Category Archives: Legal Environment

Auto Insurance, Homeowners Insurance, Insurers and the Economy, Legal Environment

Illinois Bill Highlights Need for Education
on Risk-Based Pricing
of Insurance Coverage

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Legislation being considered in Illinois underscores the need for legislators and other policymakers to become better educated about the importance of risk-based pricing and how it works.

The Motor Vehicle Insurance Fairness Act would bar insurers from considering nondriving factors, such as credit scores, when setting premium rates. The prohibitions include factors that actuaries have demonstrated correlate strongly with the likelihood of a driver eventually submitting a claim, as well as ones insurers already are prohibited from using.

This suggests a lack of understanding about risk-based pricing that is not isolated to Illinois legislators – indeed, similar proposals are submitted from time to time at state and federal levels.  

Confusion is understandable

Risk-based pricing means offering different prices for the same coverage, based on risk factors specific to the insured person or property. If policies were not priced this way, lower-risk drivers would subsidize riskier ones. Charging higher premiums to higher-risk policyholders helps insurers underwrite a wider range of coverages, improving both availability and affordability of insurance.

The concept becomes complicated when actuarially sound rating factors intersect with other attributes in ways that can be perceived as unfairly discriminatory. For example, concerns are raised about the use of credit-based insurance scores, geography, home ownership, and motor vehicle records in setting home and car insurance premium rates. Critics say this can lead to “proxy discrimination,” with people of color in urban neighborhoods being charged more than their suburban neighbors for the same coverage.

Confusion is understandable, given the complex models used to assess and price risk. To navigate this complexity, insurers hire actuaries and data scientists to quantify and differentiate among a range of risk variables while avoiding unfair discrimination.

Appropriate protections are in place

It’s important to remember that insurers don’t make money by not insuring people. They are in the business of pricing, underwriting, and assuming risk.

Because of the critical role insurers play in facilitating commerce and protecting the lives and property of individuals, insurance is one of the most heavily regulated industries on the planet. To ensure that sufficient funds are available to pay claims, regulators require insurers to maintain a cushion called policyholder surplus.

Credit rating agencies, such as Standard & Poor’s and A.M. Best, expect insurers to have surpluses exceeding what regulators require to keep their financial strength ratings. A strong financial strength rating enables insurers to borrow money at favorable rates – further promoting insurance availability and affordability.

On top of these constraints, state regulators have the authority to limit the rates insurers can charge within their jurisdictions.

No profit, no insurers — no insurers, no coverage

Like any other business, insurers must make a reasonable profit to remain solvent. Because they can’t just move money around as more lightly regulated industries can, the only way to generate underwriting profits is through rigorous pricing and expense and loss controls. Insurers don’t want to overcharge and send consumers shopping for a better price, or undercharge and experience losses that erode their ability to pay claims.

In this context, it’s important to note that personal auto and homeowners insurance premium rates have remained relatively flat as inflation and replacement costs have soared through the pandemic and supply-chain issues related to Russia’s invasion of Ukraine (see chart below).

During this period, writers of these coverages have struggled to turn an underwriting profit. Personal auto has been a primary driver of the overall industry’s weak underwriting results.  Dale Porfilio, Triple-I’s chief insurance officer, recently said the 2022 net combined ratio for personal auto insurance is forecast at 111.8, 10.4 points worse than 2021 and 19.3 points worse than 2020.  Combined ratio represents the difference between claims and expenses paid and premiums collected by insurers. A combined ratio below 100 represents an underwriting profit, and one above 100 represents a loss. 

Even as inflation moderates, loss trends in both of these lines – associated with increased accident frequency and severity in auto and extreme-weather trends in homeowners and auto – will require premium rates to rise. The question is: Will the cost fall evenly across all policyholders, or will rates more accurately reflect policyholders’ risk characteristics?

Protected classes

The United States recognizes “protected classes” – groups who share common characteristics and for whom federal or state laws prohibit discrimination based on those traits. Race, religion, and national origin are most commonly meant when describing protected classes in the context of insurance rating, and insurers generally do not collect information on these “big three” classes. Any discrimination based on these attributes would have to arise from using data that might serve as proxies for protected classes.

Algorithms and machine learning hold great promise for ensuring equitable pricing, but research shows these tools can amplify implicit biases.

