In the first part of this series, we explored what litigation funding is and its potential impact on commercial auto insurance. In this second part, we explore this topic further, and some ways insurers can help protect themselves.
The type of 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. As explained in an article in Law Journal Newsletters,1 the litigation funder provides monetary resources 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.
Impact on insurers
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), insurers can be blindsided when a case continues to grow because the plaintiff now has more financial resources. 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.
Some issues with litigation funding
Verisk staff research has shown that states and the federal government are looking into the practice of litigation funding, especially the issue of disclosure. Insurers and others are pushing for strong disclosure laws and the right to know when a third-party investor is involved. It’s not a black-and-white issue, however, as there are privacy considerations.
Additional litigation funding methods are under scrutiny because they could create other situations for plaintiffs. The U.S. News & World Report article discusses a situation where a plaintiff may have a settlement that’s not paid out yet. Instead of providing money for legal fees, the litigation funder might give advances against the final payout for other expenses, and these advances could have very high interest rates. The article also noted that as plaintiffs are often considered vulnerable targets, the Consumer Financial Protection Bureau has shown serious interest in protecting them. There’s a concern that more and longer lawsuits can add cases to an already busy legal system.
What can insurers do?
Litigation funding is a relatively new practice in the United States and has many unknowns. How does the relationship between attorneys and investors develop, and how does that affect insurers? Other than hedge funds, what’s the general profile of an investor? What are the typical returns on such cases? How many who seek litigation funding get it? What percentage of plaintiffs win these type of cases?
As investors generally take on cases they believe they can win, insurers should consider what makes a case attractive to investors:
- Did the insurer do something wrong?
- Are there commonalities in cases investors take?
- Were the policies inadequate or contain certain loopholes?
- Are the inadequacies caused by relying on incorrect policy language or the inefficient use of proprietary or non-standard forms?
Third-party litigation funding is expanding and clearly can impact commercial auto insurers. Currently there are no reliable tools to help mitigate litigation funding cases, and research is necessary to provide data and analytics. However, standardized coverage forms, assessments of risk and loss controls, and in-depth data and analytics on vehicles and drivers can help mitigate a commercial auto insurer’s exposure. Find out how Verisk's commercial auto tools can help.
1. Law Journal Newsletters, October 2017,“Third-Party Litigation Funding,” by Jonathan Friedland, Elizabeth Vandesteeg, and Jeffrey Goldberg