--Scott Harrington, U. of South Carolina; Walter Olson, Manhattan Institute
Proposition 106 and the Incompetent Consumer
--Peter Huber, Manhattan Institute
Is the "tort crisis" real or fake? Is it mostly driven by a genuine rise in lawsuits and payouts, or by misconduct in the insurance industry?
A dramatic expression of the blame-the-insurers view in its purest, most undiluted form is California's new Proposition 103, one of the most drastic schemes of government control imposed on a major American industry within living memory. 103 was in fact too extreme for many longstanding critics of the insurance business, such as the California trial lawyers' association, which supported a milder alternative. Other tort reform opponents, however, notably Ralph Nader, have put their reputations on the line to vouch for its fairness and economic soundness.
Prop 103 is built on the notion that the price of auto insurance can be rolled back by a third or more without taking any steps to reduce the cost of providing it. It starts with a decree that rates be cut to a level 20 percent below that of November 1987. Since rates had risen significantly in the meantime, the actual rollback from current levels would often amount to 30 or 35 percent. Then the rolledback rates are to be frozen for a year, and then an added 20 percent cut in rates must be offered to "good" driversa category defined so peculiarly and narrowly in the law that even a recently convicted drunk driver can qualify. In addition, a not entirely clear provision is thought to ban "territorial rating", which means rates for drivers in highclaim urban areas will presumably have to be cut still further to bring them in line with those of rural drivers.
If the rollbacks take effect, the California Insurance Department has estimated that five of the state's ten biggest property/casualty insurers will become insolvent, with 35 firms underwater by the end of the first two years. In a provision eerily reminiscent of the "hardship" rules in New York City rent control, companies approaching insolvency are to be given, not any sort of automatic right to charge something closer to what the market will bear, but only an entry ticket to a second bureaucratic labyrinth in which they may try to prove they are going broke, with no deadline set for how long the state may take to consider their plea. At any rate, says David Balabanian, a San Francisco attorney quoted in the Wall Street Journal, the "idea that you would have to bleed to death is no safety valve. It is confiscatory by definition." Unappealing as this "out" may sound, several companies have already sought to take advantage of it by declaring their own impending insolvency.
WHERE ARE THE EXITS?
Many of the larger national companies, preferring not to bleed to death in the first place, promptly announced that they would stop accepting new business from the state's drivers. One company, Travelers, threw in its licenses the day before the election and began sending its California auto customers notices of its intent to withdraw from the line entirely. But another clause in Prop 103 may be intended to make escape illegal in itself: it purports to require insurers to go on renewing nearly all of their customers' policies indefinitely, profitable or not, and also accept new customers on the same terms.
Backers of Prop 103 have also responded to signs of an impending exodus with threats of more laws and (what else?) more litigation. State Sen. Alan Robbins (DLos Angeles) has introduced a bill that would hit any insurer that pulls out of a line covered by Prop 103, or fails to renew at least 90 percent of its policies, with punitive fines of up to 50 percent of its annual premium volume. Robbins proclaimed that the "people of this state have a right to insurance," though he did not explain at whose expense. The Nader-backed Voter Revolt group has also threatened to sue companies that decline to accept new customers for engaging in an illegal boycott, and the state attorney general has talked about bringing a new antitrust action.
A great deal, then, comes down to whether companies can be forced to stay in the stateâ€™s market until their money runs out, and whether California may fairly tap the money of policyholders and stockholders in other states to support its planned low rates. If the California Supreme Court does nothing to discourage the latter view in its forthcoming review of 103, one can expect other states to retaliate with their own beggarthyneighbor legislation aimed at achieving a net inflow or at least preventing an outflow of funds. Regulators in two other states have already announced that insurers may not charge local customers extra to make up for California losses.
