I recently spent a few days in San Diego enjoying and exhibiting at the RIMS conference, which is aimed most directly at corporate risk managers. KCIC met hundreds of interesting people who enjoyed the opportunity to have some fun with our surfing-themed “Get on Board with KCIC” photo booth. I was also able to attend a few sessions. One, in particular, offered some good advice and tools for risk managers to use to make the important decision between pursuing a settlement with their insurance carriers and filing a lawsuit when disputes arise. It was titled “Sue or Settle: Strategic Thinking for Insurance Coverage Disputes”, and the speakers were David Klein, Partner at Pillsbury Winthrop Shaw Pittman LLP, and Ashraf Kilada, Senior Director, Treasury Risk Management at PepsiCo. They presented some interesting insights for a decision that companies unfortunately face far too often.
Every company dreads the day they receive the insurance company’s denial letter. Sometimes the issues can be resolved fairly easily through objective discussion with the claims handler, but when they can’t, there are many factors to consider and balance before moving forward. A company will usually engage coverage counsel before deciding how to respond. In making a decision between seeking settlement or litigation, the company should think through the implications of each – for the company and also the insurer. The insurer may be thinking about setting a precedent if the case facts are different from those that have been faced before. The cost of litigation must be weighed, both financially and in terms of time and company resources. And, of course, thinking through the likelihood of success is always one of the first things considered.
Consider a $100 million dollar environmental property damage claim that a company might be facing, involving 10 sites in four jurisdictions. Very likely, the coverage involved a portfolio of historic CGL policies spanning several years — all with their own policy language. In such a case, a company could choose to do nothing when that denial letter is received. This is essentially a “win” for the insurer, as the company absorbs the loss and potentially future risk as well. If the company sues, they will have an all-or-nothing outcome, potentially only resolving the ripe claims with the possibility of future precedent being set. If the company settles, the outcome is likely a partial recovery that has the effect of resolving all past and future claims.
The panelists presented the pros and cons of both the litigation pathway and the negotiation pathway. A few of these are listed below:
Pros of Litigation
- Potential for a “top dollar” win
- A win might increase pressure on other insurers
- Potential to secure a favorable forum in a multi-jurisdictional case
- May lead to a higher value if the settlement path is ultimately taken
Cons of Litigation
- Potential of no recovery at all
- High costs are likely incurred (both time and money)
- Potential for significant disruption to the company
- Once started, it may make settlement far more difficult
Pros of Settlement
- Company can monetize uncertain claims at “fair value”
- Shorter time to resolution
- Less costly than litigation
- Less demand on corporate resources
Cons of Settlement
- Cannot achieve a “top dollar” win
- Less pressure on the insurers
- Failure to secure choice of forum in multi-jurisdictional cases
- May require surrender of future coverage rights
So, when does litigation make sense? It makes sense when the upside greatly exceeds the cost of litigation and the corporate risk — when the upside potential is worth the investment of both time and resources. It also makes sense in cases where the facts are manageable and when early disposition of one or two issues can increase chances of a win (lowering risk).
So, when does settlement negotiation make sense? It makes sense when the zero recovery is not an option and time-to-resolution is a critical factor. It also may make more sense in cases involving many insurers.
Decision Tree Analysis
The last part of the discussion covered the use of a decision tree analysis to estimate the expected value of the different decisions. While the expected value is not the expected recovery, this analysis provides a tool to think about the issues and their potential value.
In the environmental example discussed above, the analysis might look something like this:
Looking at the analysis, we see that in the litigation scenario, a percentage likelihood is placed on various issues such as forum, damages, exclusions and allocation; the result is a variety of potential outcomes. The litigation costs are subtracted from the outcome to get an expected nominal value, which can then be discounted to arrive at a present value over the expected litigation period.
In the settlement scenario, percentages are placed on potential discounts that will be negotiated, and a similar expected value is determined.
In this example, a choice to litigate may yield $53.4 recovery, whereas a settlement may yield $46.1. The company must weigh the difference in these expected values against the risk of litigating and losing — which would yield nothing.
This type of analysis gives the company a tool to help assess the value of some of the pros and cons discussed previously. By altering the percentages and trying various scenarios, a company can determine that certain issues have a significant impact on the potential outcome, while others have little monetary effect and may not be that important after all.
At KCIC, we use this same sort of decision analysis in our consulting work as allocation experts. In working with counsel and running various scenarios through KCIC’s proprietary allocation program, we can help value the expected recoveries, and counsel can apply percentages to gauge the likelihood of prevailing on those issues.