WEB NOTES
Sixth Edition
The following are the web notes for the sixth edition of Law and Economics by Robert D.
Cooter and Thomas S. Ulen. Our intent in these notes is to extend the material in the text by describing some additional issues, articles, cases, and books. Because the fields of law, economics,
and law and economics are not standing still – because, that is, scholars are adding interesting
new material all the time, we may supplement, alter, and add to these notes from time to time.
Each note begins with a copy of the material from the text about the content of the web note
and the page on which that web note can be found. We will from time to time insert new material, update some of the entries, and add some additional material. You should be able to download pdf versions of each chapter’s web notes and of the entire set of web notes for all 13 chapters.
We have found that the very best students and their instructors from all over the world pay
close attention to these web notes. They often have good ideas about how to add to the entries
already here and suggestions about articles, cases, books, and topics that would be instructive to
add. We would be grateful for any comments or suggestions about any of the notes.
Chapter 7
Web Note 7.1 (p. 235)
We have previously mentioned the burgeoning literature in behavioral law and economics. Much of that literature relates to the examination of the economics of tort liability.
See our website for much more on the connections between behavioral law and economics and tort law.
The literature on behavioral law and economics is large and growing. Its relevance to the
economic analysis of tort liability is clear – the analysis assumes that decisionmakers involved in
the tort liability system (individuals, groups, corporations, judges, lawyers, administrative agencies, and others) are rational. As a result, they will make decisions that clearly serve their interests, subject to their own preferences and constraints. To the extent that one can imagine those
preferences and constraints, one can make predictions about how these rational people will behave.
But the thrust of behavioral analysis, as we have seen, is that people, groups, and organizations make predictable, systematic mistakes in their calculations. For instance, fixed costs tend
to loom large in people’s decisions (“I paid for the annual membership; so, I’d better go work
out.”), even though economics teaches that “bygones are bygones” and should not figure in current decisions (and assume that rational people do not pay attention to those fixed costs). And
rational people understand the probability calculus – that is, that they can form reasonable estimates of probabilities and use those to compute, roughly, expected utilities so that they can maximize subjective expected utility.
The two articles summarized here extend some of these behavioral insights to tort law. We
commend both articles for a full and careful reading. In addition, we also recommend Russell B.
Web Notes – Sixth Edition
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Korobkin & Thomas S. Ulen, “Law and Behavioral Science: Removing the Rationality Assumption from Law and Economics,” 88 Cal. L. Rev. 1051 (2000). We hope to put a copy of that article on this website for you to read.
Christine Jolls, Cass R. Sunstein, and Richard Thaler, “A Behavioral Approach to Law and Economics,” 50 Stan. L. Rev. 1471 (1998).
In this article, Jolls, Sunstein and Thaler present a broad vision of how law and economics
analysis may be improved by increased attention to insights about actual human behavior. Jolls,
Sunstein and Thaler main goal is to advance an approach to the economic analysis of law that is
informed by a more accurate conception of choice, one that reflects a better understanding of
human behavior and its wellsprings. They propose a systematic framework for a behavioral approach to economic analysis of law, and use behavioral insights to develop specific models and
approaches addressing topics of abiding interest in law and economics. Then, Jolls, Sunstein,
and Thaler suggest an approach based on behavioral economics that will help with the three categories of approach to law: positive, prescriptive, and normative. Positive analysis of law considers how agents behave in response to legal rules and how legal rules are shaped. Prescriptive
analysis considers what rules should be adopted to advance specified ends. Normative analysis
attempts to assess more broadly the ends of the legal system.
In the first part of the article, Jolls, Sunstein, and Thaler show a general framework and an
overview of the arguments for enriching the traditional economic framework. Then, they examine how a behaviorally informed law and economics analysis can help to explain the behavior of
human agents insofar as that behavior is relevant to law. And also they explain about the existing legal rules and institutions. Moreover, Jolls, Sunstein and Thaler analyze prescriptive issues,
with emphasis on how people respond to information and how this point bears on the role of law.
In addition, they outline the main problems with idea that the legal system ought always to respect informed choice, and with the idea that government decisionmakers (as behavioral actors)
can be relied upon to make better choices than citizens. Finally, Jolls, Sunstein and Thaler attempt to encourage others to continue the inquiry and research, both theoretical and empirical in
order to flesh out the behavioral approach for which they have argued in the present study, and
also transform economics into behavioral economics, and economic analysis of law into one of
its most important branches.
Ehud Guttel & Alon Harel, “Matching Probabilities: The Behavioral Law and Economics of Repeated Behavior,” 72 U. Chi. L. Rev. 1197 (2005).
Individuals often repeatedly face a choice of whether to obey a particular legal rule. Conventional legal scholarship assumes that whether such a choice is made repeatedly or is one-time
event has no effect on individuals’ decisions. In either case, individuals are expected to maximize their payoffs.
However, experimental studies suggest that individuals face a recurring choice, in contrast to
individuals making the choice only once, do not behave as maximizers. Instead, individuals facing the choice repeatedly apply the strategy of “probability matching.” For example: individuals
failed to maximize when presented with a die with four red faces and two white faces, and asked
to predict the colors of a series of rolls. Although maximization demands consistently betting on
the red, individuals preferred a “mixed” approach; red was chosen in 2/3 of the rolls and white in
1/3 of the rolls.
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Guttel and Harel show normative and descriptive applications that probability matching has
in the legal context. Normatively, they present how probability matching affects optimal investment in law enforcement. Descriptively, they consider that probability matching provides a new
rationale for existing legal doctrines, such as the imposition of punitive damages on repeated
wrongdoers, the imposition of harsher sanctions on recidivists, and rules attributing liability for
the mere infliction of risks. Then, Guttel and Harel present that experimental findings corroborate the intuition that law ought to, and in fact does, differentiate sharply between repeated and
single-instance behavior.
Web Note 7.2 (p. 236)
The remarkable story of the attempts to regulate the harms from tobacco use and to hold
the tobacco companies liable for those harms constitutes an instructive case study of the
relationships between liability and regulation. See our website for a discussion of the tobacco cases and the settlement reached in the U.S. litigation.
In late 1998 the four largest U.S. tobacco companies and the attorneys-general of 46 U.S.
states entered into the Tobacco Master Settlement Agreement. (That Master Settlement Agreement or MSA is available on-line in pdf format. The four other states – Florida, Minnesota, Texas, and Mississippi – had already reached a settlement agreement with the tobacco companies.)
Those attorneys-general had brought their actions against the tobacco companies for compensation to their state Medicaid plans for the costs of treating Medicaid recipients in those states who
had diseases caused or exacerbated by tobacco use. The MSA provided for monetary settlement
for those states (a minimum of $206 billion over the first 25 years of the agreement) and protection for the tobacco companies from private tort liability actions seeking compensation for harms
from tobacco use. The companies also agreed to cease some marketing practices (such as advertising directed at minors), to dissolve some research and advocacy groups that they had established, and to finance an anti-smoking advocacy groups called the American Legacy Foundation.
The MSA ended a period of almost 50 years of litigation and agitation regarding the tort liability of tobacco manufacturers. Private individuals who had sued the tobacco companies for,
among other things, negligent manufacture, negligent advertising, and fraud had been almost
completely unsuccessful in establishing liability. The companies were able to defend themselves
by noting, among other things, that the smokers had been warned of the dangers of smoking
(even before the famous Surgeon General’s warning of 1964, cigarettes were known as “cancer
sticks”) and that smokers were contributorily negligent in their harms. The state actions for reimbursement of public health expenses had more traction in establishing liability because they
did require a showing of individual smoker responsibility.
There have been interesting developments in the agreement since 1998. Tobacco farmers
reached an agreement with the tobacco companies to receive compensation ($12 billion between
2004 and 2014) for their lost revenues because of the anticipated decline in their sales because of
the MSA. Second, Congress authorized the Food and Drug Administration to regulate tobacco.
Third, many of the states “securitized” their entitlements to receive periodic payments under the
MSA. That is, the states issued “tobacco bonds” for which they received lump-sum payments
today equal, roughly, to the present discounted value (see Chapter 2) of the stream of settlement
payments anticipated over the following 25 or so years.
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We highly recommend Jonathan Gruber, “Tobacco at the Crossroads: The Past and Future of
Smoking Regulation in the United States,” 15 J. Econ. Persp. 193 (2001). See also W. Kip Viscusi, Smoke-Filled Rooms: A Post-Mortem on the Tobacco Deal (2002). We have also learned
much from Jeremy Bulow, “The Tobacco Settlement,” The Milken Institute Review (Fourth
Quarter, 2006), 41, and Mark Curriden, “Up in Smoke,” ABA Journal (March, 2007)., pp. 27 –
32.
Web Note 7.3 (p. 247)
When there are multiple defendants, it sometimes happens that one or more of the defendants make an agreement to settle their claims with the plaintiff and then keep the existence of that agreement secret from the other defendants. Such agreements are called
“Mary Carter agreements” after the case in which they first arose. See our website for a
history and economic analysis of Mary Carter agreements.
First, we present the history and background of Mary Carter agreement, including origin of
the term, basics elements of these agreements, and also some jurisdictions that held Mary Carter
agreement void, and some jurisdictions that accepted the use of these agreements. Our comments are based on Pat Shockley, “Comment – The Use of Mary Agreements in Illinois,” 18 S.
Ill. U.L.J. 223 (1993); and Ray J. Black Jr., “Mary Carter Agreements are Void in Texas as Contrary to Public Policy: Elboar v. Smith, 845 S. W.2d 240 (Tex. 1992),” 35 Tex. L. Rev. 183
(1994). Then, we present some important studies about Mary Carter agreements.
The term “Mary Carter Agreement” is derived from the case of Booth v. Mary Carter Paint
Co., 202 So.2d 8 (Fla. Dist. Ct. App. 1967). In Booth, plaintiff’s wife was killed in an automobile collision, and he filed suit initially against four defendants alleging that the defendants negligently operated their motor vehicles. Subsequently, the plaintiff executed a settlement agreement with two of the defendants. The agreement guaranteed a maximum liability of $12,500 to
the two settling defendants. The agreement also provided that if the verdict against the nonsettling defendant exceed $37,500, then the plaintiff would satisfy the entire judgment against
non-settling defendants and demand no contribution from the settling defendants. In addition,
the agreement provided that the settling defendants would continue as active defendants in the
litigation, and it was “agreed that the contents of this agreement would be furnished to no one,
unless so ordered by the court.” In upholding the agreement, the Florida District Court of Appeals stated that the settlement was not a release, but more akin to “an agreement that would limit the liability” of the settling defendants, which would “guarantee” the plaintiff a minimum recovery.
Despite some variations, there are four basic elements of a Mary Carter agreement: First, the
defendants entering into the agreement guarantee that the plaintiff will receive a given sum.
Second, the plaintiff agrees that this guarantee will be enforced only if the plaintiff fails after appropriate attempts to recover the guaranteed sum from the other defendants. Third, the defendants entering into the agreement agree to remain parties in the litigation. Fourth, all the parties
agree to keep the agreement confidential and to disclose it only when required by the rules of
Court.
Mary Carter agreements are known by many different names, such as “Gallagher agreements” in Arizona, and “loan receipt agreements” in Illinois. There are some variations in these
agreements.
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In 1973, the Illinois Supreme Court, for the first time, upheld the validity of “loan receipt
agreements: in Reese v. Chicago, Burlington & Quincy Railroad Company, 55 Ill.2d 356, 303
N.E.2d 382 (1973). The majority believed “loan receipt agreements,” in accordance with the
public policy of this state, encouraged settlement of litigation. The majority’s analysis in Reese
struggled with the then state of the law, which forbade contribution among joint tortfeasors. The
court cautioned that, “it may be fairly argued that a loan agreement permits a joint tortfeasors to
achieve by indirection that which he could not do directly.” Also noteworthy was the dissent
part, which opined that, the holding of the majority “serious undermines without even mentioning it, the long standing doctrine that prohibits the assignment of a cause of action for personal
injuries or wrongful death.”
In Ward v. Ochoa, the Florida Supreme Court provided a clear definition of a Mary Carter
agreement. The court stated “[a] Mary Carter agreement… is basically a contract by which one
co-defendant secretly agrees with the plaintiff that, if such defendant will proceed to defend himself in court, his own maximum liability will be diminished proportionately by increasing the
liability of the other co-defendants.” To offset the injustice of such agreements, the Florida Supreme Court held Mary Carter agreements were admissible into evidence at trial. Also, in Pennsylvania was established the rule on disclosure of the Mary Carter agreement in Hatfield v. Continental Imports, Inc., 530 Pa. 551 (1992). The Pennsylvania Supreme Court ruled that the existence of a Mary Carter agreement is admissible at trial to show “a bias to the [settling] defendants’ interest in the case which is contrary to what would be perceived as their ‘normal’ interest.”
Many states have approved the use of the Mary Carter agreements because they encourage
settlement, such as Pennsylvania, Missouri, Idaho, and Kansas. However, Mary Carter agreements have received much criticism, and even some states held Mary Carte agreements void as
contrary to public policy. The Supreme Court of Texas, in Elboar v. Smith stated:
As a matter of public policy, this Court favors settlements, but we do not favor partial settlements that promote rather than discourage further litigation. And we do
not favor settlement arrangements that skew the trial process, mislead the jury,
promote unethical collusion among nominal adversaries, and create the likelihood
that a less culpable defendant will be hit with the full judgment. The bottom line is
that our public policy favoring fair trials outweighs our public policy favoring partial settlements. This case typifies the kind of procedural and substantive damage
Mary Carter agreements can inflict upon our adversarial system. Thus, we declare
them void as violative of sound public policy.
Also, in Trampe v. Wisconsin Telephone Co., the Wisconsin Supreme Court held “Mary
Carter agreement” void, because the court felt that the agreeing party was not attempting to secure a fair settlement, but rather was trying to place the burden of liability entirely on the shoulders of the non-agreeing party. Therefore, while endorsing settlement, the court held that a party
cannot use such agreements to gain a financial advantage over a non-settling party.
In Lum v. Stinnett, the Supreme Court of Nevada held Mary Carter agreements void because
such agreements constituted maintenance and champerty and violated the canons of ethics. Further the reasoned that Mary Carter agreements contravene the policy underlying the Canons of
Professional Conduct requiring candor and fairness by counsel, and prohibiting representation of
conflicting interest, taking technical advantage of opposing counsel, and unjustifiable litigation.
