Does Tort Law Reform Help or Hurt Consumers?
15 Pages Posted: 1 Jan 2011
Date Written: November 23, 2010
Legal limits on insurance damage claims have been introduced in Australia, the United States and other jurisdictions. In this article, I construct a simple competitive model to analyse the effect of tort law reforms on consumers. The model shows that reforms to limit non-economic losses make consumers unambiguously worse off ex ante. Although insurance premiums fall and these reductions are passed on to consumers in full, this gain is more than offset by the increased risk that consumers are forced to bear. In contrast, reforms for income-related (i.e. economic) losses lead to ambiguous outcomes. The potential benefits from limits to economic loss arise due to the inability of insurers to price discriminate on the basis of income or expected loss. Because of this, there is an implicit cross subsidy from low- to high-income consumers that is embedded in the insurance premium and relevant product price. Tort law reforms partially unwind this cross subsidy. The results presented in this article show that tort law reforms may achieve their stated goal, such as lowering monetary prices, but can still make consumers worse off by introducing an uninsurable risk. There is also an important difference between reforms that limit claims for economic and non-economic losses. Insurance for economic loss will generally include an implicit cross subsidy and, as a consequence, reforms can alter the ex ante utility for different groups of consumers in different ways.
JEL Classification: K13, K29, L59
Suggested Citation: Suggested Citation