Tort reform and the theory of coordinating tort and insurance

Abstract

An important ingredient of tort reform is the substitution of the traditional – in Common Law – Collateral Source Rule for a system of deducting insurance payments from the tort award. In the paper we offer a comprehensive analysis of the effects of the mechanisms to coordinate tort and insurance payments on the three essential decisions involved, namely precaution, risk coverage and litigation. We undertake the analysis for the Collateral Source Rule (cumulation), benefits offset (deduction), and subrogation of insurer. In the presence of a liability system, the problem of coordination makes sense only in a world in which liability rules do not operate perfectly. Under an imperfect strict liability regime, we show that solely subrogation can induce optimal incentives for risk coverage. In addition, collateral offset dilutes injurer's incentives to take care as compared to the other two regimes. Under an imperfect negligence regime, incentives to buy coverage under the collateral source rule are lower. Under collateral benefits offset, the victim may prefer to ignore tort payments entirely, buying full insurance and leaving the injurer with no incentives for precaution. The paper also discusses the litigation decision and the apparently strong advantage in terms of administrative costs of the collateral offset rule over subrogation, and points out several factors that might undermine this presumed advantage.