The Law and Economics of Liability Insurance: A Theoretical and Empirical Review

50 Pages Posted: 13 Mar 2011 Last revised: 27 Jan 2012

Tom Baker

University of Pennsylvania Law School

Peter Siegelman

University of Connecticut - School of Law

Date Written: November 15, 2011

Abstract

We survey the theoretical and empirical literature on the law and economics of liability insurance. The canonical Shavell model predicts that, despite the presence of some ex ante moral hazard (care-reduction by insureds), liability insurance will generally raise welfare because its risk-spreading gains will likely be larger than its adverse effects on precautionary activities. We discuss the numerous features of liability insurance contracts that are designed to reduce ex ante moral hazard, and examine the evidence of their effects. Most studies conclude that these features work reasonably well, so that liability insurance probably does not generate substantial ex ante moral hazard. Its effects on ex post moral hazard (the increased tendency of victims to sue in the presence of insurance) are not as clear, however, and the welfare consequences of increased litigation are ambiguous, for reasons we explain. We discuss additional issues such as the effects of liability insurance when some defendants are judgment-proof, the problems posed by non-independence of liability risks owing to changes in legal doctrines, and the cyclical nature of liability insurance markets.

Keywords: Liability insurance contracts, ex ante and ex post moral hazard, risk, social welfare, canonical model of the interaction between insurance and tort liability

JEL Classification: D10, D81, G22, K13

Suggested Citation

Baker, Tom and Siegelman, Peter, The Law and Economics of Liability Insurance: A Theoretical and Empirical Review (November 15, 2011). U of Penn, Inst for Law & Econ Research Paper No. 11-09. Available at SSRN: https://ssrn.com/abstract=1783793 or http://dx.doi.org/10.2139/ssrn.1783793

Tom Baker (Contact Author)

University of Pennsylvania Law School ( email )

3501 Sansom Street
Philadelphia, PA 19104
United States
215-746-2185 (Phone)

HOME PAGE: http://www.law.upenn.edu/cf/faculty/thbaker/

Peter Siegelman

University of Connecticut - School of Law ( email )

65 Elizabeth Street
Hartford, CT 06105
United States
860-570-5238 (Phone)
860-570-5242 (Fax)

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