Voices in the insurance industry have recently called for the regulation of commercial litigation funding on the ground that it is “a key driver of social inflation.” Such calls to action lack empirical support and fail to withstand even gentle scrutiny.
Executive SummaryCountering views often expressed by property/casualty insurance organizations—notably, a recent report published by Swiss Re—Dai Wai Chin Feman, director of Commercial Litigation Strategies at Parabellum Capital, explains why commercial litigation funding is not the root of social inflation. Here, he describes the differences between consumer and commercial litigation funding, noting that commercial funders focus on areas where insurance coverage is rare. He also offers data to show that the industry is too small to materially contribute to social inflation.
In his view, regulation reforms being pushed by insurers and reinsurers would increase insurance costs and prolong case durations.
In reality, commercial litigation funding does not—and cannot—meaningfully contribute to social inflation. It should be welcomed by the insurance community as a means to decrease costs and increase exposure to meritorious affirmative litigation risk.
Overview of Commercial and Consumer Litigation Funding Markets
Non-recourse litigation funding in the U.S. consists of two separate markets: commercial and consumer. Each market involves different types of legal claims, different counterparty profiles, different deal structures, different uses of funds, and, therefore, different regulatory considerations.
Commercial funding involves investment in high-value commercial claims that are predominantly business-to-business in nature. Funders finance legal spend and provide working capital at various stages of litigation, as well as help law firms manage contingency risk. Investments primarily pertain to patent, antitrust, investor-state, contract, and other commercial disputes where insurance coverage is uncommon or unavailable. The commercial underwriting process is rigorous and can take months for each individual investment. Collectability is an important consideration, particularity given the infrequency of insurance coverage. Industry data from Westfleet Advisors reflects that the average commercial investment commitment in 2020 was $7.8 million, with 56 percent of commitments made directly to law firms rather than litigants. Returns are typically expressed as multiples of invested capital or percentages of proceeds rather than interest rates.
By contrast, consumer funding involves advances against personal injury, medical malpractice, and other tort claims (including mass torts). Consumer funding may bear more resemblance to payday lending than to the commercial market. Advances are generally made to individuals for living expenses and rarely exceed five-figure amounts. Underwriting decisions can be made “in as little as 24 hours.” Law firms also receive financing for portfolios of contingent consumer claims, often as an alternative to traditional debt. Returns are typically expressed as interest rates.
From a regulatory perspective, legislation tends to target the consumer market. Certain states have implemented interest rate caps, contractual requirements, disclosure mandates, and other measures designed to enhance consumer protection. (Notably, many bills to regulate litigation funding have failed.) To the extent a bill broadly applies to both markets, legislators have historically been receptive to excluding commercial investments entirely, where counterparties are not natural persons or where transactions exceed a dollar threshold (often $500,000).
The Call for Regulation
Commentators have casually lumped litigation funding with other purported drivers of social inflation since 2019. In December 2021, the Swiss Re Institute published a report entitled “U.S. Litigation Funding and Social Inflation: The Rising Costs of Legal Liability” (the “Report”). The Report labels litigation funding “a contributing factor to the trend of social inflation in the U.S.” and calls for “stronger regulation.” The Report principally derives its conclusions from (1) growth in commercial funders’ assets under management, paired with (2) larger general liability and vehicular negligence verdicts and (3) longer durations of personal injury cases.
The Report has received ample support from the insurance industry. Despite its almost-exclusive reliance on consumer tort data and case studies, the Report’s call for regulation does not make any distinction between the commercial and consumer markets. Nor does it address the insurance industry’s existing involvement in commercial funding through various products, ranging from capital protection insurance to after-the-event cost coverage (discussed further in the last section of this article).
Lack of Nexus Between Commercial Litigation Funding and Insurance Costs
According to the Geneva Association, “the extent to which litigation funding has unwanted effects is an empirical matter.” Yet the Swiss Re Report eschews an empirical analysis, instead linking commercial funding to social inflation based on a series of invalid assumptions and inferences. Most saliently, the Report incorrectly assumes that (1) funded commercial cases commonly implicate insurance, and (2) the volume of funded cases is sufficient to have a non-trivial impact on social inflation. Neither is true.
Lack of Coverage
The Report uses data points exclusive to consumer funding to justify commercial regulation. This is problematic given the starkly different characteristics of the two markets.
