Contingent Liability Insurance: Converting Financial Uncertainty into Financial Security

In the early 1980s, corporate risk management had a significant blind spot. Traditional insurance addressed risks such as fires, automobile accidents, and professional malpractice. But what about a multimillion dollar lawsuit already pending against a company, with an uncertain financial outcome hanging over its head?

That was the challenge I set out to address at AIG in the early to mid-1980s, helping pioneer transactional insurance solutions, including tax liability, representations and warranties (“R&W”), and loss mitigation commonly referred to as contingent liability insurance.

Unlike typical occurrence or claims-made risk transfer insurance that covers liability for bodily injury, property damage, and damages arising out of wrongful acts in the rendering of professional services, contingent liability insurance solutions address potential financial obligations that may or may not happen, depending on the outcome of a future uncertain event that is in litigation and is either uninsured or underinsured.

These uninsured or underinsured exposures can have a dramatic impact on a company. Depending on the probability and estimated financial outcome of the contingent liability, if it is likely and can be reasonably quantified, it has to be documented on the company's balance sheet or disclosed in its financial statement footnotes. For publicly traded companies, if it is only remotely probable or marginally probable and can't be quantified, it generally still must be disclosed and updated in financial statement footnotes, including SEC mandated quarterly 10-Q and annual 10-K filings.

The consequence of liability balance sheet disclosure or financial footnote disclosure is demonstrable. It can negatively impact asset sales, capital raises, market capitalization, and stock prices. If a company can, however, achieve an insurance solution to these impediments without increasing the value of the litigation outcome they are looking to protect against, then all of the above named barriers to entry for sale, recapitalization and market capitalization become neutralized.

In a subsequent blog, I will provide examples of transactions where contingent liability insurance successfully eliminated investor uncertainty, increased share prices, and improved market capitalization.

There are so many factors that come into play when putting the pieces of the puzzle together to find a contingent transactional liability insurance solution to an outstanding unquantifiable, underinsured, or uninsured litigation event.

First and foremost, never undertake a contingent liability transaction involving open-ended bodily injury exposures from a product or chemical manufacturer, including reported and unreported long-tail claims. How would you price that risk? How could you accurately forecast the number of unreported claims that may materialize from exposures dating back 40 years, only now manifesting as illness?

Do you have complete insurance records identifying available policy limits and insurers? Are those insurers still solvent? If the insurers were merged or acquired, did their successors assume the liabilities? Anyone who thinks they can accurately forecast these exposures and price the risk is a fool.

Only do contingent transactions on known litigation events that you can due diligence.

The next piece of the puzzle is working with brokers who respect the complexity of the risk and understand that the objective is to find the right solution for their client. I have an unwritten rule when dealing with brokers–a broker should not take my work, particularly the terms and pricing of a proposed transaction, to another market simply to obtain a lower premium or higher commission.

Brokers may portray this tactic as working hard for their client to secure a deal when, in fact, they may be working adverse to the interest of their client by sacrificing the expertise of the contingent liability insurer best qualified to assume the risk and compromising the financial security outcome their client was looking for.

I have walked away from unscrupulous brokers who took my terms and quotes to competitors, obtained premiums 50% lower, and returned asking me to beat that pricing. In one instance, I never dealt with that broker again, and the employee at the competing insurer was subsequently fired for doing an unprofitable deal at inadequate pricing. I will not tolerate sacrificing contingent liability due diligence, underwriting, claim expertise, and the potential favorable outcome on behalf of the insurance purchaser in exchange for the broker’s tangential interests.

By contrast, Jon Ostrou, now at Alliant, was a broker with excellent private equity relationships who understood the playing field and the complexities of these transactions.

So, what are the critical pieces of the puzzle when conducting due diligence?

Ask yourself: Where is the litigation pending, and how long has the dispute existed? Who is the judge? If the case is in federal court, which president appointed the judge, and what do the judge's reported decisions reveal about their judicial philosophy or political leanings? If in state court, how was the judge selected, and, if appointed, by which governor?

Who represents the plaintiff? How familiar are you with the underlying legal issues and applicable law? Have you previously negotiated with or litigated against plaintiff's counsel? Can you reasonably quantify the settlement value? If the case cannot be settled, what is the worst-case judgment exposure?

I currently have over 40 years of experience across casualty and specialty lines of insurance. Even though I feel qualified to evaluate all lines of exposure from product liability, to environmental, to specialty lines of professional liability, to directors & officers (“D&O”), and surety bond liability I have enough respect for my shortcomings or lack of experience to hire due diligence counsel as warranted.

When evaluating an underinsured exposure, obtain and review all existing insurance policies involved in the defense of the underlying litigation. Who is defense counsel, and can you work effectively with them? Interview them and assess your level of confidence in their experience, judgment, and litigation strategy. Ask them what are limits of existing policies, where will the contingent liability policy attach, and what are the terms of the manuscript policy sitting on top of the underinsured liability?

These are just some of the critical considerations involved in structuring a contingent liability insurance solution. Successful transactions require disciplined due diligence, sound underwriting judgment, and a thorough understanding of both the litigation and the insurance coverage.

With over 40 years of experience in casualty and specialty insurance, I am available to provide expert witness and advisory services in connection with contingent liability insurance, litigation risk assessment, and complex insurance transactions.