Mary Carter agreements have been validated by some state supreme courts. The Supreme
Court of Missouri held that the appropriate solution for examining Mary Carter agreements was
on a case-by-case basis, “rather than brand them all as outcasts.” I making this determination, the
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court determined that the strong public policies both for and against Mary Carter agreements
could coexist so long as the non-settling defendant is not deceived. Also the Supreme Court of
Pennsylvania held that the “court, as with all proffered evidence, should review the agreement,
balance the relevancy of it against the potential prejudice, and exercising judicial discretion, admit or exclude as much as it deems appropriate. In this case, the court held that the jury was entitled to be instructed about the financial interests, which the original defendants retained in the
plaintiff’s success.
According to Larry A. Mancini, a loan receipt agreement is valid in Illinois under the following circumstances: 1) if entered into prior to judgment, Kerns v. Engelke, 390 N.E.2d 859, 28
Ill.Dec. 500 (1979); 2) if disclosed to the court and parties (non-settling defendants), Reese v.
Chicago, Burlington & Quincy Railroad Company, 55 Ill.2d 356 (1973), Gatto v. Walgreen
Drug Company, 61 Ill.2d 513, 337 N.E.2d 23 (1975), Harris Trust and Savings Bank v. Ali, 100
Ill.App.3d 1, 55 Ill.Dec. 186 (1st Dist. 1981); 3) only to the extent that the money advanced
thereunder by the settling defendant is to be repaid by plaintiff, Schoonover v. International Harvester Company, 171 Ill.App.3d 882, 121 Ill.Dec.734 (1st Dist. 1988), Harris Trust and Savings
Bank v. Ali, 55 Ill.Dec. 186 (1981). If some amount of the loan is to be forgiven, that amount is
treated as an ordinary, unconditional payment for a covenant-not-to-sue, and must be set-off
against any verdict as a partial satisfaction of judgment. Greco v. Coleman, 176 Ill.App.3d 394,
125 Ill.Dec. 867, 871 (5th Dist. 1988). (Larry A. Mancini, Non-Traditional Settlement Agreements in Multi-Defendant Tort Litigation. www.settlementnegotiation.org).
While some jurisdictions have expressly declared Mary Carter agreements as void, other jurisdictions allow them under certain conditions. Most courts engage in a balancing approach by
weighing the policy supporting settlement with the potential injustices that settlement agreements have on the adversary process.
Pat Shockley, in her interesting comment The Use of Mary Carter Agreements in Illinois,
gives us a very good idea about Mary Carter agreements in Illinois. Shockley surveys the use of
these agreements in Illinois to determine whether the Supreme Court of Illinois should find the
Mary Carter agreements void. She concludes that is only necessary to abolish the injustices of
Mary Carter agreements, not the agreements themselves. The limitations and the injustices of
Mary carter agreements could be limited by applying the requirements of Reese (Reese v. Chicago B. & Q. R.R. Co., 303 N.E.2d 382 (Ill. 1973)) when determining the validity of Mary Carter
agreements. These include: (1) that the agreement be entered into before trial; (2) that the contracting defendant be dismissed from the case to minimize jury confusion and maintain the true
adversarial nature of the action; (3) that the existence of the agreement be brought to the jury’s
attention. In this way, settlement agreements would be executed in “good faith” and thus should
be allowed.
Charles W. Lowe, “Comment - Gallagher Covenants, Mary Carter Agreements, and Loan Receipt Agreements: Unsettling Contributions to Conflict Resolution,” 1977 Ariz. St. L.J. 117.
In this comment, Lowe explores the problems posed by these agreements and possible resolutions to help determine whether the benefits of such agreements can outweigh their faults. He
argues that the Mary Carter agreements and others manipulate the ultimate liability to the mutual
benefit of the plaintiff and agreeing defendant, but to the detriment of the non-agreeing defendant. These agreements not only limit the liability of the agreeing joint tortfeasor, but they also
usually require his participation as a defendant at trial, along with other tortfeasors.
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Also, Lowe affirms that Gallagher covenants, Mary Carter agreements, and loan receipt
agreements should not be categorically rejected because they have benefits and can constructively contribute to settlement. However, undesirable effects must be recognized and checked.
John E. Benedit, “Note – It’s a Mistake to Tolerate the Mary Carter Agreement,” 87 Colum. L.
Rev. 368 (1987).
Benedit affirms that Mary Carter agreement is an agreement by which the plaintiff and one
defendant enter an agreement that obligates the setting defendant to remain in the trial but fixes
his liability at a figure inversely proportional to the magnitude of the court’s judgment against
the non-settling defendant.
In this note, Benedit argues that the Mary Carter agreement distorts tort litigation by prejudicing non-settling defendants at trial, undermining the equitable apportionment of damages
among tortfeasors, and contravening legal ethics. Then, he describes the elements of the Mary
Carter device, and also analyzes the problems of the Mary Carter agreements. In addition, Benedit scrutinizes the approaches courts have used to mitigate Mary Carter distortion, and shows
that they are inadequate.
Benedit concludes that courts should avoid all Mary Carter agreements because they distort
the entire litigation process and too often prejudice the trials of non-settling defendants.
Lisa Bernstein & Daniel Klerman, “An Economic Analysis of Mary Carter Settlement Agreements,” 83 Geo. L.J. 2215 (1995).
In this paper, Bernstein and Klerman explore the social desirability of Mary Carter agreements (MCAs), a type of settlement agreement used most commonly in suits against multiple
tortfeasors. They explain that under a typical MCA one defendant either guarantees the plaintiff
a minimum recovery or extends him a loan that need only to be repaid if, and to the extent that,
the plaintiff recovers from the other defendants. Under such agreements, the settling defendant
often remains a party to the suit and is generally given the right to veto any settlement between
the plaintiff and the other defendants.
Bernstein and Klerman argue that contrary to the view of some courts and most commentators the use and availability of Mary Carter agreements (MCAs) may have socially desirable effects in a variety of circumstances. They suggest that these agreements may increase the amount
of information revealed during discovery and trial, may enable plaintiffs to finance meritorious
suits that might not otherwise have been brought, and may allocate some of the risk of trial to
those best able to bear it. Bernstein and Klerman conclude that while MCAs some of the problems suggested by their critics, these problems have been over-stated and it is important to recognize that such agreements may have offsetting benefits.
Finally, Bernstein and Klerman suggest that in some circumstances Mary Carter agreements
(MCAs) may further the compensatory and deterrent functions of tort law without adversely affecting the settlement rate, distorting the fair allocation of liability among defendants, or compromising adjudicative accuracy. The analysis suggests that discussions of suit and settlement
need to recognize that a simple monetary payment from one defendant to the plaintiff in exchange for release of the claim is only one of the many forms that a settlement can take, and that
the existence of MCAs, as well as other types of explicit agreements and implicit understandings
between the plaintiff and less than all of the defendants, or among the defendants themselves,
can have an important impact on the ways that legal rules affect parties’ litigation decisions.
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Web Note 7.4 (p. 247)
We describe some recent empirical literature on “high-low agreements” between plaintiffs and defendants.
In a recent working paper – “Trial and Settlement: A Study of High-Low Agreements,” Harvard Olin Center for Law, Economics and Business (September, 2010) – J.J. Prescott of the University of Michigan Law School, Kathryn E. Spier of Harvard Law School, and Albert Yoon of
the University of Toronto Faculty of Law propose a model of when potential litigants enter into a
high-low agreement and report on some empirical work that tests their model.
Here is the abstract of the article:
This paper presents the first systematic theoretical and empirical study of high-low agreements in
civil litigation. A high-low agreement is a private contract that, if signed by litigants before the
conclusion of a trial, constrains the future damages payment to lie between a minimum and a
maximum amount. Whereas the existing literature describes litigation as a choice between trial
and settlement, our examination of high-low agreements – a relatively new phenomenon in civil
litigation – introduces partial or incomplete settlements. In our theoretical model, trial is both
costly and risky. When litigants have divergent subjective beliefs and are mutually optimistic
about their trial prospects, cases may fail to settle. In these cases, high-low agreements can be in
the litigants’ mutual interest because they limit the risk of outlier damages awards while still allowing for an optimal degree of speculation. Using unique insurance claims data from a national
insurance company, we describe the features of these agreements and empirically investigate the
factors that may influence whether litigants discuss or enter into high-low agreements. Our empirical findings are consistent with the predictions of the theoretical model. We also explore extensions and alternative explanations for high-low agreements, including their use to mitigate excessive, offsetting trial expenditures.
The authors open their paper with this illustrative anecdote:
In the summer of 2004, a semi-trailer truck cruising at 65 miles per hour on U.S. Highway 60
rear-ended a Ford pickup truck that was stopped in a line of traffic. The pickup truck was in
flames as witnesses pulled the driver, Delbert Sanders, from the wreckage. The driver of the
semi, who had been searching for his dropped cell phone at the time of the accident, was unharmed. Although the semi driver and his insurer admitted liability for the accident, the parties
disagreed over the severity of Sanders’ alleged back injury. Settlement negotiations before trial
reached an impasse – the defendants’ offer of $500,000 to Sanders was far below the $1.3 million
that he demanded. Both sides were caught by surprise when the jury returned a $5.25 million
verdict. Sanders did not walk away with $5.25 million, however. Instead the defendants paid only $1.5 million, all that was owed under a so-called ‘high-low agreement signed by the parties before the jury rendered its verdict.
Their model begins from the observation (on which we will elaborate in Chapters 10 and 11)
that “when the costs of litigation are not too large and bother parties are sufficiently confident
about succeeding at trial [], litigants will fail to agree on an out-of-court settlement. But utilitymaximizing litigants will not necessarily pursue a ‘naked’ trial under those conditions. A highlow agreement [] can emerge as the optimal contract when at least one litigant is sufficiently risk
averse and the risk at trial is large relative to the anticipated litigation costs. In essence, a highlow agreement reduces the disutility the litigants suffer from risk while still allowing them to
speculate optimally on the trial outcome.”
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The authors then collected and coded data on all claims that were open for a national insurer
between January 1, 2004, and March 31, 2009. The company also allowed them access to their
lawyers’ litigation notes, which discussed, among other things, whether in each claim a high-low
agreement had been “discussed, negotiated and reached.” They report that the “vast majority of
claims were resolved administratively by claims adjusters without any legal action.” Approximately 5 percent of the more than 2,500 litigated claims that ended in trial or arbitration had had
high-low discussion. Approximately 4 percent of those litigated claims had high-low agreements
in place at the time of a verdict or decision. The authors report that the cases that had the highlow agreements were, as their model had predicted: “We find that those claims that are expected
to be low cost and highly volatile are more likely, relative to baseline probabilities, to involve
high-low discussions and/or result in a high-low agreement at some point during the litigation.”
The authors then conclude with some suggestions for future research:
Our paper developed a model of high-low agreements in which litigants have different subjective
prior beliefs. From a theoretical perspective, it would be interesting to explore their use in models
with asymmetric information. There are also a number of unexplored public policy issues and
concerns. For instance, because these private agreements mitigate the risk of trial for litigants,
they decrease the attractiveness of full settlement. For this reason, the use of high-lows should increase the demand for (high-low constrained) trials. This potentially imposes external costs and
benefits. First, increased demand for litigation could lead to higher overall litigation costs since
the court system—including the buildings, the court employers, and the juries—are all heavily
subsidized. Second, because there is currently no requirement in most jurisdictions to disclose the
existence of a high-low agreement, there may be a misallocation of scarce adjudicatory resources.
Web Note 7.5 (p. 250)
There has been considerable writing about the economics of comparative negligence. We
review that literature on our website.
In the text we make a case for the efficiency of comparative negligence. The gist of that case
is that by spreading the losses that might arise from mistaken evaluation of evidence or assignment of liability and thereby reducing the all-or-nothing aspect of negligence with contributory
negligence, comparative negligence reduces the dire consequences of failing to take sufficient
precaution against accidental injury. As a result, in a comparative negligence regime potential
injurers and potential victims will not self-insurance against the all-or-nothing consequences by
taking too much precaution (from a social efficiency point-of-view). That is, comparative negligence gets the parties closer to the social-cost minimizing level of care that would characterize a
world in which courts evaluated evidence perfectly and assigned liability correctly. (See also
David Haddock & David Curran, “An Economic Theory of Comparative Negligence,” 14 J. Legal Stud. 49 (1985), which makes a similar point.)
We made that argument in the mid-1980s. There have been a few attempts to address the
same theoretical issues. One of those was the article referenced at the end of this chapter by Omri Ben-Shahar of the University of Chicago Law School and Oren Bar-Gill of NYU School of
Law, “The Uneasy Case for Comparative Negligence,” 5 Am. L. & Econ. Rev. 433 (2003).
Here’s the abstract of their paper:
This paper questions, and in some contexts disproves, the validity of the efficiency justification
for the comparative negligence rule—the liability regime that divides the loss between the injurer
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and the victim. First, it has been argued that in the presence of evidentiary uncertainty, comparative negligence is generally superior. The analysis shows that this argument is theoretically questionable. It traces the analytical flaw in this claim, and conducts numerical simulations—a form
of synthetic “empirical” tests—which prove the potential superiority of other rules. The second
argument in favor of the comparative negligence rule is based on its alleged superior ability to
deal with asymmetric information. This paper develops a general approach to liability rules as
mechanisms that harness the parties’ private information—by inducing self-selection. It then
shows that the argument in the literature in favor of comparative negligence, that it induces selfselection, should be interpreted as a specific example of the general approach. Moreover, using
this approach, we develop two new models of liability under asymmetric information, which
demonstrate how negligence-type liability rules, other than comparative negligence, can induce
self-selection. These conclusions weaken the efficiency basis for current proposals to expand the
reach of the ”division-of-liability” principle within tort law and beyond.
Bar-Gill and Ben-Shahar reach a qualified endorsement of comparative negligence. Their
endorsement is qualified by the facts that (1) “given evidentiary uncertainty, the analysis
demonstrated that the traditional contributory negligence doctrine may well provide for lower
overall costs, relative to the comparative negligence doctrine,” and (2) “regarding the information-forcing role of tort liability, [we have ] shown that self-selection can be induced by
negligence-type rules without comparative negligence.” In brief, “imperfect information
does not establish as strong an economic case for comparative negligence as previously
thought.” (See also Daniel Rubinfeld, “The Efficiency of Comparative Negligence,” 16 J.
