By Diane Injic
It started in Australia, made its way to Europe, and has been growing in the United States. In fact, litigation funding has grown 414 percent in this country from 2013 to 2017, according to a 2017 report by Burford Capital. It’s now a multi-billion-dollar business.
Generally, in litigation funding, third-party investors provide funds to plaintiffs to pursue lawsuits against large companies, oftentimes insurers. It’s become a hot emerging issue and can significantly impact the insurance industry. This is especially prevalent in commercial auto insurance, where the use of litigation funding could be helping to drive up claim severity.1
With the current state of the commercial auto insurance industry being very challenging, where losses are outpacing premiums as Verisk research has shown, litigation funding could be another obstacle for profitability. Commercial auto carriers have deeper pockets, busier drivers, riskier payloads, and other conditions that make cases attractive to third-party investors willing to support higher payouts to plaintiffs for claims.
The practice of litigation funding is complicated by the fact that disclosure laws requiring plaintiffs to reveal they’re being supported by a third party are rare. In 2018, Wisconsin passed a law that requires litigants to disclose any agreements where third party funders could receive a share of earnings from the lawsuit.2 Multiple states have adopted laws regulating some aspects of litigation funding.3 Even so, insurers can be surprised by a claimant with unexpected financial resources during a legal action.
The litigation funding that can concern insurers is generally where a third-party investor provides funding for litigation costs in exchange for part of the eventual payout. The litigation funder provides money to the plaintiff and takes a calculated risk that there will be a payout in the case large enough to return the investment plus a profit.4
The percentage of the return to the investor is usually quite large, and to avoid certain penalties and limitations, the investor reportedly will structure the agreement as a non-recourse cash advance—an investment, not a loan.5 In these agreements, the plaintiff isn’t charged anything if the case is lost.
Litigation funding’s impact on insurers can be huge, starting with the potential for nuclear verdicts. Commercial auto insurers consider anticipated risks and predicted losses as part of the calculation in determining premiums. Unanticipated large claim settlements or verdicts, like those supported by litigation funding, can result in large payouts with a severe negative effect on the bottom line.
Payouts in commercial insurance cases can often be larger than in personal insurance due to the liability limits of the policy, type of plaintiff, and the other financial resources a commercial insurer may be willing to commit. Litigation funders that use the practice on a portfolio level may take on cases just to spread out their risk, lengthening the time and cost of a case for an insurer.
If litigation funding provides the incentive to bring frivolous cases, insurers have to spend time and money fighting them, increasing claims expenses. With the lack of disclosure laws for litigation funding (with the exception of Wisconsin and West Virginia), insurers can be blindsided when a case continues to grow because the plaintiff now has more financial resources.12 Many insurers may settle a case to avoid ongoing litigation and prevent increasing the size of the reward, expenses, and time spent on the case.
Insurers could face systemic liability risks from a number of trends. Are you prepared?
First published in two parts on Visualize: See Part 1 and Part 2.
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