The insurance industry has been responsive to such concerns. For example, recent Colorado legislation requires insurers to show that their use of external data and complex algorithms does not discriminate against protected classes, and the American Academy of Actuaries has offered extensive guidance to the state’s insurance commissioner on implementation. The Casualty Actuarial Society also recently published a series of papers (see links at end of post) on the topic.

Correlation matters

Certain demographic factors have been shown to correlate with increased risk of submitting a claim. Gender and age correlate strongly with crash involvement, as the National Highway Traffic Safety Administration (NHTSA) data illustrated at right shows.  

Likewise, National Association of Insurance Commissioners (NAIC) data below clearly shows higher credit scores correlate strongly with lower crash claims.

Similar correlations can be shown for other rating factors. It’s important to remember that no single factor is determinative – many are used to assess a policyholder’s risk level.

Consumers “get it” – when it’s explained to them

A recent study by the Insurance Research Council (IRC) found consumer skepticism about the connection between credit history and future insurance claims appears to decline when the predictive power of credit-based insurance scores is explained to them. Through an online survey with more than 7,000 respondents, IRC found that:

  • Nearly all believe it is important to maintain good credit history, and most believe it would be “very” or “somewhat” easy to improve their credit score;
  • Consumers see the link between credit history and future bill paying but are less confident about the link between credit history and future insurance claims.
  • After reading that many studies have demonstrated its predictive power, most agree with using credit-based insurance scores to rate insurance, especially for drivers with good credit who could benefit.

If consumers “get it” when you share the data with them, perhaps policymakers and legislators can, too.

Learn More:

Triple-I Issues Briefs

Risk-Based Pricing of Insurance

Race and Insurance Pricing

Personal Auto Insurance Rates

Drivers of Homeowners Insurance Rate Increases

How Inflation Affects P/C Insurance Premium Rates – And How It Doesn’t

The Triple-I Blog

Inflation Trends Shine Some Light For P&C, But Underwriting Profits Still Elude Most Lines

Education Can Overcome Doubts on Credit-Based Insurance Scores, IRC Survey Suggests

Matching Price to Peril Helps Keep Insurance Available & Affordable

Bringing Clarity to Concerns About Race in Insurance Pricing

Delaware Legislature Adjourns Without Action on Banning Gender as Auto Insurance Factor

Triple-I: Rating-Factor Variety Drives Accuracy of Auto Insurance Ratings

Auto Insurance Rating Factors Explained

The Casualty Actuarial Society

• Defining Discrimination in Insurance

• Methods for Quantifying Discriminatory Effects on Protected Classes in Insurance

• Understanding Potential Influences of Racial Bias on P&C Insurance: Four Rating Factors Explored

• Approaches to Address Racial Bias in Financial Services: Lessons for the Insurance Industry

Auto Insurance, Legal Environment

Florida Auto Legislation, on Heels of 2022 Reforms, Suggests State is Serious About Insurance Crisis Fix

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Florida legislation proposed last week would prevent the state’s motorists from assigning their legal rights in auto insurance claims to repair shops.  

Assignment of benefits (AOB) is a standard practice in the insurance world. In Florida, however, this efficient, customer-friendly way to settle claims has long served as a magnet for fraud. The state’s legal environment has encouraged vendors and their attorneys to solicit unwarranted AOBs from tens of thousands of Floridians, conduct unnecessary or unnecessarily expensive work, then file tens of thousands of lawsuits against insurers that deny or dispute the claims.

Legislation approved in the closing weeks of 2022 took several crucial steps toward resolving the state’s property/casualty insurance crisis, including elimination of the state’s AOB laws with respect to property claims. But it didn’t affect auto-related AOBs.

Intended to help consumers

Florida’s auto glass law – originally intended to encourage drivers to repair or replace damaged windshields by prohibiting insurers from charging deductibles for windshield damage – is being exploited by glass-repair shops all over Florida. Unscrupulous vendors hire workers to canvas neighborhoods, enticing vehicle owners to sign up for “free” windshield replacements. They get car owners to sign an AOB contract that assigns the owners’ legal rights to the repair shop.

The shop then can sue the consumer’s insurer if it doesn’t pay what the shop demands. The result is a lawsuit by the vendor in the consumer’s name.

Lawyers have a strong incentive to file suits, as the insurer is required to pay their fees if it loses in court.  This has resulted in a “sue-to-settle” system, in which lawyers file suits over very small disputes to force a settlement.