Sooner or later the courts will have to rule on whether the Venus'sflytrap model of regulation now being tried in California (and earlier pioneered in Massachusetts) is truly consistent with the Constitution's guarantees of due process and unfettered interstate commerce. If so, the term "captive insurance companies" will acquire an ominous new meaning. At the same time the pending legal and constitutional challenge to 103 is raising a host of other issues. Conceivably, for example, the state's Supreme Court could decide to throw out the whole mess under a law barring ballot initiatives that deal with more than a single subject. In the meantime, as of this writing, the court has stayed the rollback provisions while allowing most of the others to go into effect.
AFTER THE COURT RULES
Even if the "lock-in" and rollback provisions are struck down, the rest of the initiative if allowed to stand would have some dramatic implications for those who buy insurance in the Golden State. Whatever its eventual success in siphoning money from insurers to voters, for example, 103 is well calculated to siphon money from some California voters to others, especially from drivers in lowclaim rural and many suburban areas to those who live in the biggest cities. There is good evidence that the voters were aware of the crosssubsidy implied by an end to "territorial rating." The proposition was defeated in 50 of 58 counties, carrying only urban counties in the Los Angeles and San Francisco areas where premiums are highest. (Statewide, it passed by a slender margin of 51.2 to 48.8 percent.)
Experience in Massachusetts and New Jersey suggests that the suppression of territorial rating leads by direct steps to the government takeover of a large chunk of the auto insurance business. The process works as follows. A single blended rate, even if it is allowed to exceed the cost of serving the lowclaim areas, is bound to be unprofitable for much of the urban business. No company will voluntarily offer average urban drivers coverage at the permitted rate. The state must then order the coverage to be provided through assignedrisk pools or governmentsupervised reinsurance funds such as those that grew to cover 54 percent of drivers in Massachusetts and 43 percent in New Jersey (where incidentally the state fund has just been hit by political scandal). The only remaining step is for the government to begin writing the coverage directly, either for highcost drivers alone or, as in some Canadian provinces, for everyone by transforming the whole field into a government monopoly. We may therefore expect that even if all of Prop 103 is struck down but this one bit, a large share of auto insurance in California will within a few years be provided under some form of state sponsorship or compulsion.
In addition, whether the rollbacks are struck down or not, the bill prohibits all future rate changes without regulatory approval, ending forty years of determination of rates by competitive markets in the state. This supervision is apparently meant to be permanent. To politicize the setting of rates further, the state's insurance commissioner is to be elected rather than appointed.
Though 103 was sold to voters as a way of cutting auto rates, it was drafted to do much more than that. It imposes a number of unrelated regulatory schemes that probably never could have won enactment on their own. Most notably, its rollback and permanent political control of rates also extends to the kind of commercial liability insurance bought by businesses, towns, and charities. At the moment, this section of 103 has not provoked as immediate a crisis as has the auto section, in part because commercial liability rates had already fallen markedly from November 1987 levels, and in part because it is not easy to fit an effective straitjacket on a kind of policy whose terms, exclusions and rates are often tailored to individual risks. Even so, future supply and demand gyrations are likely eventually to prevent the market from clearing in this area too, so that insurers attempt to withdraw from various lines of business. That will bring about pressure for some classes of customers to subsidize others (another provision of 103 helps out here by requiring the state to order crosssubsidy plans into effect in many circumstances) and then for some degree of direct government provision. It is noteworthy that the ostensible beneficiaries of these changes, the buyers of commercial insurance, mostly opposed and continued to oppose Prop 103 because they expect it to dry up the supply of coverage.
Other parts of Prop 103 revamp state taxes to ensure that the collapse of insurance companies' revenues does not lower the amount of premium taxes they must pay, create a statesponsored but privately controlled advocacy group to oppose the companies' interests in future public debate, enact heavy criminal and civil penalties for noncompliance, repeal the industry's limited exemption from the state's antitrust laws, and allow state-chartered banks to begin selling insuranceâ€”although why they would want to do this, in the new regulatory climate, is far from clear.
A STRATEGY TO BLOCK TORT REFORM?
