In a time of ongoing economic inflation and financial pressures, trends that increase costs for consumers and businesses are unwelcome guests. And yet, a pernicious trend exists that is imposing a burden on every business and household: legal system abuse.

Also known as social inflation, legal system abuse refers to actions taking place in the court system that raise costs for defendants and lead to abnormally inflated verdicts and settlements. Prevalent aspects of legal system abuse include plaintiff’s attorney advertising that aggressively recruits plaintiffs, and third-party litigation funding.

The insurance and reinsurance industry is among the first to register the financial impact of legal system abuse. The impact manifests in rising losses and loss adjustment expenses, but ripple effects radiate widely.

Jury awards are escalating in novel ways, and that trend is putting new concepts into the lexicon. Several years ago, a million-dollar verdict might have seemed high, but today we are seeing many “nuclear verdicts” – an award that exceeds $10 million – and we are beginning to see the industry using an even newer term to describe a far higher set, called “thermonuclear verdicts.”

In 2023 alone, four verdicts topped $1.2 billion, while another six verdicts each exceeded $550 million, according to VerdictSearch. Excessive tort costs reduce US economic output by at least $429.35 billion per year, and result in a “tort tax” averaging more than $1,300 per person, according to an analysis by the Perryman Group. Other analyses show an even higher impact. The Institute for Legal Reform estimated tort system costs in 2020 equaled 2.1% of the US gross domestic product, and $3,621 per household.

A recent survey conducted by Munich Re US and the American Property Casualty Insurance Association (APCIA) found concerning results in that the majority of respondents were unaware of the key drivers of legal system abuse.

Two of the largest drivers of legal system abuse are plaintiff’s attorney advertising and third-party litigation funding (TPLF). Both practices have become widespread in the United States. A 2022 study by the American Tort Reform Association (ATRA) found that plaintiff’s lawyers spent about $6.8 billion on advertising between 2017 and 2021, translating into 77 million national and local ads.

To understand the advertising tactics of plaintiff’s attorneys in the US, all one needs to do is turn on the television, tune into the radio, or drive around one’s community. Virtually everywhere, plaintiff’s attorneys are advertising on billboards, radio, television channels, and online, touting large monetary wins and attempting to recruit clients to seek compensation.

The Munich Re US/APCIA survey results show that public awareness of legal system abuse is mixed. Although, not surprisingly, 89% of respondents reported they have seen plaintiff’s attorney advertisements, and only 41% were aware of third-party litigation funding. TPLF is a tool that allows investors, such as hedge funds or other third parties who are otherwise uninvolved in a case, to bankroll lawsuits (including commercial litigation) in exchange for a portion of a judgment or settlement. 

The following illustration shows how TPLF works:

The amount of money invested in TPLF continues to grow. A 2022 Westfleet Advisors study found 44 funders in the US market committed $3.2 billion to litigation finance in 2022, a 16% increase from the prior year. Collectively, these funding organizations hold more than $13.8 billion in assets under management.

One of the challenges in understanding and measuring TPLF is that it is mostly unregulated. Some states have introduced legislation to require disclosure of third-party funds in litigation proceedings, while others have no rules on it. A lack of transparency about the existence of TPLF in a given legal case is a persistent problem.

The negative impact of legal system abuse is not abating. If it continues unchecked, legal system abuse will likely perpetuate and send improper signals to jurors, judges, and defendants about the value of damages. In turn, this can lead to higher insurance premiums, financial strain on insurers and reinsurers, depletion of municipal resources, and disincentives for businesses to take risks.

While legal system abuse appears poised to continue costing businesses, consumers, and communities, lawmakers and the insurance industry can take steps to combat it. These include:

• Promote tort reform and transparency. In the Munich Re US/APCIA survey, 86% of respondents agreed that state and federal lawmakers should address abuses of the legal system to restore fairness and balance to the civil justice system. In addition, 88% agreed courts should require full transparency and disclosure of all the parties who have a financial stake in a civil lawsuit.
• Exercise underwriting discipline. It is important for insurers to adequately price accordingly. Many lines of coverage have not yet reached price adequacy, and economic conditions will continue to have a negative impact on insurer profitability.
• Remain diligent in claims management. Insurers’ claims teams need to stay diligent in their claims handling and be mindful of the limits deployed. In addition, some insurers are using mock juries to gauge the potential for high verdicts, which helps companies work to settle claims more quickly.
• Raise awareness. As an industry, insurers and reinsurers should take the time to educate the public and raise awareness of legal system abuse and its impact.

Munich Re US provides clients with more than just reinsurance solutions to combat legal system abuse. We share our expertise and knowledge, identify trends, and help clients manage challenges in the marketplace. This article was produced in partnership with Business Insurance.

This article is not intended to be legal, underwriting, financial, or any other type of professional advice, and the recipient should consult with its own counsel or other advisors accordingly as determined by the recipient’s particular circumstances. No representation or warranty of any kind, whether express or implied, is provided with respect to the accuracy, completeness, or applicability of this article to any recipient’s circumstances. Any descriptions of coverage are meant to be general in nature, and the insurance policy and not any descriptions or representations made here will form the contract between the insured and insurance/reinsurance company. “Munich Re US” refers to Munich Reinsurance America, Inc., and Munich Re US disclaims any and all liability whatsoever resulting from reliance upon this article.