07 August 2016

Patent Litigation Insurance – What Is It, and Should You Have It?

ArmourThe basic principle of insurance is simple.  You are at risk of some adverse event which probably – hopefully – will not happen.  But if it does happen, the consequences could be devastating.  So, to mitigate this risk you pay an insurer a known recurring amount (the premium) in exchange for a guarantee of compensation to help cover you in the event that the adverse event occurs. 

In your personal life you may have health insurance, life insurance, income protection insurance, vehicle insurance, and home and contents insurance.  The premiums for these types of insurance are typically on the order of a few hundred to a couple of thousand dollars per year, and they provide protection against events that, if they were to occur, might cost you tens or hundreds of thousands of dollars, or even more.

If you run a business, you may well have professional and/or product liability insurance, property insurance, worker’s compensation insurance, vehicle insurance, and business interruption insurance, among others.  Again, for a moderate and, importantly, known and predictable annual premium, you are hopefully protected against events beyond your control that might otherwise, in the worst case, put you out of business altogether.

But what about patent litigation insurance?  Have you ever heard of it?  Do you need it?  What does it do, and how much does it cost?

There are, in fact, two types of patent litigation insurance, neither of which is very widely available or, as I shall explain, particularly cost-effective for most businesses.  Patent enforcement insurance is intended for patent owners, and assists in covering legal costs in the event that it becomes necessary to take action against an infringer.  Patent infringement liability insurance may be relevant to any manufacturer, seller or user of goods and services that may result in an accusation of infringement of a patent owner’s rights, and assists in covering the costs of defending an infringement claim and/or the costs of compensating the patent owner if infringement is established.

Patent Litigation Insurance is Tricky and Expensive

One thing that is always worth keeping in mind when considering any form of insurance is that the insurance providers are running their own businesses, and have their own perfectly reasonable need to be profitable.  In aggregate, insured parties thus inevitably pay out more in premiums that they receive back in claims.  Indeed, considering that you would usually only need to make a claim once something bad has happened, there is much to be said for never taking anything back from your insurers!

Insurance is also a numbers game.  It is based on statistics and the probabilities of insured events occurring that may result in claims being made.  The best markets for insurance companies are therefore those in which there are large numbers of broadly comparable clients, such that the aggregate risks and annual costs of claims are well-known and do not fluctuate greatly from year to year.  Conversely, small markets combined with high uncertainty and widely-fluctuating costs make it very difficult for insurers to quantify risk accurately, and to offer competitive products.

It is therefore significant that patent litigation hardly ever happens.  Obviously that is not strictly true – in one sense, patent litigation happens quite a lot.  In 2015, according to legal data analytics firm Lex Machina, there were 5,830 patent cases filed in the US.  I do not have figures for Australia, but I dare say that up to a few dozen patent cases may have been commenced in the Federal Court during 2015, although many of these will not make it to final judgment.  However, in the scheme of things these numbers are pretty small.  In 2010, there were nearly 7.5 million businesses with paid employees in the US, and the number of non-employer businesses exceeds 20 million.  In Australia, as at June 2015 there were over two million actively trading businesses.

If you are a business trading in the US or Australia, then, the statistical likelihood that you will become embroiled in patent litigation in any given year is negligible.  All else being equal, you might expect to trade for hundreds of years, and never get sued for infringement.  But, to complicate matters further, all is not equal.  If you are a pharmaceutical company or (in the US in particular) a large high-tech company like Microsoft, Apple or Google, you are almost certain to become involved in patent litigation on a regular basis.

The costs of patent litigation also vary enormously.  Most cases never make it to trial, and while settlement terms are usually confidential it is reasonable to assume that many of these go away with relatively modest sums of money changing hands.  Most patent litigation involves questions of validity of the patent(s) as well as infringement, and so a case that does go to trial could cost each side anywhere between a few hundred thousand dollars and more than ten million dollars, depending upon complexity.  Furthermore, in countries such as Australia where a losing party is typically required to contribute to the legal costs of the victor, there can be an enormous variation in the total cost of winning versus losing.

These circumstances ensure that patent litigation insurance is a tricky business for insurers to be in.  The viable market for these products presumably consists of businesses that are at sufficient risk of becoming involved in litigation to justify taking out insurance, but not at such high risk as to be virtually uninsurable.  Within that market the risks and potential costs are difficult to quantify.  With broad-based insurances, such as property and vehicle insurance, the uncertainty is mitigated as a result of statistical averaging over a large number of insured parties, but this is not the case with patent litigation insurance given the relatively small and specialised market.

It may come as no surprise, therefore, to discover that patent litigation insurance is expensive.  in 2004, an Australian Law Reform Commission (ALRC) discussion paper noted a number of cost-based criticisms of these types of insurance policies.  (The final ALRC report noted the same criticisms, but did not retain the cost details included in the discussion paper.)

How Expensive is Patent Litigation Insurance?

Annual premiums for infringement liability insurance were found by the ALRC to be between 1.5% and 4% of the insured amount.  Thus, if you wished to obtain cover for up to a million dollars in costs (which may be barely enough for even relatively straightforward proceedings) you would be looking at between $15,000 and $40,000 in premiums.  On top of this, you would probably be expected, as a prerequisite, to obtain a ‘freedom to operate’ opinion from a patent attorney or lawyer, at your own expense.  And then, in the event of litigation, you would also be up for a co-payment of between 15% and 25%, so that you would still be liable for up to $250,000 of those $1,000,000 litigation costs!

