November 30, 1999
Punitive Damages and the Public Interest
MS.PENDELL: May I have your attention please. Good afternoon. I’m Judy Pendell, and I’m Director of the Center for Legal Policy here at the Manhattan Institute.
Welcome. We are very honored to have such a wonderful speaker and to have such a wonderful friend and scholar to introduce him, George Priest from Yale Law School.
MR. PRIEST: Thank you very much Judy. It’s a great pleasure for me to introduce our speaker today. He’s an old friend of mine; we’ve worked together many years in the tort reform effort. The concept of tort reform however, I think, is going to have to change. I regret that the words reform and tort reform are becoming a little antiquated, and I think they do not quite capture the current situation. Reform implies correction, implies some adjustments, some minor problems that have to be changed. I think that our modern situation is different, that the problems of modern tort law have reached a new level. They are no longer simply the problems of excessive compensation to some injured individuals, or compensation through the tort system that could be more effectively provided by other means.
I think we’ve seen especially in the last months or within the last year a new set of cases that are a substantially more serious threat to our economy and to the country, and these are cases where, in essence, there is no injury at all and the tort system is being invoked to attack the heart of the competitive economy. Let me give you some examples of these cases.
Last summer, you might recall that there was a $1.2 billion judgment against State Farm Insurance. Now what was their offense? State Farm had specified less expensive auto repair parts, after market auto repair parts, instead of brand new parts to repair cars that their policyholders had had in an accident. There was no injury to anyone at all in this case. Indeed, State Farm’s policy allowed them to provide insurance coverage at lower premiums than they could have provided otherwise, which should have been a reason for State Farm to be applauded, not to be sued. Again, it was a $1.2 billion verdict simply for that.
Another example, within the last two or three weeks, you may have seen in the papers that there are a number of class actions filed against our leading HMOs based on the claim that the HMOs are using cost criteria guidelines for determining levels of medical care. These are not cases where the HMO has refused to refer a patient to a cardiologist and the patient has died of a heart attack. There is no injury at all in these cases. The claim is that simply using cost criteria is an offense and ought to be punished under our tort law.
Let me give you another example that is the same in essence. Last July, General Motors was levied a $4.8 billion punitive damage judgment, later reduced to a mere $1.2 billion. There was some injury here, actual injured parties, but they received over $100 million in compensatory damages separately. What was the basis for the $4.8 billion punitive damage award? Well back in 1973, and this had nothing to do with the car in question, a GM engineer had written a memo that employed cost benefit analysis to determine whether consumers were better off with one design or another design. That to a jury was an offense worth $4.8 billion in punitive damages. The judge said; “No it’s not that bad, only 1.2 billion.”
Now cases of this nature and the legal theories behind them are not simply excesses that need some reform. I think they strike at the heart of a competitive economy. The use of cost benefit analysis, employing guidelines to constrain costs, maintaining or enhancing output by using less expensive components, these are the engines of economic growth in the U.S. and around the world.
Now there has been no more eloquent student of cost benefit analysis and risk regulation than our speaker today. Kip Viscusi is a rare economist whose work is as important in the law and on legal theory as it is in his own field. I commend his work to you. It is rich in empirical insight, and he’s going to present some of that insight this afternoon. He’s going to talk today about the effects or the lack of effects of punitive damages and the role of cost benefit analysis in punitive damages judgments. I give you Kip Viscusi.
MR. VISCUSI: First I would like to thank Judy Pendell of the Manhattan Institute for having me in a room where I can’t figure out if I’m still in Cambridge or not—[LAUGHTER]
MR. VISCUSI: As I look down Church Street here and the Radcliff there, and Copley Place over there. I would also like to thank George Priest for entering the hostile confines of the Harvard Club even though he’s a Yale Law School Professor. I agree with everything he said except for one thing. I just celebrated my 50th birthday, and I’m very sensitive to people referring to me as their old friend.
MR. VISCUSI: I’m going to talk about two papers that are related. The first is called, “Corporate Risk Analysis: A Reckless Act” which is coming out in the Stanford Law Review. The theme of that piece is that juries often penalize companies that have done benefit cost analysis. So the simple of act of doing cost analysis is a bad thing. Punitive damage awards occur frequently in these cases. That leads to the second paper called, “The Social Cost of Punitive Damages Against Corporations in Environment and Safety Torts.” In this article I ask whether or not levying punitive damages does any good? Do they serve any constructive function?