Legal Stud. 375 (1987).)
One might well argue that we are at an impasse that can only be resolved by careful empirical work (although Bar-Gill and Ben-Shahar did computer simulations to buttress their theoretical conclusions). That is, there are good theoretical arguments for the efficiency of contributory
negligence and for comparative negligence; which argument is more persuasive may well depend
on what the real world data tell us. It would, for example, be fascinating to explore the consequences in a given jurisdiction of switching from contributory to comparative negligence or to
compare the relative efficiencies of jurisdictions that rely on contributory negligence with those
that rely on comparative negligence, controlling for other differences between the jurisdictions.
To our knowledge the only studies that have done something on this order are Michelle J.
White, “An Empirical Test of the Contributory and Comparative Negligence Rules in Accident
Law,” 20 Rand J. Econ. 308 (1989, and a later, short survey by White that is available on-line.
Professor White compared rear-end automobile accidents in California during the period 19741976, given that California switched from contributory to comparative negligence in 1975. “All
cases [in the dataset] were decided at trial. The data include measures of the care levels of injurers and victims, the pecuniary damage claimed by victims, whether the injurer was found liable,
and the amount of the damage award.” White used logit regressions to estimate the probabilities
of being found liable under each form of liability as a function of injurers’ and victims’ care levels and other factors. “Increasing the injurer’s care level from very negligent to slightly negligent reduced the probability of the injurer being found liable by .64 under the contributory negligence rule, compared to only .44 under the comparative negligence rule.” As a result, “the private benefit to drivers of taking more care in terms of reduced probability of being found liable
qua injurer when accidents occur is considerably smaller under comparative negligence rule.”
Professor White then estimated the “sharing rule” for damages under each form of the liability rule. “Under both liability rules, injurers’ share of victims’ damage was found to be negatively and significantly related to injurers’ care level, but not to victims’ care level. When injurers’
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care increased from very negligent to slightly negligent, their share of victims’ damages fell by
.26 under the comparative negligence rule, compared to .20 under the contributory negligence
rule. On average, injurers who were found liable paid an average of 48 percent of victims’ damage under the contributory negligence rule, compared with only 21 percent under the comparative negligence rule.” The fascinating thing about this result is that “damage-sharing occurs under both rules.” That is, contributory negligence was not, in practice, an all-or-nothing rule. Juries had apparently found means of discounting the victims’ damages awards according to their
estimate of the victims’ fault.
Professor White then estimated the effects of the two liability rules on drivers’ incentives to
take care ex ante. She found that the “comparative negligence rule gives drivers weaker incentives to avoid accidents than the contributory negligence rule and also [] that the comparative
negligence rule gives drivers an incentive to use less than the economically efficient level of
care.”
Finally, she also summarizes several other empirical studies of comparative and contributory
fault. She reports that “insurance premiums were highest under the pure comparative negligence
rule, next highest under no-fault, next highest under the modified comparative negligence rule,
and lowest under the contributory negligence rule. The differences … were all statistically significant.” In summary, these other studies and her own “suggest[] that the comparative negligence rule results in weaker incentives to avoid accidents than the contributory negligence rule.
But the evidence concerning whether weaker deterrence under the comparative negligence rule
actually results in less care and/or more accidents is mixed.”
Web Note 7.6 (p. 257)
There is extensive literature on how regulators and other legal decision makers should
place a value on a lost life—referred to as the “value of a statistical life” or VSL. We review that literature, with examples, on our website.
Clearly, the VSL is an extraordinarily important issue for public policy consideration. In addition to the articles summarized here, we highly recommend Orley Ashenfelter & Michael
Greenstein, “Using Mandated Speed Limits to Measure the Value of a Statistical Life,” 112 J.
Pol. Econ. S226 (2004).
Partly because of the growing literature on climate change (or global warming) and the necessity of deciding what costs to incur today to prevent deaths in the relatively far future, there
has been an interesting increase in the scholarly literature on the value of a statistical human life.
See, for example, Eric Posner, “Agencies Should Ignore Distant-Future Generations,” 74 U. Chi.
L. Rev. 139 (2007) and Tyler Cowen, “Caring About the Distant Future: Why It Matters and
What It Means,” 74 U. Chi. L. Rev. 5 (2007).
Eric A. Posner & Cass R. Sunstein, “Dollars and Death,” 72 U. Chi. L. Rev. 537 (2005).
In the United States, two independent bodies of law assign dollar values to deaths. Regulatory agencies, drawing on willingness-to-pay studies, use a uniform number that takes no account
of losses to dependents and others. In wrongful death actions, courts attempt to compensate survivors, failing to incorporate the loss to the descendent and ensuring a high degree of variability
in awards. For both bodies of law, deterrence is an important goal, and from the standpoint of
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deterrence, both make serious blunders. And for both, a key question is how to combine accuracy
and administrability.
Posner and Sunstein argue that there are two major problems with regulatory law. First, the
value of a statistical life is uniform rather than disaggregated. They very theory that underlies
current practice calls for far more in the way of individualization. Second, agency figures do not
include the losses to dependents and others; the result is underdeterrence. Also, Posner and Sunstein argue that the central problem with tort law is that it does not include the welfare loss to the
decedent; its current reliance on the decedent’s pre-death losses and the dependents’ losses results in undervaluation of mortality risks, and hence underdeterrence.
In addition, Posner and Sunstein affirm that each body can learn a great deal from the other.
Then, they suggest five large-scale reforms. First, agencies should move in the direction of the
more individuated approach of tort law. They should not use a uniform number per life saved.
Also, they should consider pain and suffering, dread, and loss to dependents. These changes
would make a dramatic difference for administrative practice, replacing the crude current effort
to use a single value for statistical lives. Second, courts should move in the direction of administrative regulation by taking account of the welfare loss to the descendent. This change would
significantly alter wrongful death cases by producing far higher recoveries in many cases. Third,
agencies should move in the direction of courts by including the emotional distress and other
welfare losses incurred by dependents. While courts should not ignore losses of support for dependents (as agencies do), they should offer more accurate and fine-grained understandings of
the relevant figures. These changes would increase the stringency of administrative regulations
and promote less arbitrary figures from courts. Fourth, both courts and agencies should change
their valuation of the deaths of children by taking the child’s welfare loss seriously while also
accounting for the possibility of offsetting behavior by parents. Fifth, agencies and courts should
evaluate mortality risks that are imposed on foreigners - both alien residents and aliens nonresidents whose mortality is affected by domestic activities - in a manner that is consistent with the
diplomatic objectives of the political branches.
Finally, Posner and Sunstein conclude that if their recommendations were accepted, they
would expect tort awards to become higher, more uniform, and less arbitrary than they currently
are. Also, they would expect ‘value loss of lives’ (VSLs) used by regulatory agencies to be more
variable - in many cases lower and in many cases higher. The inclusion of losses to dependents
should result in more stringent regulations, as the effective benefit from a life saved would be
increased.
Orley Ashenfelter, “Measuring the Value of a Statistical Life: Problems and Prospects,” 116
Econ. J. C10 (2006).
Public choices about safety in democratic society estimates of the willingness of people to
trade off wealth for a reduction in the probability of death. Estimates of these trade-offs are used
in evaluating environmental issues, public safety in travel, medical interventions and in many
other areas. It has become common to call this trade-off the value of a statistical life (VSL). In
this article, Orley Ashenfelter shows the widespread use of this concept and summarizes the major issues, both theoretical and empirical, that must be confronted in order to provide a credible
estimate of a VSL. Then, he concludes with an application of these issues to a particular study of
speed limits and highway safety.
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W. Kip Viscusi & Joseph E. Aldy, “The Value of a Statistical Life: A Critical Review of Market
Estimates Throughout the World,” 27 J. Risk & Uncertainty 5 (2003).
A substantial literature over the past thirty years has evaluated tradeoffs between money and
fatality risks. These values in turn serve as estimates of the value of a statistical life. In this article Viscusi and Aldy review more than sixty studies of mortality risk premiums from ten countries and around forty studies that present estimates of injury risk premiums. This critical review
examines a variety of econometric issues, the role of unionization in risk premiums, and effects
of age on the value of a statistical life.
First, Viscusi and Aldy show an overview of the hedonic wage methodology. This approach
motivates the discussion of the data and econometric issues associated with estimating a VSL.
Although there continue to be controversies regarding how best to isolate statistically the riskmoney tradeoffs, the methodologies used in various studies typically follow a common strategy
of estimating the locus of market equilibria regarding money-risk tradeoffs rather than isolating
either market supply curves and market demand curves. Second, they explore the extensive literature based on estimates using U.S. labor market data, which typically show a VSL in the range
of $4 million to $9 million. These values are similar to those generated by U.S. product market
and housing market studies, which are reviewed in the present work. Then, Viscusi and Aldy examine the implicit value of the risk of nonfatal injuries. These nonfatal risks are of interest in
their own right and as a control for hazards other than mortality risks that could influence the
VSL estimates. In addition, they consider studies that extended such analyses to other countries.
The general order of magnitude of these foreign VSL estimates tends to be similar to that in
United States, although the quite different labor market conditions throughout the world. Finally,
Viscusi and Aldy’s meta-analyses indicate an income elasticity of the value of a statistical life
from about 0.5 to 0.6. They also present a detailed discussion of policy applications of these value of statistical life estimates and related issues, including risk-risk analysis.
Robert D. Cooter, “Hand Rule Damages for Incompensable Losses,” Working paper No. 83,
Berkeley Program in Law & Economics, U. Cal. (2003).
Money cannot compensate for some losses, as when parents suffer the death of a child. In
this study, professor Cooter argues that, for incompensable losses, courts should develop theory
and practice of damages from the way reasonable people respond to the risk of incompensable
losses. Also, professor Cooter argues that courts should apply more specifically the Hand Rule to
find damages based on the reasonable person’s point of indifference between less risk and more
expenditure on precaution. Hand Rule Damages are efficient because injurers internalize the
risks they impose on others. Hand Rule Damages are also fair in two respects. First, they require
injurers to treat others the way a reasonable person treats everyone. Second, a regime of Hand
Rule Damages and ideal insurance markets put victims in the same position as a regime that
makes people compensate others for exposing them to risk, which is fair by some understandings
of the principle of restorative justice. Empirical evidence suggests that Hand Rule Damages are
several times higher than the U.S. average for damages in automobile accident cases involving
loss of life. Thus, implementing Hand Rule Damages would cause a significant increase in damage awards and insurance costs for some important kinds of accidents.
Laura Taylor and Janus Mozrek, “What Determines the Value of Life? A Meta-Analysis,” 21 J.
Policy Analysis & Management 253 (2002).
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A large literature has developed in which labor market contracts are used to estimate the value of a statistical life (VSL). Reported estimates of the VSL vary substantially, from less than
$100,000 to more than $25 million. In this research, Taylor and Mozrek use meta-analysis to
quantitatively assess the VSL literature. Results from existing studies are pooled to identify the
systematic relationships between VSL estimates and each study’s particular features, such as the
sample composition and research methods.
Also, Taylor and Mozrek argue that this meta-analysis suggests that a VSL range of approximately $1.5 million to $2.5 million (in 1998 dollars) is what can be reasonably inferred from
past labor-market studies when “best practice” assumptions are invoked. This range is considerably below many previous qualitative reviews of this literature.
Bradley J. Bowland & John C. Beghin, “Robust Estimates of Value of a Statistical Life for Developing Economies,” 23 J. Policy Modeling 385 (2001).
Environmental economists use the value-of-statistical-life (VSL) approach to value mortality
changes resulting from environmental improvement. Because of scarce data, VSL estimates are
unavailable for most developing countries. Using robust regression techniques, Bowland and
Beghin conduct a meta-analysis of VSL studies in industrialized countries to derive a VSL prediction function for developing economies accounting for differences in risk, income, human
capital levels, and other demographic characteristics of these economies. Also, Bowland and
Beghin apply their estimated VSL to assess the willingness-to-pay for reduction in mortality
linked to air pollution in Santiago, Chile. They find willingness-to-pay estimates in the range of
1992 purchasing power parity (PPP) $519,000 – 675,000 per life.
W. Kip Viscusi, “The Value of Life in Legal Contexts: Survey and Critique,” 2 Am. Law &
Econ. Rev. 195 (2000).
Value-of-life issues traditionally pertain to insurance of the losses of accident victims, for
which replacement of economic loss is often an appropriate concept. Deterrence measures of the
value of life focus on risk-money tradeoffs involving small changes in risk. Using market data
for risking jobs and product risk contexts often yields substantial estimates of the value of life in
the range of $3 million to $9 million. These estimates are useful in providing guidance for regulatory policy and assessments of liability. However, use of these values to determine compensation, known as hedonic damages, leads to excessive insurance.
Donald Kenkel, “Using Estimates of the Value of a Statistical Life in Evaluating Consumer Policy Regulations,” 26 J. Consumer Policy 1 (2003).
In this study, Kenkel reviews selected evaluations conducted by the U.S. Environmental Protection Agency (EPA), the Economic Research Service of the U.S. Department of Agriculture
(USDA), and the U.S. Food and Drug Administration (FDA). Also, he defines and illustrates
some basic concepts about the current practice of economic evaluation of the life-saving benefits
of regulations. Then, Kenkel proposes a common-sense rule for improving current practice: The
same life-saving benefit should always be given the same value, but different life-saving benefits
should be given different values.
Finally, Kenkel argues that the evaluations of the life-saving benefits of regulations should
use consistent and specific estimates of the VSL. When different agencies reduce similar health
risks for similar populations, they should use consistent estimates of the VSL; but each agency
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lations. This presents a challenge for both the research community that generates VSL estimates
and the policymaking community that uses them. Then, he suggest that one way to develop a
catalogue of consistent and specific VSL estimates is the “monetized QALY approach” such as
that used by the FDA. However, the conceptual foundation for monetizing QALY’s needs to be
examined closely and linked to the VSL literature.
Ikuho Kochi, Bryan Hubbell, & Randall Kramer, “An Empirical Bayesian Approach to Combining and Comparing Estimates of the Value of Statistical Life for Environmental Policy Analysis,” 34 Environmental and Resource Economics 385 (2006).
