The relationship between third-party funders and after-the-event (ATE) insurers is likely to change in the coming years, it was predicted this week – while a leading ATE insurer warned funders that the honeymoon is almost over and losses will soon start stacking up.
The changing market could see ATE insurers share in the upside of a successful case, and also co-insurance because of the risk of heavy losses.
Speaking at the Westminster Legal Policy Forum’s third-party funding conference earlier this week, Nick Rowles-Davies of funder Vannin Capital said insurers are increasingly asking for full or partial up-front premiums – which the end of recoverability will fuel – but said it is more likely that insurers and funders will look at new remuneration structures.
“It has always been suggested by the ATE market that funders take the same risk for a very different return. Maybe that is how things will change going forward, with ATE providers sharing more in the upside. But there is likely to be a change from the existing set-up. Funders may use the existing ATE market less and offer indemnities within their funding agreements or set up their own captives, as some do already.
“If we do see an increase in the demand for up-front premiums, which seems inevitable, then funding for those premiums is one solution, either from the third-party funding market or from law firms raising their own capital to use for funding of their cases.”
Phil Bellamy, group underwriting, ATE and special risks manager at DAS, said there were lessons for funders in the experiences of the ATE market as it matured. Pointing to the loss suffered in the Innovator One case – the first major loss in a funded case – he said: “I think some parts of the funding industry, are in the last few days of the honeymoon period, and one or two may even be on the flight home. The £10m Innovator loss will not be the last, nor will it be the biggest. Make no mistake, the litigation funding losses have only just begun.”
He said the rosy figures coming out of funders reminded him of the early days of standard ATE insurance, when for the first few years, insurers were posting profits without any thought of a robust reserving policy, or the dangers of the long tail costs liabilities, these risks carry.
“History teaches us that anybody can make profits in the early years, as the easy cases settle, premiums and funding multiples are received, and cash flow is good. Even the cases that are abandoned, or lose at trial, will not cost that much in the early years, and can be absorbed by previous income.
“However, when the honeymoon period eventually ended for early ATE insurers, somewhere between the fifth, sixth and seventh years of trading, when significant losses from failed trials far exceeded the premium income from previous winners, a domino effect of under-reserved insurers began to leave the market, leading to reduced capacity and thereafter higher premiums.”
While accepting that funded cases are more robustly vetted than standard ATE litigation, Mr Bellamy said that where funders see a prospects of success figure of 60%, underwriters see that as a risk of failure of 40% – “which is a significant possibility of loss, and usually a total loss”.
He continued: “I already hear that capacity in certain areas is reducing, as is the maximum limit of indemnity you can secure with just one insurer. Going forward, once another one or two big losses have hit the headlines, and burnt the current ATE insurers, I predict that it will be more likely than not, that you will secure your insurance needs, through a group of ATE insurers, each writing a line of up to £1m or so, in order to spread their risk, and reduce volatility as much as possible.”
This method of group co-insurance or layering will be assisted by an increase in capacity from the ATE providers, as more seek to diversify their books to mitigate the impact of the Jackson reforms, Mr Bellamy said.