An LFJ Conversation with Stephen Kyriacou, Head of Litigation and Contingent Risk at WTW
We’ve seen increased interest in portfolio-based insurance solutions, particularly as the judgment preservation market has tightened. What’s driving this shift, and how are clients adjusting their risk strategies in response?
When I first joined the insurance industry back in 2019, after about a decade as a trial and appellate lawyer at Boies Schiller, we were primarily insuring single-case defense-side risks with what we now call adverse judgment insurance or “AJI” policies. Shortly after I started, the focus shifted to the plaintiff side, though most insurers still preferred insuring single cases with what came to be called judgment preservation insurance or “JPI” policies. These policies protected plaintiffs who had already won at trial or on summary judgment against appellate risk, effectively guaranteeing a minimum recovery from their trial court judgments no matter what happened on appeal.
JPI was the driving force behind the explosive growth in the litigation and contingent risk insurance market for several years, in large part because these policies allowed plaintiffs to monetize judgments more cost-effectively than they could without insurance. And as the market grew, so did the size of the judgments that were being insured and the amount of coverage limits that insurers were putting up, both individually and collectively, on these policies. It got to the point where policies providing over $100 million in coverage for multi-hundred-million-dollar judgments became commonplace, and several policies were written that provided more than $500 million in coverage on billion-dollar-plus judgments. Individual insurers were also sometimes betting tens of millions of dollars on the outcome of a single case as part of some of these JPI larger policies.
Unfortunately, while more modestly sized JPI policies on smaller judgments have generally performed as expected, with insurers not having to pay many claims, some of these larger, more high-profile JPI policies have run into significant challenges on appeal, on remand, and in places like the Patent Trial and Appeal Board. And the nature of this insurance is such that one big loss on a multi-hundred-million-dollar policy can more than wipe out the premium gains for insurers on several smaller policies.
The JPI losses that insurers have already incurred, and those they look likely to incur in the near term, have understandably caused many of them to reassess their approach to litigation and contingent risk insurance more broadly. For some insurers, that has meant pulling back from the space or taking a “back to basics” approach and returning to a focus on defense-side risk. But for many insurers, it has meant mirroring the pivot that much of the litigation finance industry made several years ago away from single cases – where financial outcomes can hinge entirely on one jury, one trial court judge, or one panel of appellate court judges – and toward a portfolio-focused approach that better spreads risk across multiple diverse cases or litigation-related investments, loans, or other assets. In fact, the insurers who have come into the market following the JPI boom, and who therefore have no exposure to any of the large JPI policies of recent years, are generally focused, at least for the time being, exclusively on providing this sort of portfolio-based coverage.
Our clients at WTW are embracing this new paradigm. Where a client may previously have sought to insure a single large patent infringement judgment with a similarly large JPI policy, they might now seek a portfolio-based policy that guarantees a minimum recovery from the combination of that judgment, several other earlier-stage cases that are pending in different trial courts, and numerous other patents they may seek to enforce through litigation in the future. We’re also working with litigation funders who may previously have sought to insure individual investments on a piecemeal basis once they reached the judgment stage to instead insure portfolios of diversified investments throughout all stages of the litigation lifecycle, including in some cases entire funds or designated sleeves of funds. Patent and mass tort case aggregators are also increasingly looking to avail themselves of portfolio-based insurance solutions that can be tailored to the unique risk profiles of their businesses and used as a financial tool to spur growth and increase profitability.
Law firms are getting in on the action, as well. We are seeing tremendous interest in “work-in-progress” or “WIP” wrappers that insure, on a cross-collateralized basis, a law firm’s anticipated contingency fee recovery across a portfolio of cases. Many of the recent WIP insurance placements that we’ve worked on recently have involved patent infringement cases and IP litigation boutiques, but we are also seeing interest from mass tort, personal injury, and product liability law firms, as well as among AmLaw 200 firms that focus on many different categories of high-value, capital- and labor-intensive plaintiff-side commercial litigation.
Can you walk us through what a portfolio-based insurance wrapper actually looks like – both for a litigation funder and for a law firm? How do the structures differ, and what risks are typically covered?
The basic structure of a portfolio-based insurance wrapper is very straightforward. Essentially, an insured purchases a policy with a specific amount of coverage limits that guarantees the insured will recover an amount equivalent to those coverage limits from the cases or litigation-related investments, loans, or other assets that comprise the portfolio that’s being insured. If, at the end of the policy term – or if the policy doesn’t have a specific term, once the last of the covered cases or investments has ended – the insured’s recovery is less than the limits on the policy, the insurers will pay out a “loss” on the policy that effectively trues the insured up to policy limits.
