Using Insurance to Deter Lawsuits

The conventional wisdom (my anecdotal experience, anyway) is that the availability of insurance fuels lawsuits. People that otherwise might not sue would use litigation to access insurance funds. I'm sure there's a literature on this. But most insurance covers both defense and indemnity - that is, litigation costs and settlements. But what if the insurance covered the defense and not any settlement costs? Would that serve as a disincentive to bring suit? It surely would change the litigation dynamic.

In The Effect of Patent Litigation Insurance: Theory and Evidence from NPEs, Bernhard Ganglmair (University of Mannheim - Economics), Christian Helmers (Santa Clara - Economics), Brian J. Love (Santa Clara - Law) explore this question with respect to NPE patent litigation insurance. The draft is on SSRN, and the abstract is here:

We analyze the extent to which private defensive litigation insurance deters patent assertion by non-practicing entities (NPEs). We do so by studying the effect that a patent-specific defensive insurance product, offered by a leading litigation insurer, had on the litigation behavior of insured patents’ owners, all of which are NPEs. We first model the impact of defensive litigation insurance on the behavior of patent enforcers and accused infringers. Assuming that a firm’s purchase of insurance is not observed by patent enforcers, we show that the mere availability of defense litigation insurance can have an effect on how often patent enforcers will assert their patents. Next, we empirically evaluate the insurance policy’s effect on the behavior of owners of insured patents by comparing their subsequent assertion of insured patents with their subsequent assertion of their other patents not included in the policy. We additionally compare the assertion of insured patents with patents held by other NPEs with portfolios that were entirely excluded from the insurance product. Our findings suggest that the introduction of this insurance policy had a large, negative effect on the likelihood that a patent included in the policy was subsequently asserted, and our results are robust across different control groups. Our findings also have importance for ongoing debates on the need to reform the U.S. and European patent systems, and suggest that market-based mechanisms can deter so-called “patent trolling.”

On reading the abstract, I was skeptical. After all, there are a bunch of reasons why more firms would defend against NPEs , why NPEs would be less likely to assert, and so forth. But the interesting dynamics of the patent litigation insurance market have me more convinced. Apparently, the insurance didn't cover any old lawsuit; instead, only specific patents were covered. So, the authors were able to look at the differences between firms asserting covered patents, firms that held both covered and non-covered patents, and firms that had no covered patents. Because each of these firms should be equally affected by background law changes, the differences should be limited to the role of insurance.

And that's what they find, unsurprisingly. Assertions of insured patents went down as compared to uninsured patents, and those cases were less likely to settle -- even with the same plaintiff. My one concern about this finding is that patents targeted for insurance may have been weaker in the first place (hence the willingness to insure), and thus there is self-selection. The paper presents some data on the different patents in order to quell this concern, but if there is a methodological challenge, it is here.

This is a longish paper for an empirical paper, in part because they develop a complex game theory model of the insurance purchasing, patent assertion, and patent defense. It is interesting and worth a read.