Hope for the future

“What began as a small regional issue a decade ago with a few lawyers and some auto repair shops has blown up to become a major problem throughout the state,” said Mark Friedlander, Triple-I’s director of corporate communications and a Florida resident. Between 2011 and 2021, the number of auto glass lawsuits in Florida rose more than 4,000 percent, from 591 to more than 28,000. A National Insurance Crime Bureau (NICB) analysis found that Florida had the highest number of questionable auto-glass claims among the 50 states in 2020.

WhileFlorida is a “no-fault” state – meaning both parties in an accident submit claims to their own insurer, regardless of fault – it ranks high for attorney involvement in accident claims, the Insurance Research Council (IRC) has found. Attorney involvement is associated with higher costs, and IRC also has found Florida to be among the least affordable auto insurance markets.

The new measure, filed for the 2023 legislative session that starts March 7, offers hope that Florida is finally serious about solving the decades-old mechanisms that have fed the state’s current insurance crisis. Taken together, the two pieces of legislation will help stabilize Florida’s insurance market, but it will take years for the impacts of fraud and legal system abuse to be wrung out of the system.

Learn More:

Fraud, Litigation Push Florida Insurance Market to Brink of Collapse

Florida’s AOB Crisis: A Social-Inflation Microcosm

Industry Awards & Events, Insurance Industry, Legal Environment

Florida and Legal System Abuse Highlighted at JIF 2022

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By Max Dorfman, Research Writer, Triple-I

Florida took center stage at JIF 2022, as a group of panelists discussed growing courtroom costs and the rise of legal system abuse.

“Legal system abuse is a combination of factors, including social inflation, nuclear verdicts, third party litigation funding, tort reform pullback, cost shifting schemes, and attorney advertising,” opened Ronna Ruppelt, CEO of CLM & Claims Pages, who served as moderator.

Ruppelt added, “Florida is the poster child for legal system abuse.”

The panel analyzed the general landscape of these issues, and how Florida became the epicenter of many of these issues.

They noted that in Florida, roof and windshield claims are part of this cottage industry, driven by plaintiff fee recoveries more than the subject of the litigation itself. The costs of roofs have dramatically increased even in the past three years. This is not primarily driven by disasters.

“In 2021, Florida had 116,000 property insurance lawsuits pending,” Ruppelt said. “The state is on pace for approximately 130,000 in 2022.” 

Most states only have a few hundred. California, the most populous state in the U.S., had a mere 3,500 property insurance lawsuits pending in 2021.

“The numbers highlighted are staggering,” said Fred Karlinsky, shareholder and global co-chair of Greenberg Traurig, LLP. “It’s been recognized at the highest levels of state government.”

With the recent gubernatorial election in Florida, this problem has only become more visible. Incumbent Ron DeSantis and his challenger (and former governor of Florida) Charlie Crist debated over the costs of roof replacement, as well as litigation over home insurance.

“There may be a $10,000 judgement award, but millions of dollars of fees,” Karlinsky said.

Indeed, the property insurance market has become similar to health care, with assignment of benefits (AOBs)—in which an insured signs their benefits over to the medical provider—getting paid by insurers.  AOBs utilize unscrupulous contractors that come in before the insurers, and “make your home a disaster zone.”

“The insurers have no way to know what the damage was, and now they have to fight these claims,” Karlinsky added, noting that once the insurer enters the court system, it often results in nuclear verdicts.

“Florida is tougher for adjusters,” mentioned Joseph Blanco, the president of Crawford & Company. “After we confirmed up for Hurricane Irma, there have been billboards all over the place saying don’t believe adjusters.” 

Attacking the credibility of adjusters, Blanco said, makes it very difficult for insurers. This only adds to unrealistic expectations for claims, making it more challenging to settle pre-litigation.

Though the panel recognized this kind of legal abuse began in the 80’s and experienced upward trends in the 90’s and early 2000’s, there were calls at the time for nationwide tort reform. However, the lawyers involved in these suits have become more sophisticated, making it even more challenging to confront this issue.

“The lawyers involved identify a theory of liability, find litigation funders, create advertisements, and then they go forum shopping,” said Harold H. Kim, the president of the Institute for Legal Reform, and the chief legal officer and executive vice president of the U.S. Chamber of Commerce. “They roll the dice to see if they can achieve a settlement or a nuclear verdict, which shifts the value of negotiations.”

