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USA: An Introduction to Litigation Insurance Brokers

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The Case for Litigation Insurance 

Litigation insurance is a creative solution to solve problems found at the complex intersection of business, legal, risk, and loss. Businesses that are facing known legal issues or currently engaged in active litigation face a road of unpredictable risks and unknown financial liability. From securities class actions and merger objection suits to environmental liability cases and potential regulatory investigations, litigation at the corporate level is ever-present on both the plaintiff and defense side, causing companies significant financial stress that weighs heavily on their respective balance sheets. 

Historically, once a lawsuit was initiated, in the absence of insurance markets capable of underwriting and bearing some of that risk, a corporation or law firm simply had to suffer monetary damages or fight the case. For example, a corporation facing a large lawsuit might have to reserve substantial capital on its balance sheet to cover potential damages from the litigation, even if it thinks the likelihood of having to pay the claimed damages amount is minimal. On the flip side, a corporation that won a large verdict at trial might be unable to account for the value of its judgment—a contingent legal asset—because there is a possibility that judgment will be reduced or overturned on appeal. In each of these examples, the corporation was forced to bear the entirety of this risk on its own, without the ability to cost-effectively defray a portion of that risk to an insurance market. This all changed with the adoption of litigation insurance.

Types of Litigation Insurance & Use Cases 

Litigation insurance is designed to help corporations and law firms lighten the financial load presented from active litigation. For those companies defending against a lawsuit, once litigation begins, it is incredibly difficult for the company to (i) project the realistic exposure from the case and (ii) when it might owe the plaintiff money if it loses the lawsuit. For companies prosecuting litigation, it is similarly difficult to (i) project the value of the legal claim and (ii) when the contingent asset (ie the legal claim) might be paid by the defendant. All of this breeds financial uncertainty.

Litigation insurance has several products designed to solve the uncertainty posed by active legal issues. In essence, the product helps take a contingent liability or asset (unknown amount of loss/risk or unknown future contingent legal receivable) and restructures it as a known liability or known asset once an insurance company values what they predict the loss will be or what the contingent legal asset is worth. These products can be divided into three main categories—judgment preservation insurance, adverse judgment insurance, and more bespoke structures commonly referred to as specific contingent insurance. 

Judgment Preservation Insurance 

After a corporation wins a trial, there is still a long way to go before that corporation can recognise the value of that legal victory. This causes significant financial uncertainty as the company is unable to account of the value of its contingent legal assets given the possibility that the award will be reduced or overturned on appeal. Judgment preservation insurance is a product that the insurance markets developed to address this problem.

At its core, judgment preservation insurance is straightforward in how it can be used and monetised. A plaintiff corporation wins a large judgment at trial and wants to insure against the possibility the judgment is overturned. The plaintiff can then purchase a judgment preservation insurance policy to guarantee that a portion of the award is upheld on appeal. In the event the award is overturned or reduced on appeal, the insurer will pay the difference between the insured amount and the ultimate award value pursuant to the terms and conditions of the policy.

While the risk transfer might be simple, the placement of these types of policies with the insurance markets is incredibly complex. Not only must the insurance program be appropriately structured, but the merits of the case must be strong enough to withstand the intense scrutiny of the carrier’s underwriting process. Accordingly, it is important to make sure that the insurance program is structured in such a way as to best align incentives of the insurer and the insured. It is also important to work with the plaintiff and its legal team to address all potential appellate issues and identify the “chinks in the armour” that might lead to reversal on appeal. Ultimately, this process proves to be very beneficial for the plaintiff separate and apart from the placement of the insurance itself, in that the underwriting process affords the plaintiff an opportunity to step back and objectively review the strength of its case on appeal. 

Adverse Judgment Insurance 

A defendant facing a large legal claim can limit its potential exposure from a pending lawsuit or known claim through an adverse judgment insurance policy. Adverse judgment policies are intended for legal risks that have a low likelihood of resulting in a loss but, if they do, can result in a severe financial outcome for the defendant company. It is for this reason that the ability of adverse judgment insurance to ring-fence the downside risk of existing litigation has proven to be particularly useful in the M&A context where the existence of the litigation may impede consummation of the deal itself. 

Adverse judgment policies are designed to solve the legal burdens caused by these low likelihood, high severity legal claims. For a business facing pending litigation or likely future litigation, an adverse judgment policy offers access to significant insurance capital that can effectively replace a litigation reserve. This provides an alternative to a traditional litigation-related indemnity escrow structure, eliminating what can often be a pivotal issue stalling a deal. Outside of the M&A context, these policies are helpful because they (i) cap the corporation’s exposure to a lawsuit and (ii) unlock capital that the corporation otherwise might have to reserve for the exposure from the potential lawsuit.

Given the presence of known legal issues, these policies require an in-depth and complex underwriting process led and structured by an experienced litigation insurance broker. Successful placements are designed in such a way to align incentives of all parties to attempt to resolve the dispute at a reasonable amount (eg within the self-insured layer of the insurance program). As it relates to the underwriting process, it is important to appropriately vet a matter before presenting it to the insurance markets. A substantial amount of diligence up-front will help the corporation and the insurers understand the true scope of the risk and best ascertain whether insurance is the appropriate solution of the problem the company is trying to solve. 

Specific Contingent Insurance 

Specific contingent insurance is the catch-all insurance product for offerings that do not fit neatly into adverse judgment insurance or judgment preservation insurance. The insurance market has proven to be remarkably creative in figuring out how to use insurance to solve a company’s issues related to active litigation or regulatory risk. Insurance markets have also proven willing to help resolve legal risk related to a basket of issues as opposed to a single issue. For example, a corporation facing multiple similar lawsuits can go to the insurance markets to help cap that exposure. The same can be done for corporations pursuing meritorious litigation and seeking to insure that it recovers at least its monetary investment in a portfolio of cases when those cases are all resolved. 

Future Developments in Litigation Insurance 

Litigation insurance has experienced exponential growth over the past calendar year fueled largely by increased awareness of the products carriers are offering and the seamless client experience guaranteed by brokers. It is becoming more sophisticated, trusted, and tenured as it transitions from being “new” to “novel.” Over the next year, we expect to see more even more bespoke specific contingent insurance offerings for as the markets continue to refine the contours and structures of the more developed contingent insurance products. The opportunity for innovative solution development remains limitless as newer and more complex legal risks continue to find their way to the litigation insurance market. With appropriate risk selection, underwriting and policy structuring, litigation insurance is poised to become a business necessity in the expensive, complex, and vast world of litigation.