Growing Risks Are Fueling Tax and Litigation Insurance Markets

The introduction of representations and warranties insurance has transformed mergers and acquisitions and commercial deal structures in the past couple decades by giving buyers a new layer of protection from unidentified risks.

Insurers have expanded their offerings further to include coverage for specific risks such as tax and litigation. Both products have seen tremendous growth in the last few years because of increased market awareness and use, and they’re poised for further growth in 2024.

Tax insurance is designed to transfer risk of specified tax issues from a company’s balance sheet to an insurer. The tax insurance market has seen significant growth. Two key indicators that have punctuated this recent growth are the volume and variety of tax submissions on the market. By some metrics, submissions were up by more than 30% in 2023.

Tax insurance as a product can at least partially attribute its success to greater market awareness and the utility and effectiveness of transferring tax risk. As market participants continue learning about the benefits of tax insurance, expect to see notable increases in volume.

But volume isn’t the only indicator of the market’s health—the variety of risks entering the market also has expanded.

Tax insurance traditionally was limited to a narrow band of tax risks including renewable energy credits and qualification for real estate investment trusts. In the last few years, there has been a shift in the variety of risks that parties are seeking to insure.

Now, insurable risks encompass a host of issues including international and domestic income tax matters, reorganizations, and virtually any tax issue that could arise in a deal context. The significance of this development suggests that market participants are considering the variety of tax issues facing businesses and seeking to use insurance beyond historical precedent.

While the use of tax insurance doesn’t currently appear to correlate to the broader deal market due to limited market penetration, this is changing. As awareness grows, use of the product will rise, and other market forces are likely to drive growth as well, such as greater IRS audit activity and significant changes to the tax code.

Contingent risk insurance typically comes in two forms. The first, adverse judgment insurance, typically protects defendants in pending litigation to ring-fence litigation exposure and transfer the risk to the insurance markets. It’s most commonly used as part of merger and acquisition transactions.

The second, judgment preservation insurance, protects the prevailing litigant from the risk of a judgment being reversed, reduced, or overturned on appeal. It’s often used in large commercial, patent infringement, and trade secret cases.

The contingent risk insurance industry has seen exponential growth over the last year due to several factors.

Despite being the youngest of the transactional insurance products, there has been a growing awareness of contingent products. It’s no surprise that the brokers in the industry have been driving education and increasing product awareness.

Litigation funders also have been using the product more than ever, overcoming initial hesitation. Today, they embrace contingent risk insurance as a useful litigation finance tool.

The general slowdown in the M&A market has further increased the appetite to find a noncorrelated transactional insurance product. And with hefty premiums to make, contingent risk insurance has made its way to the mainstream.

There is no indication that this market will slow down in the near future. In fact, there has been an uptick in portfolio arrangements as companies (sometimes law firms or litigation funders) seek insurance for a multitude of litigation risks. There also likely will be more adverse judgment insurance placements as M&A activity increases.

This article does not necessarily reflect the opinion of Bloomberg Industry Group, Inc., the publisher of Bloomberg Law and Bloomberg Tax, or its owners.

Author Information

Scott A. Harty is partner and co-chair of Alston & Bird’s federal and international tax group, focused on complex domestic and cross-border transactions.

Steven L. Penaro is partner on Alston & Bird’s commercial litigation team, advising on contingent risk insurance products.

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