Tag Archives: disclosure

How Fine Print Ruins Customer Experience

The insurance industry has a trust problem – and that’s not even the bad news.

Consumers’ lack of trust in the financial services sector is well-documented. The Edelman Trust Barometer found that financial services was the least-trusted industry in the eyes of consumers.  According to an Accenture study, only 27% of consumers consider insurers to be trustworthy. And Deloitte found that only 11% of people have strong trust in insurance agents and brokers.

The worse news is that the industry’s preferred instrument for narrowing this trust gap might actually be widening it.

That instrument is consumer disclosure, and it has long been the insurance industry’s go-to strategy for cultivating trust: trying to provide transparency in coverage parameters, commissions and other thorny topics.

However, as currently practiced in insurance (and most businesses), consumer disclosure is far from the elixir the industry purports it to be. If anything, it is the antithesis of transparency, for two key reasons.

Disclosure Downside #1:  Readership

First, hardly anyone reads disclosures.  Admit it – as a consumer, when was the last time you read one?

Amazon.com has underscored this point in a most amusing fashion via the terms of service it provides to software developers who use its Amazon Web Services (AWS) platform. In the excerpt below, Amazon explains that customers can’t use AWS software to build “life-critical or safety-critical systems.”

However, as the highlighted section shows, the agreement lifts this usage restriction if the U.S. Centers for Disease Control and Prevention declare the presence of a “widespread viral infection transmitted by bites or contact with bodily fluids that causes human corpses to reanimate and seek to consume living human flesh…  and is likely to result in the fall of organized civilization.”

Yes, you read that right… Amazon is disclosing a contingency for the Zombie Apocalypse. If that catastrophe befalls us, you’re allowed to use AWS software for whatever you need to survive.

The fact that the flesh-eating undead can be referenced in an official document like this, with hardly anyone noticing, speaks to a larger and more serious issue: Disclosure documents are an awful way to communicate important information to your customer.

Companies bury important details in opaque disclosures that they count on no one reading. Examples abound – conflicts of interest for your financial adviser, service fees for your bank account, cancellation fees for your gym membership, price increases for your cable TV package and – of course – coverage exclusions for your insurance.

Organizations hide behind these disclosure documents and point to them as evidence that anything important is indeed revealed to the customer. The reality, however, is that many companies (and sometimes entire industries) use disclosures to convey information that they don’t really want anyone to see.

Disclosure Downside #2:  Comprehension

The second reason why disclosures fail to advance transparency and trust is because hardly anyone can understand them.

These are typically large, dense documents filled with unintelligible legalese and fine print (a shortcoming that was noted by the Federal Insurance Office in its own study of the industry’s transparency).

The Edelman 2018 Financial Services Trust Barometer found that consumers viewed “easily understood terms and conditions” as the No. 1 factor that would increase their trust in financial services. But, as the same study revealed, a lack of information transparency is the top reason why consumers distrust this industry.

There is a fundamental misalignment between what consumers value (information transparency) and what insurance firms actually deliver (information obfuscation). That discrepancy will continue to haunt the industry until disclosures are transformed from legally mandated administrative documents into genuine displays of customer advocacy.

Moving From Confusion to Clarity

Accomplishing that transformation will require reinventing the disclosure so it clarifies instead of confuses, and inspires confidence instead of undermining it.

Here are some examples of how the insurance industry could achieve that:

  • Make disclosures obsolete. One way to attack the disclosure problem is to minimize the need for these documents in the first place. While it would be naïve to think disclosures would ever go away in the highly regulated insurance business, firms should still ask themselves: Are there changes we could make in our business practices that would reduce the need for these mind-numbing disclosures? Southwest Airlines’ highly successful “Transfarency” strategy is a great example of this approach. In contrast to many of competitors, Southwest doesn’t have to agonize over consumer disclosures because it built the business around a simplified and nearly fee-free pricing structure (i.e., no baggage fees, no ticket change fees, etc.).
  • Design for visual appeal. Today’s jargon-filled insurance policy contracts, disclosures and amendments not only appear to have been written by lawyers, they appear to have been designed by lawyers. No offense to the legal community, but creating documents with visual appeal is not their forte. That is the domain of marketers, and it appears those folks rarely have an opportunity to work their magic on these types of insurance documents. They are often walls of text with little white space and few navigation clues. That might seem like an insignificant issue – marketing “fluff” – but it’s not. The layout, design and typography of a document can materially reduce the cognitive load it creates on the reader. Put simply, a visually appealing disclosure can engage and enlighten consumers much more effectively than a poorly designed one.
  • Use vignettes to build understanding. Even the most jargon-free disclosures suffer from an important shortcoming – they describe terms and conditions in an almost academic fashion, detached from the realities of people’s everyday lives. One can read a disclosure paragraph and gain a theoretical understanding of a concept (e.g., damage from floods vs. wind-driven rain), yet not fully grasp its practical application. This is where explanatory vignettes can be used to great effect. Serving as a complement to traditional disclosure language, these are short “stories” that depict a common customer episode and more vividly illustrate how the legal terms translate into real life impacts. (Some insurers, for example, use this approach to underscore what types of calamities are, and aren’t, covered by a policy.)
  • Leverage other communication platforms. The way people like to consume information has changed drastically in recent years, yet disclosures have not evolved accordingly. In today’s digitally enabled world, many consumers like to learn more by watching (video) than by reading (documents). Complex concepts that are conveyed in a written disclosure could be reinforced in a more engaging fashion via a few short videos delivered right to a policyholder’s inbox. The media used to communicate insurance disclosures haven’t changed in decades, but consumer behavior certainly has. It’s time for insurers to bring disclosures into the 21st century and leverage the digital communication avenues that so many other industries are using to great effect.

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If insurance providers want to strengthen their customer relationships and instill greater trust in their industry, they need to move beyond regulator-mandated disclosure. After all, just because something is legal, doesn’t make it right for your customer.

The key is to communicate with consumers in a clear and forthright way – and disclosures, if properly constructed, can help advance that cause.

It’s a cause that insurance firms should vigorously embrace because, when companies communicate with clarity, they send an unmistakable signal to consumers. It’s a signal that you’re advocating for them, that you’re helping them avoid unpleasant surprises – be it in the form of uncovered losses, unexpected fees or the zombie-induced fall of organized civilization.

And in the insurance business, that’s the kind of advocacy that makes for a great, trustworthy customer experience.

Future of Securities Class Actions

Securities litigation has a culture defined by multiple elements: the types of cases filed, the plaintiffs’ lawyers who file them, the defense counsel who defend them, the characteristics of the insurance that covers them, the way insurance representatives approach coverage, the government’s investigative policies – and, of course, the attitude of public companies and their directors and officers toward disclosure and governance.

This culture has been largely stable over the nearly 20 years I’ve defended securities litigation matters full-time. The array of private securities litigation matters (in the way I define securities litigation) remains the same – in order of virulence: securities class actions, shareholder derivative litigation matters (derivative actions, board demands and books-and-records inspections) and shareholder challenges to mergers. The world of disclosure-related SEC enforcement and internal corporate investigations is basically unchanged, as well. And the art of managing a disclosure crisis, involving the convergence of shareholder litigation, SEC enforcement and an internal investigation, involves the same basic skills and instincts.

But I’ve noted significant changes to other characteristics of securities-litigation culture recently, which portend a paradigm shift. Over the past few years, smaller plaintiffs’ firms have initiated more securities class actions on behalf of individual, retail investors, largely against smaller companies that have suffered what I call “lawsuit blueprint” problems such as auditor resignations and short-seller reports. This trend – which has now become ingrained into the securities-litigation culture – will significantly influence the way securities cases are defended and by whom, and change the way that D&O insurance coverage and claims need to be handled.

Changes in the Plaintiffs’ Bar

Discussion of the history of securities plaintiffs’ counsel usually focuses on the impact of the departures of giants Bill Lerach and Mel Weiss. But although the two of them did indeed cut a wide swath, the plaintiffs’ bar survived their departures just fine. Lerach’s former firm is thriving, and there are strong leaders there and at other prominent plaintiffs’ firms.