The outcome confirms that insurance companies, much like oil companies in the 1970s, are becoming a target of choice for political entrepreneurs. The insurance industry spent an estimated $57 million in the campaign, of a total $75 million spent by all sides. Yet it badly lost the baffle for public opinion. Its perceived sponsorship alone was apparently enough to sink, by a crushing threetoone margin, an otherwise promising nofault initiative that would probably have saved drivers a good deal of money, though it is true that the plan in question was weighed down by other industrybacked provisions, aimed at blocking competing initiatives, that drew fire from the influential Los Angeles Times, among others. And possibly, with the free lunch of uncompensated rate cuts in view, voters no longer cared for the nourishing but paid lunch of no-fault.
Prop 103 and its forthcoming imitations in other states have direct appeal to voters upset at high rates, of course, but they can equally well be seen as part of a shrewd strategy aimed at blunting the movement for liability reform. The clearer the link between litigation outlays and insurance rates in the public mind, the more powerful the movement for tort reform will be. If this connection can be broken, and the idea fostered that rising litigation in no way affects the public's own pocketbook, much of the resistance to the expansion of liability can be expected to dissipate. As a dividend, measures like 103 serve to punish one industry that has vocally supported tort reform and warn other prospective supporters that they too can be dealt with. Which is why the outcome in California should be of interest not just to those who happen to sit on the insurers' side of the table, but to everyone interested in the health of the legal system and the U.S. economy.
--Scott Harrington, U. of South Carolina;
Walter Olson, Manhattan Institute
Scott Harrington is an adjunct scholar of the Manhattan Institute's Project on Civil Justice Reform and a specialist on insurance. He teaches at the College of Business Administration of the University of South Carolina and formerly taught at the Wharton School, University of Pennsylvania. His articles on this subject have appeared in Science (February 12, 1988), Best's Review (October 1988), and the 1988 Brookings Institution volume Liability: Perspectives and Policy, edited by Robert Litan. Walter Olson is director of the Project on Civil Justice Reform. His reports on the Massachusetts situation appeared in Barron's, November 2, 1987 and May 9, 1988.
Another measure on the California ballot this year was Prop 106, which would have limited lawyers' contingency fees. It didn't pass, but the idea is expected to recur in state tort-reform skirmishes in coming years. Manhattan Institute Senior Fellow Peter Huber wrote this slightly tongueincheek commentary that circulated before the California vote.
PROPOSITION 106 AND THE INCOMPETENT CONSUMER
If a passenger in a plane crash really wants to pay one-third of the damages he is sure to collect to his contingency-fee lawyer, why should a state law get between them? If the occupant of a telephone booth hit by a truck driver concludes that nothing less than a twothirds cut will attract legal talent to press an outlandish claim against the booth manufacturer, why not let lawyer and client go ahead? In short, why should the state of California, through Proposition 106 or otherwise, be telling consenting adults how they may deal with their own lawyers in personal injury lawsuits? Ironically, trial lawyers themselves have provided the most persuasive answer.
Until the late 1950s, liability law viewed the average consumer as reasonably intelligent and competent. If you bought a hedge trimmer, a sail plane, a tummy tuck, or pretty much any product or service, you and the seller could decide between yourselves just who would be responsible, and for how much, in case of an accident. The freedom to make contracts, even stupid contracts, was a fundamental pan of the broader freedom to take care of your own affairs in cooperation with whomever you pleased.
Then the trial bar persuaded influential courts, most notably the California Supreme Court, that the consumer was not really competent to make binding deals of this kind. Standardized contracts between a knowledgeable, crafty seller and a small, gullible consumer, were successfully attacked as contracts "of adhesion." Joe Consumer, the argument ran, never bothers to study the contract he accepts when he buys his airline or bus ticket, his toaster, or his appendectomy, and even if he did, General Motors, General Electric, United Airlines, or the city hospital would laugh if Joe proposed to renegotiate the terms. California led the nation in adopting this view, in the landmark Vandermark v. Ford Motor Company ruling of 1964.