“It’s so pernicious that the corporate community is in the crosshairs,” Kim added. “The stability of the rule of law and the ability to operate a business is critically challenging.”

The panelists agreed that problems surrounding legal abuse are only growing more significant.

“What we have seen is the use of plaintiff attorneys are moving out of Florida to you,” Karlinsky said. “AOBs and the roof phenomena are not just going to be in the large states. We’re seeing them all over the place. The plaintiff’s bar does not have the same restrictions as the insurance industry.”

“What happens in Florida doesn’t stay in Florida,” concluded Kim.

Catastrophes, Coastal Property, Disaster Preparedness, Disaster Resilience, Flood Insurance, Floods, Homeowners Insurance, Legal Environment

Lawsuits Threatento Swell Ian’s Price tag

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Litigation costs could add between $10 billion and $20 billion to insured losses from Hurricane Ian, adding to the woes of Florida’s already struggling homeowners’ insurance market, says Mark Friedlander Triple-I’s corporate communications director.

Early estimates put Ian’s insured losses above $50 billion.

“Based on the past history of lawsuits following Florida hurricanes and the state’s very litigious environment, we expect a large volume of lawsuits to be filed in the wake of Hurricane Ian,” Friedlander said in an interview with Insurance Business America.

Most suits are expected to involve the distinction between flood and windstorm losses. Standard homeowners’ policies exclude flood-related damage from coverage, but differentiating between wind and flood damage in the aftermath of a major hurricane can be challenging.

Flood insurance is available from FEMA’s National Flood Insurance Program, as well as from a growing number of private carriers.

Trial attorneys are “already on the ground” and soliciting business in some of the hardest hit areas, Friedlander said. “This will be a key element in the solvency of struggling regional insurers who are already facing financial challenges.”

Six Florida-based insurers have already failed this year. Florida accounts for 79 percent of all U.S. homeowners’ claims litigation despite representing only 9 percent of insurance claims, according to figures shared by the Florida governor’s office. Litigation has contributed to double-digit premium-rate increases for home insurance in recent years, with Florida’s average annual home-insurance premium of $4,231 being among the nation’s highest.

“Floridians are seeing homeowners’ insurance become costlier and scarcer because for years the state has been the home of too much litigation and too many fraudulent roof-replacement schemes,” Triple-I CEO Sean Kevelighan said. “These two factors contributed enormously to the net underwriting losses Florida’s homeowners’ insurers cumulatively incurred between 2017 and 2021.”

Trevor Burgess, CEO of Neptune Flood Insurance, a St. Petersburg, Fla.-based private flood insurer, said that in all locations pummeled by Ian, the percentage of homes covered by flood policies is down from five years ago. Friedlander told Fox Weather that, while more than 50 percent of properties along Florida’s western Gulf Coast are insured for flood, “inland…the take-up rates for flood insurance are below five percent.”

While Florida is at particularly severe and persistent risk of hurricane-related flooding, the protection gap is by no means unique to the Sunshine State. Inland flooding due to hurricanes is causing increased damage and losses nationwide – often in areas where homeowners tend not to buy flood insurance.

In the days after Hurricane Ida made landfall in August 2021, massive amounts of rain fell in inland, flooding subway lines and streets in New York and New Jersey. More than 40 people were killed in those states and Pennsylvania as basement apartments suddenly filled with water. In the hardest-hit areas, flood insurance take-up rates were under five percent.

Damaging floods that hit Eastern Kentucky in late July 2022 and led to the deaths of 38 people also were largely uninsured against. A mere 1 percent of properties in the counties most affected by the flooding have federal flood insurance.

“We’ve seen some pretty significant changes in the impact of flooding from hurricanes, very far inland,” Keith Wolfe, Swiss Re’s president for U.S. property and casualty, said in a recent Triple-I Executive Exchange. “Hurricanes have just behaved very differently in the past five years, once they come on shore, from what we’ve seen in the past 20.”

Auto Insurance, Legal Environment, Regulation

Delaware Legislature Adjourns Without Action on Banning Genderas Auto Insurance Factor

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Delaware’s state Legislature adjourned for the year without the House taking action on Senate Bill (SB) 231, which called for prohibiting the use of gender as a rating factor in personal automobile insurance policies.

