Commercial Liability Insurance Research Articles

The Cost of Duplicative Regulation: Evidence From Risk Retention Groups

AbstractA vast majority of insurers are regulated by each state in which they conduct business; however, a small subset of specialized firms, risk retention groups (RRGs), are largely exempt from most aspects of duplicative regulation no matter how many states they operate. This article analyzes the differences between RRGs and standard insurers specializing in commercial liability insurance to determine the cost of duplicative regulation. The costs associated with multi‐state regulation are significantly higher than those for single‐entity regulation. These high regulatory compliance costs reduce the technical efficiency of firms, deter firms from operating in additional states, and increase the price of insurance.

The Cost of Duplicative Regulation: Evidence from Risk Retention Groups

A vast majority of insurers are regulated by each state in which they conduct business; however, a small subset of specialized firms, risk retention groups (RRGs), are largely exempt from most aspects of duplicative regulation no matter how many states they operate. This article analyzes the differences between RRGs and standard insurers specializing in commercial liability insurance to determine the cost of duplicative regulation. The costs associated with multi‐state regulation are significantly higher than those for single‐entity regulation. These high regulatory compliance costs reduce the technical efficiency of firms, deter firms from operating in additional states, and increase the price of insurance.

Medical Malpractice and the Chest Physician

The US malpractice system is based on tort law, which holds physicians responsible for not harming patients intentionally or through negligence. Malpractice claims are brought against physicians from most medical disciplines in proportion to their numbers in practice and to the frequency with which they perform procedures. Claims against chest physicians most commonly allege injuries caused by the following: (1) errors in diagnosis, (2) improper performance of procedures, (3) failure to supervise or monitor care, (4) medication errors, and (5) failure to recognize the complications of treatment. Most of these injuries occur in hospitals, and many of the injured patients die. The social goals of the medical malpractice system include the following: (1) compensating patients injured through negligence, (2) exacting corrective justice, and (3) deterring unsafe practices by creating an economic incentive to take greater precautions. Some patients injured through negligence are compensated, but most are not. Claims are brought against some negligent physicians but also some who are not negligent, and being negligent does not guarantee that a claim will be brought. The deterrent effect of medical malpractice is unproven, and the malpractice system may prompt defensive medicine and increase health-care costs. And by stressing individual accountability, it conflicts with a systems-oriented approach to reducing medical errors.

Tort Liability Litigation Costs for Commercial Claims

This article analyzes tort liability litigation costs using the Texas Department of Insurance Commercial Liability Insurance Closed Claim database for the years 1988?2004. Insurer costs to defend claims in which a suit was filed average $35,000 per claim in 2004$, which corresponds to a share of 0.18 of total expenditures. Claims with higher stakes and complexity lead to greater reliance on outside counsel and less reliance on in-house counsel. Total transactions costs for each dollar received by claimants average $0.75 for all claims and $0.83 for claims in which the claimant retained an attorney and a suit was filed.

Tort Liability Litigation Costs for Commercial Claims

This paper analyzes tort liability litigation costs using the Texas Department of Insurance Commercial Liability Insurance Closed Claim database for the years 1988-2004. Insurer costs to defend claims in which a suit was filed average $35,000 per claim in 2004$, which corresponds to a share of 0.18 of total expenditures. Claims with higher stakes and complexity lead to greater reliance on outside counsel and less reliance on in-house counsel. Total transactions costs for each dollar received by claimants average $0.75 for all claims and $0.83 for claims in which the claimant retained an attorney and a suit was filed.