So the cardinal principle of modern liability law came to be: The consumer is never responsible. Safety disclaimers are sweepingly denounced as "unconscionable," "contrary to public policy," or "inconsistent with natural justice and good morals." Contract terms concerning the safety of a car, or a lawn mower, or an airplane are no more enforceable than a Venetian merchant's promise to guarantee repayment of a loan with a pound of his own flesh.
If the consumer has no responsibility when he buys the product, of course he has none when he uses it. The old rule of "contributory negligence" was simple: you couldn't sue if your own carelessness contributed in any way to your injury. But enforcement of the rule has all but disappeared. A driver pushed his Mercury Cougar to more than 100 miles per hour and was killed when one of its Goodyear tires exploded. The tires were designed for a maximum safe speed of 85 miles per hour, but Goodyear and Ford were held liable nonetheless. A Pennsylvania farmer ordered a skid loader but specifically asked the International Harvester Company to remove a standard protection cage around the driver's seat so that the loader could pass through his low barn doors. Harvester honored the request; the operator was later crushed in an accident that the standardissue cage would have prevented, and Harvester was held liable for the injury. With astonishing candor, the California Supreme Court in a 1978 ruling rejected the suggestion that accident costs should be allocated among all responsible parties, including the accident victim, according to the relative degree of responsibility. "[E]ven when a plaintiff is partially at fault for his own injury," the court announced, "a plaintiff's culpability is not equivalent to that of a defendant." (American Motorcycle Association v. Superior Court)
The tobacco cases are the absurdly logical conclusion of this silliness. Plaintiffs who have puffed away for twenty-five years, brushing aside warnings on the cigarette packages themselves and ignoring pleas from the Surgeon General, the family doctor, and every solicitous mother in the land, turn around when the cancer materializes and sue the tobacco company. Most courts, fortunately, have finally drawn the line at such claims. But a few months ago the plaintiffs nevertheless won their first victory in New Jersey, and the cases are still being pressed in courtrooms across the country.
The principal beneficiaries, of course, are the trial lawyers of America. Most accidents do not involve collisions among strangers at an intersection; most arise in the context of commercial acquaintance, where the parties would allocate risks, benefits, and insurance responsibilities for themselves, if the law allowed them to. When the courts nullified contract, a flood of new accident cases arrived in court. It has been happy days for the trial lawyer ever since.
Almost everyone else has suffered. Without a robust law of contract it has also become increasingly difficult to buy such things as novel contraceptives, experimental lightplane designs from Burt Rutan, morning sickness drugs, obstetrical help in rural areas, and countless other products and services that producers simply will not or cannot provide under the openended threat of tort liability. The availability of liability insurance has declined too. No one who understands markets should be surprised. Courts and juries, modem tort law assumes, must operate for the consumer in loco parentis, now and forevermore. This attitude robs us of our most important economic freedom, the freedom to plan, to make advance commitments, and to arrange deals on terms mutually agreeable to the parties involved. Modern tort law abrogates our freedom to cooperate. The costs of modern liability have far outweighed the benefits.
But for the purposes of Proposition 106, that is almost beside the point. At the very least, the law should be consistent. If the average Californian is too uninformed, irresponsible, or otherwise incompetent to make legally binding deals with his psychotherapist or skislope operator, he surely does not have what it takes to strike a fair deal with his lawyer. If takeitorleaveit contracts "of adhesion" are inherently unjust, contracts with trial lawyersâ€”who offer almost nothing elseâ€”should be treated accordingly.
So Californians should hold their noses and pass Proposition 106. It's a drastic remedy. But nothing less will force the courts and lawyers to come to grips with the marketdestroying rules that they themselves have invented in the past two decades. When the law is once again ready to treat the consumer as an adult, capable of making binding agreements and abiding by them, there will be time enough to return to unregulated freedom of contract between lawyers and their clients.
--Peter Huber, Manhattan Institute