Timothy T. Taylor Home Page
Journal of Economic Perspectives
Articles and Writing
Economics Textbook
Classroom Teaching
The Teaching Company
High School Pedagogy

Articles and Writing

July 21, 1989
"A Premium Example for Auto Insurance"
San Jose Mercury News
By Timothy Taylor
<< Back to 1989 menu

REMEMBER when there was a crisis in medical malpractice insurance? From 1983 to 1986, for example, total premiums paid increased by 125 percent! Doctors were quitting specialties with a high risk of lawsuits, like obstetrics, and prescribing "defensive medicine" that defended them from lawsuits, rather than patients from illness.

But the explosive growth in malpractice insurance premiums seems to have slowed to a halt recently. Total malpractice premiums paid increased by 56 percent in 1985, by 26 percent in 1986, by 15 percent in 1987, and then actually fell by 2.5 percent in 1988.

Those who are now contemplating the mess that is California auto insurance in the aftermath of Proposition 103, like Insurance Commissioner Roxani Gillespie and the state Legislature, can learn from how California led the way in bringing malpractice insurance rates to heel.

When the problem of medical malpractice insurance exploded in the mid-1970s, the California Legislature could have pretended to solve the problem in the style of Proposition 103 by passing a law to cut all malpractice insurance rates by 20 percent, with an additional 20 percent cut for "good doctors."

Instead, the Legislature tried to do something constructive. It set a national precedent by passing the Medical Injury Compensation Reform Act of 1975, which attempted to alter the system that was leading to a crisis in malpractice insurance.

MICRA, as it is commonly known, had four main provisions. Lawyer contingency fees were limited, providing less financial incentive for lawyers to push for the highest possible award. Damages in the nebulous category of "pain and suffering" were limited to $250,000. Malpractice awards could be made gradually, over time, rather than in a single lump sum. Finally, the amount of other settlements an injured person had received -- like workers' compensation -- was entered into the decision of setting the malpractice award.

Those who have been following the Proposition 103 tangle can guess what happened next: The bill was challenged in court and never had a chance to kick in. Appeals dragged on for a decade. Meanwhile, malpractice insurance rates continued to climb.

But in 1985, MICRA was finally upheld by the California and U.S. Supreme Courts. With its constitutionality clear, many other states began passing laws that copied bits and pieces of California's example. This year, malpractice insurance rates are likely to fall or hold steady in most states.

Malpractice insurance rates in California used to be among the highest in the country. They are now near the national average, and far below rates in states that have not adopted MICRA-style reforms. For example, a general surgeon in California pays malpractice premiums of about $25,000 a year, compared with $59,000 in New York, $81,000 in Michigan and over $90,000 in Florida. General surgeons also pay malpractice premiums of more than $30,000 a year in Arizona, Colorado, Georgia, Kentucky, Maine, Missouri, Ohio, Oregon, and Texas.

Although many observers believe that the changes in state law were the single biggest factor in helping to tame the malpractice insurance monster, they clearly aren't the only reason. When many commercial insurance companies fled the malpractice market in the mid-1970s, physician-owned companies took up the slack. In California, these companies now hold over 90 percent of the market, and they have worked to help doctors avoid malpractice lawsuits. Also, juries seem less willing to hand out huge awards, at least in most states.

In general, these reforms of law and attitude add up to a recognition that insurance is not just a big pile of money waiting to be handed out. Instead, insurance is a way of sharing risk.

In a way, an insurance company is like a big lottery: many losers, some who break even and a few big winners. The difference is that for insurance, the biggest "winners" are people who have had terrible catastrophes, while "losers" are people who pay their premiums, year after year, even though nothing bad has ever happened to them, or ever will happen to them.

I'm sure that most doctors and most drivers are perfectly willing to be insurance "losers" -- that is, they would be perfectly willing to pay the premiums, be protected against catastrophe, and never need to file a claim. But there are limits. Neither good doctors nor good drivers are willing to write blank checks to everyone who wins a settlement, especially when the amount of those checks is increasing rapidly every year.

Any serious reform of California auto insurance will have to tackle the rules of the system that are helping to produce high rates, just as MICRA and its offspring in other states amended some of the causes of rising malpractice insurance rates. Instead of bashing the insurance companies, which is a policy step that almost everyone can agree on, real insurance reform will be controversial. Should there be limits on some types of auto insurance awards? Limits on the right to sue? Higher deductibles and copayments? Some form of no-fault?

The insurance business has two ends, like a length of garden hose. If you want to cut back on how much needs to go in, you have to limit how much will be paid out.

<< Back to 1989 menu