In this study, Kochi, Hubbell and Kramer, use an empirical Bayes pooling method to combine and compare estimates of the Value of a Statistical Life (VSL). The data come from 40 selected studies published between 1974 and 2002, containing 197 VSL estimates. The estimated
composite distribution of empirical Bayes adjusted VSL has a mean of $5.4 million and a standard deviation of $2.4 million. The empirical Bayes method greatly reduces the variability around
the pooled VSL estimate. They conclude that the pooled VSL estimate is influenced by the
choice of valuation method, study location, and union status of sample but not to the source of
data on occupational risk or the consideration of non-fatal risk injury.
Eeckhoudt L. R., and Hammitt J. K., “Does Risk Aversion Increase the Value of Mortality
Risk?,” 47 J. Environ. Econ. & Management 13 (2004).
According to the authors, it is often asserted that individual willingness to pay to reduce mortality risk is greater among individuals who are ''more risk-averse.'' If risk aversion is defined in
the colloquial sense of distaste for mortality risk, the assertion is tautological since a larger value
of statistical life (VSL) represents a higher rate of substitution between money and mortality risk.
If risk aversion is defined in the technical sense of distaste for mean-preserving increases in the
spread of a lottery, the assertion appears to be a non sequitur since mortality risk is a binary lottery between fixed endpoints and VSL does not depend on local aversion to financial risk. In this
study, Eeckhoudt and Hammitt examine the relationship between aversion to financial risk and
willingness to pay to reduce mortality risk. Then, they find that it is sensitive to what other characteristics of the utility function are held constant as risk aversion is altered. Although aversion
to financial risk increases VSL in definable cases, under many plausible assumptions the relationship between risk aversion and VSL is ambiguous.
Ike Brannon, “What is a Life Worth?,” Regulation, Winter 2004-2005.
Economists and other researchers have used a variety of analyses to determine the value of a
statistical life. Ike Brannon, in this article, examines how economists assign a number to the value of a statistical life, and consider criticisms of both their methodologies and the very concept
of a VSL. Then, Ike Brannon concludes that while more informed debate on regulatory matters
might make sense, it is also necessary to realize that society cannot spend an infinite amount of
money to protect and extend each person’s life, and some choices have to be made in the realm
of health and safety regulation. We have to decide to what extent we are willing to expend resources to prevent unnecessary death rather than improve education, increase handicap access, or
ensure a cleaner environment. To resist placing a dollar value on a statistical life is to abdicate
any sense of rational decision-making in the regulatory realm.
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Web Note 7.7 (p. 257)
Another difficult category of damage to evaluate for the purposes of compensation is
“pain and suffering.” (We saw in the previous chapter that there is principled argument
to be made for not awarding pain-and-suffering damages. But most jurisdictions do so.)
On our website we report on some recent empirical evidence that seeks to understand
how jurors make decisions about how much money to award for “pain and suffering.”
In this note, we present some important works about pain-and-suffering damages. We examine two very interesting studies by professor Ronen Avraham. In his first work professor Ronen
Avraham analyzes the people demand for monetary coverage and for pain-and-suffering insurance. In his study, the majority of participants treated the two types of insurance the same. Then,
in his second work, professor Ronen Avraham explores the idea of putting a price on pain and
suffering and also proposes a new way to price pain and suffering. Also, we present a great article by Steven P. Croley and Jon D. Hanson that challenges the view that tort compensation for
pain-and-suffering is incompatible with consumers’ insurance preferences. Moreover, we show
additional interesting literature on pain-and-suffering damages.
Ronen Avraham, “Should Pain-and-Suffering Damages be Abolished from Tort Law?: More
Experimental Evidence,” 55 U. Toronto L. J. 941 (2005).
Professor Avraham affirms that most legal economists accept the notion that tort law (which
is essentially a system of third-party insurance) and first-party insurance markets act as alternative solutions to the problem of allocating accident costs. Using this perspective, the optimal level of tort compensation should equal the amount of first-party insurance coverage purchased by
an independent, rational, and fully informed consumer (‘sovereign consumer’) in a world without
tort laws. But only empirical or experimental data can indicate whether sovereign consumers
would buy pain-and-suffering coverage in a world without tort law.
In this article, professor Avraham argues that the sovereign consumer is the relevant way to
explore the desirability of pain-and-suffering damages in tort law. He presents direct experimental evidence on consumers’ demand for pain-and-suffering coverage relative to their demand
for monetary coverage. And also, he demonstrates that people demand not only monetary coverage but pain-and-suffering insurance as well. Then, professor Avraham considers that pain-andsuffering damages may play a vital role in achieving not only the deterrence rationale but also
the insurance rationale of tort law.
Professor Avraham shows the methodology and results of two experimental studies he performed to study the demand for pain-and-suffering coverage. The experiments were designed to
see whether the participants perceived any difference between insurance coverage for monetary
damages and coverage for non-monetary damages. Each participant faced several insurance decisions for different products: padding for roller skates ($ 40), a portable saw ($ 100), a facial
cream ($ 100), a computer monitor ($ 250), a trampoline ($ 600) and tires for a car ($ 800). Each
product was associated with different types of injuries, ranging from a migraine, to brain damage
resulting in a comatose state. Participants stated the price they were willing to pay, above the
price of each product, for insurance to cover monetary damages and pain-and-suffering damages.
Then, he compared the demand for monetary coverage with the demand for pain-and-suffering
coverage.
Professor Avraham results in both studies show that the vast majority of the participants (89
per cent in both studies) treated both types of insurance the same – either they bought them both
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or they bought neither. Moreover, on average, in both studies the majority of participants treated
both types of insurance exactly the same – that is, they paid exactly the same amount of money
for both types of insurance. Of those who did not treat both types the same, the majority preferred monetary to pain-and-suffering insurance.
Ronen Avraham, “Putting a Price on Pain-and-Suffering Damages: A Critique of The Current
Approaches and a Preliminary Proposal for Change,” 100 Nw. L. Rev. 87 (2006).
In this study, Avraham attempts to explain and explore a number of proposals for pricing
pain and suffering. Then, he argues that all of these proposals are analytically problematic, and
undesirable as a matter of policy. Avraham adopts a theoretical approach to the pricing of pain
and suffering, which is to analyze it from a law and economics standpoint, which also incorporates a limited notion of global fairness. Also, Avraham proposes a system of age-adjusted multipliers would be assigned to plaintiffs’ medical costs in order to calculate the pain-and-suffering
component. The multipliers would be nonbonding, allowing the jury to fairly deviate when justice required. Avraham asserts that this system solves the problem of unpredictability and, at the
same time, approximates optimal deterrence, all at very low administrative costs. It combines the
advantages of efficiency and fairness by having a jury determine awards on a case-by-case basis,
without the high complexity of assessing pain-and-suffering losses present in other proposals.
Steven P. Croley and Jon D. Hanson, “The Nonpecuniary Costs of Accidents: Pain-andSuffering Damages in Tort Law,” 108 Harv. L. Rev. 1785 (1995).
In this article, Croley and Hanson challenge the now-dominant view that tort compensation
for pain and suffering is incompatible with consumers’ insurance preferences. First, they accept
the received theoretical framework foe considering consumer demand for nonpecuniary-loss insurance and then explain the ambiguous conclusion that framework yields. In addition, they offer
a more nuanced framework for understanding why consumers might very well demand insurance
against pain and suffering. Moreover, Croley and Hanson argue that their suggested framework
illuminates more clearly just what is at stake when a consumer contemplates such a purchase,
and it leads to the conclusion that consumers likely do demand some level of pain-and-suffering
insurance.
Also, Croley and Hanson show that the empirical evidence regarding actual consumer demand suggests that legal economists may have reached the wrong conclusion even within their
own well accepted theoretical framework. Then, they affirm that the evidence supports the conclusion that, although several significant impediments prevent the emergence of a robust market
for insurance against pain-and-suffering losses, consumers in fact do demand such insurance.
Thus, some amount of compensation for consumers’ pain and suffering serves tort law’s insurance goal of providing insurance that consumers demand against accidents. Moreover, to the extent that the tort system overcomes the impediments that prevent the emergence of a robust market for insurance against pain and suffering, tort law may be the only institution capable of satisfying consumer preferences. In conclusion, the tort system has several advantages that may render it a superior institution for providing nonpecuniary-loss insurance.
Neil Vidmar, “Empirical Evidence on the Deep Pockets Hypothesis: Jury Awards for Pain and
Suffering in Medical Malpractice Cases,” 43 Duke L. J. 217 (1993).
First, Vidmar affirms that the role of the jury in medical negligence cases ranks among the
most contentious issues in contemporary debate about the merits of the tort system. A common
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complaint from all sides of the political spectrum is that jurors are biased against doctors and
hospitals have the “deep pockets” to provide the compensation. Then, Vidmar reviews these
claims and critique a prior empirical research alleged to support them. In addition, she describes
a controlled experiment that tested the hypothesis that jurors are prone to award excessive
amounts for pain and suffering when the defendants are doctors or hospitals; and concludes that
neither the prior research nor the experiments results support the deep pockets hypothesis. Finally, Vidmar discusses these findings in the context of other research as well as the debate about
medical negligence and the tort system.
Mark Geistfeld, “Placing a Price on Pain and Suffering: A Method for Helping Juries Determine
Tort Damages for Nonmonetary Injuries,” 83 Cal. L. Rev. 773 (1995).
The absence of well-defined legal standards for assessing tort damages for nonmonetary injuries such as pain and suffering largely explains why jury awards for pain and suffering vary
widely for similar injuries. In response, many states have enacted legislative reforms that limit
pain-and-suffering awards. Meanwhile, many tort-reform advocates call for eliminating painand-suffering damages altogether. In this article, Geistfeld argues that pain-and-suffering awards
are desirable and proposes a method for calculating nonmonetary injuries that could be implemented without resort to radical reform measures. Geistfeld surveys and assesses the various
types of reforms that have been proposed to remedy the problems with the current system. And
also he shows that full compensation is desirable since eliminating or reducing nonmonetary
damage awards would create significant inefficiencies and inequities. Applying well-accepted
economic principles, Geistfeld suggests the juries assess damages from an ex ante perspective
that asks how much a reasonable person would have paid to eliminate the risk that caused the
pain-and-suffering injury. Then, he demonstrates that this methodology is appropriate for all tort
cases; that it would yield reasonably accurate results despite data limitations; and that it can and
should be implemented within the current system. For these reasons, the ex ante fullcompensation award is a dramatic improvement over the current approaches to calculating painand-suffering damages.
Eugene Kontorovich, “Comment: The Mitigation of Emotional Distress Damages,” 68 U. Chi. L.
Rev. 491 (2001).
In this comment, Eugene Kontorovich describes the contours of emotional distress liability
and then explains the mitigation doctrine and its goals of reducing the moral hazard. And also he
shows that courts have failed to apply mitigation to emotional distress, while applying it to all
other areas of tort liability. Then, Kontorovich finds that moral hazard exists in emotional distress liability, resulting in systematic overcompensation. However, the level of hazard varies
across the different contexts in which plaintiff recover for emotional distress.
Also, Kontorovich examines what emotional distress mitigation would look like. He rejects
the superficially appealing standard of psychotropic mitigation as being unlikely to satisfy the
joint-cost minimization criteria in a large number of cases. Then, he finds unsatisfactory an alternate paradigm, willpower mitigation, whereby plaintiffs must take reasonable efforts to exercise
self-control and discipline to reduce their emotional distress. Moreover, Kontorovich considers
ways courts can reduce the moral hazard inherent in emotional distress damages without a mitigation rule. He suggests limiting the availability of emotional distress damages to objectively
defined categories, and eliminating the subjective severity test used by some courts in the tort of
negligent infliction of emotional distress.
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Web Note 7.8 (p. 261)
In addition to the Kahneman, Sunstein, et al. piece cited in footnote 36 above, there has
been much additional interesting literature on the economics of punitive damages, including an important article by Polinsky and Shavell. We review that literature on our website.
The article that most caught our attention on punitive damages is A. Mitchell Polinsky &
Steven Shavell, “Punitive Damages: An Economic Analysis,” 111 Harv. L. Rev. 870 (1998).
Here’s the abstract of the article:
The imposition of punitive damages is one of the more controversial features of the
American legal system. Trial and appellate courts have struggled for many years to develop coherent principles for addressing the questions of when punitive damages should
be awarded, and at what level. In this Article, Professors Polinsky and Shavell use economic reasoning to provide a relatively simple set of principles for answering these questions, given the goals of deterrence and punishment. With respect to the deterrence objective, on which their Article focuses, they argue that punitive damages ordinarily should
be awarded if, and only if, an injurer has a significant chance of escaping liability for the
harm he caused. When this condition holds, punitive damages are needed to offset the deterrence-diluting effect of the chance of escaping liability. (They mention as well a deterrence rationale for punitive damages that does not rest on the possibility of escape from
liability – that punitive damages may be needed to deprive individuals of the socially illicit gains that they obtain from malicious acts.) Professors Polinsky and Shavell also discuss the tension between the implications of the deterrence objective and present punitive
damages law, including the law's emphasis on the reprehensibility of a defendant's conduct and on a defendant’s wealth. With respect to the punishment objective, Professors
Polinsky and Shavell stress that the imposition of punitive damages on corporations may
fail to serve its intended purpose (although the imposition of punitive damages on individual defendants accomplishes punishment in a straightforward manner). Punitive damages against corporations may be ineffective primarily because the payment of punitive
damages awards by corporations often does not lead to greater punishment of culpable
employees, but instead punishes the corporation's shareholders and customers.
We use their concept of the punitive multiple in the text as a means of establishing what the
level of punitive damages should be. This same concept figures in the economic analysis of punishment for committing crimes, as we shall see in Chapter 12.
Another article well worth studying on punitive damages is Catherine Sharkey, “The Exxon
Valdez Litigation marathon: A Window on Punitive Damages,” 7 U. St. Thomas L. Rev. 1
(2010). This is an article about the U.S. Supreme Court’s decision in Exxon Shipping Co. v.
Baker, 554 U.S. 471 (2008). That action stemmed from the 1989 Exxon Valdez oil spill of about
11 million gallons of crude oil in Prince William Sound, Alaska – until the Deepwater Horizon
spill of Summer, 2010, the largest oil spill and environmental disaster in U.S. experience. In the
original litigation between Baker and Exxon Shipping Co., an Alaskan jury awarded Baker $287
million in compensatory damages and $5 million in punitive damages (determined, the jury
thought, to be equal to one year’s profit at Exxon). Exxon appealed to the Ninth Circuit, and that
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court eventually reduced the punitive damages award to $2.5 million in 2006. Exxon then appealed to the U.S. Supreme Court, which, in a 5-3 vote, reduced the punitive damages to $500
million. Justice Souter held that the ratio of compensatory to punitive damages in admiralty cases, which this was, must be one-to-one. (The Court found that Exxon had paid a total of $507
million in compensatory damages to Baker, Alaska Natives, commercial fisherman, and all others harmed by the oil spill.)
