Legal expenses insurance, risk aversion and litigation

Abstract

The risks involved in litigation are well documented; they include the risk of incurring legal expenses. While much literature focuses on contingent fees as a mechanism for litigants to shift this risk, there is little work on legal expenses insurance-the dominant means of shifting this risk in Europe. In our model, a risk averse plaintiff may purchase legal expenses insurance. The defendant makes a single settlement offer but is uninformed about the plaintiff's degree of risk aversion. We investigate the effects of insurance cover on settlement amounts, settlement probabilities, the volume of accidents and the ex ante volume of trials. We also investigate the insurance decision. We find that more insurance hardens the plaintiff's negotiating stance and increases the defendant's level of care, but that the overall effects on other variables of interest depend on the plaintiff's risk aversion. Insurance can increase or decrease ex ante welfare. © 2004 Elsevier Inc. All rights reserved.