Daniel P. Kessler [*]
Medical malpractice liability law has two principal objectives: to compensate patients who are injured through the negligence of health care providers, and to deter providers from practicing negligently. Considerable evidence indicates that the current liability system in the United States is not achieving its compensation goal. Awards for medical malpractice claimants are subject to lengthy delays: on average, it takes around four years to resolve a malpractice claim.  In addition, the current system is neither sensitive nor specific in its distribution of awards. Only 1 in 15 patients who suffer an injury because of medical negligence receives compensation, and five-sixths of the cases that receive compensation have no evidence of negligence. 
The unpredictability of malpractice compensation suggests that the system may not be achieving its second objective: to provide incentives for physicians to take optimal precautions against patient injury. Injury attributable to medical care generally, and to negligence specifically, is surprisingly common. Nearly 4 percent of hospital admissions in New York state in 1984 involved an injury that was attributable to medical care, with roughly one-quarter caused by negligence (the proportion of serious injuries that were attributable to negligence was even higher). 
At the same time, U.S. health spending has reached unprecedented levels, with no clear sign of slower growth rates in sight. Does the malpractice system lead physicians to take too little care to avoid harming patients? Or does it lead to "defensive medicine" -- costly precautionary treatments with minimal expected medical benefit administered out of fear of legal liability? Why has the liability system performed poorly in the health care sector? What policy reforms might improve the ability of the system to meet its twin goals? My research with Mark B. McClellan addresses these questions.
Why the Liability System Leads to Nonoptimal Health Care Decisions: Insurance
In theory, the liability system should provide physicians with incentives to take the socially optimal amount of care against accidental medical injury. Doctors bear the costs of injuries that they negligently cause. With their patients, they balance the costs of injuries against the costs of precautionary medical treatment and undertake those tests and procedures that are worthwhile from the perspective of social welfare.
But the pervasiveness of insurance in the health care sector drives a wedge between these seemingly sensible incentives and socially optimal medical decision making. On the one hand, because physicians have insurance against the financial costs of malpractice that is not strongly experience-rated, they may bear little of the costs of medical injuries  This could lead physicians to take fewer precautions than the low costs of diagnostic tests, for example, would warrant. On the other hand, because most health care is financed through health insurance, patients and physicians bear little of the costs of pre cautionary medical care in any particular case. Generally, insured expenses for drugs, tests, and other services performed for precautionary purposes are much larger than the uninsured cost of the physician's own effort. Insensitivity to the true costs of health care could lead physicians to take socially excessive precautions against injury -- to practice defensive medicine. Thus, even a perfectly functioning liability system could lead to socially undesirable medical treatment decisions -- either too much or too little health care.
Do Doctors Practice Defensive Medicine?
The direction and extent of the divergence between the privately and socially optimal levels of precaution depend in part on states' medical malpractice liability laws. Although the basic "negligence rule" -- which states that damages equal to the harm suffered should he awarded in cases of negligence -- applies to most medical malpractice claims in the United States, individual states have modified their liability laws along various dimensions over the past 30 years. …