< meta name="DC.Date.Valid.End" content="20050825"> Amendment Nine: A Modest Proposal for Tort Reform

Tuesday, January 18, 2005

A Modest Proposal for Tort Reform

Earlier, I proposed that for every dollar spent on frivolous plaintiff's claims, two are spent on frivolous defendant appeals. I'd like to now propose what I consider a soft solution (credit for this solution goes to Federalist X, though I've modified his approach a little) to the current lawsuit "crisis".

Assume a medical malpractice case is at hand and assume plaintiff would settle for $10. The insurance company, egged on by its counsel, refuses ("don't want to be seen as a money machine afterall!"). Case goes to trial and the cost of litigating is $8. Now the cost to the insurance is $18, but the jury, as juries often do, awards $20. The case goes on in appeals for two more years. The appeals are unlikely to succeed of course, but the insurance company is persuaded that it doesn't want any "bad precedent on the books."

So the $20 is put in an interest bearing account at 7%. Of course, the appeals cost the insurance company another $5. Now plaintiff at the end of the day walks away with $21.50, but the insurance company ends up shelling out $25, all for a suit they could have disposed of for $10. Take the $5 they wasted on appeal and add interest to it so now the loss goes up to over $5.50. In other words, the defense has managed to inflate the cost to the insurance company by 255% (and thats the same even if the cause of action wasn't frivolous to begin with, but legitimate!) One sees here that no matter what the merits of the claim, the resolution process for these actions is a massive inflation of cost paid primarily by the insurance company.

Here is where the soft solution comes in. Assume a hedge fund comes in and says to plaintiff: "we'll buy your cause of action for $10, but you must give us all rights to litigate." Plaintiff and her attorney agree, and walk out with cash.

Now all of a sudden, plaintiff is no longer a poor, weak, reluctant participant in the court system. Instead, plaintiff is a well financed, smart, agile hedge fund capable of putting a great deal of time, energy and other resources into the suit. The bargaining table has changed, and defense counsel is faced with lots of dollars and lots of smarts across from them. The insurance company, now afraid that a well financed opponent could do significant damage, ignores defense counsel's earlier advice and prepares to settle.

Everyone knows that the fund came in at $10. So the "settlement price" is not the problem. The question now is, how much of a return will the fund get? We aren't greedy, a dollar or two is fine (depending on the merits of course!). Insurance company settles for $11.75. Hedge fund gets a 17.5% return, and insurance company saves at a minimum $8.25 or, about 41%.

Administrative and other transaction costs not discussed are also eliminated. Everyone goes home happy. There are laws on the books in many states though that prohibit the assignment of personal injury claims. They do so out of a policy concern, and it is one that I believe is dated. If the premise that there is a crisis of frivolous lawsuits is correct, this is a quick way to bring that crisis to a halt and restore some sanity to an otherwise perversely incented negotiation process. However, until the perverse incentive problem is addressed, the whopping punishment to insurance companies who want to avoid "bad precedent" will remain.

Of course, there are also many states that do not prohibit such a deal. Those states might be seeing more of me in the very near future.