Insurance liability costs: an important and difficult problem

Business is understandably concerned about the apparently spiralling cost of public liability insurance premiums and its crippling effect on business. The problem though of escalating claims and insurance costs is not a new one. Indeed, it has been a recurring issue in the commercial landscape of the United States of America, England, Australia and elsewhere for well over a decade. Not only is the problem not new, but as repeated studies have shown, any real solution to this problem involves some very difficult choices for a democratic liberal society and government, as well as business.

There is no doubt that there has been an ongoing trend for an increasing number of liability claims to be made by the public. This trend has been driven by changing community attitudes and expectations. Following the collective suffering of the Second World War, society abandoned the previous approach of stoically accepting an accident on the basis that the loss from an accident must lie where it falls and instead, increasingly expected that if an individual has been injured through somebody else’s fault, then the injured victim should receive compensation. Furthermore, ideally, the accident victim should be compensated so he or she is put back into the same position as if the accident had not occurred. Reinforcing these changes, was a belief that the costs of compensation were a valid cost of the enterprise which could be distributed through the price of the business’ products or services, as well as spread through insurance.

Where the system has broken down, as it currently has in Australia and previously has elsewhere, is when insurance becomes unavailable or prohibitively expensive. America has been through its own insurance crisis – three in fact: a medical malpractice explosion in the mid 1970s, a product liability crisis in the late 1970s and a general claims and insurance crisis in 1986. It was this last crisis which prompted Time magazine’s cover story: "Sorry, America, Your Insurance Has Been Cancelled". It also prompted a wide ranging and intensive review of the compensation regime in America and its possible reform. The lessons to be drawn from the American experience for Australia are subtle, but significant.

Despite the incentives for and studies to change the compensation regime in America following the 1986 crisis, almost without fail the recommended reforms and changes made were confined to various procedural and other incremental reforms. This was an especially surprising result, given that after the medical malpractice insurance crisis in America in the 1970s, caps were placed on the damages which could be awarded for pain and suffering. When the impact of these reforms were reviewed a decade later, the conclusion was that the reforms had had the desired effect in reducing the damage awards, as well as the frequency of such claims.

Hence, the American experience in relation to medical malpractice claims, supports the Federal Minister for Small Business, Joe Hockey’s, belief that caps on damage payouts is required as part of the suggested national public liability insurance scheme. Yet the relevance of this precedent goes further, for despite its success in the medical malpractice sphere, this initiative has generally not been implemented in America since. Broadly, the reason for this appears to have been a value judgment that to deny a negligently injured person full compensation, is contrary to society’s expectations and community values. An added objection to placing limits on damages awards and/or restricting individuals’ common law rights, was that such a course was regressive and unfair. For in effect, placing caps on damages awards means that the person in the worst position to do so, the accident victim, effectively subsidises the cost of cutting insurance premiums. For example, if an accident victim’s medical costs, loss of income and pain and suffering costs is $100,000.00, but the accident victim only receives the capped award of say $50,000.00.

Another aspect which appears to have carried some weight in America, is the argument that to cap damages’ awards as a reform measure, is to confuse symptom and cause. For if liability insurance costs are increasing, this is arguably not just because the community is more prepared to make claims than they previously were, but also because negligently inflicted injuries are becoming more frequent. Hence, if liability insurance costs are to be reduced, the focus should be on the causes of liability and how to minimise this, rather than the victim’s compensation.

This though is not the end of the possible solutions to this problem. The cost of public liability claims (and its insurance) is a product of the frequency of the claims made, coupled with the size of the damages awards, plus the so called transaction costs – the administrative costs and profits of the insurance companies, as well as the costs of justice. If the transaction costs can be minimised to make the liability system affordable, while at the same time properly compensating accident victims, would be an excellent result. It is for this reason that so many studies and reform initiatives have focussed on this aspect. Again however, previous studies and initiatives reveal (contrary to popular rhetoric) that this option does not provide an easy solution either.

Although it has often been said that one of the reasons for the insurance cover and instead have the "crippling rises in public liability insurance" is the insurance companies’ profits, recent events in Australia would suggest that this is not the case (and indeed, the absence of past profits may be the reason why premiums have jumped so suddenly). Another option, as Oliver Wendell Holmes recognised over a century ago, is to abolish private insurance cover and instead, have the "state ... make itself a mutual insurance company against accidents to distribute the burden of its citizens’ mishaps amongst all its members". This is one of the options which is presently being advocated for Australia. This course has been adopted in New Zealand through the state-owned monopoly Accident Compensation Corporation and for different classes of risk, such as the Transport Accident Commission in Victoria. Opinion as to the merits of these initiatives appear to be divided. It is notable that this is not an approach which has been widely adopted to date – perhaps because such a proposal raises the usual array of economic issues and concerns presented by any monopoly.

The next option is procedural reform, so as to simplify and minimise the cost of determining if a defendant (say business) is liable and if so, how much compensation should be paid. Clearly, if procedural reform could be implemented, whereby the system can be made more cost efficient and yet deliver both the plaintiff and defendant a fair right to be heard, then such reform would be invaluable. Previous studies suggest however that even if all of the transaction and legal costs were stripped out of the compensation regime, the real driver of the increased costs remain – namely the increasing number of claims being made, coupled with the fact that the cost of properly compensating the injured victims is increasing. Also, in determining the optimum procedural reform, it needs to be borne in mind that the legal process of determining if an individual is liable for the accident and the extent of the alleged injuries, acts as a very effective check and balance to false or exaggerated claims.

There is another aspect to this issue, which is often overlooked. Ultimately, the compensation regime and insurance system is a market mechanism which translates the failure to act carefully into damages awards and insurance premiums. These costs act as a deterrent to negligent behaviour and a financial incentive to minimise the risks to the public. Leaving aside the vexed topic of whether the compensation and insurance regime does this efficiently and equitably, there is no doubt that an "ounce of prevention is worth a tonne of prevention" and rising insurance premiums should prompt an added focus on risk management and prevention. It will also no doubt prompt a fresh analysis by business (if not the community generally) of the need for, appropriateness of and alternatives to insurance to effectively transfer or manage risk. This is a healthy and commercially sensible response. It is also a positive by-product of the cyclical nature of the insurance industry and its premium fluctuations.

As the recent flurry of public comment in response to the suggestion to implement a national accident compensation scheme with fixed pay out levels illustrates, the issues presented by increasing public liability claims and costs are complex. They go to the core of the community’s expectations of business, the legal system and how an individual should be compensated for accidents which are not their fault. America’s experience since 1986 illustrates that, contrary to much of the current comment in Australia, there is no simple answer. This of course doesn’t mean that a proposal to explore ways to more cost efficiently and effectively deliver compensation to accident victims shouldn’t be explored. Yet to be worthwhile, such an investigation and proposed reform needs to be carried out in recognition of the fact that there is no easy, if single answer or solution.