The advantages and disadvantages of stepped premiums, in comparison to other methodologies, has been covered by previous editions of Litigation Funding but it is now impossible to refute that the stepped premium methodology is the dominant structure in the after-the-event (ATE) insurance market. It seems to me to be the natural time to explore how the stepped premium has evolved, how it has helped shape the ATE market over the last decade, and how it might continue to do so.
VARIATIONS ON A THEME
Three industry professionals have each claimed to me that they invented the concept. I do not know who has the most legitimate claim and frankly it doesn’t matter; whoever it was won’t exactly be appearing in the Queen’s Birthday Honours list for services to the market, considering that the government appears to believe it is an unnecessary industry. Whoever it is should, however, be proud that their idea has been replicated, adapted, renamed and rebranded repeatedly over the last decade to the extent that, in one form or another, it is now the market norm. I have myself successfully tweaked the stepped model to suit niche areas of practice, like so many others.
The most common type of stepped premium is a premium which increases according to specified events in the litigation timeline, such as the commencement of proceedings or exchange of expert evidence, for example. Of course, the steps could just as easily be expressed as ‘discounts’ or ‘rebates’ against the full trial premium.
Less common but increasingly adopted in potentially very long-tail litigation are steps based on the number of months for which the litigation has been running. Frequently, this type of staging is accompanied by a minimum and maximum premium cap.
Using the limit of indemnity remains constant regardless of the premium structure, but occasional variations involve staggered limits of indemnity which increase together with the premium as the case passes the specified trigger points.
Some stepped premiums leave the trial stage premium open-ended so that underwriters can set the price based on the prevailing circumstances (that is, chances of a claim being made and the potential size of the same). The policy considered in Rogers v Merthyr Tydfil CBC adopted such a premium structure and DAS referred to basing the trial stage premium on its estimated maximum loss (EML).
We are seeing an increasing number of steps connected to the commencement of appeals and the integration of ADR where it is known or anticipated that there will be mediation. Some of the largest policies that we have brokered, with multi-million pound limits of indemnity, incorporate very large discounts if the cases settle at mediation. In one instance, where such a case did settle at mediation, the solicitor later told me that the tailored step was a major catalyst for settlement.
In large commercial cases, the first step is very occasionally payable upfront (and payable regardless of the outcome), with the subsequent steps remaining contingent on success (and therefore deferred until the outcome is known). Rather still, and possibly even extinct now, are the so called ‘tranched premiums’, which require each premium step to be paid up front as each trigger point is hit.
A certain amount of care has to be taken with stepped premiums, particularly when the milestones are being drafted. I have seen things go wrong for underwriters on more than one occasion. Where there is any ambiguity over whether the milestone has been reached, this can lead to a conflict between the solicitor and insurer. I have recently seen witness evidence being a trigger point; it was later pointed out that there would be no formal exchange of witness statements. Had the policy been executed in that draft form and had the case settled after proceedings had been issued but before trial, it would have been difficult to know how much premium was due.
While some variations are more advantageous for insurers are some are better for policyholders, the fact that there are several versions of the stepped premium model serves to underline to its popularity within the market.
IMPACT ON THE COURT PROCESS
The modification to the N251 Notice of Funding to include the stepped premium trigger points illustrates the impact that the stepped premium methodology has had on the legal process. As a direct consequence of stepped premiums, the Court of Appeal in Rogers decided that claimant solicitors should be notifying the defendants of the exact points at which the premium reaches the applicable steps. I was in the court when this was debated, so I witnessed the unanimous agreement that this would be a good idea. It must be that disclosing the premium steps, whether mandatorily or voluntarily, has helped cases settle and is generally fairer all round. (The requirement to disclose the limit of indemnity was not such a good idea in my view as it prejudices the position of the litigant with less resource. Surely security for costs applications provides adequate protection for defendants concerned about the ability of the claimant to pay adverse costs.)
IMPACT ON PRICING
Evidence presented by insurers in Rogers suggested that there is actually very little difference between flat premiums and stepped premiums in terms of the insurer’s income. However, I believe that recoverability of the stepped premium methodology has driven the pricing of the ATE class down in a way that flat premiums would not.
This is because the stepped premium model has changed the behaviour of defendants in some areas of practice. In areas like clinical negligence and professional negligence, where there are a small number of opponents who deal with repeat litigation, you can track that change in their behaviour. For instance, one delegated authority client used his ATE bordereau as evidence to show me that the NHS Litigation Authority had begun to settle a far greater proportion of his cases pre-issue, since the introduction of the ATE scheme. It is possible that the trend coincided with a change of policy at the authority, of course, but the point is that when repeat defendants are more accustomed to the impact of stepped premiums, they will adapt to them. This discussion took place well before the new N251 form, but the mandatory disclosure of the milestones will only serve to prolong the trend in areas of practice where there are repeat defendants.
The question is whether the identified trend will, stimulated by the stepped premium structure, eventually lead to lower premiums. To put it another way, are stepped premiums making the market cheaper? In a normal competitive market, that would surely be the case but whether that description applies to the ATE market is another debate entirely. In my experience though, ATE premiums in personal injury litigation have reduced due to competitive forces over time and it is the pre-issue step that has dropped the fastest and furthest, implying that it is the defendant’s readiness to settle early that is driving the pricing. I would argue that their readiness to settle has itself been stimulated by expensive trial premiums. Therefore, stepped premiums can and have made ATE insurance cheaper.
WHAT HAPPENS POST-JACKSON?
If recoverability is abolished, the claimants will feel the impact of the stepped premium model in the way defendants are currently. Will they adapt their behaviour in the way that defendants have done to cope with the impact? I think so. The stepped premium will become an incentive for claimants to settle. It already happens in commercial litigation where there are global settlements, as well as in cases outside England and Wales. The claimant’s liability for the next ATE premium step is relevant in many cases, particularly low-value claims.
However, we should not necessarily assume that the popularity of the stepped premium will continue. Currently, solicitors tend to like stepped premiums as they can demonstrate to the defendant that they had a chance to settle for a lower premium. Post-reform, however, the emphasis will be on price, not recoverability. Solicitors (and their clients) will not be concerned with what could be the cheapest premium if everything runs perfectly; instead they will be concerned with what will realistically be the cheapest premium. The claimant will likely choose the premium methodology that is likely to result in the lowest premium and not necessarily one that could possibly (but improbably) be very cheap if the matter were to settle at an extremely early stage.
I predict that insurers will experience a new form of adverse selection, one that sees claimants trying to pick the methodology to suit them and certain more aggressively than they do now. Claimants may elect for the certainty of one single price, particularly in cases which they expect to fight to trial. Stepped premiums will be more popular where there is a genuine belief that the case will settle early. Insurers will probably have to offer multiple options to avoid losing orders to more flexible rivals and that will mean reliance on some detailed actuarial models to ensure their portfolio does not become lopsided.
Those insurers that succeed in the post-Jackson market will manage to deploy stepped premium policies among other structures in a balanced portfolio. Insurers cannot rely completely on stepped premiums in the way many do now.