The measure was based on research conducted with the Consumer Federation of America that contended many insured Delaware women are charged more than men, even when all other factors are the same. If signed into law, it would have required Delaware’s auto insurers to revisit how they price their personal automobile insurance policies for all drivers. Six states – California, Hawaii, Massachusetts, Michigan, North Carolina, and Pennsylvania – already have similar laws in place.

“The Delaware state Legislature and the Department of Insurance have the right and responsibility to govern and regulate how insurance companies conduct business within the State of Delaware,” Triple-I Chief Insurance Officer Dale Porfilio wrote in response to SB 231, which was approved by the Delaware Senate in April 2022. However, in his letter to Delaware Insurance Commissioner Trinidad Navarro, he raised several concerns with the underlying research, including:

Website Quotes vs. Issued Policies. While the Internet and electronic processing of quotes have dramatically improved the speed and accuracy of quotes, Porfilio wrote, “Many details can change for the portion of quotes which ultimately become issued policies, causing quotes to not be 100 percent accurate for issued premiums.”

Single Hypothetical Insured vs. Range of Actual Insureds. The report studied hypothetical 35-year-old drivers, then drew a conclusion about the full breadth of female and male drivers in the state of Delaware.

Aggregation across Zip Codes. Pricing methodologies are refined to very specific territorial definitions, which vary by insurer, and the report does not describe how the sample was aggregated across Zip Codes.

Porfilio explained that a consequence of enacting S.B. 231 would be a redistribution of who pays how much premium, with most of the premium increases paid by female policyholders (notably at younger ages), and a majority of the premium decreases received by male policyholders.

Critics of U.S. auto insurer pricing practices have expressed concerns that certain rating factors discriminate against certain groups. Triple-I has explained in multiple contexts how U.S. auto insurers use a wide variety of rating factors to accurately price policies.  These factors must conform to the laws and regulations of the state in which the auto insurance policies are sold,  and eliminating any one could force less-risky policyholders to overpay and allow those with greater risk to pay less than they should.

Learn more about auto insurance pricing

Triple-I: Rating-Factor Variety Drives Accuracy of Auto Insurance Pricing

Why Personal Auto Insurance Rates Are Likely to Keep Rising

IRC Releases State-by-State Auto Insurance Affordability Rankings

Auto Insurance, Legal Environment

IRC Study: Public Perceives Impact of Litigationon Auto Insurance Claims

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Most Americans believe attorney advertising increases the number of liability insurance claims and lawsuits, according to recent research from the Insurance Research Council (IRC). The survey also indicated that consumers see a connection between attorney advertising and insurance costs.

The IRC – like Triple-I, an affiliate of The Institutes – also found that consumer awareness of third-party litigation funding has increased, though many Americans remain uncertain what to think of the practice. Litigation funding – in which third-party investors assume all or part of the cost of a lawsuit in exchange for a percentage of the settlement – is often cited as contributing to “social inflation.” Social inflation refers to the impact of rising litigation costs on insurers’ claim payouts, loss ratios, and, ultimately, how much policyholders pay for coverage.

“The public sees a connection between attorney ads and the cost of insurance,” said IRC President and Triple-I CEO Dale Porfilio, FCAS, MAAA. “Two-thirds of respondents who had an opinion said advertising by attorneys increases the number of liability claims and lawsuits. Fifty-nine percent said such advertising increases the cost of insurance.”

The survey also found 81 percent of Americans had seen an attorney advertisement within the past year. Thirty-nine percent had never heard of the term “litigation funding.”

The IRC study, Public Attitudes on Litigation Trends and the Role of Attorneys in Auto Insurance Claims, consisted of an online survey with over 1,500 respondents. It also uncovered that:

  • Consumers generally expect insurers to settle auto insurance claims fairly and quickly, but one in four say they would hire an attorney before even contacting an insurer;
  • The views of many consumers about the benefits of hiring attorneys to help with insurance claims conflict with evidence from claims-based research;
  • Most Americans believe there are too many personal injury lawsuits today;
  • Significant generational differences exist on these topics, with younger respondents being far more likely than older respondents to favorably view attorney involvement and litigation; and
  • The public’s level of understanding suggests some educational opportunities for those seeking to address costs in the insurance system.

