The price of all forms of liability insurance (insurance that covers homeowners, businesses and motorists when they hurt others) rose dramatically between 1985 and 1987, provoking a furor first among members of the business community and, eventually, among motorists. 1 This so-called “insurance crisis” garnered the attention of lawmakers throughout the nation, spurring many proposals intended to address the perceived causes of the problem.
To understand the origins of the insurance crisis, it is critical to recognize the fundamental shift in the structure of the 250-year-old property/casualty insurance industry. Initially, insurance pools served as a mechanism for mutual risk sharing. Modern insurance companies, however, are financial institutions seeking to maximize profits, just like banks and savings and loans. While the sale of insurance–the underwriting process–is the principal source of revenue for insurance carriers, the income from investing those premiums is the principal source of profits for the industry.
Insurance rates, accordingly, reflect conditions in the financial marketplace as well as the assessment of risk. When interest rates are increasing, investment income from premiums produces a high return. Under such conditions, insurance companies reduce their prices and solicit and underwrite greater risks to attract capital for investment. When interest rates are low, however, and investment yields are correspondingly reduced, the industry increases premiums to maintain profit levels. This is known as the “insurance cycle.” 2
The insurance “crisis” of the mid-1980s corresponded exactly to a trough in this financial cycle. Interest rates reached extraordinary levels in the United States in the early 1980s. 3 Insurance companies responded aggressively, competing for premium revenue to invest by lowering prices, despite, in many instances, clear indications that the risk of a sizable loss warranted higher rates. When interest rates dropped, however, so did the insurance industry’s investment income. Moreover, many insurers found themselves paying costly claims on policies that had been under-priced relative to their risk in order to attract investment capital. To make matters worse, some of the insurers’ hasty investments–in real estate and projects financed by savings and loans–had turned into major debacles. Finally, by 1984, faced with significant financial losses, the industry had only one choice in order to maintain profits: sharply increase premiums. During 1985 and 1986, the cost of liability coverage for businesses, municipal governments, non-profits, and ultimately, motorists, rose rapidly. The industry also reduced the availability of coverage; the resulting shortages further boosted prices.
For industry observers, this “crisis” was hardly unexpected. A leading stock analyst described the process as the “boom and bust nature of the industry . . . as predictable as the tide in a three-year swing from flood to ebb.” 4 A spokesperson for the Professional Insurance Agents, a trade association, stated that “[insurance companies] did not underwrite the business as well as they should have . . . . But it’s very tempting to get the money in today to earn 21% interest and worry about the losses later.” A Washington state task force likewise concluded that the “insurance crisis” was “mostly a result of poor management practices by the [insurance] companies.” A report to the New York Governor’s Advisory Commission on Liability Insurance concluded that “the industry’s poor recent financial condition largely reflects self-inflicted wounds.” 5
Insurance Company Officials Blame the System of Justice
However, when insurance policyholders and, later, elected officials demanded a justification for the rate increases, policy cancellations, and non-renewals, they received an entirely different explanation. The insurance industry insisted that an enormous increase in claims and “excessive” jury verdicts–a “litigation explosion”–was forcing insurers to increase prices. The industry’s solution was “tort reform”: legislative alteration of the common law applicable to negligent or intentional wrongdoing to (1) limit compensation to plaintiffs; (2) tighten pleading, evidentiary, and other procedural requirements in such cases; and (3) reduce the attorneys’ fees that could be negotiated through contingency fee arrangements. The insurance industry and many of its customers, particularly in the business and health care communities, became proponents of “tort reform.”
Insurance company lobbyists argued that such revisions in state tort laws would (1) enable actuaries to better quantify risks for underwriting purposes and (2) limit overall claims payments, thus enabling insurers to lower the price of insurance. Certainly, cutting back compensation paid to victims would reduce insurers’ costs; whether the insurance companies would pass those “savings” on to consumers was another matter. But the most important purpose of the “tort reform” proposals was to provide a scapegoat for the premium hikes imposed by insurance companies.
Business groups supported “tort reform” because of (1) the promised premium reductions and (2) the financial benefits of limiting their own legal accountability for defective products, medical negligence, environmental pollution, and even drunk driving.
