Third Party Litigation Funding Is One of The Key Enablers of Social Inflation
Nicola Parton, head of P&C Business Management at Swiss Re, explains how the rapid growth of third-party litigation funding could threaten the affordability – and even insurability – of some liability risks.
What is third party litigation funding?
It is when a third party finances the legal representation of a party in litigation. It's much broader than ‘no win no fee’ arrangements, which are typically funded by law firms. Investment companies are now providing serious amounts of funding – whether directly to help third parties bring litigation or to fund law firms to seek out litigation.
What impact is it having on social inflation – and on the (re)insurance industry?
Third party litigation funding is one of the key enablers of social inflation, both in the US and elsewhere. Our industry needs to pay attention to whether that growth in third party litigation will continue to impact results.
There’s now a question of whether certain risks will in the future be unable to get cover.
In the US, we have seen combined ratios in liability that have for the past seven years exceeded 100%. We're seeing the same in medical malpractice, and in commercial auto combined ratios have exceeded 100% for the past ten years. We've seen some significant premium increases in liability lines, but there’s now a question of whether certain risks will in the future be unable to get the cover that was previously available. I think this raises serious concerns for both insureds and, ultimately, our industry, if there isn't that availability of insurance to provide protection.
What changes have you seen in third party litigation funding?
Investment funding in third-party litigation has grown rapidly. In 2020, $30 billion was invested globally and we're predicting that will expand to $55 billion by 2028.
It’s also expanding into new geographies. It began in Australia and in the UK back in the 1990s and grew quickly, so that between 2014 and 2018, over 60% of class actions in Australia were paid for by third party litigation funds. It has since moved to the US, where it now dominates.
But, despite its prolific growth, there hasn’t been an increase in regulation of third-party litigation funding. There are currently few requirements to disclose whether a third-party litigation firm is involved, or how much it would take from any court award.
Aren’t they increasing access to justice?
Litigation funding has a role to play in an efficient legal system, but it’s led to a situation where those claimants who deserve the most compensation are receiving less. Often, plaintiffs who use third party litigation funding are receiving as little as 40% of awards.
In the past few years, we’ve seen these funds make returns as high as 35% on their investment, outperforming many other risky asset classes. It should support access to justice, but in fact we see it most in commercial litigation.
In recent years, litigation funds have focused on mass torts and product liability claims. Last year, a multidistrict litigation was filed in the US against a firm that manufactured earplugs, in which over 200,000 individual plaintiffs are named. So, we're seeing both increased verdicts and settlements in these sorts of claims, as the amount of money that it takes to prosecute and then defend those cases drives up settlements. Cases are also getting lengthier, because of the amount of money funding these bigger claims.
What would you like to see done?
We understand that third party litigation funding is here to stay, and it's likely to expand further, but we think that it's critical there’s an increased awareness and understanding of its dynamics.
There hasn’t been an increase in regulation of third-party litigation funding.
We’d recommend three main changes. The first is mandatory disclosure of where third-party litigation is involved. The second is increased regulation, perhaps including caps on how much they take from court awards. Because, of course, when you're dealing with litigation funds, you know there are going to be other drivers to those settlements in terms of expected returns over and above the actual compensation of those that have been injured. Third, we would encourage governments to ensure that people do have the access to justice that they deserve, whether that’s through legal aid policies or insurance.
Has any action been taken so far?
It’s been the subject of much discussion in Australia in recent years, and they are now putting in place full disclosure requirements. In the US, it's spotty: some states have regulations, others not. In 2019, a federal act was put forward to try and address this, but that languished because of COVID-19. It remains to be seen whether that piece of legislation will be revived.