“This survey builds on many years of IRC work examining the role of attorneys in insurance claims and the resulting consequences,” Porfilio said. “Our longstanding series of closed auto injury claim studies has shown an ever-increasing rate of attorney involvement, even among no-fault claims.”

Porfilio noted that these studies consistently show that claimants who hired attorneys waited significantly longer to receive their settlements and – after medical expenses and legal fees – those settlements were smaller than for claimants who did not.

“Given the costs added to the system and the lack of evidence of clear benefit for the claimant, it is important to understand public attitudes about attorney involvement,” Porfilio said.

Homeowners Insurance, Insurers and the Economy, Legal Environment

Fraud, Litigation Push Florida Insurance Market to Brink of Collapse

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With its abundance of unneeded new roofs on homes – and flashy lawyer billboards at every turn claiming massive settlements on claims – Florida’s insurance market is on the verge of failure. This man-made catastrophe is causing financial strain on consumers, as the annual cost of an average Florida homeowners insurance policy will skyrocket to $4,231 in 2022, nearly three times the U.S. annual average of $1,544.

“Floridians pay the highest homeowners insurance premiums in the nation for reasons having little to do with their exposure to hurricanes,” said Triple-I CEO Sean Kevelighan.  “Floridians are seeing homeowners insurance become costlier and scarcer because for years the state has been the home of too much litigation and too many fraudulent roof-replacement schemes. These two factors contributed enormously to the net underwriting losses Florida’s homeowners’ insurers cumulatively incurred between 2016 and 2021.” 

Two major hurricanes made landfall in the state since 2016: 2017’s Irma and 2018’s Michael.

No direct hits occurred in Florida over the past three hurricane seasons. 

Florida, however, is the site of 79 percent of all homeowners insurance lawsuits over claims filed nationwide, even though Florida’s insurers receive only 9 percent of all U.S. homeowners insurance claims, according to the Florida governor’s office. To illustrate how lawsuits have weighed on insurer operating costs, JD Supra, citing the Florida Office of Insurance Regulation (OIR), reported $51 billion was paid out by Florida insurers over a 10-year period, and 71 percent of the $51 billion went to attorneys’ fees and public adjusters. The 2020 and 2021 cumulative net underwriting losses for Florida homeowners’ insurers totaled more than $1 billion each year.

“The state’s homeowners’ insurers have been forced to respond to these unfortunate market trends this year by restricting new business, non-renewing existing policies, and even canceling policies mid-term,” Kevelighan said. “What’s more, four homeowners insurance companies have been declared insolvent since February — all while more Americans are moving to Florida than any other state.”

Citizens Property Insurance Corp., the state-backed property insurer of last resort in Florida, has seen its policy count rise to nearly 900,000 this month statewide.  Its policy count figure stood at about 420,000 in October 2019.  Citizens provides insurance coverage to homeowners unable to find a private-sector insurer willing to sell them a homeowners insurance policy.

Placing further pressure on the affordability and availability of homeowners’ insurance in the state, third-party rating bureaus have downgraded the financial ratings of some insurers operating in Florida.

The typical Florida homeowners’ insurance policyholder paid $2,505 for coverage in 2020, Triple-I found, and that figure rose to $3,181 in 2021.  Triple-I’s analysis was based on data and analyses from Florida’s OIR, the National Association of Insurance Commissioners (NAIC), and Triple-I’s estimates of what insurers are paying today for home replacement costs.

During a special legislative session in May 2022, Florida lawmakers passed Senate Bill 2B, which Gov. Ron DeSantis signed into law. The measure is aimed at easing homeowners’ premium increases and reducing excessive litigation.

To help Floridians and others residing in natural disaster-prone states better manage risk and become more resilient, Triple-I launched a few years ago its Resilience Accelerator initiative, Kevelighan said.

The Resilience Accelerator’s goal is to demonstrate the power of insurance as a force for resilience by telling the story of how insurance coverage helps governments, businesses and individuals recover faster and more completely after natural disasters. “The insurance industry’s focus on resilience is starting to pay dividends as more Americans recognize the very real risks their residences face from floods, hurricanes, and other natural disasters,” Kevelighan added.

Insurers and the Economy, Legal Environment

Litigation-Funding Law Found Lacking in Transparency Department

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Piecemeal efforts to bring transparency to third-party litigation funding continued apace (albeit a snail’s pace) with legislation the governor of Illinois signed into law on May 27th.