Recovery against the policy limits is measured differently depending on who the insured is: for litigants insuring pools of plaintiff-side litigation, insurers look to any amounts the litigant earns through damage awards and settlements on those cases; for litigation funders, hedge funds, or others insuring investments in litigation-related assets, insurers look to their returns on those investments; for lenders insuring loans to law firms or other participants in the plaintiff-side litigation ecosystem, insurers look to the amount of principal plus interest repaid on those loans; and for law firms insuring their work-in-process or “WIP” on a group of cases, insurers look to the contingency fees that the law firm collects on those cases.
For a litigation funder, it’s as simple as identifying a set of investments, loans, or other assets to go into the portfolio, identifying the amount the funder has invested in whatever it is that collateralizes the portfolio, and then insuring a minimum recovery that is some significant percentage of the funder’s overall investment. And as I mentioned earlier, these policies can insure an entire fund, a designated portion of a fund, a specific LP within a fund, or even a more bespoke portfolio comprised of select investments from within a given fund or from a cross-section of different funds.
As with portfolio policies for litigation funders, WIP policies can be placed on a programmatic basis across a firm’s entire contingency fee case book or on a more selective basis across certain specifically identified cases. Here’s an example of how a WIP policy might work: Imagine that a law firm was litigating ten cases on contingency, with an anticipated recovery of more than $100 million in contingency fees and expected WIP of $50 million across the portfolio of cases. The firm could potentially purchase a WIP policy with a $40 million limit, equal to 80% of its expected WIP, which would provide coverage if, over what is typically a five- to seven-year policy term, the ten cases in the portfolio collectively earn the firm less than $40 million in total contingency fees. If, at the end of the policy term, the firm had only recovered $20 million in total contingency fees, the policy would cover the $20 million shortfall against the $40 million in policy limits.
WIP policies are often used as a mechanism to attract litigation funding at a much lower cost of capital than otherwise would be available without insurance, including from sources of capital that don’t typically invest in litigation-related assets because of the high risk involved. There are dozens of different capital sources beyond traditional litigation funders – including hedge funds, family offices, private equity firms, private credit lenders, and other alternative sources of capital – who are keenly interested in lending against WIP policies, as well as against other portfolio-based and single-case insurance policies.
WIP insurance can also be a very useful tool for lawyers within firms where the billable hour is king to get approval from executive or contingency fee committees, or from the broader partnership, to bring high-value contingency fee cases. These policies provide the firm with a guaranteed minimum recovery from contingency fee litigation by the end of the policy’s term such that, if the cases don’t ultimately work out as planned, the financial result to the firm will be the same as if the lawyers on those cases had spent several years simply billing their time on non-contingency fee matters for clients who received a small discount on those lawyers’ hourly rates.
I should also note that, for any portfolio-based policy, as with some of the more traditional single-case policies like judgment preservation and adverse judgment insurance, premiums are generally in the form of one-time upfront payments. But for portfolio policies more than single-case policies, there are also mechanisms like deferred and contingent or “D&C” premiums that insurers are increasingly willing to employ to bring down the upfront premium cost in exchange for a modest piece of the recovery waterfall if the cases or investments that comprise the insured portfolio are highly successful.
How are insurers underwriting these portfolio-based structures differently than single-case policies? Are there specific underwriting thresholds, case mix requirements, or expected returns that make a portfolio “insurable”?
Most insurers define a “portfolio policy” as one that is insuring at least three to five cases, and the more the merrier. These cases should be uncorrelated, such that they should not all rise and fall together, and the more diversity that can be introduced into the portfolio – with regard to identity of plaintiffs, identity of defendants, specific causes of action, subject matter of the litigation, etc. – the better, as well.
That being said, it is common for an insured portfolio to be comprised of cases from a single plaintiff or representing only a single subject matter area from a litigation funder, law firm, or group of lawyers within a law firm who specialize in that subject matter area – think patent infringement, antitrust, or mass tort litigation. And of course, insurers are highly vigilant about adverse selection, and will not insure portfolios that they suspect to be comprised of a prospective insured’s cherrypicked worst or riskiest cases or investments. The easiest way to mitigate this suspicion as a prospective insured is to insure a “complete set” – whether the entirety of a given fund from a litigation funder, a law firm’s entire contingency fee case book, a patentholder’s entire patent portfolio, or a litigant’s entire portfolio of plaintiff-side cases.
