Evaluating the Benefits of Liability Insurance in Litigation
Katy Strand, J.
When you think of insurance, do you think of a safety net waiting to catch you or do you think of big corporate interests charging fees to clients they hope never make a claim? Lately, insurance has gotten a bad reputation. Some think insurance companies will do anything to keep from paying out. The reality is that insurance companies rarely fail to pay when the coverage is unambiguously activated.
So why does the insurance industry get such a bad rap? Perhaps it is because too often it appears to be something you buy and will never need. In economics and decision theory, loss aversion refers to people’s tendency to strongly prefer avoiding losses to acquiring gains. Kahneman, D. & Tversky, A., Advances in Prospect Theory: Cumulative Representation of Uncertainty, J. of risk AND uNcerTAiNTY 5:297–323 (1992), available at http://psych.fullerton.edu/ mbirnbaum/psych466/articles/tversky_kahneman_jru_92.pdf. When people consider insurance, it is this aversion to loss that makes people focus on their fear of that loss rather than seeing the insurance as a way to gain protection. It could also be that the insurance industry, like the legal industry, is closely tied to the most calamitous events of people’s lives and is therefore seen in a negative light.
So, is insurance a net positive or negative? In particular, how is it beneficial to allow parties to insure against the costs of litigation? This article will discuss the arguments for the benefits provided by insurance covering only defense costs. First, it will discuss the benefits provided by society paying the costs of litigation collectively, then it will discuss the benefits to individual companies that may not be able to afford their own defense costs. Finally, it will evaluate how insurance lowers the overall cost of litigation.
There are three arguments for why society should encourage insurance of defense costs. The first and more often used is that by encouraging all people to pay the premiums, the cost to each individual...