See also Joni Hersch & W. Kip Viscusi, “Punitive Damages by the Numbers: Exxon Shipping
Co. v. Baker,” 18 Sup. Ct. Econ. Rev., 259 (2010). Here is the article’s abstract:
The U.S. Supreme Court decision in Exxon Shipping Co. v. Baker is a landmark that establishes
an upper bound ratio of punitive damages to compensatory damages of 1:1 for maritime cases,
with potential implications for other types of cases as well. This article critiques the Court's reliance on the median ratio of punitive to compensatory damages in samples of verdicts to set an
upper bound for punitive damages awards. Our critique of the approach draws on the properties
of statistical distributions and a new analysis of cases with punitive damages awards. The Court's
conclusion that a 1:1 ratio establishes a fair upper bound lacks a sound scientific basis.
Professor Sharkey in her University of St. Thomas Law Review article identifies two camps in
the scholarly literature on punitive damages. One group is very skeptical of punitive damages,
particularly of the manner in which juries reach a decision about the appropriate amount of punitive damages to award. She quotes Kahneman, Schkade, and Sunstein (Punitive Damages: How
Juries Decide (2002)): “A deep skepticism of the role of the jury, and its capacity to transform its
expression of moral outrage into a dollar value – characterized as ‘scaling without a modulus’ –
pervades criticisms of punitive damages.”
The other camp, which she calls the “defensive camp[,]” “claims that the withering attack on
the jury and punitive damages awards is all sound and fury – the rhetoric is belied by the underlying empirical evidence, which reveals a picture of relatively predictable, stable, not to mention,
rare, punitive damages awards, characterized by a steady relationship to the size of compensatory
damages.” She cites, as a leading proponent of this view, Professor Ted Eisenberg of the Cornell
Law School. See Eisenberg et al., “Variability in Punitive Damages: An Empirical Assessment
of the U.S. Supreme Court’s Decision in Exxon Shipping Co. v. Baker,” 166 J. Institutional &
Theoretical Econ. 5 (2010) (arguing that punitive damages are not unpredictable); Eisenberg &
Martin T. Wells, “The Significant Association Between Punitive and Compensatory Damages in
Blockbuster Cases: A Methodological Primer,” 3 J. Emp. Legal Stud. 175 (175 (2006); and Eisenberg et al., “Juries, Judges, and Punitive Damages: Empirical Analyses Using the Civil Justice Survey of State Courts 1992, 1996, and 2001 Data,” 3 J. Emp. Legal Stud. 263 (2006) (finding steady ratios of punitive damages to compensatory damages in jury and bench trials in thousands of cases).
Web Note 7.9 (p. 261)
The United States Supreme Court has handed down several important recent decisions on
the constitutionality of punitive damages. We describe these holdings and relate them to
the material of this section on our website.
We mention in the text that popular commentators and the public seem to be far more worried about punitive damages that is warranted. Punitive damages are rare, and “blockbuster”
damages awards – those that are either over $1 billion or are so disproportionate to the level of
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actual (compensatory) damages – are even rarer. One recent study found that fewer than two
percent of civil cases result in an award of punitive damages and that the median amount of those
damages is between $38,000 and $50,000. Those data would seem to make this a non-issue.
What seems to bother many is that there is no principled method by which to determine punitives. (This was part of what motivated Polinsky and Shavell to focus on the punitive-multiple
analysis described in the previous Web Note.) As a result, there is a great fear that once a jury or
other decision-maker decides to award punitive damages, prejudice, revenge, dislike, and other
inappropriate factors may become the basis for the determination.
The United States Supreme Court has taken up the challenge of trying to establish some principles for determining punitive damages. Their basis for doing so is a concern for “due process
of law,” as contained in the Fifth and Fourteenth Amendments to the United States Constitution.
In three recent cases the Court has established some constitutional guidelines for the award of
punitive damages. Please note, as you read the brief summaries of these cases, that the Court has
not relied at all on the economic literature on punitive damages. Rather, the Court seems to be
groping toward some intuitively acceptable means of putting a ceiling on the ratio between compensatory and punitive damages. You might discuss whether this seems to be a plausible means
of addressing this issues.
The first case in the modern trilogy dealing with punitives is BMW of America v. Gore, 517
U.S. 559 (1996). Dr. Gore purchased a BMW as “new” but discovered that it had been repainted
and, possibly, repaired before he had bought it. BMW revealed at trial that its policy was to sell
a car as “new” if it had damage that could be fixed to factory standards for less than three percent
of the car’s market cost. At trial an Alabama jury awarded Dr. Gore $4,000 in compensatory
damages (computed to be the reduction in the value of the car) and $4 million in punitive damages (subsequently reduced to $2 million by the Alabama Supreme Court).
The U.S. Supreme Court, in a majority opinion written by Justice Stevens, found the punitive
damages to be suspiciously high and, therefore, violative of the Fourteenth Amendment’s due
process clause. It established a three-prong guideline to guide lower courts regarding what level
of punitive damages the Court would find acceptable and remanded the case to Alabama for action not inconsistent with the opinion.
The Alabama Supreme Court ordered a new trial, unless Dr. Gore would remit all but
$50,000 of the punitive damages he had previously been awarded.
The second important case heard by the U.S. Supreme Court on punitive damages is State
Farm Mutual Insurance Co. v. Campbell, 538 U.S. 408 (2003). The facts and disposition of the
case are given in this syllabus from the Supreme Court’s opinion:
Although investigators and witnesses concluded that Curtis Campbell caused an accident in
which one person was killed and another permanently disabled, his insurer, petitioner State Farm
Mutual Automobile Insurance Company (State Farm), contested liability, declined to settle the
ensuing claims for the $50,000 policy limit, ignored its own investigators’ advice, and took the
case to trial, assuring Campbell and his wife that they had no liability for the accident, that State
Farm would represent their interests, and that they did not need separate counsel. In fact, a Utah
jury returned a judgment for over three times the policy limit, and State Farm refused to appeal.
The Utah Supreme Court denied Campbell’s own appeal, and State Farm paid the entire judgment. The Campbells then sued State Farm for bad faith, fraud, and intentional infliction of emotional distress. The trial court’s initial ruling granting State Farm summary judgment was reversed on appeal. On remand, the court denied State Farm’s motion to exclude evidence of dissimilar out-of-state conduct. In the first phase of a bifurcated trial, the jury found unreasonable
State Farm’s decision not to settle. Before the second phase, this Court refused, in BMW of North
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America, Inc. v. Gore [] to sustain a $2 million punitive damages award which accompanied a
$4,000 compensatory damages award. The trial court denied State Farm’s renewed motion to exclude dissimilar out-of-state conduct evidence. In the second phase, which addressed, inter alia,
compensatory and punitive damages, evidence was introduced that pertained to State Farm’s
business practices in numerous States but bore no relation to the type of claims underlying the
Campbells’ complaint. The jury awarded the Campbells $2.6 million in compensatory damages
and $145 million in punitive damages, which the trial court reduced to $1 million and $25 million
respectively. Applying Gore, the Utah Supreme Court reinstated the $145 million punitive damages award.
The Court held that a “punitive damages award of $145 million, where full compensatory
damages are $1 million, is excessive and violates the Due Process Clause of the Fourteenth
Amendment.” The Court also said “few awards exceeding a single-digit ration between punitive
and compensatory damages, to a significant degree, will satisfy due process” Campbell, 538 U.S.
at 425. (In BMW v. Gore, the Court suggested that it deemed “ratios in the 3:1 or 4:1 range as
reasonable,” Gore, 517 U.S. at 580-81.)
The third case is Philip Morris USA v. Williams, 549 U.S. 346 (2007). Here is a description
of the facts and of the central issue from the majority opinion of Justice Breyer:
The question we address today concerns a large state-court punitive damages award. We are
asked whether the Constitution’s Due Process Clause permits a jury to base that award in part upon its desire to punish the defendant for harming persons who are not before the court (e.g., victims whom the parties do not represent). We hold that such an award would amount to a taking of
“property” from the defendant without due process. …
This lawsuit arises out of the death of Jesse Williams, a heavy cigarette smoker. Respondent,
Williams’ widow, represents his estate in this state lawsuit for negligence and deceit against Philip Morris, the manufacturer of Marlboro, the brand that Williams favored. A jury found that Williams’ death was caused by smoking; that Williams smoked in significant part because he thought
it was safe to do so; and that Philip Morris knowingly and falsely led him to believe that this was
so. The jury ultimately found that Philip Morris was negligent (as was Williams) and that Philip
Morris had engaged in deceit. In respect to deceit, the claim at issue here, it awarded compensatory damages of about $821,000 (about $21,000 economic and $800,000 noneconomic) along with
$79.5 million in punitive damages.
The trial judge subsequently found the $79.5 million punitive damages award “excessive[.]”
… Both sides appealed. The Oregon Court of Appeals rejected Philip Morris’ arguments and restored the $79.5 million jury award. Subsequently, Philip Morris sought review in the Oregon
Supreme Court (which denied review) and then here. We remanded the case in light of State
Farm Mut. Automobile Ins. Co. v. Campbell []. The Oregon Court of Appeals adhered to its original views. And Philip Morris sought, and this time obtained, review in the Oregon Supreme
Court.
Philip Morris then made two arguments relevant here. First, it said that the trial court should
have accepted, but did not accept, a proposed “punitive damages” instruction that specified the jury could not seek to punish Philip Morris for injury to other persons not before the court. In particular, Philip Morris pointed out that the plaintiff ’s attorney had told the jury to “think about
how many other Jesse Williams in the last 40 years in the State of Oregon there have been. … In
Oregon, how many people do we see outside, driving home … smoking cigarettes? …
[C]igarettes … are going to kill ten [of every hundred]. [And] the market share of Marlboros [i.e.,
Philip Morris] is one-third [i.e., one of every three killed].” []. In light of this argument, Philip
Morris asked the trial court to tell the jury that “you may consider the extent of harm suffered by
others in determining what [the] reasonable relationship is” between any punitive award and “the
harm caused to Jesse Williams” by Philip Morris’ misconduct, “[but] you are not to punish the
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defendant for the impact of its alleged misconduct on other persons, who may bring lawsuits of
their own in which other juries can resolve their claims …” [] The judge rejected this proposal
and instead told the jury that “[p]unitive damages are awarded against a defendant to punish misconduct and to deter misconduct,” and “are not intended to compensate the plaintiff or anyone
else for damages caused by the defendant’s conduct.” Id., at 283a. In Philip Morris’ view, the result was a significant likelihood that a portion of the $79.5 million award represented punishment
for its having harmed others, a punishment that the Due Process Clause would here forbid.
Second, Philip Morris pointed to the roughly 100-to-1 ratio the $79.5 million punitive damages award bears to $821,000 in compensatory damages. …
The Oregon Supreme Court rejected these and other Philip Morris arguments. In particular, it
rejected Philip Morris’ claim that the Constitution prohibits a state jury “from using punitive
damages to punish a defendant for harm to nonparties.” [] And in light of Philip Morris’ reprehensible conduct, it found that the $79.5 million award was not “grossly excessive.” []
Philip Morris then sought certiorari. It asked us to consider, among other things, (1) its claim
that Oregon had unconstitutionally permitted it to be punished for harming nonparty victims; and
(2) whether Oregon had in effect disregarded “the constitutional requirement that punitive damages be reasonably related to the plaintiff’s harm.” [] We granted certiorari limited to these two
questions.
For reasons we shall set forth, we consider only the first of these questions. We vacate the
Oregon Supreme Court’s judgment, and we remand the case for further proceedings.
Be certain to look at the brief description of the most recent case in this area – Exxon Shipping Co. v. Baker – discussed in the previous Web Note.
There is some controversy about exactly what all this means. Many courts and commentators understand the Campbell decision to hold that a ratio of 10:1 or greater between compensatory and punitive damages is unconstitutional. That is not what the Court said (it said that ratios
that exceed single digits will excite special scrutiny), but this interpretation seems to command
widespread agreement.
Similarly, it is not exactly clear what the Williams court held. One widely held interpretation
is that the Court held that harms done by the wrongdoer to parties not before the court cannot be
used in calculating punitives for this defendant but can be used to determine the reprehensibility
of the defendant’s actions. In his dissent to the majority opinion, Justice Stevens wrote that the
subtlety of that distinction eluded him. We agree.
As you contemplate these cases, think about whether you could make an argument for basing
the constitutionally tolerable level of punitives on the concept of the punitive multiple.
Web Note 7.10 (p. 263)
A central issue for the economic analysis of tort law is the extent to which exposure to
tort liability induces parties to behave in an efficient manner. In the last few years there
has been an outpouring of scholarship designed to explore this matter with careful empirical studies. We review this literature on our website.
The point raised in the note is really at the heart of much of what law-and-economic analysis
is all about. As important as it is to get the theoretical and philosophical bases of law correct
(and that is very important), it is also extremely important to know what effects the law has on
the behavior that it seeks to affect. Tort law seeks to induce people to take care so as to minimize the social costs of accidents. The text has given an account of how that is supposed to hap23
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pen. But we have largely (not entirely) left open the question of whether the tort liability system
achieves our economic goal of minimizing the social costs of accidents.
There are some formidable problems in measuring the deterrence effect of tort liability. One
problem is that we are interested in knowing how many accidents did not occur. At best, we
have information on the number of accidents that did occur. How can we draw inferences about
the accidents that were avoided because of precaution? Second, and relatedly, there are some
accidents that occur but are less severe than they might otherwise have been, due to attempts to
avoid tort liability. Can we measure how much causal effect to attribute to tort liability in reducing not just the number but also the severity of accidents? Third, there are other policies and actions besides tort liability that may reduce the probability and severity of accidents. Safety regulation – such as that undertaken by the Occupational Health and Safety Administration, the Consumer Product Safety Commission, and the National Highway Transportation Safety Administration – may play a significant role in minimizing the social costs of accidents. And, of course,
private industry has an incentive to invest in better design, manufacturing, and warning in order
to reduce their own liability (and, thereby, to minimize the social costs of accidents). Technological innovations may be, in part, spurred by the tort liability system. Assuming that accident
losses have fallen over some time period, can we apportion responsibility for the reduction in
those losses among all these (and other) causes?