The more fundamental shifts in the plaintiffs’ bar concern changes to filing trends. Securities class action filings are down significantly over the past several years, but I’m confident they will remain the mainstay of securities litigation and won’t be replaced by merger cases or derivative actions. There is a large group of plaintiffs’ lawyers who specialize in securities class actions, and there are plenty of stock drops that give them good opportunities to file cases. Securities class action filings tend to come in waves, both in the number of cases and type. Filings have been down over the last several years for multiple reasons, including the lack of plaintiff-firm resources to file new cases as they continue to litigate stubborn and labor-intensive credit-crisis cases, the rising stock market and the lack of significant financial-statement restatements.

Although I don’t think the downturn in filings is, in and of itself, very meaningful, it has created the opportunity for smaller plaintiffs’ firms to file more securities class actions. The Reform Act gave plaintiffs’ firms incentives to recruit institutional investors to serve as plaintiffs. For the most part, institutional investors, whether smaller unions or large funds, have retained the more prominent plaintiffs’ firms, and smaller plaintiffs’ firms have been left with individual investor clients who usually can’t beat out institutions for the lead-plaintiff role. At the same time, securities class action economics tightened in all but the largest cases. Dismissal rates under the Reform Act are pretty high, and defeating a motion to dismiss often requires significant investigative costs and intensive legal work. And the median settlement amount of cases that survive dismissal motions is fairly low. These dynamics placed a premium on experience, efficiency and scale. Larger firms filed most of the cases, and smaller plaintiffs’ firms were unable to compete effectively for the lead plaintiff role, or make much money on their litigation investments.

This started to change with the wave of cases against Chinese issuers in 2010. Smaller plaintiffs’ firms initiated most of them, as the larger firms were swamped with credit-crisis cases and likely were deterred by the relatively small damages, potentially high discovery costs and uncertain insurance and company financial resources. Moreover, these cases fit smaller firms’ capabilities well; nearly all of the cases had “lawsuit blueprints” such as auditor resignations or short-seller reports, thereby reducing the smaller firms’ investigative costs and increasing their likelihood of surviving a motion to dismiss. The dismissal rate has indeed been low, and limited insurance and company resources have prompted early settlements in amounts that, while on the low side, appear to have yielded good outcomes for the smaller plaintiffs’ firms.

The smaller plaintiffs’ firms thus built up a head of steam that has kept them going, even after the wave of China cases subsided. For the last year or two, following almost every “lawsuit blueprint” announcement, a smaller firm has launched an “investigation” of the company, and these firms have initiated an increasing number of cases. Like the China cases, these cases tend to be against smaller companies. Thus, smaller plaintiffs’ firms have discovered a class of cases – cases against smaller companies that have suffered well-publicized problems that reduce the plaintiffs’ firms’ investigative costs – for which they can win the lead plaintiff role and can prosecute at a sufficient profit margin.

To be sure, the larger firms still mostly will beat out the smaller firms for the cases they want. But it increasingly seems clear that the larger firms don’t want to take the lead in initiating many of the cases against smaller companies, and are content to focus on larger cases on behalf of their institutional investor clients.

These dynamics are confirmed by recent securities litigation filing statistics. Cornerstone Research’s “Securities Class Action Filings: 2014 Year in Review” concludes that (1) aggregate market capitalization loss of sued companies was at its lowest level since 1997, and (2) the percentage of S&P 500 companies sued in securities class actions “was the lowest on record.” Cornerstone’s “Securities Class Action Filings: 2015 Midyear Assessment” reports that two key measures of the size of cases filed in the first half of 2015 were 43% and 65% lower than the 1997-2014 semiannual historical averages. NERA Economic Consulting’s “Recent Trends in Securities Class Action Litigation: 2014 Full-Year Review” reports that 2013 and 2014 “aggregate investor losses” were far lower than in any of the prior eight years. And PricewaterhouseCoopers’ “Coming into Focus: 2014 Securities Litigation Study” reflects that in 2013 and 2014, two-thirds of securities class actions were against small-cap companies (market capitalization less than $2 billion), and one-quarter were against micro-cap companies (market capitalization less than $300 million). These numbers confirm the trend toward filing smaller cases against smaller companies, so that now most securities class actions are relatively small cases.