Tort Liability, Insurance Rates, and the Insurance Cycle

Markets for many types of property and casualty insurance exhibit soft-market periods, where premium rates are stable or falling and coverage is readily available, and subsequent hard-market periods, where premium rates and insurers' reported profits significantly increase and less coverage is available. Conventional wisdom among practitioners and other observers is that soft and hard markets occur in a regular "underwriting cycle." Like price fluctuations in equity markets, fluctuations in insurance premium rates and coverage availability are difficult to explain fully by standard economic models that assume rational agents and few market frictions. The mid-1980s "liability insurance crisis" remains the most infamous hard market in the United States. The dramatic increases in commercial liability insurance premiums and reductions in coverage availability for some sectors received enormous attention, motivating extensive research on those specific problems and on fluctuations in insurance prices and coverage availability more generally. Large losses from natural catastrophes in the United States during the late 1980s and early 1990s spurred further interest in and research on the dynamics of pricing in reinsurance and primary insurance markets following large, industry-wide losses. The hard market for commercial property and casualty insurance that began in late 2000 and accelerated following the destruction of the World Trade Center in September 2001 focused renewed attention on markets for commercial [End Page 97] property, medical liability, general liability, and workers' compensation insurance. With respect to general liability and medical liability insurance, substantial debate has arisen concerning the causes of increases in rates and reductions in coverage availability and the attendant implications for policy, such as tort reform, to reduce the expected value and uncertain costs of liability insurance claims or additional regulation of insurers to control allegedly imprudent underwriting and investment. This paper provides an overview of volatility in premiums, coverage availability, and insurers' reported profits in U.S. commercial general liability insurance and examines its broad relation to the U.S. tort liability system.1 I begin with a synopsis of the perfect markets model of insurance prices (sometimes called the arbitrage model) and its implications for commercial liability insurance. I next describe fluctuations in U.S. general liability insurance premiums, coverage availability, and reported profits during the past two decades and examine whether the perfect markets model is consistent with that evidence. I then summarize other factors that may affect insurance market volatility and provide new evidence concerning one alternative: that aberrant pricing by some firms aggravates soft markets and, by implication, the severity of subsequent hard markets. I conclude with a brief summary of policy implications and areas for future research. Competitive Insurance Premiums with Frictionless Capital Markets With rational insurers and policyholders, competitive insurance markets, and frictionless capital markets, insurance premiums will equal the risk-adjusted discounted value of expected cash outflows for claims, sales expenses, income taxes, and any other costs, including the tax and agency costs of capital. The levels and changes in premium rates will coincide with the levels and changes in discounted expected costs. Because the timing of payouts for claims incurred in a given year, nonclaim expenses, and capital costs should be comparatively stable over time, rate changes will primarily reflect changes in expected (forecast) claim and claim settlement costs and changes in interest rates. [End Page 98] In this perfect markets framework, long-run levels and short-run changes in premium rates for general liability insurance will reflect levels and changes in the following: Expected claim costs (incurred losses) and claim settlement costs, The timing of future claim payments for incurred losses, Interest rates used to discount expected future claim and claim settlement costs, Underwriting expenses (commissions, wages to underwriters, policy issue costs, premium taxes, and so on), Uncertainty about the frequency and severity of claims, including uncertainty about the form and parameters of the relevant probability distributions, which in turn affects the amount of capital that insurers need to hold to protect themselves against...

The Rise and Fall of Commercial Liability Insurance

The Rise and Fall of Commercial Liability Insurance

Great (And Not so Great) Expectations: An Endogenous Economic Explication of Insurance Cycles and Liability Crises

ABSTRACT The causes of insurance cycles and liability crises have been vigorously sought, claimed, and debated by academic investigators for years. The model provided here partially synthesizes several stands of this literature and provides an additional cause. In addition to causes such as the loss-shocks and interest-rate changes included as explanations in the literature, this model posits changing expectations about the parameters of corporate net income as causes of cycles and crises. Since both sides of the market form expectations about losses and interest rates, changes in both demand and supply in the market are incorporated in the explanation. Changing expectations during the crisis reduced supply and made it more inelastic. The same changing expectations increased demand and made it more inelastic and so amplified the effect due to a change in supply. The model predicts an increase in the equilibrium premium, when the mean and variance of losses increase. The model also predicts an increase in the equilibri um premium when the mean interest rate decreases and variance increases. The empirical results of cross-sectional regression and time-series analyses are consistent with the predictions. The analysis then provides some insight on how to dampen future cycles and reduce the effect of future liability crises. INTRODUCTION Insurance cycles [2] have been recognized for decades and have been the object of study by academic investigators for that long (see Cummins, 1987). The reason for this intense study is both basic (theoretical) and practical. At a basic level, questions arise about whether such cycles conflict with rational corporate decision making in an efficient financial market. From a practical perspective, such cycles can, at their extreme-most valleys, create crises in affordability and availability of insurance, affecting the very productivity of the country involved. The liability insurance crisis in the United States from late 1984 through 1986 is an example of such an extreme in the insurance cycle, being characterized by significant economic disruptions in commercial liability insurance markets. The disruptions created concerns about both the availability and affordability of certain covers. For example, professional and commercial liability insurance consumers were adversely affected by the crisis, as were others such as chemical and pharmaceutical companies, day-care centers, doctors, and municipalities. The cycle ultimately resulting in the crisis was characterized by a sudden increase in liability premiums in late 1984 after about six years of relatively stable prices. An additional response to changes in this cycle included the lowering of policy limits and a reduction in scope of coverage in commercial liability lines that were characterized by long-tails. In addition, insurers were unwilling to provide any coverage at all for some risks, e.g., those involving pollution liability exposures. [3] Academics, attorneys general, consumers, insurers, and regulators have not agreed on the causes of insurance cycles, and the causes of the commercial liability insurance crisis of the late 1980s are still debated. The cycles and crisis theories that do appear in the literature share at least two common characteristics. First, the theories focus on the supply of liability insurance and ignore the demand. Although it is implicit in some theories, the demand for liability insurance during the cycles and crisis is generally not addressed. Second, the theories emphasize a single factor as the cause of the crisis or cycle, although exactly what the single factor is has varied from explanation to explanation. This shared single-factor approach to insurance cycle and crisis explications creates problems. First, the single-factor theories do not explain enough aspects of the crisis, even though each offers some insight. For example, the U. S. Justice Department (Justice, 1986) has cited the expansion of business liability under tort law as the factor explaining higher premiums and reduced coverage limits. …

