Loss Mitigation Underwriting

Many insurers are now willing to issue policies insuring existing or imminent litigation or loss which is otherwise uninsured or inadequately insured. Frequently referred to as Loss Mitigation Underwriting ('LMU'), this type of risk transfer arrangement presents to insurers and insureds both significant underwriting challenges as well as tremendous potential benefits.

Examples of situations where LMU insurance may be useful to a company include the following:

Strategic Transaction

A desirable strategic transaction (such as an acquisition of the company, a securities offering or a debt restructuring) may not be possible unless the company conclusively contains a potentially catastrophic lawsuit or loss exposure. But the company may not be able to negotiate and finalize a settlement with plaintiffs or to quantify the loss within the limited time frame of the strategic transaction. LMU insurance can contain the risk exposure, thus allowing the strategic transaction to proceed.

Stock Price

When a company faces a potentially catastrophic lawsuit or loss, the market price of its stock may be suppressed, thereby creating discontent among shareholders, impairing the company's financing alternatives, and projecting a false image of fundamental financial distress. This market response frequently is an over-reaction based on a false impression that the claim is worse than it really is. An LMU can provide comfort to the securities market that the perceived catastrophic exposure is quantified and contained, thereby allowing the company's stock price to return to its true value.
 
Unreasonable Plaintiff

The plaintiffs in a lawsuit may have grossly unreasonable expectations regarding the value of the claim, thus forcing defendants to defend the case up to and perhaps through trial. In large cases, plaintiffs frequently use the threat of a 'runaway' jury verdict to coerce an excessive settlement from defendants. An LMU can allow defendants to contain their financial exposure from the claim sooner rather than later and can potentially assist in settlement negotiations with plaintiffs by showing that the defendants are no longer concerned about a large jury verdict. In addition, in some instances the LMU insurer may be able to assert greater leverage over plaintiffs and may be able to more persuasively negate plaintiffs' threat to take the claim to trial. For example, the insurer may have a large number of cases with the plaintiffs' counsel and may be able to more convincingly say 'no' to an unreasonable settlement offer from plaintiff.

Tax Issues

Insurance premiums generally are deductible for federal income tax purposes. However, many settlements, judgments and other losses are not deductible. For example, costs incurred to resolve a shareholder class action arising out of the company's sale of securities may be a capital expenditure which cannot be fully deducted in the year incurred. In some instances, an LMU may enable a defendant to convert a non-deductible loss into a deductible insurance premium.

Although there is an infinite number of LMU variations, the most frequent LMU structures include:

1. Additional insurance coverage directly excess of the company's existing insurance. Because this structure simply increases the total amount of insurance available for the subject claim without creating any structural barriers to accessing the new coverage, this approach is at times less attractive to insurers than other alternatives.
      
2. High level additional insurance coverage that is excess of both the company's existing insurance and a large self-insured retention ('SIR')which applies once the existing insurance is exhausted. By placing a large SIR between the existing coverage and the new coverage, the Insureds retain a strong economic incentive to minimize loss from the subject claim and the plaintiff cannot directly reach the new insurance without first exhausting the large SIR through recovery from the Insured's own assets. Insurers typically favor this structure because it minimizes the risk of the LMU changing the Insureds' and the plaintiffs litigation settlement strategies, expectations, and behavior.
     
3. The Insurer's complete assumption of the entire claim, including full claims control. The Insurer's rationale for this extraordinary assumption of risk is the belief that the Insurer can successfully negotiate an acceptable settlement with the plaintiff by utilizing the Insurer's vast resources, experiences and perceived leverage over the plaintiff. Unlike the Insureds, the Insurer probably has a large 'inventory' of claims with plaintiffs' counsel, thereby potentially giving the Insurer greater credibility and leverage in settlement negotiations. Obviously, because this structure involves the greatest amount of risk transfer, this structure typically involves the largest amount of premium.
     
4. Insurance coverage only for judgments, not settlements or defense costs, in the lawsuit. Because the vast majority of claims which are subject to LMUs are settled rather than tried to judgment, this structure arguably transfers to the Insurer less risk while still providing the Insureds with desirable catastrophic loss protection in the event of a large judgment. This structure may also facilitate more reasonable settlements by showing to plaintiffs that defendants are not afraid to try the case if necessary. As a practical matter, this structure may also afford coverage for large settlements since the Insurer may conclude that it is in the Insurer's best interest to make a voluntary contribution to a settlement in order to facilitate such a settlement, thereby eliminating the risks associated with a trial of the claim.
    

LMU policies are usually manuscripted to address the unique features of each situation. Typically, an LMU provides very broad coverage for the specified claim(s) or loss, frequently subject to a co-insurance provision, and either a return premium or additional premium provision depending on whether the Insurer ultimately pays any loss under the LMU. The LMU coverage can be either following form to existing underlying insurance or broader than existing underlying insurance. Typically, LMUs have relatively few exclusions. The most common include fraud, illegal profit, costs to comply with non-monetary relief, fines and penalties and, with respect to professional liability coverage, bodily injury, property damage and claims by Insureds.