These articles are intended to educate the reader on the pre-settlement loan industry.  In previous posts, we discussed the administrative tasks needed to offer lawsuit loans to plaintiffs who need cash while they wait for their case to settle.  This post will discuss money management as it relates to the lawsuit cash advance funding industry.

Cost of Money Affects Investor Returns

In any business, investors seek a return on capital larger than they could otherwise obtain and in accordance with their risk tolerance.  Normally, investors expect to “earn” more money investing in a “riskier” venture than simply placing money in “safe” investments such as government bonds or precious metals.  The lawsuit funding business is really no different.  Since the inventory of a lawsuit loan outfit is money itself, its cost – which is basically the investor return – is of paramount importance.

When assessing risk, investors generally are more comfortable with ventures which have a proven track record of providing the expected return.  That is not to say there are no “good” years or “bad” years, but generally speaking, investors would be more likely to invest in operations with a several year history of positive returns.  The more positive years, the better – as far as investors are concerned.

Since the lawsuit funding industry is approximately 10 years old, investors demand a better than average return in consideration for the use of their investment capital.  Lawsuit funders have to comply if they want to tap into these sources.  Accordingly, this cost must be passed on to the end user (usually the plaintiff) and is reflected  in the current market pricing for these transactions.  Pre settlement funding companies simply cannot currently afford to offer “bank rates” to plaintiffs.  Currently, applicants for pre settlement cash advances can expect to pay between 30%-80% “interest” for immediate cash against their lawsuits.

Protecting Against Losses

But cost of capital is only one of many line items which are part of the lawsuit funding business model.  Also of major importance is the loss ratio which signifies the percentage losses a pre settlement loan enterprise encounters during a litigation cycle.  Lawsuit loans are non-recourse, so every loss is a total loss of investment.  Accordingly, lawsuit funding companies are very careful to take this ratio seriously.

Let’s take a quick view of  the type of issues lawsuit funding enterprises encounter when evaluating the effect of portfolio losses.

For example, let’s say a pre settlement advance company has a bankroll of $100,000.  And a lawsuit loan is approved for a $10,000 contract, that amount advanced,  and is ultimately lost.  The amount of the loss in percentage terms, is 10% of the total portfolio.  What amount amount of return on the remainder of the portfolio would bring the portfolio back to even?

Many would quickly answer – 10%.  But those people would be incorrect.  A 10% return on the portfolio would fail to bring the portfolio back to $100,000 because 10% of the remaining portfolio is actually $9,000 ($90,000 x .10).  In fact, the portfolio would have to “gain” more than 11% to get back to even.  Taking this a step further, if the funding company forecasted a 10% return to its investors, a total of 22.22% would have to be earned on the remaining capital to meet the forecast.

The purpose of the above exercise is only to show the often unseen effects of risk capital being lost on lawsuit cash advance fundings or any investment for that matter.  A loss is actually more destructive than one would think since the lost capital is now unable to earn a return.  This is just one example of money management considerations facing investment professionals such as those employed by lawsuit funding companies.

In the next post, we will examine the typical causes of these losses.  Later, we will illustrate how current market pricing takes into consideration these factors.

Thank you for your interest in the lawsuit funding business.