Using Insurance to Change the Paradigm of Litigation Finance

Feb 27, 2024 Blog
Using Insurance to Change the Paradigm of Litigation Finance

Insurance companies are entering the litigation finance space in a variety of ways. But they must learn how to work with funders and not compete with them, experts say.

Litigation financing has become a vital resource for claimants, law firms, and companies looking to break down financial barriers to accessing justice. It has also helped to deflate the costs associated with bringing cases through trial.

Insurance is a contract between an insurer and a policyholder.

The insurance industry relies on contracts to define and enforce the terms and conditions of their relationships with clients. This is especially true for insurance policies, which are complex instruments with wide-ranging ramifications for individuals and businesses alike. However, not all contracts are created equal. Understanding the distinction between two types of crucial contracts can help you make better decisions about how to manage your risks.

Litigation financing, third-party funding, litigation capital and dispute finance are just some of the monikers given to an emerging industry that provides capital to law firms and claimants collateralized solely by the future proceeds of their meritorious legal claims and cases. In addition to facilitating access to justice on a broader scale, it can also provide lawyers and claimants with the flexibility to resist low-ball settlement offers.

Until recently, the stifling financial barriers of high-stakes litigation have forced many claimants to forgo legal recourse, even when they have strong claims that should be litigated. This imbalance in resources can distort the legal outcome for under-capitalized litigants, and it is a major impediment to the fair and efficient resolution of disputes. Lawsuit financing addresses this problem by providing cash-starved plaintiffs with an effective substitute for traditional lines of credit such as loans.

Litigation finance can be broken down into two categories: consumer lawsuit financing and commercial litigation funding. The former may include personal injury cases that serve to support injured claimants, while the latter typically consists of corporate disputes and commercial matters.

In the United States, the use of litigation finance has been subject to significant legal challenges, primarily in the form of state statutes and case law that prohibit the practice. Despite this, the market has grown significantly over the past decade. There are now several national litigation finance firms that specialize in these areas.

Despite the fact that it is illegal to violate state laws prohibiting the practice, federal courts have been reluctant to enforce these provisions. In fact, in a key case called Miller UK Ltd. v. Caterpillar Inc., the court ruled that the funding agreement was not what the Illinois legislature intended to prevent, and therefore was legal.

Insurance is a form of risk management.

The insurance industry faces many risks, including credit risk and operational risk. Credit risk arises from the inability of policyholders to pay premiums, which could result in a loss for the insurer. Operational risk relates to the ability of employees and systems to fulfill policies. The best way to manage these risks is by identifying and implementing controls that will minimize their impact. These control activities can be as simple as centralizing incidents and analyzing data to identify trends, or they can be more complex, such as deploying a new technology that reduces the probability of system failure.

Litigation finance is a growing industry that provides capital to claimants, law firms, and companies to help them fund their legal disputes. It also enables businesses to offset litigation risk and optimize their balance sheets. Litigation finance can be divided into two categories: consumer and commercial litigation funding. Consumer lawsuit funding includes funds for personal injury and wrongful death claims, while commercial litigation financing supports businesses involved in high-stakes business cases.

Unlike traditional debt, which can have an ongoing repayment obligation regardless of the outcome of a dispute, litigation financing is non-recourse. This means that investors only receive a return on their investment if the case is successful. This removes the risk of unfavorable cost judgments from the investor’s perspective, and it also alleviates the burden of ongoing interest payments for the funding recipient. Moreover, litigation funders’ investments are collateralized by the lawsuit itself, so in the event of a dispute resolution, the investors’ assets remain protected.

In addition to the financial benefits of litigation finance, the industry also delivers significant accounting advantages to companies and law firms. Unlike loans, which increase operating expenses and reduce profitability, dispute funding can be reported as revenue and can even be off-balance sheet until the matter is resolved. Moreover, the use of litigation financing avoids the costs associated with maintaining attorney-client privilege and work product immunity.

