4 July 2011
After-the-event insurance is changing, and it is the smaller cases that will suffer
The past 12 months in the litigation funding and insurance market has been overshadowed by the impending changes to the recoverability of conditional fee arrangements (CFAs), or success fees, and after-the-event (ATE) premiums. Although the debate continues, change seems inevitable.
Attention is now turning to the future and how commercial litigants will manage their legal cost exposure under the new regime, where ATE premiums and CFAs cannot be recovered from the losing party.
The likely impact will vary depending on the size of the case. For large-value cases, with costs of more than £1m, the impact will be minimal. Cases where the amounts in dispute are large have always been the ’sweet spot’ for alternative litigation funding. Healthy margins between costs and damages mean that this is prime hunting ground for third-party litigation funders, while ATE insurers have now secured a firm foothold in this arena.
Just five years ago, insurers would struggle to write £2m of insurance cover for a given case, but in today’s market indemnities are available in excess of £20m.
This sector of the market is now highly sophisticated, with insurers underwriting the insured’s own solicitors’ fees, which can be combined with lightly discounted, or no, CFAs and novel funding products to create bespoke risk-management packages. Premiums are also routinely contingent upon success, irrespective of the policy limit.
It is this end of the market that is likely to see little, if any, negative effect from the proposed reforms. While premiums and success fees are currently recoverable, global settlements are the natural outcome where significant damages are at play. Accordingly, the eradication of recoverability is unlikely to have a significant impact on this sector.
On the contrary, many would argue that the new framework will lift many of the restrictions on the current market and will create a more mature and dynamic market with significant opportunity for forward-thinking lawyers and their clients. The introduction of US-style contingency fees coupled with total flexibility in the way that insurance can be structured will mean that clients with high-value cases will be spoilt for choice with risk-hedging options.
Life gets somewhat more troublesome when it comes to medium-sized cases, with costs of between £250,000 and £1m. If a case is valued at £1m but it will cost each party £350,000 to litigate to trial, an impecunious client will face real difficulty. Even on a conservative basis, the cost of an ATE insurance policy covering the opponent’s costs and own side’s disbursements, together with a success fee attached to a discounted CFA, could easily wipe out 50 per cent of damages when added to the inevitable shortfall on recovered costs.
Defendant lawyers and insurers will, of course, argue that this merely redresses the balance. If someone chooses to take out insurance and instruct solicitors on a CFA, they should have to pay the price. However, this assumes that they have a choice, which is often not the case and it will be clients of limited resources that will see access to justice eroded.
Cases involving non-financial remedies add a further degree of complexity. Garnering support from funders or insurers where damages are not the primary remedy will be problematic. Various solutions have been mooted, but none come close to providing a sustainable and wide-ranging solution.
Small-value cases with a close cost-versus-damages ratio arguably face the most turbulent time ahead. These cases will suffer similar issues as those described above, although with the added factor that the damages involved make the current products unworkable rather than simply more expensive or less attractive.
The only solace for such litigants is that where costs are smaller, the impact of a loss on parties hedging the risk is less severe, and as such ought to result in a greater willingness to speculate for smaller returns. A squeeze on pricing is inevitable, particularly as litigants will have greater incentive than ever to shop around for competitive terms. However, there will be a floor below which rates cannot fall because cases will lose.
While the changes will have a range of impacts depending on the economics of the case in question, standard billing with 100 per cent risk retention by litigants is unlikely to be a feature. The good news for lawyers is they can be confident that the industry of ’litigation speculators’ - funders and insurance - will adapt and evolve.
During the next 12 months, new litigation funding products will emerge to reshape the funding market. Commercial ATE insurers will continue to innovate to remain the most cost-effective risk-hedging tool for commercial litigants.
An increasing number of City law firms will be hit with claims for failing to provide sufficient Rule 2 discussions, in particular resulting from inaccurate representations of available options. There has already been a rise in such claims this year.
Competitive tendering among larger practices will increase with greater pressure on firms to deliver creative solutions to achieve cost certainty. There will also be increased pressure from corporates on external counsel to advise on risk-management options, particularly with forthcoming press coverage concerning other blue-chip companies actively hedging their positions.
James Delaney is director of litigation funding brokers TheJudge