Given these daunting conceptual and measurement problems, it is surprising to report that
some empirical studies of the effects of the tort liability system have been made. In a superb article, (“Reality in the Economic Analysis of Tort Law: Does Tort Law Really Deter?,” 42 UCLA
L. Rev. 377 (1994)) the late Gary Schwartz sought to survey all the existing empirical studies to
see the extent to which they had reached a consensus about the effects of the tort liability system
in deterring accidental harms. He concluded that “tort law provides something significant by
way of deterrence.” For example, with respect to workplace injuries Schwartz reports on a study
that compared injuries on the job before and after the institution of workers’ compensation systems in the 1910s and reports that “workers’ compensation … reduces the workplace fatality rate
by about 33 percent.”
In a slightly later study, Donald Dewees, David Duff, and Michael Trebilcock, in Exploring
the Domain of Accident Law (1996), reached a similar conclusion. Theirs was a comprehensive
study of automobile, medical, product, environmental, and workplace injuries with a view to establishing the effectiveness of tort liability and administrative agency safety regulation at reducing injury in those areas. Here is how they summarize their findings:
[T]he empirical evidence has convinced us that a single instrument, the tort system, cannot successfully achieve all [] of the major goals claimed for it, and attempting to use it in pursuit of objectives for which it is not well suited is both costly and damaging to its ability to perform well
with respect to other goals that it is better able to realize. … Since the middle of [the 20th] century, no-fault compensation systems have been adopted in various jurisdictions to compensate
victims of automobile accidents, complementing regulatory systems for reducing risks to motorists. We endorse these moves and propose extensions of them with three caveats: compensation
schemes must be separately funded in each of the accident areas; premiums for compensation
schemes must be risk-rated to preserve deterrence incentives; and tort should not be entirely displaced, but should have a residual role in cases of egregious behavior causing serious harm.
However, we do not see these compensation schemes operating in the areas of product or environmental injuries.”
We allude to or mention explicitly some other empirical findings about the effects of the tort
liability system in other notes in this chapter (such as the following note about medical malprac24
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tice). You should be aware of two additional sources. First, the Center for Disease Control and
Prevention maintains a fascinating website with statistics about accidents:
http://www.cdc.gov/nchs/fastats/acc-inj.htm.
Second, you should periodically check the table of contents of the Journal of Empirical Legal Studies (at http://onlinelibrary.wiley.com/journal/10.1111/%28ISSN%291740-1461) to see if
there are new studies published there about the deterrence effects of the tort liability system.
Web Note 7.11 (p. 266)
Some prominent legal scholars have been using a remarkable data set from the State of
Texas to explore many issues in medical malpractice. We summarize their work on our
website.
We highly recommend the work of Bernie Black, David Hyman, Bill Sage, Charlie Silver,
and Kathryn Zeiler, who have been using a data set from Texas to throw light on medical malpractice issues. Two of their many articles, and the abstracts of those articles, follow:
“Physicians Insurance Limits and Medical Malpractice Payments: Evidence from Texas Closed
Claims, 1990 – 2003,” 37 J. Legal Stud. S9 (2008).
Physicians’ insuring practices influence their incentives to take care when treating patients, their
risk of making out-of-pocket payments in malpractice cases, and the adequacy of compensation
available to injured patients. Yet, these practices and their effects have rarely been studied. Using
Texas Department of Insurance data on 9,525 paid malpractice claims against physicians that
closed 1990-2003, we provide the first systematic evidence on levels of coverage purchased by
physicians with paid liability claims and how those levels affect out-of-pocket payments and patient compensation. We find that these physicians carried much less insurance than is conventionally believed, that their real primary limits declined steadily over time, that policy limits often act
as effective caps on recovery, and that personal contributions by physicians to close claims were
rare. Our findings call into question a number of common assumptions about the relationship between physician insuring practices and the medical malpractice liability system.
“The Effects of ‘Early Offers’ in Medical Malpractice Cases: Evidence from Texas,” 6 J. Emp.
Legal Stud. 723 (2009).
Medical malpractice litigation is costly and time consuming. Professor Jeffrey O’Connell, with
various co-authors, has long advocated “early offer” rules that would encourage defendants to offer to settle for economic damages plus attorney fees, and punish plaintiffs who refuse such offers. Using detailed closed claims data from Texas for 1988–2005, we simulate the effects of
these “early offers.” Under a base set of assumptions, early offers will sharply reduce payouts in
cases with small economic damages (under $100,000, all amounts in 1988 dollars); will moderately reduce payouts in currently tried cases with economic damages from $100,000–$200,000
and would normally increase payouts (and therefore will not be made) in tried (settled) cases with
economic damages over $200,000 ($100,000). Overall, we predict that early offers will be made
in 72 percent of all cases, and will result in a 16 percent (20 percent) decline in payouts in tried
(settled) cases. Almost all this effect comes from the sharp decline in payouts in cases with small
economic damages. Defense costs will drop by roughly 60 percent (20 percent) in currently tried
(settled) cases in which an early offer is made, and by about 13 percent overall. An early offer
program will have very different effects on different types of plaintiffs, with especially large payout reductions for elderly and deceased plaintiffs. An early offer program also overlaps substan25
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tially in its effects with a statutory cap on noneconomic damages (which 26 states already have).
Defendants in many of these states have already realized large reductions in payment of noneconomic damages; the additional reductions from an early offer program are modest and would often affect plaintiffs whose recoveries were already limited by damage caps. Our mixed results
contrast sharply with dramatic claims by O’Connell and co-authors, who predict 70 percent reductions in both payouts and defense costs. Their estimates reflect the compound effects of a series of unreasonable assumptions.
One of the most readable and comprehensive book-length treatments of these issues is Tom
Baker, The Medical Malpractice Myth (2005). Bake is the Here are the first four paragraphs of
that book:
Medical malpractice premiums are skyrocketing. ‘Closed’ signs are sprouting on health clinic
doors. Doctors are leaving the field of medicine, and those who remain are practicing in fear and
silence. Pregnant women cannot find obstetricians. Billions of dollars are wasted on defensive
medicine. And angry doctors are marching on state capitols across the country.
All this is because medical malpractice is exploding. Egged on by greedy lawyers, plaintiffs
sue at the drop of a hat. Juries award eye-popping sums to undeserving claimants, leaving doctors, hospitals, and insurance companies no choice but to pay huge ransoms for the release from
the clutches of the so-called ‘civil justice’ system. Medical malpractice litigation is a sick joke, a
roulette game rigged so that plaintiffs their lawyers’ numbers come up all too often, and doctors
and the honest people who pay in the end all lose.
This is the malpractice myth.
Built on a foundation of urban legend mixed with the occasional true story, supported by selective references to academic studies, and repeated so often that even the mythmakers forget the
exaggeration, half-truth, and outright misinformation employed in the service of the greater good,
the medical malpractice myth has filled doctors, patients, legislators, and voters with the kind of
fear that short circuits critical thinking.
Professor Baker goes on to summarize (on p. 3) five, accurate findings from the scholarly literature on medical malpractice:
First, we know [from various studies, like those reported above] that the real problem is medical
malpractice, not too much litigation. Most people do not sue, which means that victims – not
doctors, hospitals, or liability insurance companies – bear the lion’s share of the costs from medical malpractice.
Second, [from those same studies] we know that the real costs of medical malpractice have
little to do with litigation. The real costs of medical malpractice are the lost lives, extra medical
expenses, time out of work, and pain and suffering of tens of thousands of people every year, the
vast majority of whom do not sue. There is lots of talk about the heavy burden that ‘defensive
medicine’ imposes on health costs, but the research shows this is not true.
Third, we know that medical malpractice premiums are cyclical, and that it is not frivolous
litigation or runaway juries that drive that cycle. The sharp spikes in malpractice premiums in the
1970s, 1980s, and the early 2000s are the results of financial trends and competitive behavior in
the insurance industry, not sudden changes in the litigation environment.
Fourth, we know that ‘undeserving’ people sometimes bring medical malpractice claims because they do not know that the claims lack merit and because they cannot find out what happened to them (or their loved ones) without making a claim. Most undeserving claims disappear
before a trial; most trials end in a verdict for the doctor; doctors almost never pay claims out of
their own pockets; and hospitals and insurance companies refuse to pay claims unless there is
good evidence of malpractice. If a hospital or insurance company does settle a questionable
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claim to avoid a huge risk, there is a very large discount. This means that big payments to undeserving claimants are the very rare exception, not the rule.
Finally, we know that there is one sure thing – and only one thing – that the proposed remedies can be counted on to do. They can be counted on to distract attention long enough for the inevitable turn in the insurance cycle to take the edge off the doctors’ pain. That way, people can
keep ignoring the real, public health problem. Injured patients and their lawyers are the messengers here, not the cause of the medical malpractice problem.
We highly commend the entire book.
See also Tom Baker & Timothy D. Lytton, “Allowing Patients to Waive the Right to Sue for
Medical Malpractice: A Response to Thaler and Sunstein,” 104 Nw. U. L. Rev. 233 (2010). In
their book Nudge: Improving Decisions about Health, Wealth, and Happiness (2008) (which we
have recommended earlier), Thaler and Sunstein had advocated allowing patients to waive their
right to a medical malpractice action. Allowing that freedom between patient and doctor, they
argued, might reduce healthcare costs and would almost certainly improve the relationship between doctor and patient. Thaler and Sunstein view the right to sue for malpractice as an insurance policy for the patient. In the best of all worlds, this insurance policy would induce extra
precaution and prudence on the doctor’s part (see the next article for an estimate of how much
this may be worth). But Thaler and Sunstein believe that behavioral considerations push patients
to retain this insurance option even when it is not worth it to them – as would be the case if the
increase in costs that doctors incur to avoid medical malpractice liability is greater than the benefits that the extra precaution confers on the patient.
(Another way of looking at this point is to view the right to sue for medical malpractice as
the default option (which we discuss in the text in Chapter 8), and to consider the potentially
great difference between “opt out” and “opt in” regimes for medical malpractice. Because default options are “sticky,” people frequently remain with a default option even when they prefer
an alternative. The current system is an “opt out” regime – a patient has the right to sue for medical malpractice unless he waives it. Most people are not even aware of the fact that they might
opt out of this regime. Thaler and Sunstein might be understood to be advocating for simply telling patients that they can opt out. But why not go to the other end of the spectrum?: Make the
default rule that one does not have the right to sue for medical malpractice but can opt into that
system if one wants to do so. This is probably infeasible, but it is an interesting possibility for
discussion.)
Baker and Lytton argue that there are two things wrong with the Thaler-Sunstein proposal.
First, it is not clear that the medical malpractice system is broken (that is, that patients are enduring costs because of the hospitals’ and doctors’ fears of liability that exceed the benefits of the
increased healthcare; indeed, they believe that the benefits exceed the costs). Second, they are
not persuaded that the cognitive imperfections that Thaler and Sunstein cite as leading patients to
misperceive the benefits of having the right to sue for medical malpractice are, in fact, operative.
A recent article (Michelle M. Mellow, Amitabh Chandra, Atul A. Gawande, & David M.
Studdert, “National Costs of the Medical Liability System,” 29 Health Affairs, 1569 (2010),
gives a careful estimate of the cost of the medical malpractice system in the U.S.
The authors begin with what they call “the most widely cited academic paper on the topic[ of
defensive medicine costs]”: Daniel Kessler & Mark McClellan, “Do Doctors Practice Defensive
Medicine?,” 111 Q.J. Econ. 353 (1996).
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Kessler and McClellan examined the effect of tort reforms that directly reduce expected malpractice awards – such as caps on noneconomic damages – on Medicare hospital spending for acute
myocardial infarction and ischemic heart disease from 1984 to 1990. The reforms lowered hospital spending by 5.3 percent for myocardial infarction and 9.0 percent for heart diseases … Two
other studies could not replicate these findings for other health conditions. Consequently, national extrapolations from Kessler and McClellan’s estimates should be interpreted with considerable
caution. … In our analysis, we used a value of 5.4 percent of the effects of defensive medicine
on hospital spending, a conservative assumption that represents the lower of Kessler and McClellan’s original estimates and the midpoint between their latest estimates. National health spending
for 2008 was estimated to have been $2.3 trillion, of which $718.4 billion was hospital spending.
Our 5.4 percent estimate suggests that $38.8 billion of this spending could be reduced through direct tort reforms. (at 1573)
The authors note that this calculation may understate the extent of defensive medicine expenditures under two conditions: (1) if tort reform reduces only a portion of defensive medicine
expenditures (as would, no doubt, be the case), and (2) “if physicians perceive that elderly patients [and, recall that the Kessler-McClellan estimates were from a Medicare sample] are less
likely than other patients to sue or, if they sue, to recover large awards.” These concerns might
offset one another.
The authors further estimate that tort reform, in addition to lessening defensive medicine expenditures in hospitals, might further induce physicians individually to save an additional $6.8
billion.
So, the total estimated defensive medical expenditures for 2008 are $45.6 billion.
The following is their summary table of the national costs of the medical liability system:
Exhibit 1
Estimates of National Costs of the Medical Liability System
Component
Indemnity payments
Estimated Cost
(billions of 2008 dollars)
$5.72
Economic damages
$3.15
Noneconomic damages
$2.40
Punitive damages
$0.17
Administrative expenses
Plaintiff legal expenses
Defendant legal expenses
Other overhead expenses
Defensive medicine costs
Hospital services
Physician/clinical services
$4.13
$2.00
$1.09
$3.04
$45.59
$38.79
Quality of evidence supporting
cost estimate
Good as to the total; moderate
as to the precision of the split
among the components
Moderate
Good
Moderate
Good
Low
$6.80
Other costs
Lost clinical work time
$0.20
Moderate
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Price effects
Reputational/emotional harm
Total
Cooter & Ulen
--$55.64
Law
No evidence
The total expenditure -- $55.64 billion – is approximately 2.4 percent of total health care
spending.
In addition to the scholarly work that we have cited here, we very highly recommend the
work of Atul Gawande, who is a surgeon. Gawande writes extremely readable work on health
care and medicine in The New Yorker magazine. He has had several collections of those essays
published: Complications: A Surgeon’s Notes on an Imperfect Science (2003), Better: A Surgeon’s Notes on Performance (2008), and The Checklist Manifesto (2009).