Annual premiums for enforcement insurance, by comparison, were found to be around $4000 for $500,000 in coverage which, at less than 1% of the insured amount, does not seem too bad.  However, this still typically requires the insured to obtain a patent validity opinion at its own expense, and the same co-payment arrangements apply as for infringement liability insurance.

Current information provided by an Australian-based insurance brokerage firm confirms that the costs and conditions of both types of patent litigation insurance have not changed significantly since the ALRC’s review in 2004.

Could Patent Litigation Insurance Be Made Affordable?

The European Commission (EC) funded a study of patent litigation insurance, the final report on which was published in 2006 [PDF, 640 kB].  The EC study was particularly focussed on the feasibility of introducing new insurance schemes against patent litigation risks.  Conclusions from this study included (see Sections 3.2 and 5):
  1. in no part of the world has Patent Litigation Insurance (PLI) been particularly successful;
  2. no insurance scheme had shown any capacity to provide adequate cover at premiums affordable by patentees in general;
  3. although PLI had tacitly been assumed to be widely and successfully used in the USA, this belief proved to be unsupported by any real evidence; and
  4. round-table discussions with stakeholders revealed a broad acceptance that only a compulsory scheme could achieve the volume necessary to spread risk and permit low premiums;
Needless to say, there has been no further progress in Europe – or anywhere else in the world – towards the kind of mandatory scheme proposed in the report.

While many companies, when asked, have expressed interest in affordable patent litigation insurance, the reality is that available products meet the requirements of only a very small market.  This is hardly surprising: in the scheme of things, patent litigation is rare, but when it does occur it comes with very high risks and unpredictable costs.

Is Patent Litigation Insurance Good Policy?

Despite the apparent (if short-lived) EC interest in a broad-based scheme, in my view patent litigation insurance not only makes little sense for most businesses, it is probably not a desirable thing from a broader policy perspective. 

Frankly, I cannot see how patent enforcement insurance makes any sense at all.  From one perspective, a patent is already a form of insurance.  Specifically, it insures the patentee against the consequences of a competitor copying an invention, and thus destroying the value of the original investment in research, development and commercialisation.  Commencing infringement proceedings is, in this context, a business decision.  If the cost of litigation and/or the risk of failure exceeds the cost to the business of the supposed infringement, then perhaps litigation – and maybe even maintaining the patent itself – is not worthwhile. 

Patent infringement liability insurance is also potentially problematic.  As matters presently stand, the majority of patent disputes settle on commercial terms either prior to, or in the early stages of, litigation.  Often this is because the value of the allegedly infringing product or service to the accused business is not high enough to justify the cost of defending a claim, and it makes more sense (usually on both sides) to reach a commercial settlement.  The last thing we need in such cases is for litigation to proceed not because, all else being equal, there is a sound commercial basis for going to trial, but simply because one or both parties are able to claim on their expensive insurance policy to help fund otherwise unjustifiable litigation.

The EC study acknowledged that widespread use of patent litigation insurance would likely lead to an increase in patent applications (because applicants would have greater confidence in their financial capacity to enforce their rights) as well as patent litigation (which would be funded by insurers).  To put this bluntly, it is an acknowledgement that patent litigation insurance would further distort the market by enabling and encouraging otherwise uncommercial litigation.

The patent system is itself already a market intervention, but it is at least one in which the legislature retains a degree of control over the balance between public and private interests through the particular legal requirements, standards and limitations that are established for valid ownership and use of patent rights.  The commercial nature of patent acquisition and enforcement places further constraints on the ways in which the system can reasonably be used by operating businesses.  Widespread affordable patent litigation insurance would substantially remove these commercial constraints – which is, probably, why it does not exist.

Conclusion – Should Anyone Have Patent Litigation Insurance?

So, now you know what patent litigation insurance is, should you have it?  The short answer is ‘probably not’.  Unless your business is in the very small minority for which the risk is high enough to justify the expense, but not so high that nobody would insure you, then you are really not going to see any value.  And even if you do fall into the ‘insurable’ category, you need to keep in mind that it is more likely than not that you will never claim on your policy (the insurance providers are not stupid), and that even if you do you will still be responsible for paying as much as 25% of your litigation costs.

It seems to me that patent litigation insurance appears, in principle, to offer a ‘solution’ to a ‘problem’.  In practice, however, the problem is largely illusory.  Certainly patent litigation is expensive, but it is not the only – or even the most common – mechanism for resolving patent-related disputes.  For the vast majority of businesses there are more cost-effective ways to mitigate the risk of becoming embroiled in patent litigation than paying, perhaps, tens of thousands of dollars each year in insurance premiums.

Patent litigation insurance is a largely unsuccessful product that is virtually unavailable from any insurers outside the US.  There are, I am certain, very good reasons why this is the case, and why the value of this type of insurance should be viewed with extreme scepticism.


Post a Comment

Copyright © 2014
Creative Commons License
The Patentology Blog by Dr Mark A Summerfield is licensed under a Creative Commons Attribution-NonCommercial-ShareAlike 3.0 Australia License.