The funding of lawsuits by investors with no stake beyond the potential to profit from any settlement has been a growing contributor to the phenomenon known as “social inflation”: Increased insurance payouts and higher loss ratios than can be explained by economic inflation alone. These increased costs necessarily end up being shared by all policyholders through increased premiums.

Litigation funding not only drives up costs – it introduces motives beyond achieving just results to the judicial process. This is why the practice was once widely prohibited in the United States. As these bans have been eroded in recent decades, litigation funding has grown, spread, and morphed into forms that can cost plaintiffs more in interest than they might otherwise gain in a settlement. In fact, it can encourage lengthier litigation to the detriment of all involved – except for the funders and the plaintiff attorneys.

Funding of lawsuits by international hedge funds and other third parties has become a $17 billion global industry, according to Swiss Re. Law firm Brown Rudnick sees the industry as even larger, at $39 billion globally, according to Bloomberg.

But it’s hard to actually know how big the industry is and how much harm it may be causing because, in most cases, plaintiffs’ attorneys are not required to disclose whether, to what extent, and under what terms third-party funders are involved in the cases they bring to court.

Inching toward transparency

In April, we reported on the partial, creeping progress toward bringing greater transparency to this practice in courtrooms and state legislatures. Last year, the U.S. District Court for the District of New Jersey amended its rules to require disclosures about third-party litigation funding in cases before the court. The Northern District of California imposed a similar rule in 2017 for class, mass, and collective actions throughout the district. Wisconsin passed a law requiring disclosure of third-party funding agreements in 2018. West Virginia followed suit in 2019.

At the federal level, the Litigation Funding Transparency Act was introduced and referred to the House Judiciary Committee in March 2021. The measure was referred to the Subcommittee on Courts, Intellectual Property, and the Internet in October of last year.

The Illinois legislation, originally introduced in 2021, has some similarities to Wisconsin’s law – but the version signed last week contained “insufficient regulatory safeguards,” the American Property Casualty Insurance Association (APCIA) said. In its letter urging Gov. J.B. Pritzker to veto the measure, APCIA said a major concern is that it authorizes an interest rate to be paid by the plaintiff/borrowers in such cases “that shall be calculated as not more than 18 percent of the funded amount, assessed every six months for up to 42 months.”

The legislation does not clarify whether the 18 percent rate calculation is simple, compound, or cumulative interest over the 42-month period.

“This lack of clarity is problematic, as a cumulatively calculated interest rate could run as high as 126 percent!” APCIA said. “It is essential for the protection of consumers that this interest rate calculation be clarified.”

Further, APCIA explains, “The parties to these funding agreements are not required to disclose their existence, so that the courts and defendants are typically not aware of the presence or identity of the funders as real parties in interest to the litigation. The economic interests of the funders in these transactions are substantially enhanced by prolonged litigation and discouraging the amicable settlement of disputes, all to no ones’ best interests except those of the money lenders.”

Even the legal profession is concerned about the ethical implications of litigation funding. In 2020, the policymaking arm of the American Bar Association (ABA) approved a set of best practices for these arrangements. The resolution lists the issues lawyers should consider before entering into agreements with outside funders – but it doesn’t take a position on the use of such funding.

A standardized approach to disclosure would go a long way toward helping policymakers and decision makers determine an appropriate path forward.

Emerging Risks, Legal Environment, Regulation

A Piecemeal Approach Toward Transparency In Litigation Finance

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A U.S. District Court judge in Delaware made his courtroom the latest jurisdiction to require lawsuit participants to disclose whether third-party investors have any stake in litigation being brought before him.

While this is a step toward greater transparency with regard to third-party litigation funding, the standing order by Chief Judge Colm F. Connolly only affects cases in his court. The other three district court judges in Delaware have not issued similar decrees. But the order was made in an extremely influential district. More than half of publicly traded U.S. corporations are incorporated in Delaware, and the state’s laws often govern contracts between businesses.

A booming global industry

Funding of lawsuits by international hedge funds and other financial third parties – with no stake in the outcome other than a share of the settlement – has become a $17 billion global industry, according to Swiss Re. Law firm Brown Rudnick sees the industry as even larger, at $39 billion globally, according to Bloomberg.