Principles of Risk Management and Insurance

PART ONE: BASIC CONCEPTS IN RISKMANAGEMENT AND INSURANCE Chapter 1. Risk in Our Society Chapter 2. Insurance and Risk Chapter 3. Introduction to Risk Management Chapter 4. Advanced Topics in Risk Management PART TWO: THE PRIVATE INSURANCE INDUSTRY Chapter 5. Types of Insurers and Marketing Systems Chapter 6. Insurance Company Operations Chapter 7. Financial Operations of Insurers Chapter 8. Government Regulation of Insurance PART THREE: LEGAL PRINCIPLES IN RISK AND INSURANCE Chapter 9. Fundamental Legal Principles Chapter 10. Analysis of Insurance Contracts PART FOUR: LIFE AND HEALTH RISKS Chapter 11. Life Insurance Chapter 12. Life Insurance Contractual Provisions Chapter 13. Buying Life Insurance Chapter 14. Annuities and Individual Retirement Accounts Chapter 15. Individual Health Insurance Coverages Chapter 16. Employee Benefits: Group Life and Health Insurance Chapter 17. Employee Benefits: Retirement Plans Chapter 18. Social Insurance PART FIVE: PERSONAL PROPERTY AND LIABILITY RISKS Chapter 19. The Liability Risk Chapter 20. Homeowners Insurance, Section I Chapter 21. Homeowners Insurance, Section Ii Chapter 22. Auto Insurance Chapter 23. Auto Insurance and Society Chapter 24. Other Property and Liability Insurance Coverages PART SIX: COMMERCIAL PROPERTY AND LIABILITY RISKS Chapter 25. Commercial Property Insurance Chapter 26. Commercial Liability Insurance Chapter 27. Crime Insurance and Surety Bonds

An Empirical Analysis of the Effects of Product Liability Laws on Underwriting Risk

