The problem with third-party litigation financing
TPLF is a money-making scheme that turns our civil justice system into 'a casino.'
If you’re a commercial lines insurance agent, you know all too well the impact of rising litigation costs on the availability and pricing of coverages such as commercial auto, general liability and professional liability insurance.
It’s been almost two years since AM Best characterized the U.S. commercial general liability segment as having a negative outlook due to concerns over social inflation and third-party litigation financing (TPLF). As AM Best noted then, insurers have responded by pursuing large rate increases and tighter terms and conditions.
Anyone looking at the market now can see that conditions haven’t improved. As of March 2022, commercial auto, general liability, professional liability and medical liability all rate a negative outlook from AM Best. In all cases, to varying degrees, elevated litigation costs are a concern.
“Social inflation” is the term often used in our industry to describe the rising cost of insurance claims from increased litigation, larger jury awards, broader liability definitions and increased attorney advertising.
As an example, a recent Casualty Actuarial Society Research Paper, “Social Inflation and Loss Development,” found that “social inflation increased commercial auto liability claims by more than $20 billion between 2010 and 2019.” The authors, Jim Lynch and Dave Moore, also found evidence of a similar trend in other lines of liability insurance.
TPLF is pushing up insurance costs, too.
More recently, third-party litigation financing has become another, significant driver of social inflation. The U.S. Chamber Institute for Legal Reform describes TPLF as a “global multibillion-dollar secretive industry” that “allows hedge funds and other financiers to invest in lawsuits in exchange for a percentage of any settlement or judgment.”
TPLF involvement in cases is largely undisclosed and unregulated, so it’s hard to measure its full effect on insurance losses. However, a November 2021 study released by the Swiss Re Institute found that of the $17 billion invested in TPLF globally in 2020, fully half of the funds went to U.S. litigation funding companies.
Among the findings of the Swiss Re Institute:
- “TPLF is a contributor to social inflation, increasing the frequency of large claims and reducing insurability.”
- “TPLF cases push up costs by taking longer to resolve, and plaintiffs often do not see the benefit of higher awards.”
- “TPLF does not evidently enhance access to justice and creates ethical conflicts.”
The Swiss Re Institute concluded, “The result is an opaque, bottom-up wealth transfer from consumers to sophisticated investors, and a less efficient legal system, paid for through higher prices and insurance premiums.”
Commercial auto, general liability and medical professional liability are some of the insurance markets that third-party investors are thought to have targeted. Trucking, in particular, has been hard hit by litigation financing and “Nuclear Verdicts®.”
An adverse impact on trucking
A 2020 study by the American Transportation Research Institute (ATRI) revealed that the average size of a trucking industry lawsuit verdict grew from $2.3 million in 2010 to $22.3 million in 2018, an increase of 967%. ATRI found that verdicts far exceeded standard inflation and health-care cost increases. “From 2010 to 2018, mean verdict awards increased 51.7% per year in contrast to inflation and health-care costs, which on average grew 1.7% and 2.9% per year, respectively,” ATRI reported.
ATRI found that insurance rates increased at similar rates as litigation awards. “Over the last two to five years,” ATRI said, “commercial truck insurance premiums have increased annually between 35% and 40% for low- to average-risk carriers.”
ATRI reports that insurers have raised annual premiums across all fleets, regardless of safety ratings; are being more selective in who they insure; and, in some cases, are withdrawing from the market altogether.
Ripe for reform
The practice of financing lawsuits isn’t new, but it seems to be growing unchecked. Aside from contributing to social inflation, there are several other very troubling aspects to TPLF that make it ripe for reform:
- TPLF agreements are potentially unethical because the plaintiff’s attorney may feel obligated to maximize a case’s return for the investors, which may not be in the client’s best interest. An attorney’s duty should be to the client, not a hedge fund.
- TPLF runs counter to the nature of the contract of insurance. Policy coverages are intended to restore and compensate an individual or business in the event of loss. They are not intended to enrich a group of largely detached and disinterested investors.
At Westfield, we believe when we make a payment on a policy, the injured party’s interest should predominate. TPLF undermines the intent of insurance to fairly make whole the claims of those who are actually harmed and entitled to restitution.
What can be done?
At a minimum, litigation-financing agreements should be disclosed to all parties in a suit. Several states and federal district courts have acted to require disclosures, but more needs to be done.
Consumers must be better protected from egregiously high interest rates on the money advanced to pay for a lawsuit. Recognizing that need, a bill being considered in Missouri, HB 2771, would give consumers the right to cancel their funding contracts within five business days without penalty. The bill also makes it clear that these consumers don’t owe anything if their lawsuit is unsuccessful and won’t have to pay more than the recovery amount if they win.
Insurers have also sought approval from state insurance departments to include “defense-within-limits” provisions in liability policies to cap legal expenses and give plaintiffs an incentive to avoid lengthy litigation.
Agents can get behind groups such as the American Property Casualty Insurance Association (APCIA) and their Big “I” state association in their fight to stop insurance lawsuit abuse. They also can work with their clients to identify and reduce the types of claims that are most likely to lead to a costly lawsuit.
In the end, we need to get more courts and legislatures to see TPLF for what it really is: a money-making scheme that turns our civil justice system into “a casino,” as APCIA characterizes it, rewarding wealthy speculators, distorting insurance markets and contributing to the high prices we pay for goods and services.
Robyn Hahn is president of commercial lines at Westfield. She can be reached at RobynHahn@westfieldgrp.com. A leading property-casualty carrier founded in 1848, Westfield provides personal insurance in 10 states, commercial insurance in 21 states and surety products in all 50 states. It is based in Westfield Center, Ohio.
These opinions are the author’s own.
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