A Suggested Role For Collateral Souces Of Indemnification In Tort Reform Legislation

• Author: Manfred H. Ledford
• Position: Is Associate Professor of Finance in the School of Business Administration, University of Miami
• Pages: 05

Manfred H. Ledford, Ph.D. is Associate Professor of Finance in the School of Business Administration, University of Miami, Coral Gables, Florida.

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TORT REFORM HAS RECENTLY BEEN ADDED to the national agenda by President Bush as evidenced by his commitment to raising and discussing the issue in his 2004 re-election campaign. The focus of the discussion, both in the Presidential and Vice-Presidential debates during the fall of 2004, as well as on the stump, was caps on awards for non-economic damages (e.g., pain and suffering, loss of consortium, etc.). The clear purpose of instituting caps is to reduce the financial exposure of business and government entities in potentially large liability claims and, therefore, to reduce general operating expenditures through either the expected concomitant reduction in liability insurance premiums or directly through reduced exposure to retained liability risks and, consequently, making the American economy more competitive in the international arena. The same logic applies to liability insurance premiums for individuals since the less they spend for a given quantity of any economic good, the more of their disposable income there is available for either spending on other economic goods or to devote to saving.

While the debate regarding the limitation of compensation for non-economic damages and implementation of caps is not entirely new (e.g., current caps on pain and suffering awards in medical malpractice actions in California), it does, by the very nature of the issue, tend to be conducted on a subjective level. After all, the emotional feeling of a trier of fact in favor of a plaintiff and against an alleged tortfeasor, or vice versa, most probably controls the reasoning which leads to a decision regarding the amount of an award for general damages. This is clearly a subjective exercise on the part of triers of fact. There is another issue in liability tort cases that, being more objective in nature, should be considered in the tort reform discussion. This is the treatment of collateral sources as offsets for awards of special damages.¹ Collateral sources are payments received by or payable to injured, or allegedly injured, parties in tort actions from third parties that mitigate economic damages claimed by them. Examples of collateral sources in personal injury/wrongful death litigation are income disability insurance policy payments, life insurance proceeds, medical expense and wage loss benefits in personal auto policies under Personal Injury Protection coverage, wage continuation benefits, and workers¥ compensation benefits.

There are others. Nearly half of the 50 states have legislated provisions as part of their respective wrongful death and/or personal injury statutes that allow consideration of at least some types of payments by third party payers to be used as offsets to court awards for special damages in personal injury and wrongful death cases. These provisions are generally referred to as ¥collateral source rules.¥ The sources of payments, past and legally obligated in the future, that are allowed or specifically prohibited by these various statutory provisions reflect no consensus. While most collateral source rules do not allow the trier of fact to consider sources of government transfer payments such as Medicare and Medicaid benefits or benefits paid or payable by third parties that have a legal or mandatory right of subrogation, such as Workers¥ Compensation payments, the other sources of payments that are excluded from consideration by triers of fact vary Page 28 dramatically amongst those states that have enacted collateral source rules. Also, some statutes restrict the use of collateral payments as offsets to damage awards only in certain types of actions.²

One commonly excluded collateral source is proceeds from life insurance policies paid or payable to surviving claimants in wrongful death cases. According to current information published by the National Association of Mutual Insurance Companies, of the twenty four states that have enacted collateral source rules, ten are identified as not allowing the use of life insurance proceeds to offset awards for special damages. 3 This number is at least one greater as while this source does not identify Florida in this group, the Florida statute clearly prohibits the consideration of life insurance proceeds (i.e., Florida Statutes XLV 768.76 (2)(a)2). This prohibition may well apply, at least in case law, in many of the states that have no statutory rule. The prohibition of the use of life insurance proceeds in wrongful death actions and income disability insurance payments in personal injury actions to offset awards for special damages quite likely produces sub-optimal economic results for society in its entirety. Also, as a result of the violation of the principle of indemnity, these prohibitions produce exactly the same result that caps on awards for non-economic damages are argued to eliminate.

In the remainder of this piece, a simple micro-economic model is developed to show that collateral source rules that allow claimants to be over indemnified because of prohibitions regarding the use of un-subrogated insurance benefits as offsets to economic damage awards produce economically inefficient results, with claimants receiving windfalls at the expense of the rest of society. While there are multiple sources of un-subrogated insurance benefits to which the model could be applied, in the interest of simplicity, life insurance benefits are used as the object of analysis. The model is based on the theory of consumer choice and employs the Edgeworth-Bowley box technique.³ The analysis shows the method in...