Covid-Claim Investors Seek Windfall Over Denied Coverage

(Bloomberg) -- A growing market niche where investors profit from others’ legal troubles is getting a boost from Covid.

Distressed-investing funds and litigation-finance boutiques are likely to be spoiled for choice after a landmark U.K. court ruling last month rejected pleas from insurers looking to dodge pandemic payouts. They’re looking to finance or buy denied Covid-19 insurance claims for policyholders without the means or stomach for taking their insurers to court.

“This is going to be huge,” said Steve Cooklin, chief executive officer of London-based litigation funder Manolete Partners Plc, whose biggest shareholder is veteran distressed investor Jon Moulton. “It’s hard to say at this stage how big exactly this issue is, but it’s probably going to be in the hundreds of millions of pounds.”

Insurers have warned that Covid-19 coverage claims could top as much as $100 billion –- potentially the industry’s largest loss in history. Business-interruption coverage -- which protects against losses when companies have to shut for a period of time -- has been one of the most costly and contentious policy lines in the pandemic. U.K. virus-related claims, including on business-interruption policies, could exceed $2 billion.

For investors in a zero-yield world of spiraling stock prices, the insurance payout battles present opportunities that can be profitable regardless of how debt and equity markets perform -- they’re “uncorrelated,” in the jargon of the trade.

Assets held by litigation funders in the U.K. hit a record high of 1.9 billion pounds ($2.6 billion) last year, an analysis by law firm Reynolds Porter Chamberlain LLP shows. It’s a market that has lured hedge funds including D.E. Shaw & Co., Fortress Investment Group and Elliott Management Corp.

Yield-Hungry Investors Brave Risks as Litigation Finance Expands

“Sustained tailwinds” are in store for litigation funders, according to Bloomberg Intelligence analyst Tamlin Bason. “The uncorrelated, counter-cyclical nature of those returns could make litigation finance an attractive hedge during periods of market volatility.”

Much of the opportunity for investment may be in the U.K. rather than the U.S., where judges have ruled that many American policies don’t cover Covid-19 losses because the virus didn’t cause physical damage or losses. But in Britain, last month’s ruling by the main financial regulator was bolstered prospects for policyholders. It means firms that initially rebuffed Covid-19 claims, including Hiscox Ltd. and RSA Insurance Group Plc, now must honor them.

To be sure, the language in every policy varies, with only a handful clearly saying whether they would or would not cover losses stemming from a pandemic. In the U.S., many cases are being thrown out after judges find the policies have specific virus exclusions.

“There is quite a variety of different approaches to this that insurers have taken and some of them are going to be happy and some are going to be miserable,” Andrew Lundberg, a managing director at Burford Capital Ltd., the biggest litigation funder, said in an interview.

Retail Crisis

New York-based Cherokee Acquisition is in talks with a number of U.K.-based retailers over purchasing their claims on behalf of investors, having looked at similar transactions in the U.S. For many of Britain’s retailers, the shuttering of main street was the final nail in the coffin. Arcadia Group, the retail empire founded by billionaire Philip Green, collapsed into insolvency late last year.

The Supreme Court ruling “will result in more sale interest from larger claimants whose calculation of damages is being disputed by the insurers, rather than smaller claimants whose claim amounts have already been reconciled,” said Bradley Max, a director at Cherokee. “It’s an opportunity for a seller to get the bird in the hand.”

A trade can work like this: First, a company that had business-interruption coverage is rebuffed by its insurer, which argues the policy excludes coverage of pandemics or doesn’t cover the type of damages sought. A judge often must parse the policy, and that can take years and hundreds of thousands of dollars -- if not millions -- in legal fees.

Making a pitch to save policyholders time and money, litigation funders offer to immediately buy the Covid-19 claim at a discount, sometimes for less than a third of the total value. The funds make money by taking the dispute to court, betting the ultimate payout will dwarf the purchase price.

Insurers Face More Covid Payouts as U.K. Court Appeal Fails

The practice is routine in U.S. bankruptcy cases, said Chuck Tatelbaum, a Florida-based bankruptcy lawyer who represents big-name clients, such as Toyota Motor Corp., in Chapter 11 cases. “It’s very much like commodities trading,” he says.

A real-world example involves bankrupt U.S. department-store operator Century 21’s decision to sell its rejected business-interruption claim for $59 million in December, according to court documents. The Gindi family, which owns the retailer, bought back the right to the $150 million policy, betting it will pay off in the long run.

So far, insurers are faring well in the U.S. courts, where judges have backed coverage rejections at a rate four times higher than the claims that are being allowed, according to an analysis by a University of Pennsylvania researcher.

The key to making this new form of litigation arbitrage pay is a cold-eyed policy assessment by seasoned insurance lawyers to find language backing up coverage demands, said Stuart Grant, head of Bench Walk Advisors, a litigation funder with offices in New York and London.

“These are challenging investments,” Grant said in an interview. “Since this is bespoke financing, you have to tread carefully.”

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