While insurers regularly cover consumer claims, coverage is rare or non-existent for the majority of funded commercial cases in the United States. As the Report acknowledges, “commercial litigation financing has focused on disputes involving antitrust, intellectual property, and business contract issues, as well as international arbitration.” Unsurprisingly, commercial fund documents frequently prohibit investments in non-commercial claims. Consequently, commercial funds are not driving the “nuclear trucking verdicts” oft-cited by the insurance and defense lobbies as demonstrative of the dangers of litigation funding.
The Report admits that commercial investments “are mostly removed from consumer claims.” Nevertheless, the Report’s cursory commercial conclusions are founded solely on general liability and vehicular negligence data. Observing that “U.S. general liability and commercial auto lawsuit data show a strong rise in the frequency of multi-million-dollar claims over the past decade,” the Report cites data that “the average size of trucking claims increased by nearly 1000 percent from 2010 to 2018” to argue that “nuclear verdicts against trucking companies are driving up insurance premiums.”
The Report also claims that litigation funding “is associated with longer cases,” citing only the average duration of funded “personal injury cases.” Furthermore, the Report specifically cites the commonplace funding of “trucking accidents, bodily injury, product liability mass torts, and medical liability claims etc.” as affecting general liability and commercial auto lines.
As insurance professionals know, coverage for patent and antitrust claims is the exception rather than the norm, and it is non-existent for investor-state arbitration (disputes against sovereigns often related to investment expropriation). Coverage of contract and business tort claims is also uncommon. And even where coverage is present, it may ultimately be limited to defense costs in light of the intentional misconduct frequently at issue.
Accordingly, there is no actual support for the claim that the growth of commercial funding corresponds to any real rise in insurance costs.
Even if financed commercial disputes were likely to involve insurance (which is not the case), the size of the commercial market would render any impact on social inflation negligible.
Commercial litigation funding does not—and cannot—meaningfully contribute to social inflation. It should be welcomed by the insurance community as a means to decrease costs and increase exposure to meritorious affirmative litigation risk.
The Swiss Re Report states that litigation funding is a $17 billion market based on “investment into litigation funding globally in 2020.” The $17 billion figure is repeated five times in the Report and repeatedly in follow-on articles from insurance trade publications, including Carrier Management. While the Report’s emphasis on investor capital commitments may seem significant, it is a red herring. The number of cases actually financed is a more important indicator.
Funders are highly selective and seek only meritorious investments. As a result, funders rarely make more than a handful of commercial investments per quarter. Public filings reflect that Burford Capital—the largest funder in the U.S. and world—made 18 new North American investments in 2020. Omni Bridgeway, which has the second largest commercial investment team in the U.S., reported nine new U.S. investments in its active U.S. fund in 2020 in its 2020 fiscal year. Burford and Omni Bridgeway together account for approximately 48 percent of the commercial market according to the Report.
(Editor’s Note: Read the Carrier Management article, “An Innovator’s Journey: From Star Litigator to Litigation Finance,” profiling Burford Capital CEO Chris Bogart to learn about Burford’s strategies)
Statistics from Burford’s public filings indicate that the proportion of financed cases with insurance coverage is likely to be a minority of overall investments. Specifically, of Burford’s 18 North American investments, six were antitrust and seven were intellectual property investments. In the aggregate, Burford has invested approximately 1 percent of its portfolio in “tort” matters (with no such investment made since 2018), whereas it has made 56 percent of its investments to antitrust, intellectual property, and international arbitration matters. Burford has made an additional 9 percent of investments to asset recovery and 8 percent to contract claims, categories also unlikely to have coverage.
Commercial figures—even when conservatively extrapolated—pale in comparison to the consumer market, which witnesses thousands upon thousands of transactions per year. (Oasis Financial, one of multiple major players in the consumer market, claims to have made “more than 250,000” investments.) Thus, even if commercial funding affected social inflation, its impact would be de minimis.
Regulation of Commercial Funding Would Be Inimical to the Insurance Industry
The Report argues that both the commercial and consumer markets should be subject to enhanced regulation “to support consumer protection and an efficient legal system.” Such regulation would consist of “disclosure of funding arrangements to all involved parties” and “greater transparency and consumer protection in funding terms.”
As an alternative to litigation funding, the Report cites the availability of “legal aid for consumer protection claims” and advertises “legal expense insurance.”
The Report’s regulatory goals are misguided and short-sighted.