Well I got interested in this area of corporate risk analysis because this is essentially what I do, I am a benefit cost analyst. Last summer, as George mentioned, there was a $4.8 billion punitive damages award after a Chevy Malibu was rear-ended. It was subsequently reduced to $1.2 billion, but that’s still real money; and the problem is GM undertook tradeoffs that the plaintiff’s attorneys characterized in court as a “cold-blooded calculation”. This phrase, “cold blooded calculation”, comes up again and again—typically in automobile cases. This made me wonder whether, if I presented mock jurors with different scenarios in which companies did a benefit cost analysis in a way I would like them to do it, would juries react differently?
In the cases that have been publicized, such as the Ford Pinto case from decades ago, as well as the more recent cases involving the Edward Ivy memo, benefit cost analysis typically valued life at $200,000 or a number that was substantially below what the government uses. Alternately, what would happen if the company did exactly what the government would do as part of a benefit cost analysis: did the analysis, and concluded that the costs were greater than the benefits, and therefore did not install the safety device in question. Would prospective juries be more receptive to that approach?
I ran a series of scenarios on mock jurors, and we have distributed the handouts describing some of them. One is called Table 3. We had 489 adult participants brought in in Phoenix, Arizona. I divided the sample into roughly five equal groups, each of which was presented a different scenario.
In the first two scenarios, the company didn’t do a benefit cost analysis at all. So I’ve varied the cost per life saved. In one case it cost $4 million to save a life and in the other case it cost $1 million dollars to save a life. I’ll just read you the pertinent portions of one of these scenarios.
A major auto company with annual profits of $7 billion made a lot of cars with a defective electrical system design. This failure has led to a series of fires in these vehicles causing ten burn deaths per year. Changing the design to prevent these deaths would cost $10 million for the 100,000 vehicles affected per year or $100 each. The company thought that there might be some risks from the current design, but did not believe that they were significant. The company notes that even with these injuries the vehicle has one of the best safety records in its class.
The courts have awarded each of the victim’s families $800,000 in damages to compensate them for income loss and pain and suffering that resulted. After these losses, the company altered future designs to eliminate the problem. I then asked how many mock jurors would favor punitive damages. If so, in what amount from a multiple choice format.
Scenarios three, four, and five are variations in which the company did a benefit cost analysis of various kinds, but for simplicity let me just focus on scenario four. The story line runs the same, except we said the company estimated that the annual safety benefits of the safer design would be $30 million, ten expected deaths (prevented) at $3 million per death; total costs from expected design changes would be $40 million.
To determine whether the safety improvement was worthwhile, the company used the value of $3 million per accidental death, which is the value used by the National Highway Traffic Safety Administration in setting auto safety standards. Based on this analysis, the company believed that other safety improvements might save more lives at less cost. Although it was couched as a standard benefit cost analysis, the company followed the exact same procedures as were used by a government agency, and since the benefits were not as great as the total costs they didn’t repair the design.
Well what happened? Let me just focus on the combined analysis. As you can see, if a company performed an analysis, it increased their probability of punitive damages by about 5 or 6 percent. It’s hard to get much higher than 100%. The noteworthy shift we saw was that if you performed a benefit cost analysis, the damage award increased substantially. The geometric mean award was $2.9 million if you didn’t do an analysis, $4.6 million if you did. The median award was $1 million if you didn’t do it, $10 million if you did.
What happened? Instead of rewarding companies for doing a benefit cost analysis, the mock jurors penalized them.
What’s happening here is that the higher the figure used by the company in its analysis as the value of human life, the higher the baseline award that the jurors used to determine punitive damages. If a company used a $3 million value of life, the jurors reasoned that they had to “send the company a message”, resulting in a damages award larger than $3 million. We are left with the perverse result that the more responsible the company is in one sense, in terms of using a higher value of life, the more it is penalized in terms of damages. So not only are you penalized for doing benefit cost analysis, but you’re hit with higher damages awards if you value life by a greater amount.
I’ve also done detailed statistical analysis on these and other results. What’s noteworthy is that the factors that should drive whether or not there is a punitive damages award, or its amount, never matter. The actual that should be asked, “What’s the cost per life saved? How expensive is it to save a life in a given context?”, is never asked. That factor never has a statistically significant effect on what these mock jurors did.
How about the level of the risk? If the risk is bigger, I vary that cost scenario. Does that affect what the jurors do? No. All they care about is whether you’ve done a benefit cost analysis—which is the only factor that has a differential effect on the outcome.
Well, this is quite consistent with the anecdotal evidence generated by actual cases. Again and again we see the story line where a company is penalized for conducting a benefit cost analysis. There is the Ford Mustang II case where there is a rear-ending of the Ford Mustang, and the company was hammered for doing an analysis in which it computed the marginal costs and marginal benefits of design changes. In the Miles v. Ford Motor Company case, the company was hammered for undertaking “a cost benefit analysis” to see what the cost would be to fix or repair the defect in question. The text from that case goes on and on describing the evil science of benefit cost analysis.
