Legal-Expenses Insurance and Settlement

Abstract

In this paper we consider the effects of legal-expenses insurance on settlement. Using a one-shot asymmetric information model of litigation, we scrutinize the litigants' interactions under the situations that the plaintiff is before-the-event insured, after-the-event insured or self-funded. We investigate the effects of insurance on settlement probabilities, settlement amounts, care levels and the plaintiff's welfare. We also show how the model can be amended to include a "recoverable" element of the insurance. Our results exhibit that insurance increases the plaintiff's expectation on settlement amount but its effects on settlement probabilities and care levels depend on the distribution of the accident loss. This is partly because asymmetric information distorts the litigants' negotiation power. Insurance can either increase or decrease welfare.