Third-party litigation funding was once widely prohibited. As bans have been eroded in recent decades, it has grown, spread, and become a contributor to “social inflation”: increased insurance payouts and loss ratios beyond what can be explained by economic inflation alone.

Efforts at transparency

Some progress in toward greater transparency has been made in recent years. Last year, the U.S. District Court for the District of New Jersey amended its rules to require disclosures about third-party litigation funding in cases before the court. The Northern District of California imposed a similar rule in 2017 for class, mass, and collective actions throughout the district. Wisconsin passed a law requiring disclosure of third-party funding agreements in 2018. West Virginia followed suit in 2019.

At the federal level, the Litigation Funding Transparency Act was introduced and referred to the Senate Judiciary Committee in October 2021.

Panelists at Triple-I’s Joint Industry Forum in December 2021 agreed on the importance of requiring disclosure of litigation funding. Insurance groups and the U.S. Chamber of Commerce say litigation funding needs more rules to prevent abuses of the legal system and to protect consumers, who often pay exorbitant interest rates on money they borrow to pay legal expenses.

“By its very nature, third-party litigation financing promotes speculative litigation and increases costs for everyone,” said Stef Zielezienski, executive vice president and chief legal officer for the American Property Casualty Insurance Association in a press release about the Delaware order. “At its worst, outside investment in litigation financing dependent on a successful verdict creates incentives to prolong litigation.”

The Delaware judge’s order requires, in addition to disclosing the name and address of any third-party funder, that parties to any case before his bench must also disclose whether approval by the funder is necessary for settlement decisions and, if so, the terms and conditions relating to that approval.

While strides like this may be small, they add up in the fight to make disclosure of third-party litigation financing a priority in states and in courthouses nationwide.

Learn More:

Social Inflation: What It Is and Why It Matters

Triple-I, CAS Quantify Social Inflation’s Impact on Commercial Auto

What Is Social Inflation and What Can Insurers Do About It?

IRC Study: Social Inflation Is Real, and It Hurts Consumers, Businesses

ESG, Legal Environment, Regulation, Risk Management

Bringing Clarity
to Concerns About Race
in Insurance Pricing

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There is no place for discrimination in today’s insurance marketplace. In addition to being fundamentally unfair, to discriminate on the basis of race, religion, ethnicity, sexual orientation – or any factor that doesn’t directly affect the risk being insured – would simply be bad business in today’s diverse society.

Concerns have been raised about the use of credit-based insurance scores, geography, home ownership, and motor vehicle records in setting home and car insurance premium rates. Critics say using such data can lead to “proxy discrimination,” with people of color sometimes being charged more than their neighbors for the same coverage. Insurers reply that these tools reliably predict claims and help them match premiums with risks – preventing lower-risk policyholders from subsidizing higher-risk ones.

Public confusion around insurance rating is understandable. The models used to determine insurance rates are complex, and actuaries have to distinguish causal relationships from superficial correlations to appropriately align insurers’ prices with the risks they’re covering. If they get it wrong, the insurers’ ability to keep their promises to pay policyholder claims could be compromised.

And they have to do this while complying with regulations and statutes in 50-plus U.S. jurisdictions. As one of the most heavily regulated industries in the world, insurers have strong incentives to comply with anti-discrimination rules.

To help clarify this complexity, Triple-I has published an Issues Brief on the subject, and the Casualty Actuarial Society has published a series of four research papers, drilling down deep into the topic:

• Defining Discrimination in Insurance

• Methods for Quantifying Discriminatory Effects on Protected Classes in Insurance

• Understanding Potential Influences of Racial Bias on P&C Insurance: Four Rating Factors Explored

• Approaches to Address Racial Bias in Financial Services: Lessons for the Insurance Industry

“Insurance pricing is a high-wire act,” CAS says.  “As regulation and society’s understanding of discrimination evolve, however, it is necessary for us to keep abreast of changes in the manner in which discrimination is defined and adjudicated.”

Insurers are well aware of the history of unfair discrimination in financial services. While it would be disingenuous to suggest that all traces of bias have been wrung out of the system, the insurance industry has been responsive over the decades to concerns about fairness and equity. Insurers and actuaries are uniquely positioned to continue helping policymakers, corporate decisionmakers, and the public understand these inequities and to play a constructive role in the policy discussion.