For companies, the risk of rising litigation costs increases

The prosecution in court is primarily about justice. But very often it is about a lot of money. The sums of money being litigated have been rising sharply for years. Last year alone, there were 27 court cases in the USA in which compensation of more than 100 million dollars was awarded each – and the trend is rising sharply.

More expensive than natural disasters

Litigation has become big business. Many players are fueling the trend because they are making money from it. An analysis by the Swiss Re Institute shows that the increased number of extreme court rulings has led to liability claims in the USA increasing by 57 percent in the last ten years. The behavior in court is becoming increasingly aggressive.

The study was presented on Saturday at a reinsurance industry meeting in Monte Carlo. When reinsurers are mentioned, the focus is often on natural disasters, especially since these costs are largely borne by the reinsurers. But the fact is that the companies' business is increasingly being shaped by exploding litigation costs and increasingly serious liability cases.

For example, over the past five years, commercial liability claims in the United States have increased by 11 percent per year to $143 billion in 2023. According to the study, this sum is already significantly higher than the total insured losses from all natural disasters worldwide of $108 billion in the same year.

The costs are borne by the customers

In the industry, people talk about “social inflation”. This refers to the phenomenon that has been observed since the 1980s, whereby insured liability claims are rising much faster than can be explained by economic factors such as wages and consumer prices. While normal inflation in the USA rose by 3.7 percent per year between 2017 and 2022, “social inflation” rose by 5.4 percent.

Jérôme Jean Haegeli, chief economist at Swiss Re, said: “Unlike economic inflation, social inflation shows no signs of abating.” The costs of litigation are rising and are now the main driver of liability claims. As a result, the costs of liability insurance are also rising sharply. Private individuals and companies are having to dig deeper into their pockets to pay their premiums.

Swiss Re sees three historical cost increases in this form of inflation: In the US liability crisis of the 1980s, many companies and insurers were held retroactively liable for environmental and asbestos damage. In the early 2000s, class action lawsuits gained in importance. And currently, the number of large individual lawsuits is increasing, with the focus on personal injuries rather than economic damage in the narrower sense.

Generous jurors

The trend also reflects social changes. Consumer protection is becoming more comprehensive in many countries. In addition, public criticism of corporations is growing and the belief that they are directly responsible for an ever wider range of problems is growing. This also fits with the distorted image that corporations are fundamentally financially strong and can easily shoulder even gigantic fines.

In the USA, the tendency to settle damages in court seems to be particularly pronounced. This is also reflected in the balance sheets of American insurers. Their personal injury liability business recorded an underwriting loss of 43 billion dollars over the last five years. The increase in premiums has not kept pace with the increase in costs.

Is the American appetite for expensive litigation spreading to other regions? Swiss Re sees such a danger due to international insurance, even if the problem is unlikely to be as serious in other jurisdictions as it is in the USA. One reason is America's juries. These, often under public pressure, seem much more willing to impose enormous fines.

Litigation financing as an asset class

Anglo-Saxon countries with comparable legal systems, such as Canada, Great Britain and Australia, are particularly at risk of “social inflation”. Contagion can occur, for example, if a company makes corresponding claims against its British insurer following an expensive damages judgment in a court case in the USA.

In continental Europe, juries are less important and most professional judges determine sentences, but the risk of escalating litigation costs appears to be lower. The Netherlands is most at risk because it already has a system for class actions and an established market for third-party litigation funding.

Such third parties finance legal disputes, charging a fee only if they win. This makes it easier for plaintiffs who would otherwise not be able to afford to go to court to litigate. However, it also means that settlements and judgments are becoming increasingly expensive. Third-party litigation funding is already an 18 billion dollar market and an asset class in its own right – with respectable returns.

Fines in the billions

These financial firms especially deserve verdicts that far exceed expectations, with corporations in the dock. In the industry, convictions of $10 million or more are referred to as “nuclear verdicts.” The number of these increased by 27 percent in 2023, as an analysis by Marathon Strategies shows. These usually involve damages that are difficult to quantify, such as the value of a life.

In May of this year, ExxonMobil was ordered to pay $725 million to a gas station employee who had developed leukemia as a result of exposure to benzene. In 2022, an American cable company was fined $7.4 billion after an employee murdered an elderly woman. A judge later revised the fine down to $1.2 billion, but that is still a lot of money.