After the LA case, the plaintiff’s attorney came out and said that the memo describing cost benefit analysis performed by Edward Ivy showed that GM was caught “red handed.” The jurors wanted to send a message to General Motors that human life was more important than profits. They interviewed jurors after the case who basically said: “We’re just numbers, I feel, to them; statistics. That’s something that is wrong. There is no evidence that the car that they put out there was as safe as what they could have put out there.
This is true whenever you stop spending money and do not have an infinite value of life. You can always put out a safer car. I don’t think many people here drive Hummers, but I think those vehicles are much safer than the cars you’re going to drive home this evening. The bottom line here is that jurors not only seem to be incapable of trading off lives versus money, but if a company trades off lives versus money, they don’t like this at all.
There’s also a substantial effect of hindsight bias with respect to benefit cost analysis. When a company is making a decision with respect to a part, it’s making a small investment in a particular car. There is low probability of an accident that you use to multiply by the damage associated with it. Let’s say it’s a burn injury. There may be a small expected benefit from the safety improvement because of a very low probability of harm. However, after the fact, jurors did not take probability into account as a decision making factor. All they do is compare the magnitude of the injury versus the cost of replacing one defective part: $8.59. Surely a burn injury is much more severe than $8.59. Therefore they reason that the company was reckless and irresponsible.
There’s a distinct failure to integrate into the analysis the fact that there is a low probability of accident in these cases. What jurors should do (rationally) is compare the expected benefits with the costs before the accident, rather than being in the hindsight position of saying we have an identified victim, and there is a certainty of death after the fact. The company certainly did not know beforehand that this was going to be the case. The central theme of this paper is that juries do a very bad job in figuring out when to award punitive damages, with the perverse result that they award more damages when the company is behaving in a more socially responsible manner.
Well, the next question is, do we need punitive damages at all? The typical approach in the law and economics literature is to develop some hypothetical scenario where you have costs and benefits for the party causing the accident, and you have effects on the accident victim, and you to try and construct some artificial scenario in which there is some constructive role for punitive damages. I took the opposite approach. Instead of projecting some way in which we can conjure up a role for punitive damages, why don’t we take the global perspective and ask whether on balance punitive damages serve a constructive function at all? In other words, given the way that punitive damages are actually applied by juries now, can we find any beneficial effect from them?
In attempting to answer this question, I set out to look at every possible index of a deterrent effect that I could find. I looked at toxic chemical accidents, toxic chemical accidents involving injury and death, toxic chemical releases off the EPA TRI data, reductions in toxic discharges that were reported, reductions in surface water discharges, reductions in total releases, accidental fatality rates, medical misadventure deaths—which sort of has an upbeat label to it,
MR. VISCUSI: I want to tell my doctor I would not want to experience a medical misadventure today.
MR. VISCUSI: I looked at insurance premiums, total insurance premiums, medical malpractice premiums, product liability premiums, and other liability premiums. This was an analysis by state, and I found that there’s no difference in the performance of the states without punitive damages. Michigan, Nebraska, New Hampshire, and Washington do not permit punitive damages. The state of Louisiana does not permit it for product liability or medical malpractice cases. These states do not perform worse on any of the safety indices I just mentioned. If you turn the handout in question, you will see that there is no evidence of any deterrent effect of punitive damages in states that have them as opposed to those that don’t.
I also looked at different punitive damage regimes for the states that do have punitive damages. It doesn’t matter whether punitive damages are insurable or not. In some states they’re insurable, in some states they’re uninsurable, and in other states the legal status regarding insurability is uncertain. That has no effect either. So when you look at it, if you’re out there searching for some kind of deterrent effect produced by punitive damages, you simply can’t find it.
Well when I published this, we had a couple of hostile commentators on this paper in Georgetown, from the Georgetown Law Journal, one of whom suggested that we can’t find a deterrent effect because government regulation produces most of the safety benefits you might otherwise expect to find. I agree totally. It’s not that punitive damages do nothing, but the effect is such a small fraction of the overall regulatory environment that it is undetectable. We have government regulation, we have market incentives, and we have private insurance incentives. Frankly, we don’t need random large hits to companies to provide constructive incentives for corporate responsibility. The net result of the system now is that we have damages inflicted on corporations but because they’re not systematically predictable and correlative with the actual behavior of companies there is no evident deterrent effect.
Consequently, if we abolish punitive damages the bottom line is that I would see no significant loss of any deterrent effect, at least as far as I’ve been able to ascertain. I should also mention that if you look at the literature, there is no evidence for a deterrent effect from punitive damages whatsoever. There’s no empirical study that’s ever been done that shows that punitive damages have any constructive function. What we have now is a penalty system with no benefits and all costs.