Consequences for Securities Litigation Defense

Securities litigation defense must adjust to this change. Smaller securities class actions are still important and labor-intensive matters – a “small” securities class action is still a big deal for a small company and the individuals accused of fraud, and the number of hours of legal work to defend a small case is still significant. This is especially so for the “lawsuit blueprint” cases, which typically involve a difficult set of facts.

Yet most securities defense practices are in firms with high billing rates and high associate-to-partner ratios, which make it uneconomical for them to defend smaller litigation matters. It obviously makes no sense for a firm to charge $6 million to defend a case that can settle for $6 million. It is even worse for that same firm to attempt to defend the case for $3 million instead of $6 million by cutting corners – whether by under-staffing, over-delegation to junior lawyers or avoiding important tasks. It is worse still for a firm to charge $2 million through the motion to dismiss briefing and then, if it loses, to settle for more than $6 million just because it can’t defend the case economically past that point. And it is a strategic and ethical minefield for a firm to charge $6 million and then settle for a larger amount than necessary so that the fees appear to be in line with the size of the case. .

Nor is the answer to hire general commercial litigators at lower rates. Securities class actions are specialized matters that demand expertise, consisting not just of knowledge of the law but of relationships with plaintiffs’ counsel, defense counsel, economists, mediators and D&O brokers and insurers.

Rather, what is necessary is genuine reform of the economics of securities litigation defense through the creation of a class of experienced securities litigators who charge lower rates and exhibit tighter economic control. Undoubtedly, that will be difficult to achieve for most securities defense lawyers, who practice at firms with supercharged economics. The lawyers who wish to remain securities litigation specialists will thus face a choice:

  1. Accept that the volume of their case load will be reduced, as they forego smaller matters and focus on the largest matters (which big law firms are uniquely situated to handle well, on the whole);
  2. Rein in the economics of their practices, by lowering billing rates of all lawyers on securities litigation matters and by reducing staffing and associate-to-partner ratios; or
  3. Move their practices to smaller, regional defense firms that naturally have more reasonable economics.

I’ve taken the third path, and I hope that a number of other securities litigation defense lawyers will also make that shift toward regional defense firms. A regional practice can handle cases around the country, because litigation matters can be effectively and efficiently handled by a firm based outside of the forum city. And they can be handled especially efficiently by regional firms outside of larger cities, which can offer a better quality of life for their associates and a more reasonable economic model for their clients.

Consequences for D&O Insurance

D&O insurance needs to change, as well. For public companies, D&O insurance is indemnity insurance, and the insurer doesn’t have the duty or right to defend the litigation. Thus, the insured selects counsel, and the insurer has a right to consent to the insured’s selection, but such consent can’t be unreasonably withheld. D&O insurers are in a bad spot in a great many cases. Because most experienced securities defense lawyers are from expensive firms, most insureds select an expensive firm. But in many cases, that spells a highly uneconomical or prejudicial result, through higher than necessary defense costs or an early settlement that doesn’t reflect the merits, but that is necessary to avoid using most or all of the policy limits on defense costs.

Given the economics, it certainly seems reasonable for an insurer to at least require an insured to look at less expensive (but just as experienced) defense counsel before consenting to the choice of counsel – if not outright withholding consent to a choice that does not make economic sense for a particular case. If that isn’t practical from an insurance law or commercial standpoint, insurers may well need to look at enhancing their contractual right to refuse consent, or even to offer a set of experienced but lower-cost securities defense practices in exchange for a lower premium. It is my strong belief that a great many public company CFOs would choose a lower D&O insurance premium over an unfettered right to choose their own defense lawyers.

Because I’m not a D&O insurance lawyer, I obviously can’t say what is right for D&O insurers from a commercial or legal perspective. But it seems obvious to me that the economics of securities litigation must change, both in terms of defense costs and defense-counsel selection, to avoid increasingly irrational economic results.