Insurance Market Responses to the 1980s Liability Reforms: An Analysis of Firm-Level Data

Abstract

Introduction One of the most salient policy events in recent U.S. insurance market history is the liability insurance of the mid-1980s. Premiums soared, and there was widespread anecdotal evidence of major insurance market disruptions. General liability and medical malpractice insurance were particularly affected by this surge in liability costs. During the period, insurers reported policy losses well in excess of premiums. Insureds also began to experience substantial disruption, as cases of denials of insurance coverage to entities such as municipal playgrounds were highly publicized. Coney Island temporarily discontinued the Cyclone ride because of insurance market difficulties, motels removed diving boards from swimming pools, and research on new contraceptive products in the United States was all but eliminated (see National Academy of Sciences, 1990, for a discussion of the effect of liability on contraceptive product research). The two-year period between 1984 and 1986 saw a concentrated surge in general liability premiums, which increased almost threefold. By almost any standard, the effect on insurance market operations merited the crisis designation. Although the rise in interest rates and possible performance of reinsurance markets no doubt were instrumental,(1) this also stemmed in part from long-run shifts in ton liability, which, in turn, were reflected in premiums. Over the 1958 through 1968 period, general liability premiums rose by 6.5 percent per year. Over the next decade, from 1969 through 1978, premiums increased by 19.1 percent annually; from 1979 through 1988, premiums increased by 11.4 percent annually. The liability was not confined to the 1980s, as the major surge in liability costs began in the 1970s. What distinguished the 1980s was the highly concentrated increase in general liability premiums during a two-year period (1985-1986). The coupling of the price signals of escalating costs with anecdotes pertaining to quantity rationing suggested that the insurance market was in disarray. One factor contributing to the rise in liability premiums was an expansion in the scope of tort liability (see, among others, Viscusi, 1991a, 1991b; Epstein, 1980; Priest, 1985, 1987; Schwartz, 1988; Stewart, 1987; and Winter, 1988). A variety of changes in liability doctrine contributed to the surge. In the 1960s, the courts expanded the range of circumstances under which firms could be held liable for accidents by introducing the strict liability doctrine. Strict liability broadened the circumstances under which defendants would be liable. The 1970s witnessed a rise in design defect and hazard warnings cases. At the end of the 1970s and in the 1980s, toxic tort litigation such as that over asbestos became a major player. Indeed, by the end of the 1980s, the majority of all cases in U.S. federal courts were asbestos-related. Because of the expanded liability doctrine and the surge in premium costs, insurers and insured firms sought relief through product liability reform. These sought to decrease the costs arising from tort liability. In this article we will not question the wisdom of these or explore their social desirability. Reform efforts decrease the costs of liability to insurers and policyholders, but they also decrease the amount of damage payments to parties who are injured. Judgments regarding the attractiveness of the depend in large part on the optimality of the provisions of tort liability subject to reform. For example, the earlier tort liability regime may have been inadequate so that an expansion in liability was desirable. The fact that costs surged does not imply that the earlier low-cost liability regime was socially desirable. Similarly, not all policy reforms that decrease costs are necessarily desirable. However, disruption in insurance markets and market conditions that lead to the denial of insurance coverage necessarily creates some inefficiencies. …