An Empirical Analysis of the Effects of Product Liability Laws on Underwriting Risk Abstract This article investigates the relationship between the civil justice system and the performance of the commercial liability insurance industry. It uses loss ratio data to examine whether a state's tort doctrines affect the relative prices of liability insurance and underwriting risk in that state. The empirical results suggest that tort doctrines can have an adverse effect on systematic underwriting risk and mean loss ratios. Problems concerning the affordability and availability of commercial liability insurance continue to be of considerable concern. On the one hand, spokesmen for the insurance industry and various manufacturering associations assert that the root of these problems lies in the civil justice system. Legal factors such as the expansion of liability and large awards for non-economic damages have led to serious problems in the provision of insurance.(1) On the other hand, consumer advocacy groups claim that these problems are caused by the non-competitive ratemaking practices of the insurance industry. According to this view, the insurance crisis of the mid 1980's was manufactured by the industry as a response to a fall in the rate of return that insurers receive on their investments, and their solution would be to impose further regulation on the industry. The purpose of this article is to investigate this issue by examining the effects of tort law on the performance of commercial liability insurers. Strict products liability is the prevailing tort doctrine for most of the United States. According to this doctrine, manufacturers are liable for all harms that are proximately caused by defective products, regardless of negligence on their part. This does not mean, however, that manufacturers are liable for all harms caused by their products. In theory, the doctrine of strict liability limits manufacturers' liability to harms caused by defective products, and then only when it is the case that the harm is proximately caused by a defect rather than by consumer misuse or voluntary assumption of risk. In practice, however, these theoretical limitations are often unclear and unpredictable.(2) Under a doctrine of absolute liability suppliers would be liable for all accident losses that resulted from the use of their products. Thus, the difference between strict and absolute liability is that the former places limitations on suppliers' obligations and duties to consumers. When the modern doctrine of strict liability fails, in practice, to place feasible and consistent limits on the size and scope of manufacturers' liability, it tends toward a standard of absolute liability which creates serious legal hazards for the provision of insurance. Under the doctrine of strict liability a supplier must offer an implicit warranty that the product is safe and free from defect. Strict products liability may be thought of as a type of mandatory accident insurance because it requires that manufacturers indemnify the users of their products against any harms that are the result of latent defects. Whether manufacturers self insure or purchase products liability insurance, placing limitations on the extent of their liability is necessary in order to facilitate the process of making actuarially sound estimates of expected losses. Without these limitations insurers will find it increasingly difficult to predict what harms suppliers will be liable for, and how large the damages will be. Thus as tort standards tend toward absolute liability, it becomes increasingly difficult for the insurance industry to assess risks and establish appropriate premiums. This article uses loss-ratio data by state and insurer group to assess empirically the manner in which liability doctrines affect both relative prices and underwriting risk faced by commercial liability insurers. …

Punitive Damages: Punishment or Further Compensation?

The purpose of this paper is to provide evidence about court practice in awarding punitive damages. Of the four prominent theories of punitive damages, the validity of the Punishment-Deterrence Theory and Compensation Theory were determined to be quantifiable for testing. Regression analysis is employed to relate the size of punitive damages to measures of financial punishment, compensation, punitive damages insurability, degree of malice, and type of liability claimed. The analysis was applied to several samples of cases in which punitive damages were assessed against corporations. Support for the Compensation Theory is evident in all of the samples. Support for the Punishment-Deterrence Theory is evident in a precisely-defined sample. These results indicate that the size of the punitive damages award is substantially determined by the compensatory award given the plaintiff and to a lesser degree by the financial status of the defendant. Liability issues have received extensive attention recently due in large part to the unavailability of affordably-priced commercial liability insurance. One aspect of that attention has been proposals to limit punitive damages. Although the desirability and appropriate application of punitive damages has long been an item of debate,' these proposals seem to be the first significant attempt at the legislative level to limit the scope of punitive damages awards. Much of the debate about these legislative actions has been anecdotal. In this paper an attempt is made to provide some empirical evidence of the practice of awarding punitive damages. Development of such evidence should help assess the impact of proposed and recently enacted laws related to punitive damages.

Captive Insurance Companies and the Management of Environmental Risks

Recent publicity has focused on the crisis in the market for commercial liability insurance. Industries and professionals concerned with air pollution are among those facing an acute shortage of insurance coverage. Captive insurance companies are gaining popularity as a means of securing comprehensive pollution liability coverage. Captives are separate corporations established by companies with similar risk management problems to write policies covering pollution emissions. Federal tax law requires that captives be set up properly, with transfer and distribution of risk, before premiums paid by the member companies are deductible. Financial responsibility requirements of the EPA are being redesigned, and may be favorable to the use of captives. Six states and several off-shore countries have statutes allowing captive insurance companies. Attention to practical details can lead to success in using captives to secure business advantages as well as protection from the risk of environmental impairment. Several of such considerations are discussed in light of the tax, environmental, and state regulatory issues relevant to the question, with an eye toward giving practical legal advice for structuring captives.

Product safety for a monopolist under strict liability

This paper views strict producer liability as essentially requiring the producer to provide a tie-in sale of full coverage insurance to its customers. The output and safety levels under strict producer liability are compared to those that would exist when the consumer retains all liability. The risk averseness of the producer and the availability of commercial liability coverage are shown to affect the producer's output and safety decision. In general, a shift from consumer to producer liability might not encourage the production of safer products, either with or without the availability of commercial liability insurance to the producer.