Thus, “tort reform” was in the self-interest of insurance companies and many business groups.
Between 1985 and 1987, forty-one states adopted one or more significant changes in their tort laws to limit the rights of injured Americans or, in the case of wrongful deaths, their next of kin. In the context of auto insurance premiums, the preferred tort “reform” was no-fault.
“Tort Reform” Campaigns Exposed as Fraudulent: Studies Show Premiums Did Not Drop
By 1986, however, many investigators and policymakers had begun to raise substantial doubts about the origin of the insurance crisis and the legitimacy of tort reform as the solution. 6 States that had enacted tort reforms had not obtained the promised rate reductions.
A highly damaging indictment of “tort reform” came from the insurance industry itself in April, 1987. The Insurance Services Office (ISO), the industry’s principal data collection and distribution agency, released the results of a study intended to respond to demands from legislators across the country that the industry provide empirical data to support its claims that changes in tort laws would lower insurance premiums. The study examined the responses of 1262 insurance adjusters from nine property-casualty insurance companies and two independent adjusting firms located in 24 states. The adjusters were asked to determine the impact of actual restrictions in the tort laws of 15 of the states on six hypothetical injury cases. In addition, they were asked to judge the impact of similar proposals that did not become law in the remaining nine states. Much to the chagrin of the insurance industry, the ISO report concluded that changes in tort laws would have little, if any, impact upon insurance rates. 7
One insurance industry official stated, “Some state legislators are going to be shaking their heads after hearing us tell them for months how important tort reform is, and now we come out with a study that says the legislation they passed was meaningless.” 8
Another blow to the insurance industry’s campaign came from Florida. Legislation enacted in Florida in the spring of 1986 at the behest of a coalition of insurance companies, medical lobbies, and corporations contained a panoply of restrictions on victims’ tort rights. But the legislation also required insurers to reduce their insurance rates concomitantly, unless they could demonstrate to state regulators that the limitations on consumers’ tort law rights would not reduce their costs. Six months after the law was enacted, two of the nation’s largest insurance companies told the Florida Insurance Department that limiting compensation to injury victims would not reduce insurance rates. 9
St. Paul Fire & Marine Insurance Co., the nation’s largest medical malpractice insurer, and Aetna Casualty & Surety Co. provided an extensive “actuarial analysis” of five legislated limitations on tort law (including a $450,000 cap on non-economic damages and limits on punitive damages awards) that the insurance industry had promised would reduce premiums.
The Aetna report concluded that one provision–reducing compensation to victims by the amount of compensation paid by collateral sources–would reduce rates by a maximum of .04%, while the other tort restrictions would have “no impact” on rates. Aetna asked for a 17% rate increase for its business contractor liability policy based on its analysis of the impact of the law. 10
Insurance Companies’ Profits Increase in Midst of “Crisis”
Perhaps most devastating to the insurance industry’s campaign to restrict legal rights were reports of massive increases in the insurance industry’s profits. They appeared to belie the insurers’ claims that higher premiums were necessary at all.
The insurance industry’s profits grew at a furious pace during the period when insurers had insisted that they were forced to raise premiums in order to cover claims. Profits of the property/casualty industry increased from 2.4% return on net worth in 1985 to 16.0% in 1987–an increase of 567%.11 Between 1975 and 1984, the entire property/casualty insurance industry made a record-breaking profit of $75 billion, yet, due to preferential treatment under federal tax laws, paid no federal income tax, according to the U.S. General Accounting Office. 12
A 1986 analysis prepared by six state Attorneys General reached the following conclusion:
The facts do not bear out the allegations of an “explosion” in litigation or in claim size, nor do they bear out the allegations of a financial disaster suffered by property/casualty insurers today. They finally do not support any correlation between the current crisis in availability and affordability of insurance and such a litigation “explosion.” Instead, the available data indicate that the causes of, and therefore the solutions to, the current crisis lie with the insurance industry itself. 13
In California, where insurance rates blew off the charts in 1985, the insurance industry sponsored a controversial ballot proposition in 1986, to “relieve” the crisis. It restricted compensation for pain and suffering experienced in cases in which there are more than one defendant. In a statement printed in the official state voter pamphlet, an executive of the insurance industry promised that if the measure (Proposition 51) passed, “[l]iability insurance, now virtually impossible to obtain, would again be available to cities and counties,” and that “[p]rivate sector liability insurance premiums could drop 10% to 15%.”14
But the measure did not deliver the premium savings promised. Its failure shifted the focus of insurance reform in California from proposals limiting victims’ tort rights to scrutiny of the practices of the insurance industry itself and the inability of state regulators to ameliorate the destabilizing insurance cycle.
