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When do liability costs exceed liability benefits?

December 7, 2011 8:15 AM

Ted Frank

Professor Svorny's response commits the same error I identified in my opening post. There's an intermediate position between "the system is entirely rational" and the strawman "the system is entirely haphazard," but Svorny isn't willing to recognize it. As such, she only considers the benefits of liability, and not the costs. Certainly, when the judicial system correctly imposes costs for malpractice, it sends economic signals to reduce malpractice. But at the same time, when the judicial system imposes costs upon doctors who have done nothing wrong—and there is no doubt that it does—it sends economic signals that reduce medical practice, as well as weakens the incentive to avoid engaging in malpractice, because the marginal cost of doing so becomes lower. There becomes some point where the costs of the inaccuracies of the malpractice system outweigh the benefits, where it deters more beneficial medical practice than harmful medical malpractice. We can dispute where that inflection point is, but nothing in Svorny's paper attempts to make the evaluation in the first place, or even acknowledges that the evaluation is necessary.

The fallacy of this can be seen by a hypothetical alternative medical malpractice regime. The benevolent dictator of Fredonia, Rufus T. Firefly, reads Svorny's paper. "Ah ha!" he says, "Liability encourages insurance companies and doctors to avoid malpractice, and caps on liability harm consumers. If some liability is good, then more liability is better." Therefore, Fredonia decrees, any doctor found having committed malpractice shall surrender her entire wealth to their victim, and be executed by firing squad.

I'd hope Svorny would concede that the hypothetical (and, yes, ridiculous) Fredonia legal regime would produce health results inferior to the status quo. But to do so is a concession that excessive liability for judicial findings of malpractice can have adverse effects—adverse effects that are entirely ignored by Svorny's paper. Nowhere does Svorny's paper acknowledge the problem of incommensurate noneconomic damages (or the evidence that such damages are, indeed, relatively haphazard, or the evidence that consumers rationally prefer not to insure for noneconomic damages when given the choice in states like New Jersey), and the in terrorem effect of eight-digit noneconomic damages awards, much less how to avoid these problems without some sort of cap on noneconomic damages.

In the Huffington Post, Svorny goes farther, and says that "reducing liability, as caps do, is rarely a good idea in any situation." It seems hard to believe that Svorny actually believes that. We, as a society, reduce liability all the time because we recognize that the costs of liability exceed the benefits.

For example, most states refuse to allow a wife to sue her husband and the other woman for infidelity; a cap of zero, though the noneconomic damages from being cheated upon are just as real as the noneconomic damages in medical malpractice cases. Corporate executives have the defense of the business judgment rule: they can not be held liable by shareholders for business malpractice, even when good-faith incompetent business decisions create very real economic damages to those shareholders. In both sets of cases, the judicial system recognizes that the costs of liability and after-the-fact second-guessing exceed the benefits of judicial intrusion; indeed, we don't even blink twice in the twenty-first century that these suits are not permitted.

Closer to home, Professor Svorny's students are not allowed to sue her for any alleged educational malpractice, another cap of zero. I trust that Svorny's lack of incentives created by liability do not reduce her efforts in teaching, even though she does not have an educational malpractice insurer charging her a quarter of her salary to work with her to minimize the risk of a student not being taught properly. How much more would Svorny demand in pay to keep teaching if she were exposed to potential liability, even if she believed the system was 100% rational and had no risk of haphazard false positives? (Even if the system never fails, Svorny would face real insurance costs, assuming she's not a perfect teacher. And note that even meritless claims properly dismissed by the courts would be costly to insure, because under the American system the winner of a lawsuit does not recover costs from the loser.) How many fewer students would take Svorny's classes because they couldn't afford to pay that marginal increase in cost? Would that be a social cost militating against liability for educational malpractice or not? Why is it inappropriate to apply the same analysis to doctors?

Returning to the anesthesiologists, we know that their case is unique because their case is unique. It's not like anesthesiologists have been exposed to malpractice liability that other doctors aren't. Svorny can't have it both ways: if the risk of liability is what caused anesthesiologists to engage in sounder practices, then the reason that neurologists and obstetricians have not been able to make similar safety improvements is because they're already working at close to the optimal safety level. Svorny's argument makes testable predictions that have already been falsified: medicine in Texas (despite a fairly pathetic licensing board) hasn't gotten unsafer in the wake of caps. If anything, the state of healthcare there has improved, as more doctors have entered the state in response to the incentive of lower insurance costs. Doctors in New Zealand haven't turned into the second coming of Sweeney Todd despite the absence of any individual malpractice liability in that jurisdiction. There's no evidence for the legal system working as well as Svorny necessarily presumes it to work for her conclusions.

Certainly, Svorny is correct that caps on damages create the possibility of false negatives where legitimately aggrieved patients are undercompensated. But she fails to acknowledge that the status quo creates numerous burdensome false positives that impose real costs on doctors and consumers. The public policy goal should be to minimize the total social cost of these false positives and false negatives, but that necessary balancing is not acknowledged, much less attempted by Svorny before she issues her sweeping conclusions. Fortunately, contrary to Svorny's public-policy prescriptions, there is no liability for public-policy malpractice.

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Rafael Mangual
Project Manager,
Legal Policy

Manhattan Institute

Published by the Manhattan Institute

The Manhattan Insitute's Center for Legal Policy.