Whenever a discussion of insurance comes up, I’m reminded of a tale of two friends, both of whom lost their homes in the fires that hit Colorado in 2012 and 2013. One had insurance and the other didn’t. You can guess which one turned out okay and which one turned out poorly.
By definition, insurance is a hedge against catastrophic loss. After catastrophes like the Colorado fires, I have often heard that having too much insurance is never a bad thing.
However, as is often the case, the utility of a product or service is different depending on whether you are an individual or a business. This is very much the case when it comes to personal insurance such as car or health insurance and business insurance.
When it comes to a business, having too much insurance is often not a good thing and can, in fact, be a lightning rod for lawsuits. Allow me to explain my thinking.
Most people who suffer personal injury or loss seek out a lawyer to take their case on what is known as a contingency basis. When a lawyer takes a case on a contingency basis the plaintive is not responsible for paying for the lawyer based on the lawyer’s time and expenses. In exchange, the plaintiff agrees to give the lawyer a share of any money collected. Therefore, many plaintiffs who agree to pay their lawyer on a contingency basis are either not well off enough financially to cover a lawyer’s retainer, have a shaky case they are not sure they can win and want upside payment if they win and no downside risk if they lose or both. This is because if they had a strong case, some savings, with a sizable potential award, the plaintiff would be much better off paying for the lawyer’s time and materials rather than giving up typically 1/3 or more of an award or settlement to the lawyer.
Moreover, smart lawyers who take cases on a contingency basis know that winning a case and collecting are two very different things. Therefore, the first thing that any lawyer getting paid on a contingency basis wants to know is the ability of the defendant to pay damages.
Studies show that 78% of all Americans live paycheck to paycheck and have very limited savings. Unless the defendant is a high net worth individual, the plaintiff’s lawyer is very reluctant to take a case on a contingency basis since there is a good possibility they will not get paid, unless of course if the defendant has insurance.
Moreover, a lawyer, like any other business person, wants to extract the maximum return for the least amount of effort. Lawyers know that while the policyholders are the ones that pay the premiums that drive the revenue for insurance companies, the insurance company’s priority is to maximize the returns to its shareholders.
Cases that are brought to trial are very expensive and time consuming for both the plaintiff and the defendant. The insurance companies, that represent the defendant, therefore have an incentive to settle out of court to avoid the cost of a trial. Lawyers know this fact and will often represent a plaintiff on a contingency basis that has little or no chance of winning a case that goes to trial provided the defendant has insurance.
Even in frivolous cases with a low probability of success by the plaintiff, so long as the settlement amount is less than the defendant’s cost of a trial, the insurance company is better off paying a settlement. Defendants often have insurance and the ability to pay while plaintiffs often have a minimal financial resource to cover even legal expenses.
For example, it is better for an insurance company to pay the plaintiff $20k in an out of court settlement than go to trial costing $30k. While the insurance company may know the plaintiff is unlikely to prevail in court, they would still be out $30k in trial costs. Since most plaintiffs live paycheck to paycheck and have limited savings, there is little opportunity for insurance companies to recover the cost of a trial even when they win. Therefore from the insurance company’s shareholder perspective, it is better to lose $20k to a settlement then $30k to a winning trial. Knowing this math, lawyers will take as many of these cases as they can get because it is not about winning but about collecting.
In conclusion, collecting from an insurance company is relatively easy and more reliable than collecting from an individual. Insurance companies often settle quickly and out of court, meaning less effort and fewer costs for the lawyer.
Lawyers also know that individual defendants without insurance are less likely to settle out of court. Also, the defendant can easily skip the jurisdiction of the courts in a civil case they lose by simply moving to a different jurisdiction.
Furthermore, lawyers for the plaintiff know that small business owners are generally “all-in” and have few liquid assets that are not pledged as collateral for business debts. Therefore, a smart lawyer is very unlikely to accept or recommend any legal action on a small business unless there is an insurance company involved.
In the end, I believe that when it comes to business insurance, rather than being a hedge against catastrophic loss, insurance can actually create a sort of gravity for lawsuits.
Is your business insurance actually creating gravity for lawsuits?
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