The Report’s concentration on “consumer protection in funding terms” has no application to commercial funding. The commercial market is comprised of sophisticated actors represented by competent legal counsel. Funders made 56 percent of commercial investment commitments to law firms rather than litigants in 2020, obviating consumer protection concerns for the majority of capital committed. The Report also supports increased usury restrictions, which do not apply to commercial funding due to the high risk inherent in non-recourse commercial investments. Legal aid is similarly unsuitable for funded commercial disputes, where expert expenses alone routinely run into the millions. Finally, legal expense insurance is a nascent market that, as conceded by one of the Report’s sources, is similar to litigation funding “as far as the volume of litigation, the quality of litigation, and the timing of settlements is concerned.”
The only regulatory reform relevant to commercial funding for which the Report advocates is disclosure. The Report argues that “disclosing funding arrangements to courts, opposing parties, arbitration tribunals and counsel would facilitate the assessment of potential conflicts of interest; discussion of cost shifting and allow all parties to realistically assess the prospects of settlement of the case.” The Report further avers that “disclosure also enables litigants to transparently assess parties’ fiduciary duties and calculate attorneys’ fees.”
The objective of such disclosure is clear: to obtain tactical advantages for defendants that will prejudice funded cases by providing insight into issues ranging from case budgets to analysis of case merits. The scope of such disclosure far exceeds that necessary to “facilitate the assessment of potential conflicts of interest” and would have no relation to “cost shifting” under the American Rule. It also exceeds the level of financial disclosure applicable to insurers and defendants by leaps and bounds.
Putting aside that a potential detriment to insurers does not necessarily warrant regulation, the Report unfortunately ignores the costs and legal framework associated with disclosure. Implementing disclosure regimes would actually increase defense costs and prolong case durations by causing frivolous satellite litigation over discovery. That is because once litigation funding is disclosed, defense counsel invariably seek additional disclosure of funding terms and communications between funders and litigants. Such efforts seldom yield results. Courts have overwhelmingly rejected attempts for discovery of funding arrangements on the grounds of relevance and privilege. (Source: ” What Courts Are Saying About Litigation Finance Disclosure,” Law360.com, subscription required) So too have legislatures and other bodies, such as the Civil Rules Advisory Committee and Uniform Law Commission, both of which have declined to recommend mandatory disclosure mechanisms.
To the extent the Report sincerely seeks to enhance consumer protection and improve efficiencies in the legal system, it should tailor its efforts exclusively to the consumer market. Commercial players would have no objection to enhancing true consumer protection or limiting liability for trucking claims. But attempts to regulate the commercial industry lack any legitimate basis and will only serve to ironically increase insurance lobbying and litigation costs. Indeed, one could argue that resistance to litigation funding is itself stoking social inflation.
Clear Upside of Commercial Funding Outweighs Amorphous Downside
The Report attempts to cast a negative spotlight on commercial funding. Looking past the Report’s unsupported assessments regarding social inflation, the insurance industry should embrace commercial funding as an opportunity for the development and expansion of new and existing business lines.
Notwithstanding the rarity of insurance in funded commercial cases, insurers should appreciate the benefits of commercial funding. Duty-bound to seek efficient returns for investors, funders filter out frivolous claims, prioritize the likelihood of settlement in underwriting, and structure transactions that incentivize early resolutions. In addition, funders are rational and independent economic actors that do not make decisions driven by emotional or other non-monetary factors. As a result, funders favor settlements and attempt to avoid the binary risk inherent in trials.
Insurance and commercial funding already enjoy significant synergies. For example, AmTrust invested in Therium, an established commercial funder. It has also arranged insurance wrappers for limited partnership interests of commercial funds, and wholly-owns a law firm that provides “litigation funding services.” Insurers have entered into agreements with litigation funders to provide adverse cost coverage across portfolios of investments. Thomas Miller acquired TheJudge Group to start “a new litigation finance business with access to $1 billion in capital.” Aon, Marsh, Gallagher, and Lockton all have insurance litigation groups that broker products such as plaintiff-side judgment preservation insurance, insurance-backed judgment monetizations, after-the-event cost insurance, principal protection insurance for litigation-related investments, and insurance for law firms on contingency.
Beyond existing lines of business, the insurance industry has ample opportunities to increase exposure to commercial funding in ways that would be mutually beneficial. Doing so would be a net positive for insurers. A social inflation stamp should not stand in the way.