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Legal costs are once again a key talking point in litigation circles as the working party appointed by the Civil Justice Council (CJC) to implement changes emanating from the MoJ's response to Lord Justice Jackson's proposals for civil litigation costs reform gets to work.

Many believe that, if implemented, the reforms will lead to troubled waters for thousands of litigants. The fact is, however, that the process for implementation appears to be well underway. On the legal cost reduction agenda is the eradication of CFA success fees and after-the-event (ATE) premium recoverability. What will this mean for the third-party risk carriers market? There are three key sectors to the risk transfer marketplace:

• before-the-event (BTE) insurance;
• ATE insurance; and
• third-party litigation funding.

Each sector faces different challenges on the road ahead.

An impractical shift

The BTE insurance market is the oldest and most established of the three. For decades, some of the largest insurers have sought to increase distribution of BTE policies but sceptics believe there is a natural ceiling to the size of the UK market. This is because most individuals do not envisage becoming embroiled in a legal dispute and thus see no real value in a BTE policy.

The result is distribution via other insurance lines; for example, BTE insurance is sold on the back of household insurances or car insurance.

An additional problem for the BTE insurance market is that, because of the difficulty in distribution, price sensitivity has been rife. This has resulted in insurers seeking alternative methods to generate revenues to balance their accounts. This, in turn, has led to a mass culture among some of the largest insurers of charging referral fees to panel lawyers.

The BTE insurer will receive a small premium from the insured at the outset and a far larger fee (typically £200 to £1,000 or more), paid by their panel lawyers. The referral fee culture is another area the government is addressing, understandably so. However, if referral fees are banned, the law of unintended consequences will strike again.

BTE insurers will argue that they are not banking sufficient premium income based on current market prices, as the shortfall is currently met through referral fees income. If referral fees go, insurers will have to harden their premium rates which, when coupled with the public's perception of lack of value, will manifest the problem of not being able to increase distribution. On the contrary, market penetration could conceivably fall.

Another difficulty in treating ATE and BTE as direct 'substitute' products is the significant difference in mindset between the two.

The objective of the BTE insurer is to sell a policy and hopefully not hear from the insured until policy renewal. Where a claim is made, the first motivation is to see if a claim can be rejected irrespective of its merits; e.g. late notification, pre-existing knowledge, etc. Conversely, an ATE underwriter wants to find a way to insure cases with good merits.

BTE policies will typically be extremely narrow in terms of the types of dispute covered, whereas an ATE insurer can feasibly consider all areas of litigation as cases will either be individually assessed or insured under some form of delegated authority scheme arrangement.

The flaw in seeking to increase BTE distribution was highlighted during the consultation period when most leading BTE providers commented it was simply not practical to see a fundamental shift.

The limits of price-driven competition

So, what then of the ATE market in a non-recoverable regime? A significant advantage of ATE insurance is that the cost of the premium is currently recoverable. In fact, premium recoverability is crucial where the cost-to-damages ratio is tight, often the case with many civil claims.

For example, it is not unrealistic to expect a cost exposure in a professional negligence case worth £100,000 to be in the region of £50,000 (in respect of adverse costs and own disbursements). At present, CFAs and ATE insurance are readily available for a case of this nature. Assuming the premium cost is 35 per cent of the sum insured (£50,000 x 35 per cent = £17,500) and the lawyer's success fee is 50 per cent of the £35,000 fees incurred (perhaps a generous assumption, as they will often be 100 per cent), this gives an aggregate success fee and premium cost of £35,000.

Of course, any practitioner will advise a cost recovery of around 66 per cent might be the norm, so let's assume that an additional 33.33 per cent of own solicitor's fees cannot be recouped (£11,650). Now assume the client is awarded £75,000 in damages rather than the fully pleaded £100,000.

In the present recoverable regime the client would deduct the £11,650 unrecoverable costs and walk away with the balance (£75,000 '“ £11,650 = £63,350, assuming a reasonable success fee/premium is charged). However, in a non-recoverable regime the client would walk away with just £28,350. Not a great result if, say, your house is sinking with subsidence as a result of the original negligence and you have only recovered roughly a third of your actual loss.

Such difficulties over economics will unfortunately be rife in a non-recoverable regime. Greater price-driven competition among insurers can be expected as clients will clearly be seeking to obtain the policy with the best value (as they ought to be already), but there is only so far premiums can fall. Indeed, if ATE insurers were all basking in huge profits then one would expect the available pool of insurers to be much larger than it is.

For medium to high-value cases where the legal cost/damages ratio is far wider, stripping recoverability is less problematic; there should be enough headroom in the claim to pay the costs. Many would argue that this is already happening, where the natural conclusion for large commercial cases is global settlements.

Unanswered questions

And what about third-party litigation funding, another area much emphasised by Lord Justice Jackson in his recommendations? As any commercial litigator knows, most funders expect large returns on their investments (far larger than those charged by insurers or indeed lawyers' success fees). Price sensitivity will hopefully intensify '“ it is difficult to see how certain models can survive in the long term as more capital becomes available in the marketplace. However, there is still a question mark as to how active funders can consider smaller cases.

Many of these companies lack the economies of scale to be able to assess large volumes of cases, not to mention the substantial financing fees often excluding mid-sized disputes from being funded in any event.

If changes are implemented as proposed and your client is a non-injury litigant of the future with a medium to high-value case, very little will change; in fact there will likely be even more flexibility afforded over the various types of arrangements available. However, if your client is a litigant with a smaller-value case whose cost/damages ratio is narrow, significant difficulties could be faced. Even more problematic are those claimants whose remedy is not largely damages-based.

However, the positive has to be that where there is demand (as clearly there will continue to be) then creative innovations will likely occur. While not necessarily a holistic answer to the problem, these innovations may at least provide some solace that the effects can be mitigated for some.