Is Litigation Funding the New Cost of Doing Business?

For the past decade, the small and midsize businesses we protect have been watched by anonymous, predatory investors waiting for just the right injury to pounce.

Often at the expense of the injured party, and always trying to inflict maximum damage on the businesses and insurers in their sights, third-party investors turn the financial promise an insurance company makes to its customers into an attorney-driven game of chance.

The Secrecy of Third-Party Litigation Funding

Third-party litigation funding (TPLF) is a side financial deal in which an entity, such as a hedge fund, helps pay for a plaintiff’s legal claim despite having no claim in the dispute. In return, the third-party funder receives a significant portion of the proceeds if the case is successful. It transfers the financial risk of a lawsuit from the plaintiff to an investor.

Although proponents argue litigation funding gives more access to justice for individuals with valid claims, this practice makes lawyers more willing to proceed with questionable lawsuits of low success probability or merit, as they do not incur the protracted expense of such cases. In contrast, according to Accenture, the top 50 U.S. insurance carriers in 2022 spent on average $500 million on litigation expenses. These investment gambles drive up insurance premiums and leave policyholders covering their costs.

Businesses in these cases often do not know who is funding the litigation. A defense team looking to settle a claim is not actually negotiating with the plaintiff; instead, it is negotiating with a faceless third party it didn’t know existed. This makes it impossible to determine if a plaintiff’s attorney is negotiating to fairly compensate an injured party or holding out for an investment windfall.

At a minimum, this anonymity must change. It has raised questions in Congress and state legislatures regarding national security and missing tax revenue. There is concern that foreign entities may be working to undermine U.S. companies using the legal system, while also reaping significant investment returns that avoid U.S. taxes since they are not disclosed as a party to the suit in any way.

Third-Party Funding Impacts Agents, Clients

Insurance rates are primarily driven by the frequency, severity, and costs of claims. Third-party litigation funding increases all three by encouraging lawsuits, setting unrealistic client expectations that are detached from the actual merits of a claim, and unnecessarily increasing the time and expense incurred to resolve the case. Whether they realize it or not, policyholders shoulder a significant burden when investors profit from the injury or claims of others.

• Increased rates. According to AM Best, litigation management costs for the combined property and casualty industry increased by 19% from 2018 to 2023. That represented an increase of $4 billion to $5 billion, bringing total litigation expenses to roughly $24 billion of loss adjustment expense. Concurrently, Swiss Re estimates that about $8 billion was invested into U.S. litigation in 2020, and that number is expected to reach $30 billion by 2028.
• Reduced coverage access. The commercial auto industry has been a major TPLF target in recent years, but so has professional liability, product liability, and director/officer liability. Insurers are making tough decisions to walk away from some of these lines of business due to the threat of continuous litigation. As an example, Nationwide exited our E&S Commercial Auto book in part because of litigation costs.
• Business brand and reputational damage. Bolstered by outside investments, plaintiffs’ attorneys wage massive advertising campaigns that cast doubt on companies and their products in front of large audiences, regardless of whether their claims are supported. According to X Ante, nearly 800,000 television advertisements for mass litigation ran in 2023 at a cost of more than $160 million. To the average consumer, more cases signal greater legitimacy of accusations against a company or product, causing further reputational harm to the business in the court of public opinion.

What Can Agents and Brokers Do?

Agents and brokers are the proverbial tip of the spear in countering legal system abuse and insulating their clients from its effects.

• Encourage clients to strengthen risk mitigation practices. A common plaintiff tactic is to highlight the failure to implement policies and practices that reduce the frequency and severity of losses. This can be a key driver of large court settlements and jury verdicts. Because of this, insurance professionals should work with their clients to reduce the risk of severe loss events with a proactive plan to mitigate exposures.
• Remind clients to report claims immediately. A recent Sedgwick study found that 55% of litigated commercial auto claims have attorney involvement before, or the same day as, the report to carrier date. To remediate this practice, agents and brokers should remind their clients to file claims as soon as possible. Prompt reporting gives claims experts a head start on case assessment and investigation of potential damages.
• Leverage technology to prevent incidents. Wearable devices, drones, smart sensors, and virtual reality can all be used to prevent injuries that often result in litigation. For example, Kinetic has developed a wearable device that reduces the incidence of workplace injuries by automatically detecting unsafe postures and providing workers with real-time feedback whenever a high-risk motion occurs.

Consumers Must Engage

It is important that insurance professionals convey to their clients the impact of legal system abuse on their premiums, deductibles, and coverages. As you review casualty products with them, consider educating clients on anonymous third-party litigation funding and encouraging them to engage with their chambers of commerce and lawmakers about social inflation legislation within their state. If this third-party litigation funding continues unchecked, it will drive more money into the hands of investors at the expense of policyholders—driving unnecessary premium pricing increases long into the future. We need our customers to vocally support efforts to reform this type of legal system abuse at the federal and state levels.