The Multiplication Effect of Legal Insurance
32 Pages Posted: 16 Dec 2016
Date Written: December 15, 2016
Because legal insurance policies cover the expenses of plaintiffs in bringing legal claims, such policies increase the risk of negligent or careless acts by tortfeasors. For this reason, potential tortfeasors would prefer to avoid injuring holders of legal insurance policies. Since insurance coverage (or lack thereof) is not observable to a tortfeasor prior to an accident, tortfeasors can never exercise this preference ex ante. As a result, insured tort victims provide deterrence benefits to those that are uninsured by increasing the overall expected costs of engaging in negligent, harmful behavior. In magnifying a tort offender’s overall risk of facing legal action, this multiplication effect of insurance policies enhances deterrence, inducing increased overall safety levels.
Unfortunately, however, the multiplication effect of legal insurance reduces the demand for legal expense insurance policies. Because policyholders do not capture the full benefits of legal insurance policies on safety, too few individuals sign up for such policies. As a result of this public good effect, the average price of insurance policies remains high, which reduces the demand for legal expense insurance policies. In revealing these overlooked collective action issues, this Article opens new inroads for policy discussions regarding legal insurance markets.
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