The result was California Proposition 103.
1. For a more detailed description of the events, see The Manufactured Crisis, CONSUMER REP. 51, Aug. 1986, at 544. See also Nancy Nichols, The Manufacturing of a Crisis, THE NATION, Feb.15, 1986, at 173 (discussing the sharp rise in premiums); Premium Increases and Refusals to Deal in the Property/Casualty Insurance Industry: Hearing Before the Judiciary Comm., 99th Cong. 5 (1986) (statement of Jay Angoff, Counsel, National Insurance Consumer Organization) (citing BEST’S INS. MGMT. REP. 31, Dec. 30, 1985, at 9).
2. For more information on the insurance cycle, read: Leonard W. Schroeter & William J. Rutzick, “Tort Reform”–Being an Insurance Company Means Never Having to Say You’re Sorry, 22 GONZ. L. REV. 31 (1986- 87); Robert B. Bienstock et al., Analysis of Liability Insurance Crisis, 1986 INST. OF PUB. LAW, U. N.M. 1.
3. Interest rates of 20% were not uncommon through the early 1980s. See U.S. BUREAU OF THE CENSUS, U.S. DEP’T OF COMMERCE, TABLE NO. 806, STATISTICAL ABSTRACT OF THE UNITED STATES 507 (1992).
4. James Nolan, Investors Light on P/C Firms, J. COM., May 15, 1986, at 14A.
5. The Manufactured Crisis, at 544.
6. For a comprehensive critique of the “litigation crisis” by consumer advocate Ralph Nader, read The Corporate Drive to Restrict Their Victims’ Rights, 22 GONZ. L. REV. 15 (1986-87).
7. See HAMILTON, RABINOVITZ & ALSCHULER, INC., CLAIM EVALUATION PROJECT: NATIONAL OVERVIEW 7 (1997).
8. Robert A. Finlayson, Insurers Fear Reform Foes to Capitalize on ISO Study, BUS. INS., May 18, 1987, at 2.
9. National Ins. Consumer Org., “Tort Reform” a Fraud, Insurers Admit (Oct. 20, 1986) (a news release).
10. Letter from Thomas L. Rudd, Superintendent of Insurance Department Affairs, Commercial Lines, Aetna Casualty & Surety Co., to Bill Gunter, Florida Insurance Commissioner, and Charlie Gray, Chief of Bureau of Policy and Contract Review for the Florida Department of Insurance (Aug. 8, 1986).
11. NATIONAL ASS’N OF INS. COMM’RS (NAIC), REPORT ON PROFITABILITY BY LINE BY STATE 1991 (1992).
12. Profitability of the Property/Casualty Insurance Industry: March 13, 1986: Hearing before the Subcommittee on Oversight of the Committee on Ways and Means, 99th Cong. 4 (1986) (statement of William J. Anderson, Director, General Government Division, U.S. General Accounting Office (GAO)). An October, 1989, GAO report concluded that the industry generated $78 billion in after-tax income from 1978 to 1987. U.S. Gen. Accounting Office, INSURANCE: PROFITABILITY OF THE AUTOMOBILE LINES OF THE INSURANCE INDUSTRY 2 (Oct. 1989).
13. Francis X. Bellotti et al., An Analysis of The Causes of The Current Crisis of Unavailability and Unaffordability of Liability Insurance, 1986 NAT’L ASS’N OF ATT’YS GEN. AD HOC COMM. ON INS. 45.
14. Proposition 51 enacted section 1431 of the California Civil Code, which limited the application of the common law tort doctrine of joint and several liability to awards of compensation for non-economic damages. CALIFORNIA SECRETARY OF STATE, BALLOT PAMPHLET, ARGUMENT IN FAVOR OF PROPOSITION 51, at 34 (1986).