As the industry has grown, questions have arisen about its regulation. In response, the ICCA-Queen Mary taskforce on litigation funding developed a set of guidelines to ensure consistent rules and procedures across jurisdictions. These guidelines are based on the principles of fairness, openness, and transparency. They also address ethical considerations, such as conflicts of interest and the need to preserve the integrity of the justice system.

Insurance is a business model.

Insurance companies are fascinating machines that balance risk, investment, and the need to make a profit. Essentially, they are in the business of predicting the unpredictable and putting a price tag on it, then investing that money to pay for what may or may not happen in the future. This is known as the ‘float’ and it forms an essential part of an insurer’s revenue stream.

Litigation finance has come into vogue in the United States as a way to give claimants, law firms, and companies better access to the American justice system. However, the industry is not without its critics. Many have questioned the legitimacy of litigation funding, accusing it of violating established legal doctrines of champerty and maintenance. But the use of third-party funding is a viable model that allows legal professionals and businesses to pursue meritorious cases, lower their litigation costs, and achieve fairer legal outcomes in court.

Disputes and litigation can be expensive, time-consuming, and disruptive. For many claimants, the prospect of having to pay for a lawyer or fund their own defenses is enough to discourage them from filing a lawsuit. Wrongdoers can also weaponize their financial superiority by dragging out disputes and driving up legal costs.

This is why it’s so important for businesses to consider litigation financing as a way to lower their legal costs and increase the likelihood of winning a case. Fortunately, there are several litigation finance firms that can provide non-recourse funding for a variety of claims. These funds are typically invested in securities, equities, and cash, and are subject to regulatory oversight by the state in which the case is filed.

The emergence of Insurance-as-a-Service (IaaS) models is making it easier for global enterprises to integrate a full suite of legal and insurance services into their digital ecosystems. These specialized insurtechs can deliver a fully integrated platform with the capability to instantly scale and consume insurance capacity. This enables them to compete with traditional brokers, while reducing the cost and complexity of the integration process. For example, Cowboy, a Belgian e-bike brand, leveraged IaaS platform Qover to offer its customers the option of buying bike insurance directly through the app.

Insurance is a financial product.

There is a large untapped market for insurance-backed legal finance. Insurance is a powerful tool that allows funders to leverage their portfolios and mitigate risk. In addition, it enables funders to offer a broader range of financing options for their clients. Insurance can also be used for a variety of purposes, including litigation and arbitration.

Insurance backed legal finance is quickly gaining traction in the litigation funding industry. Insurers are offering innovative products that can help firms manage risk and gain settlement leverage. These products can be tailored to the specific needs of each case. They can also be used in conjunction with other legal finance solutions, such as litigation funding and ATE insurance.

Litigation insurance is an attractive alternative to traditional funding sources, especially in cases where a high-value verdict may be expected or where the plaintiff has substantial financial assets that could be used as collateral for a loan. It also provides a way to hedge exposures, which can reduce the cost of capital for investors in complex commercial cases.

The emergence of insurers in the legal finance industry has been a boon for both plaintiff and defendant side lawyers. However, the two sectors must learn to coexist. For example, plaintiff side attorneys need to be able to explain to their client the risks of litigation financing to help them make an informed decision. Insurers, on the other hand, need to be aware of the potential for fraud and other legal issues associated with litigation financing.

Many large litigation funds rely on insurance-backed financial structures to finance their investment portfolios. This allows them to secure a larger amount of financing from their institutional investors and to mitigate the risks of large individual cases.

While some funding companies have been accused of overstating their abilities, most are reputable and have a track record of success. However, there are also bad actors in the industry who take advantage of vulnerable consumers. These funders are often not licensed with state regulators and do not disclose their funding arrangements to clients. They may even give kickbacks to medical professionals or other parties involved in the case, and they often charge extremely high interest rates. The Alliance for Lawful Access to Funding (ALFA) has supported legislation in several states to regulate these practices.

By Gabriel