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