Trinity Term · MMXXVI · 6 min
The Optimism Discount
Why claimant damage models overshoot, and how the discipline of a ten to twenty percentage point discount protects the underwriting.
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By Jonathan Adeyemi, Head of Underwriting.
Every damages model presented to a funder carries within it a theory of the future. It supposes that a judge or an arbitrator, having read the same record we have read, will arrive at a number roughly equal to the one the claimant has already privately arrived at. This is a defensible starting point. It is not a defensible price.
The Optimism Discount is the discipline of subtracting between ten and twenty percentage points from the claimant’s expected recovery before any multiple, any tenor assumption, or any waterfall is applied. It is not a haircut for conservatism’s sake. It is a correction for a set of cognitive and structural biases that appear in every claim file we have ever underwritten.
Where the optimism lives
Three sources account for most of the drift. First, the expert. A damages expert engaged by the claimant is retained to build the strongest defensible case, not the median one; the resulting number sits at the top of a range that the tribunal, in practice, tends to compress. Second, the selection effect on precedent. Cases that settled quietly below expectations rarely appear in the comparables; the record over-represents the outliers. Third, the passage of time. A claim priced today at present value tomorrow will have absorbed years of counsel fees, interlocutory setbacks, and the slow attritional discounting that every long matter undergoes.
None of these are failures of good faith. They are the ordinary posture of a party that has decided, correctly, to litigate. But a funder is not a party. A funder’s position sits behind the claimant’s in the waterfall and ahead of the claimant’s in duration risk. The model that governs the deployment must reflect that asymmetry.
How the discount is set
The band is ten to twenty points, not a fixed number. Where within the band a particular matter falls turns on three readings:
- The expert’s method. A DCF or market-multiple approach with sensitivities is treated more gently than a single-scenario lost-profits number without a downside case.
- The forum. Arbitral tribunals that historically award closer to claimant asks receive a lighter discount; forums with documented compression patterns receive a heavier one.
- The record. A liability case that is documentary rather than testimonial tightens the discount; a case that turns on credibility findings widens it.
What the discount is not
It is not a bid. HLC does not treat the discount as leverage in a term-sheet negotiation. The discount is a private input to underwriting; it is what determines whether we deploy at all and, if we do, at what multiple. It is disclosed to counsel in general terms, so that no party is surprised by the price that emerges from it, but the specific figure applied to a particular model is a decision of the Investment Committee.
Nor is it a substitute for the Seriousness Test. The Optimism Discount corrects a serious claim; it does not rehabilitate an unserious one. A matter that fails the Seriousness Test is declined at the top of the funnel and never reaches the modelling stage.
The point of the discipline
Ten to twenty points is a small number in isolation. Applied consistently across a book, it is the difference between a portfolio that returns its base case and a portfolio that does not. A funder that prices at the claimant’s ask and hopes for the median is not a funder; it is a co-plaintiff without a seat at counsel table. The Optimism Discount is how we remain the former.
❦
J. Adeyemi
Jonathan Adeyemi, Head of Underwriting.
Every damages model presented to a funder carries within it a theory of the future. It supposes that a judge or an arbitrator, having read the same record we have read, will arrive at a number roughly equal to the one the claimant has already privately arrived at. This is a defensible starting point. It is not a defensible price.
The Optimism Discount is the discipline of subtracting between ten and twenty percentage points from the claimant’s expected recovery before any multiple, any tenor assumption, or any waterfall is applied. It is not a haircut for conservatism’s sake. It is a correction for a set of cognitive and structural biases that appear in every claim file we have ever underwritten.
Where the optimism lives
Three sources account for most of the drift. First, the expert. A damages expert engaged by the claimant is retained to build the strongest defensible case, not the median one; the resulting number sits at the top of a range that the tribunal, in practice, tends to compress. Second, the selection effect on precedent. Cases that settled quietly below expectations rarely appear in the comparables; the record over-represents the outliers. Third, the passage of time. A claim priced today at present value tomorrow will have absorbed years of counsel fees, interlocutory setbacks, and the slow attritional discounting that every long matter undergoes.
None of these are failures of good faith. They are the ordinary posture of a party that has decided, correctly, to litigate. But a funder is not a party. A funder’s position sits behind the claimant’s in the waterfall and ahead of the claimant’s in duration risk. The model that governs the deployment must reflect that asymmetry.
How the discount is set
The band is ten to twenty points, not a fixed number. Where within the band a particular matter falls turns on three readings:
What the discount is not
It is not a bid. HLC does not treat the discount as leverage in a term-sheet negotiation. The discount is a private input to underwriting; it is what determines whether we deploy at all and, if we do, at what multiple. It is disclosed to counsel in general terms, so that no party is surprised by the price that emerges from it, but the specific figure applied to a particular model is a decision of the Investment Committee.
Nor is it a substitute for the Seriousness Test. The Optimism Discount corrects a serious claim; it does not rehabilitate an unserious one. A matter that fails the Seriousness Test is declined at the top of the funnel and never reaches the modelling stage.
The point of the discipline
Ten to twenty points is a small number in isolation. Applied consistently across a book, it is the difference between a portfolio that returns its base case and a portfolio that does not. A funder that prices at the claimant’s ask and hopes for the median is not a funder; it is a co-plaintiff without a seat at counsel table. The Optimism Discount is how we remain the former.