Puzzle 1: How Inefficient is Tort Law?

Does the tort system generate significantly greater administrative cost than comparable first-party insurance, such as health insurance and workers' compensation? It is commonly thought so. In their 1987 book, Landes and Posner called the tort system “an exceedingly costly insurance mechanism.” Others have made the same criticism, noting that tort awards are much greater than amounts paid under comparable first-party insurance policies. 

There are two issues here. The "high costs" of the tort system, relative to first-party insurance, could be due to (i) its greater administrative cost or (ii) its broader coverage (or both). It is well known that tort law offers broader coverage than market insurance. Most notably, it compensates noneconomic harms, such as the pain and suffering arising from an accident. This undoubtedly raises the cost of the tort system relative to first-party insurance. But it’s a separate question whether tort law generates greater administrative expense, per dollar of compensation paid, relative to first-party insurance. Although it is widely believed that the tort system is administratively inefficient, what data support this claim?

The ideal dataset would permit a comparison of (i) claims brought under the tort system and (ii) identical claims brought under first-party insurance. By identical, I mean claims for the same kinds of injuries—economic (medical bills) as well as noneconomic (pain and suffering). The empirical difficulty here is obvious: generally, first-party insurance does not cover noneconomic harms. There is, however, an exception to this rule: most, if not all, states require their auto insurance carriers to offer uninsured motorist (UM) policies that cover both economic and noneconomic harms. These policies protect a policyholder when she is injured, in an auto accident, by a negligent uninsured motorist. Instead of bringing suit against the injurer, who generally can pay nothing, the policyholder brings a claim against her own insurance company under the UM policy. This policy provides the same compensation that she would have recovered, under tort law, if the injurer had not been judgment-proof.

Contrast this with the process when the victim of an auto accident is injured by an insured motorist. Here, the victim will file a tort claim, which will be processed, litigated, and (if necessary) paid by the injurer's insurance company. The victim's claim can be divided into two parts: claims for bodily harm and noneconomic injury (BI) and claims for property damage (PD).

Thus, one way to assess the administrative efficiency of the tort system, at least in the automotive context, is to compare (a) BI claims to (b) comparable UM claims. BI claims are tort claims; UM claims are first-party claims. Do BI claims generate greater administrative cost than UM claims?

Of course, a difficult question remains: how do we measure administrative cost? I'm working on that, but one proxy is the proportion of claims in which the claimant was represented by an attorney. My hypothesis is that the cost of processing a claim rises when attorneys are involved. Is attorney involvement greater among BI (tort) claims than UM (first-party) claims?

As a preliminary step down this road, I compared BI and UM claims from the 1992 Insurance Research Council (IRC) closed claim database (to which I had access when I was a visiting scholar at the University of Wisconsin-Madison Department of Economics). This database includes about 39,000 automotive insurance claims that were “closed” (paid or otherwise compromised) during a two-week period of Summer 1992. The data were submitted by a group of insurers that, together, account for over 70% of the national automobile insurance market.

Most of the claims are tort claims. Only about 10% involve UM policies. I eliminated several types of claims in order to preserve comparability between BI and UM claims. For example, I dropped all claims filed in states with no-fault laws. After making these and other exclusions, my sample size dropped to 29,000.

Is attorney involvement more common in BI claims than UM claims? Surprisingly, no. Preliminary summary stats appear at the end of this post. The asterisks indicate whether the estimate in the BI column is statistically different from the corresponding estimate in the UM column. Notice that attorney involvement is generally higher in UM claims—just the opposite of the usual assumption. Attorney involvement is significantly higher (in a statistical sense) among BI claims only when we consider the most severe accidents, and even this difference (.861 versus .797) does not seem very large or indicative of some serious “inefficiency” in tort compensation.

This is a bit surprising. At least as measured by attorney involvement, the administrative costs of tort law are not much different from first-party insurance. To be sure, I’m ignoring the cost of judges, juries, and the rest of the court system. So my analysis is incomplete. But it seems interesting that one common measure of tort law’s inefficiency—attorney involvement—is not a good measure after all.

Then again, these patterns may be unique to automotive accidents. In this realm, insurance companies run the show; rarely do cases go to court. It may matter little whether the victim files a tort claim or a claim under a UM policy; either way, the victim will be negotiating with an insurer. In a sense, then, insurance markets have reduced the inefficiency of the tort system: they have reduced it to the level of inefficiency inherent in insurance claims processing generally. A related theme—the role of insurance companies and other institutions in shaping tort law—is developed in a recent (non-empirical but still very good) article by Sam Issacharoff and John Witt, The Inevitability of Aggregate Settlement: An Institutional Account of American Tort Law, Vanderbilt Law Review, Vol. 57, p. 1571 (2004).

Are there better measures of tort law’s administrative efficiency?

 

                                                       

Table
	Proportion of Claims Handled by an Attorney
	UM Claims   (First-Party Insurance)	BI Claims   (Tort Law)
Full Sample	.595   (.0080)   (3,795)	.561**   (.0031)   (25,307)
Claims under $5,000	.541   (.0091)   (2,996)	.500**   (.0035)   (20,939)
Claims under $1,000	.291   (.0134)   (1,151)	.250**   (.0044)   (9,761)
Claims over $10,000	.797   (.0216)   (349)	.861**   (.0080)   (1,901)
Soft injury claims	.604   (.0099)   (2,419)	.567**   (.0039)   (16,231)
Hard injury claims	.462   (.0214)   (545)	.429   (.0078)   (4,068)
Severe hard injury claims	.597   (.0319)   (238)	.605   (.0130)   (1,410)
Notes: The first parenthetical in each cell indicates the standard error of the estimate; the second indicates the number of observations. The symbol ** indicates that the estimate in the BI column is significantly different—at the 1% level—from the corresponding estimate in the UM column. The symbol * denotes a difference at the 5% level. “Soft injury claims” are claims involving only sprains or strains; “hard injury claims” involve no sprains or strains; “severe hard injury claims” involve fatalities, brain injuries, loss of body parts, paralysis, temporomandibular joint disfunction, loss of one of the senses, internal organ injury, fracture of a weight-bearing bone, scarring or permanent disfigurement, concussion, serious laceration, or other fracture.