Underwriting one of these portfolios is a very different exercise than underwriting a JPI or AJI policy. Rather than a single case with an extensive, well-developed record (including, as was often the case with JPI placements, the exact appellate record that would be put before an appellate court when they are asked to decide the case), insurers are often faced with a high number of cases and less detailed and voluminous information about each individual case. Often, cases that are already underway will have a limited history of case filings and unfiled cases will have only a preliminary case description and damages evaluation. Accordingly, while the number of cases increases substantially, having less information per case can result in the amount of underwriting time, and associated underwriting fees, being relatively similar to a JPI or AJI policy.
In terms of the actual underwriting process, it’s important to keep in mind that insurers do not need to put all their eggs in a single basket on portfolio polices like they do for a JPI or AJI policy. Instead, they determine the likelihood of success for each case in the portfolio and then assign an expected return to that case. Then, using a weighted average of all the cases, the insurer determines exactly how likely it is that the portfolio will collectively return an amount that exceeds the limits being purchased. Insurers are also looking at other things, as well, like a law firm or litigation funder’s track record on similar cases or investments, the underwriting guidelines being used to select cases or investments, the bona fides of the key individuals involved, case budgets, and the judgment collection and enforcement risk presented by the relevant defendants.
It’s also important to keep in mind that the structure of portfolio-based insurance policies makes it much less likely that a policy could suffer a full limit loss given the number of cases or investments that would need to go poorly in order for that to happen. This is another key differentiator from JPI, where a single adverse appellate court decision or bad remand outcome can sometimes cause a full limit loss.
Lastly, as I noted earlier, insurers will often look to include a deferred and contingent or “D&C” premium in portfolio-based policies, which allow the insurer to participate in the upside of a portfolio of cases or litigation-related investments if the portfolio turns out to be highly successful. Since a D&C premium only kicks in after the insured has recovered an amount in excess of coverage limits, underwriters of portfolio-based policies with a D&C component will also evaluate the probability that a portfolio brings in proceeds well in excess of limits, thus entitling them to that additional backend premium.
For litigation funders raising capital or structuring new vehicles, how critical is it to have an insurance solution baked in from day one? Are LPs demanding it, or is it still seen as an optional enhancement?
It ultimately depends on the type of investment capital that a funder is looking to attract. Traditional litigation finance LPs, who seek to make high-risk, high-reward investments, often view insurance as antithetical to why they are investing in litigation finance in the first place, because the premium costs – whether upfront or D&C – cut into their returns. These investors, and those funders who follow the same ethos, are generally not interested in wrapping their funds with any form of principal protection insurance coverage because they don’t want to forfeit any of their upside in order to do so.
On the other hand, a litigation funder who wraps a new fund with principal protection insurance can attract an entirely new class of investors that typically does not invest in litigation finance – investors who don’t need to understand litigation funding, or even litigation itself, in order to invest. These LPs may invest in an insurance-wrapped fund precisely because their downside is de minimus or, depending on the limits of the relevant policy, essentially zero, but with a high potential upside – albeit, not as high as the upside would be without insurance. This makes insurance-wrapped funds an ideal target for certain investment banking, pension fund, private equity, private credit, university endowment, sovereign wealth, family office, and other investors who will happily accept lower returns in exchange for lower – or, again, depending on the specific policy structure, potentially zero – risk.
So based on that, I see insurance coverage on a fund-wide basis as an optional enhancement that is very funder- and LP-dependent. But it’s important to remember that we have a significant amount of flexibility in how we can structure these policies to best achieve our clients’ financial and risk management goals. To give one example, there was a deal I worked on that involved a loan that a funder made to a law firm where the funds for the loan came from multiple different LPs, some of which needed principal protection coverage and some of which did not. We were able to structure an insurance policy that only insured the portion of the loan attributable to the LPs who needed insurance coverage and effectively treated the portion of loan funds that came from the other LPs as co-insurance on the policy. The significant co-insurance piece brought the cost of coverage down from where it would have been had we insured the entirety of the loan or a high percentage of the loan funds coming from all LPs. So even in situations where there are distinct or even polar opposite LP needs on a single investment, loan, or other transaction, we can often create an insurance-based solution that works to deliver an optimal balance of risk and reward for everyone, enabling deals to get done that just would not have happened without insurance.