Web Note 7.12 (p. 266)
Product liability might be triggered by a design defect, a manufacturing defect, or a failure to warn consumers (and intermediaries) of risk of harm. On our website we discuss
some economics of the duty to warn and some recent empirical evidence on the effectiveness of that duty.
Some beneficial products are inherently dangerous for everyone, such as dynamite and pesticides, and other products have dangerous side-effects for some users, such as heart medicines.
Even without being defective, an inherently dangerous product can cause injury. The law requires the manufacturer to warn users about the inherent dangers of products. Victims may try to
recover damages by alleging that a defective warning caused their injury.
In this section, we develop an economic theory of the duty to warn. The model of warnings
is basically the same as the model of precaution. Efficiency usually requires the injurer and victim to take precaution. In the simple model of precaution, a rule of no liability causes the injurer
to take too little precaution, a rule of strict liability causes the victim to take too little precaution,
and a rule of negligence causes the injurer and the victim to take efficient precaution. Similarly,
in a model of warnings, efficiency usually requires the manufacturer to issue an effective warning and the consumer to heed it. In a simple model of warnings, a rule of no liability causes the
manufacturer to issue a warning that is too weak, a rule of strict liability causes the consumer not
to heed the warning, and a rule of negligence causes the injurer to issue the efficient warning and
the victim to heed it. In this section, we will demonstrate these facts and then discuss briefly
some modern issues concerning warnings.
To keep the analysis simple, assume that each consumer either buys exactly one unit of the
product or does not buy any of it. Consumers differ according to their risk when using the product. In the first figure, the horizontal axis indicates the degree of risk associated with different
consumers. Moving from left to right in the figure, the amount of risk associated with a consumer increases. The “low risk” consumers on the left run little risk of an accident from using the
product, so the expected cost of harm is low for them. In contrast, the “high risk” consumers on
the right run a high risk of an accident from using the product, so the expected cost of harm is
high for them. Moving to the right in the figure, the expected cost of harm increases as we pass
from low risk to high risk consumers.
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We want to consider the social value of different consumers using the product. In addition to
risking harm, consumers enjoy the benefits of consumption. As we move from low risk to high
risk consumers in the figure, the benefits of consumption may increase or decrease. Finally, producers bear the costs of production. As we move from left to right in the figure 9, more goods
must be produced for more consumers. The costs of producing the additional goods may rise or
fall. For purposes of analysis, we have drawn a line in the figure depicting consumers’ benefit
minus the producers’ cost. As drawn, this curve rises more slowly than the other curve.
The intersection of the two curves, denoted n*, identifies consumer for whom the benefit
from consumption, minus the cost of production, equals the risk. n* identifies the riskiest consumer for whom consuming the product is efficient. Efficiency requires all consumers of lower
risk than n* to use the good, and efficiency requires all consumers of higher risk than n* not to
use the good.
To illustrate with numbers, assume that the expected benefit of relieving a severe headache
equals $100, the drug costs $70, and, with probability p, the drug causes nausea with a cost of
$50. Efficiency requires consuming the drug so long as the expected benefit exceeds the manufacturing cost minus the expected harm:
$100 > $70 + p$50
=>
p < .2.
Thus, efficiency requires the consumer to use the drug so long as the probability of it causing
nausea is less than .2, and consumers should not use the drug for whom the probability exceeds
.2.
We identified the efficient consumers of the good by examining the marginal cost functions
in the figure. Now we consider the incentives for consumers to buy the product and use it. Consumers make this decision by considering their private benefits and costs. The consumer enjoys
the benefit from consuming the good. The consumer also pays the market price of the good. In
addition, the consumer bears the expected harm. Finally, depending upon the law and facts, the
consumer may or may not receive damages as compensation for harm:
consumer’s = consumption - price - (probability)(harm) + damages
net benefit
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If the consumer’s net benefit is positive, the rational consumer will buy the good. If the consumer’s net benefit is negative, the rational consumer will not buy the good. If the consumer’s
net benefit equals zero, the consumer is marginal. The marginal consumer represents the tipping
point between users and nonusers.
To illustrate by the preceding example, assume the expected benefit of relieving a severe
headache equals $100, the price of the drug equals $70, and, with probability p, the drug causes
nausea with a cost of $50, for which the consumer receives compensatory damages D. The marginal consumer is determined by solving the following equation for p:
$100 = $70 + p($50-D).
The solution is easy when consumers receive no compensation for the harm that they suffer
(D=0). Substitute D=0 into the preceding equation and solve it to show that p=.2. Every consumer whose probability of harm falls below .2 buys the good, and every consumer whose probability of harm exceeds .2 does not buy it.
Recall that p =.2 is the also the cut-off for efficient consumption of the product. These facts
about efficient incentives generalize. A rule of no liability causes consumers to internalize the
benefits and costs of using the product. If consumers have accurate information, they will accurately compute risks. Consequently, a rule of no compensation and perfect information results in
efficient consumption of an inherently dangerous good by consumers. (In the long run, a rule of
no liability erodes the credibility of warnings, which is problematic when consumers have imperfect information. In order to establish credibility, firms will invest in creating brand names. We
cannot investigate the resulting equilibrium here.)
In contrast, consider a rule of strict manufacturer’s liability for the harm suffered by consumers, and assume that compensation is perfect. Perfect compensation externalizes the risk of harm
for consumers and gives them no incentive to heed warnings. Consequently, more risky consumers than n* will want to buy the product. Furthermore, the high cost of liability raises the
price at which manufacturers sell the product. In brief, strict liability with perfect compensation
results in demand for inherently dangerous goods by excessively risky consumers and an excessive price for the good.
Next, consider a rule of strict liability with imperfect compensation, by which we mean that
the harm suffered by the consumer exceeds the damages received as compensation. The consumer internalizes part of the cost of accidental harm and externalizes part of it. Consequently,
consumers respond to warnings but do not heed them as fully as under a rule of no liability. In
order to reduce his liability, the manufacturer has an incentive to issue warnings that are too
strong relative to the efficient warning. (More specific assumptions determine the equilibrium.
For a demonstration that a rule of strict liability with perfect compensation for harm, but no
compensation for litigation costs, will cause the manufacturer to issue too strong a warning, see
Cooter, “Defective Warnings, Remote Causes, and Bankruptcy: Comment on Schwartz,” 14 J. Legal
Stud. 727 (1985).)
Finally, consider the effect of a negligence rule, which imposes a legal standard for warnings
as depicted in the next figure. The horizontal axis in that figure indicates the strength of the manufacturer’s warning, from “strong” on the left to “weak” on the right. When warnings are effective, a weaker warning causes more risky consumers to buy the product. As more risky consumers buy the product, the cost of accidental harm increases. Thus the curve labeled “cost of acci-
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dental harm” slopes up in the figure. (The height of the curves in the figure indicate marginal
values and the area under the curve indicates total values.)
In Chapter 6, we used x~ to denote the legal standard. Under a negligence rule, a manufacturer who issues a weaker warning than the legal standard is liable for the accidental harm that an
legal warning would have averted. To illustrate, assume that the manufacturer issues the warning x^, as depicted in the figure. x~>x^ implies that the warning x^ falls short of the legal
standard, causing the accidents denoted B1+B2 that an efficient warning averts. Thus the manufacturer is liable under a negligence rule for the accidental harm corresponding to B1+B2.
The figure also depicts the manufacturer’s gross profit, by which we mean his profit before
paying any costs of liability. As the warning becomes weaker, the manufacturer sells more of the
good, so gross profits increase, and presumably, they increase at a decreasing rate. The curve
labeled “gross profits” in the figure depicts this fact. The height of the curve indicates gross
profits at the margin, which decrease, and the area under the curve indicates total gross profits,
which increase.
Net profit refers to gross profit minus the costs of liability. Under a negligence rule, when
the manufacturer’s actual warning x exceeds the legal standard x~, he is in the zone of “no liability.” In the zone of no liability, net profit equals gross profit. Under a negligence rule, there is
no liability until the warning crosses the threshold of inadequacy and becomes too weak.
As the manufacturer’s actual warning x becomes weaker, it eventually falls below the legal
standard x~, and he enters the zone of “liability.” In the zone of liability, he must compensate the
victims of injuries that an adequate warning would have averted. The manufacturer’s liability
costs jump sharply at the threshold, as depicted in the figure where the arrows point to the line
indicating the manufacturer's liability costs, which jump up at the legal standard x~. In the zone
of liability in the figure, the manufacturer’s net profits are found by subtracting the cost of accidental harm from gross profits. Net profits are negative at the margin in the zone of liability. The
profit-maximizing manufacturer will, consequently, conform to the legal standard, or slightly
exceed it in order to allow for a margin of error by courts.
To illustrate, assume that the manufacturer issues the warning x^, which is weaker than the legal
standard x~. The area labeled (B1+B2) indicates the accident costs that a legal warning would
have avoided. Thus the manufacturer must pay damages corresponding to the area (B1+B2).
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Clearly the manufacturer would increase net profits by issuing a stronger warning that conformed to the legal standard x~. In the second figure, the profit-maximizing firm chooses the
weakest warning at which its gross profits are at least as large as its liability. The gross profits
curve intersects the liability curve at its discontinuity; so, the profit-maximizing warning equals
the legal standard.
The jump in costs is so precipitous that the manufacturer will continue to conform to the legal standard, even if liability is imperfect in the sense that damages do not perfectly compensate
victims. In general, a negligence rule with an efficient legal standard causes manufacturers to
issue efficient warnings and consumers to heed them as required by efficiency. This is true even
if some benefits are externalized due to imperfect liability and imperfect compensation.
Like the model of precaution, the model of warnings begins with simple assumptions. Since
you already understand the model of precaution, you should be able to explain what happens
when the assumptions are relaxed in the model of warnings, as required to answer some of the
following questions.
Questions
1. Is there any difference between a negligence rule for warnings and strict liability for defective warnings, where a defect is defined as a warning that falls short of the legal standard?
2. How will manufacturers respond to errors in setting the legal standard for warnings under a
negligence rule?
3. If manufacturers escape legal liability in some instances because of imperfections in the legal
system, how will this fact affect the analysis of strict liability and negligence for warnings?
4. Strict liability provides a constant pressure towards accident-reducing innovation by manufacturers. In contrast, insofar as the manufacturer escapes liability by issuing an adequate
warning, he has little incentive to invest in innovations that would reduce accident costs.
Given these facts, what are the consequences of holding the manufacturer liable for failing to
warn about risks that were unknown at the time the warning was issued?
5. How would the high cost of litigation affect the analysis of strict liability and negligence as
applied to warnings?
Web Note 7.13 (p. 268)
In a recent article in the Harvard Law Review, Professors Polinsky and Shavell discuss
the “Uneasy Case for Product Liability.” We discuss that article and several comments on
it in this web note.
The three articles discussed in this note are A. Mitchell Polinsky & Steven Shavell, “The Uneasy Case for Product Liability,” 123 Harv. L. Rev. 1437 (2009); John C.P. Goldberg & Benjamin Zipursky, “The Easy Case for Products Liability Law: A Response to Polinsky and Shavell,”
123 Harv. L. Rev. 1919 (2009); and Polinsky & Shavell, “A Skeptical Attitude About Product
Liability Is Justified: A Response to Professors Goldberg and Zipursky,” 123 Harv. L. Rev. 1949
(2009).
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The American legal system takes it as almost a truism that product liability law is an invaluable way to protect consumers from potentially harmful products, compensate victims for their
injuries, and induce companies to manufacture safer goods. But is this really the case?
Using a good old-fashioned cost-benefit analysis, Professors A. Mitchell Polinsky and Steven
Shavell argue that in some industries at least, products liability law is at best redundant and at
worst harmful. They suggest that market forces, government regulations, and first-party insurance improve product safety and victim compensation without the significant costs imposed by
torts litigation.
They argue that the risk of adverse media coverage, which is certain to follow in the wake of
any major product safety incident, encourages firms take extra precautions to avoid this kind of
publicity. As an example, they cite Ford’s response to the media maelstrom surrounding the explosive fuel tanks on 1970s Pintos. The company carried out a voluntary product recall and replaced the fuel tanks before being required by law or court order to do so. Government regulation, so common in many industries, provides a similar nudge for firms to act before anyone actually gets hurt.
Polinsky and Shavell also note that first-party insurance compensates victims better than
products liability law anyway. Most home, car, health, and life insurance policies reimburse the
victim fully, minus deductibles. Products liability litigation, on the other hand, often diverts as
much money into the hands of lawyers and court costs as it distributes to injury victims.
The professors also refer to a number of empirical studies that show no increase in product
safety even as litigation-related costs have risen dramatically. They cite the example of a certain
vaccine, the cost of which has risen twenty-fold in recent decades due to extensive litigation.
During this time, there is no evidence that the vaccine has become less likely to cause harm to
the people receiving it.
Polinsky and Shavell thus argue that in industries that are well-covered by the media and
well-monitored by regulators, the costs of products liability law outweigh the benefits. They do
concede, however, that products liability law might improve product safety in industries that are
not as visible or widely-followed.
Like any good law and economics paper, this piece inspired a scathing response paper by
Professors John C. P. Goldberg and Benjamin C. Zipursky. The response focused on what it
perceives as an irrational confidence in market and regulatory incentives, and a willingness to
throw the baby out with the bathwater.
Goldberg and Zipursky doubt the market’s abilities to inspire product safety in most industries. They note that given the lengthy development phase of products such as vaccines, market
signals do not reach firms in time to actually influence design safety.
Another issue with which they take exception has to do with private first-party insurance.
Goldberg and Zipursky rightly point out that many people have no insurance at all, and those that
do have policies are often uninsured as to the accidents that do end up happening. Because most
insurance policies are not open-ended, they argue that the compensation for many uncovered accidents must fall to the courts.
In what is perhaps their most thought-provoking point, Goldberg and Zipursky suggest a
normative as well as a positive approach to products liability. They suggest that there is nothing
wrong with the moral sentiment, widely held in Western culture, that an injured party should
have direct redress against the party that injured him.
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Polinsky and Shavell, of course, felt the need to provide a retort to these criticisms. Although it is beyond the scope of this paper to re-hash every one of their arguments, suffice it to
say that these exchanges provide an interesting insight into the competitive world of academia.
