Settlement in the Presence of Insurance

Abstract

This paper studies the combined effects of legal fees and legal expenses insurance. We use a litigation model to compare litigants' settlement decisions under a before-the-event insurance plus an hourly fee contract (BTE) and an after-the-event insurance plus a conditional fee contract (ATE). These contracts represent the most relevant policy combinations in practice. The criteria for comparison include: settlement amounts, settlement probabilities, the volume of accidents, demand for trials, and welfare. We also investigate risk aversion, insurance recoverability and the timing of settlement in extensions of our basic model. We find that, compared to the BTA contract, the ATE contract increases the plaintiff's expectation of the settlement amount. However, the overall effects on other variables of interest depend on the distribution of the accident loss. If the accident loss is uniformly distributed, the ATE contract leads to a faster settlement.