to accept, never mind implement, not least from an affordability perspective.

In addition, the traditional sole practitioner / partnership set ups have not historically led to profits being reinvested in the business, with profit often taken as drawings instead. This makes it harder to fund working capital within a personal injury business, as all banks have now invested in sector specific knowledge, and are reluctant to underwrite such businesses without a proven track record of success in the areas already covered.

Firms must be proactive, decide on a strategy and restructure their businesses accordingly, or they may need to exit the claimant personal injury sector if the funding, source of work and appetite to restructure is not there.

Law firm mergers

Those firms that did not restructure in the run up to 1 April are now likely to be considering their options, and while there are number of choices, doing nothing is not one of them.

There are a growing number of acquisitive firms looking to absorb or merge with others. The criteria
or fit of these firms tend to fall into two camps. The first are robust, financially sound firms with strong management, tangible routes to market and also scale, which are seeking to merge. The second are more frantic, with firms looking to leverage their historic financial prudence and use their reserves to buy up other law firms or books of businesses at discounted values.

Whatever camp a personal injury law firm lies in, there will be several pricing strategies for acquiring another personal injury business, based on a price/earnings ratio, a discounted work-in-progress value, or a combination of both. Another option for firms looking to move out of the sector is to run off the existing case load within the firm; while a further option now available to personal injury law firms is to outsource this run off, effectively selling the business for a deferred consideration.

Tough decisions will have to be made, and so the sooner these are tackled, the better.

PI Focus October - Heightened Risk (5.3 MiB)