Web Note 7.14 (p. 270)
The tragic events of September 11, 2001 gave rise to mass torts. See our website for a
discussion of the methods by which the federal government put together an administered
compensation package for those who lost relatives and others in the tragedy.
A “mass tort” arises when a very large number of people are injured by a single defendant or
in a single incident. The tort liability system can, in principle, efficiently deal with mass torts. It
can do so directly through a consolidation of lots of individual complaints against the alleged
wrongdoer – class action lawsuits, which we discuss in Chapters 10 and 11 – or indirectly
through encouraging settlement negotiations prompted by a desire to avoid the expenses of litigation. An alternative to using suit or settlement is an administered-compensation scheme.
These schemes can take several forms. One is a no-fault insurance system (such as those used in
twelve U.S. states for automobile accident injury compensation and have been used for nearly
100 years in all states for workplace injuries under the workers’ compensation systems). In a nofault system, an injured person is compensated for her injuries by her insurance provider without
any attempt to ascertain fault for the injuries.
Another form for an administered-compensation scheme is an ad hoc fund designed to get
compensation to victims of a mass tort. An ad hoc administered-compensation fund can be created by a governmental entity, as, for example, in the case of the Agent Orange compensation
scheme of the early and mid-1980s. Or the fund can be established by a private entity, either a
charitable group, as in the case of the Hokie Spirit Memorial Fund, or, possibly, the alleged injurer, as British Petroleum has done in the late Summer, 2010 – both of which we will describe
later.
There are multiple reasons to invoke an administered-compensation system for dealing with
mass torts. One reason that looms large is that the administrative costs of dealing with the claims
of many victims can be much less in an administered-compensation plan than they are in the tort
liability system. For example, while there are, as we shall see, administration-cost issues of determining eligibility for recovery and the level of appropriate compensation in both systems,
there are typically no issues of causation or fault in the administered-compensation plan. This
means that victims receive compensation much quicker and at much lower cost than if they had
to go through the tort liability system. Usually, in exchange for this greater speed and certainty
of recovery for victims, two tradeoffs occur: (1) victims may receive less per claim than they
would receive in a successful individual tort action, and (2) injurers are relieved of future liability for any other losses arising from the tortious event or events. An additional aspect that is
sometimes included to save administrative costs is that claimants may receive the same amount,
regardless of their actual losses, or there may be a relatively straightforward table of compensation for specific injuries (as, for example, is the case with regard to workers’ compensation,
wherein a claimant receives a certain, fixed amount for the loss of a finger, the loss of an arm,
and so on).
There has been very little written about the circumstances in which the government or private
entities ought to set up an administered-compensation system to replace (or supplement) the tort
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liability system. The considerations that would motivate a private injurer to prefer administeredcompensation to litigation are straightforward: the total amount that the injurer is likely to pay
out (in claims and in administrative costs) is likely to be less in an administered compensation
system. This, presumably, is the calculation that motivated BP to set up its administered compensation fund. In a similar vein, it is straightforward to see the appeal of no-fault insurance as
an alternative to tort liability. (See, for example, Jeffrey O’Connell & Christopher J Robinette, A
Recipe for Balanced Tort Reform: Early Offers with Swift Settlement (2008), and Randall R.
Bovbjerg & Frank A. Sloan,” No-Fault for Medical Injury: Theory and Evidence,” 67 U. Cin. L.
Rev. 53 (1998).) But there is no general theory, to our knowledge, of when a governmentfinanced compensation system is advisable. There have been only a few academic attempts to
write about these matters broadly, all with regard to the compensation fund set up by the federal
government after 9/11: see Peter Schuck, “Special Dispensation, “American Lawyer (June,
2004); Anthony J. Sebok, “What’s Law Got to Do With It?: Designing Compensation Schemes
in the Shadow of the Tort System,” 53 DePaul L. Rev. 501 (2003); and Gillian Hadfield, “Framing the Choice Between Cash and Courthouse: Experiences with the 9/11 Victim Compensation
Fund,” 42 Law & Society Rev. 645 (2008). There is more to be written on this topic.
You should also be aware that there are critics of these administered-compensation funds –
see, prominently, Owen M. Fiss, “Against Settlement,” 93 Yale L.J. 1073 (1984). Fiss argues
that there is something to be said for the public airing of litigation and against the secrecy of settlement, and that lawyers perform a valuable function in seeking justice for individuals who have
been harmed and against those who have done wrong.
Consider the administered-compensation system established in the wake of the tragic events
of September 11, 2001. That horror cost nearly 3,000 lives in New York City, Pennsylvania, and
Washington, DC, injured thousands more, destroyed millions of dollars in property, caused the
interruption of business, and traumatized the nation. This was not just a national tragedy; it was
also one of the worst mass torts in our history.
Shortly after the events of September 11, 2001, Congress began to do what it could to address some of the issues that the attacks raised. For example, there were fears that the airline industry – already working with thin profit margins because of vibrant competition – would be
driven into dire financial straits and possibly bankruptcy. By September 22 Congress had passed
the Air Transportation Safety and System Stabilization Act, designed to limit the airlines’ exposure to liability for what had happened. The Act did not abrogate any tort claims of victims or
their survivors; rather, it established a cap on all common law tort claims equal to the preexisting
insurance policy limits of the airline carriers and other possible defendants. (Several weeks later
Congress “extended the [Act] to limit suits against the City of New York, the Port Authority of
New York and New Jersey, the other airports, Boeing (who made the airplanes used in the attack), and the jet fuel manufactures (who sold the fuel to the airlines).” (From Sebok at 501.))
Addressing the financial viability of the airline industry was the Act’s principal business. As
an afterthought, Congress decided to include the September 11th Victim Compensation Fund
(VCF). The hurry with which this provision was added to the Stabilization Act meant that the
statute included broad outlines rather than detailed guidelines. Claimants against the VCF were
to be the spouses, domestic partners, families, and dependents of those who died, those who were
injured in the attack, and emergency responders who came to the aid of those in the World Trade
Center and Pentagon. The compensation was to be tax-free, but those who received compensation would have to file their claims by mid-December, 2003, and would have to agree to forego
any additional tort actions stemming from the incident.
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A Special Master (to be appointed by the Attorney General without any Congressional hearing or consent) would administer the VCF, and he or she was to have a great deal of discretion in
determining the details of the compensation. In November, 2001, the Attorney General, John
Ashcroft, appointed Kenneth R. Feinberg as Special Master for the Fund. Feinberg (see Terry
Carter, “The Master of Disasters: Is it just him, or is Kenneth Feinberg changing the course of
mass tort resolution?,” ABA Journal (January, 2011)) had extensive experience as a mediator and
arbitrator of mass tort awards. He had been appointed by Judge Weinstein in the early 1980s to
administer the Agent Orange settlement fund among Vietnam Veterans and had also been the
administrator of the “Hokie Spirit Memorial Fund, in which he parceled out a privately raised $8
million to families of the 32 people massacred and 17 injured at Virginia Tech in 2007 by a deranged gunman.”
The Stabilization Act established eligibility criteria for the VCF. Claimants had to opt in –
that is, they were presumed not to be a party to the Fund unless they filed forms. “The Fund administrator then had 120 days to reach a decision, and monies were to be distributed within 20
days of that final determination.” (See James Copland, “Tragic Solutions: The 9/11 Victim
Compensation Fund, Historical Antecedents, and Lessons for Tort Reform,” Manhattan Institute,
Center for Legal Policy Working Paper (January 13, 2005), available at http://www.manhattaninstitute.org/pdf/clpwp_01-13-05.pdf.)
Participation in the Fund was initially slow, probably because the terms on which compensation would be given were uncertain. “By August, 2003, only some 40 percent [of those] who
were eligible had submitted a claim to the Fund. By the end of 2003, however, 97 percent of the
2,976 individuals killed in the attacks had submitted a claim, leaving only 97 families outside the
Fund apparatus.” (Copland.)
The Stabilization Act laid out three parts that would form each individual award: (1) economic loss suffered by the survivors of someone who died or suffered physical injury – that is, the
present discounted value of the decedent’s lost lifetime income; (2) noneconomic loss – that is,
pain and suffering before death; and (3) the deduction of all collateral benefits – that is, any other benefits, such as life insurance proceeds, that the survivors received – from the amount awarded by the VCF.
Each of these elements of compensation presented complex and controversial issues. For example, because the statue expressly forbade an equal payment to each claimant and expressly
articulated economic loss, the administrators of the Fund would have to make an estimate of the
annual income of each of the decedents, including making projections forward to the end of each
decedent’s working life. This meant that claimants would receive potentially very different sums
of money, which would raise issues of equity. The survivors of a young stock broker who was
earning $3 million per year would receive vastly more than the survivors of an older, undocumented immigrant dishwasher who had been earning $20,000 per year. On the other hand, had
there been a series of individual claims against airlines and others by these disparate victims, the
tort liability system would have performed precisely this same calculation of economic loss, and
those calculations would have been perfectly natural and accepted. How could what is acceptable in a private tort action become unacceptable as part of an administered-compensation fund?
As he explains in What Is Life Worth?: The Unprecedented Effort to Compensate the Victims
of 9/11 (2005), a book that we very highly recommend, Feinberg used his discretion to minimize
the potentially very large administrative costs of establishing economic loss for the nearly 3,000
claims on behalf of survivors. For example, he set an upper limit on income of $231,000 (even
though he knew that there were some who earned far more than that). Why did he choose this
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figure? He adduced statistics to show that 98 percent of Americans earned $231,000 or less in
2001, and he asserted that earnings above that amount “tend to be speculative and uncertain.” In
the end, he claims that this rough rule saved a great deal of administrative overhead without doing much harm to the claimants: “Over 43 percent of all families filing a death claim with the
fund had income levels under $100,000; less than 7 percent claimed income over $1 million.”
(The Act did not specify a maximum total amount that the VCF could award; so, in theory, the
Fund could have made calculations of economic loss as generously as it chose to do. This fact
suggests that there were administrative cost and equitable reasons for setting the annual income
limit at $231,000.)
With regard to the second element of the compensatory awards, Feinberg decided to standardize the compensation for noneconomic loss – $250,000 for the pain and suffering of each victim and $50,000 for the emotional distress suffered by each surviving spouse, domestic partner,
and dependent. Ultimately he decided to raise the $50,000 payment to $100,000. In essence, the
$250,000 figure became the minimum amount that any claimant would receive from the VCF.
Feinberg writes that he used the $250,000 figure as a minimum “because of precedents in longestablished federal law governing death benefit payments to police officers and firefighters, as
well as subsidized life insurance payments made to survivors of the military personnel killed in
action.”
The third element of the compensatory awards – the offset of any collateral benefits – was,
perhaps, the most controversial of the Act’s guidelines. The Act instructed that VCF awards
should be reduced by the amounts of “life insurance, pension payments, workers’ compensation,
social security death and disability payments, public victim assistance, [and] any one-time death
benefit paid to surviving families by the victim’s employer. (For more details and analysis, see
Kenneth S. Abraham & Kyle D. Logue, “The Genie and the Bottle: Collateral Sources under the
September 11th Victim Compensation Fund, 53 DePaul L. Rev. 591 (2003).) Many victims’
families (and many commentators) were outraged by this provision. Many families reported that
they had received workers’ compensation payments for the death of their family members but
that the workers’ compensation insurers demanded reimbursement from any compensation that
the families received from the VCF (on the theory that those benefits would not be deducted by
the Fund). Feinberg decided not to offset these collateral benefits; to have done otherwise would
have disadvantaged those families that received workers’ compensation payments. Again exercising his broad discretion, he also decided that any charitable benefits received by survivors
were not to be deducted as collateral benefits.
There were considerable administrative issues facing the Fund. For example, there were foreign nationals among the victims of 9/11. So, the Fund had to find a way to notify the families in
foreign countries of their entitlement to compensation and to help them with the completion and
filing of the requisite forms. Another group that required special care were the survivors of undocumented immigrants. Many of those survivors were frightened about coming forward to file
a claim, fearful that the Immigration and Naturalization Service (INS) would use the occasion to
punish them. Feinberg had to work with the INS to give these survivors immunity against any
sanctions for their being undocumented. In fact, Feinberg saw to it that as part of the compensation, the INS gave the survivors green cards to allow them to be documented and to continue to
stay and work in the U.S.
The staff of the Fund was understandably worried about fraud among the claimants, but in
the end that proved to be a minor issue. Feinberg reports in What Is Life Worth? that the staff
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referred only 26 instances of fraud to the Department of Justice for investigation and that, of
those 26 instances, only six were prosecuted and convicted.
The staff of the VCF ultimately included 450 people. Nonetheless, administrative costs
amounted to 1.2 percent of the total funds disbursed.
“Payouts for death claims after collateral offsets ‘ranged from $250,000 to $7.1 million, with
a mean of $2.08 million.’ The Fund also compensated 2,677 individuals injured in the attacks,
with compensation ranging from $500 to $8.6 million. Total payouts from the Fund were approximately $6.9 billion.” (Copland.)
The Fund ceased operation on June 15, 2004. See Final Report of the Special Master for the
September 11th Victim Compensation Fund (December, 2004), available at
http://www.justice.gov/final_report.pdf, See also Lloyd Dixon & Rachel Kaganoff Stern, Compensation for Losses from the 9/11 Attacks (RAND Institute for Civil Justice, 2004), available at
www.rand.org/publication/MG/MG264/.
What lessons does Feinberg draw from his administration of the VCF? “I think it would be a
mistake for Congress or the public to take the 9/11 fund as a precedent for similar programs.
Despite its success, I would not use the fund as a model in the event of future attacks. … If the
9/11 fund is regarded as a model, why shouldn’t all of life’s misfortunes by subject to public
compensation?” This was one of the questions asked repeatedly when the VCF was established.
What about the victims of the U.S. Embassy bombing in Kenya, the victims of the domestic terrorist attack in Oklahoma City, the victims of the terrorist attack on the U.S.S. Cole, and so on?
Feinberg also suggests that in the future there be no attempt to distinguish among the claimants as was done with the VCF. “[I]f Congress decides to provide compensation in the event of a
new terrorist attack, all eligible claimants should receive the same amount.”
More recently, Feinberg has served as the “pay czar determining compensation levels for executives at more than 400 corporations receiving bailouts under the Troubled Asset Relief Program.” And more recently still he has been appointed to administer BP’s $20 billion Gulf-ofMexico compensation fund to deal with claims arising from the Summer, 2010, Deepwater Horizon oil rig disaster.
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