Christopher Swift, chair and chief executive officer of The Hartford, was taken aback by a question from an analyst during the company’s second-quarter earnings call about the impact of litigation finance on the insurer’s results.
“It’s showing up in our loss trend [and] our allocated loss expenses. We’re spending more time and money on something that turned our judicial system into a gambling system. Are you serious?”
The analyst restated the question, explaining to Swift that he is aware that a variety of issues come together to create social inflation. What he wanted the CEO to pin down was the isolated impact of third-party litigation funding (TPLF), apart from factors such as negative public sentiment and eroding tort reforms.
Swift didn’t have figures to share. But two months earlier, an actuary speaking at the Casualty Actuarial Society’s Seminar on Reinsurance, said the top end of a range of estimates of direct costs that will be paid to funders by casualty insurers is $25 billion over a five-year period (2024-2028).
Mike McComis, a senior manager for EY and a Fellow of the Casualty Actuarial Society, revealed the results of a model developed by his firm last year to measure the impact of litigation funders, using some information from funders’ reports about annual returns and a variety of assumptions to develop the figure. McComis gave an overview of the steps involved in constructing the model and flagged some of the most tenuous assumptions–including a somewhat shaky guess that insurers will pay about 90% of funders’ returns.
He also provided a range of estimates based on 720 scenarios tested with the model, revealing that the five-year cost is most likely to fall between $13 billion and $18 billion (the 25th to 75th percentile), with a mid-range average coming in at around $15.6 billion for the five years from 2024-2028.
(Editor’s Note: McComis revealed that the EY study was performed late last summer, which explains why the estimates begin with the year 2024.)
The figures, he said, represent direct costs–the portion of TPLF returns that come out of the coffers of P/C insurers. But then there are indirect costs to consider.
“That’s just how much the funders are making. The other element to this is where is that funding going,” he said, suggesting that when funding goes to law firms, they may be able to advertise more, bring in more cases, and fight claims longer. “They have this capital backing, which means they don’t have to settle for cash flow reasons,” he said.
This adds an indirect cost to insurers, McComis said, noting that when cases go on longer, insurers have to pay more legal fees.
“There’s also the potential ability of this to drive up actual results for the plaintiffs, the injured parties themselves,” he said, referring to rising verdict and settlement trends presented by co-panelist Jonathan B. Hayes, managing director and reinsurance actuary at Aon.
“Presumably more of that should be going to the injured parties,” he said.
While McComis and his colleagues didn’t unearth evidence of that as they undertook a massive research project to develop inputs for the model, he did say there is one study that puts total costs, including indirect costs, at roughly double the amount of direct costs. Without identifying the source, McComis noted that if this were true, the high end of the range–now $50 billion–could add 7.8 points to the commercial liability industry loss ratios for each of the next five years, with the most likely scenario (50th percentile) falling between 4.5 and 5.5 loss ratio points. (McComis estimated the loss ratio boost using 2023 earned premiums for commercial auto liability, other liability occurrence, and medical professional liability.)
Returning to the direct costs modeled by EY, McComis displayed line graphs plotting the most likely (25th and 75th percentile) modeled estimates, as well as the minimum and maximum modeled estimates for each year from 2019 through 2028. The most likely estimates shown on the graphs started at about $1 billion in 2019, growing to $2.5 billion in 2019, and then climbing to around