With a Republican in the White House and Republicans controlling both houses of Congress, prospects looked bright earlier this year for property/casualty insurers to achieve long-sought reforms of the civil-justice system. President Bush had made tort reform a major plank of his legislative agenda, and three bills—on medical-malpractice liability, class actions, and asbestos litigation—had received the approval of the Senate Judiciary Committee. But after a vigorous counterattack by trial-lawyer groups and organized labor, it now appears that only the class-action legislation has a clear chance of passage.
Still, insurance executives like Jeff Post, president and CEO of Fireman's Fund Insurance Co., are sanguine despite the apparent setbacks. "The issue is now out in the open, and the American public is aware of the injustices of a system that, in the case of asbestos liability, rewards people who manifest no illnesses to the financial detriment of those who are truly sick," says Post, a former CFO of the Novato, California-based insurer with $12 billion in assets and $4.3 billion in annual gross premiums.
Post believes Congress eventually will pass tort reforms because the economy depends upon insurance to grease the wheels of industry. "Without tort reforms, the insurance industry will cease to exist in this country," he says. "The industry will simply disappear."
Already, he says, several old-guard insurance companies are ailing or have failed under the weight of asbestos, environmental, and other liability losses, among them Reliance Insurance and Kemper Insurance. Meanwhile, many other insurers have curtailed their underwriting of liability lines, such as The St. Paul Cos., which stopped underwriting medical-malpractice insurance. "I was a medical-malpractice actuary at St. Paul in the 1980s and '90s, and this line of business was our financial bread and butter," says Post.
It's not far-fetched to imagine insurers of other lines—from directors' and officers' (D&O) liability to workers' compensation—following a similar path. But more problematic are the insurers that have been forced to curtail underwriting. In the 18 months ending in June, in fact, 44 insurance companies had been put under regulatory supervision or placed in liquidation by regulators, according to A.M. Best Co. The Oldwick, New Jerseybased rating agency says insurer-insolvency rates are at their highest level in 10 years—the industry failure rate was 1.03 percent in 2002 compared with 0.23 percent in 1999. Standard & Poor's confirms the trend, downgrading the ratings of close to 30 insurers this year.
The problem, say rating agencies, is that insurers have not reserved enough cash to pay for past losses—particularly claims from asbestos and environmental litigation. The result, according to A.M. Best estimates, is that the industry is short some $80 billion. And the solution, insurers believe, is to temper rising jury awards in liability cases, arguing that it will stabilize more players and lead to lower premiums for buyers.
"When it comes to liability lines like D&O, product liability, or medical malpractice, our cost is essentially the cost of verdicts and settlements," explains John J. Degnan, vice chairman of The Chubb Corp., a Warren, New Jersey-based insurer with $9 billion in net premiums written and $9 billion in revenues. "It is the fear and reality of outrageous liability judgments that has contributed to the dramatic escalation in insurance prices. If we can get the system fixed, we can more-predictably and more-appropriately price our products."
Just how expensive is America's tort system? According to a study released earlier this year by TillinghastTowers Perrin, total tort costs exceed $200 billion annually—more than 2 percent of the country's gross domestic product. That percentage has proven to be significantly higher than in any other developed nation, maintains the New York-based consultancy. And of the $200 billion, 19 percent—almost $40 billion—goes to the plaintiffs' attorneys.
But that's just money. In the case of asbestos litigation, insurers argue that thousands of plaintiffs who have no demonstrable illness are receiving payments, while those in the late stages of mesothelioma are given crumbs from the pie. The Manville Personal Injury Settlement Trust, a fund set up in the 1980s to pay claims on behalf of former asbestos manufacturer Johns-Manville Corp., estimates that 91 percent of the claims it received in 2002 were for nonmalignant asbestos cases, not for cancer cases. Those claims have received as much as 76 percent of the trust's funds. "Asbestos is the poster child for the abuse of the tort system," says Julie Rochman, senior vice president of public affairs at the American Insurance Association, in Washington, D.C.
The AIA and other insurance interests were hopeful that the asbestos litigation reform bill, S.1125 (sponsored by Sen. Orrin G. Hatch, R-Utah), would make it through to President Bush's desk intact. But the bill, which would create an administrative mechanism to enable companies to compensate asbestos victims, was "made worse" in markup, and is now "politically trapped," says Rochman.
Others agree the asbestos bill as it came out of the Judiciary Committee would not receive the 60 votes needed in the Senate to achieve cloture and avoid a bill-busting filibuster, and must be reformulated to have a chance of getting to the floor. "There were four promises in the bill that are effectively missing in the current legislation," explains Rochman. "They include an exclusive remedy that would take these cases out of the tort system entirely, certainty as to who would receive payments, finality in the amount claimants are paid, and fair allocation of resources—the amounts that defendant companies and their insurers must set aside to provide compensation." Without those, she says, "the bill would actually make things worse for insurers."
Chubb's Degnan concurs the bill as it now stands is poor. "It doesn't take attorneys' fees out of the system, doesn't achieve finality, and reverts cases back to the tort system on a number of contingencies," he says.
The bill, however, is not dead. An 11th hour proposal by Senate Republican leader William Frist (Tenn.) calls for a nearly $114 billion asbestos trust fund for victims, in which defendant manufacturers would pay $67 billion and insurers $46 billion—$1 billion more than they agreed to originally. While insurers balked at the extra cost, they indicated their willingness to back it if Frist ensured finality; that is, no additional contingency funding beyond this baseline. He agreed to these terms, and both groups gave their support.
As CFO went to press, Frist was in the thick of meetings with labor groups to obtain their much-needed support to bring the bill to a vote. "The big hurdle remains labor and the trial lawyers," says Robert Hartwig, chief economist at the New Yorkbased Insurance Information Institute. "Labor does have a sympathetic ear to this, since they've seen thousands of union members lose their jobs as companies impaired by asbestos go out of business. But they may not budge on the loss of contingency funding. As for the trial lawyers, they have no vested interests and won't support asbestos liability in any form."
Meanwhile, medical-malpractice reform has run out of chances. Although legislation passed the House of Representatives, a Senate version (S.11, the Patients First Act of 2003), which like the House bill calls for a $250,000 cap on noneconomic damages in medical-malpractice claims, was blocked by a filibuster and stalled. Although both bills stipulated that patients harmed by a doctor's negligence would receive 100 percent compensation for their economic losses, the damages cap did in the Senate version. "The cap became a significant impediment and was strenuously opposed by labor groups and the trial attorneys," says Paul Smith, executive vice president at Willis Group Holdings.
Hartwig concedes that federal malpractice-liability reform is "currently dead in the water. We are, however, seeing significant reforms enacted in individual states. West Virginia, Arkansas, and Idaho have passed noneconomic caps over the loud objections of the trial bar. It shows that when it's doctors versus lawyers, in some states doctors win."
Rochman, for one, expects medical-malpractice reform to be revived nationally next year. "It's an appealing campaign issue," she says, "and the President has put some White House clout behind the bill." Rochman is also hopeful that the U.S. Supreme Court's April decision to disallow a $145 million punitive-damages award against State Farm Mutual Automobile Insurance Co. will provide ammunition to impose noneconomic caps in other liability arenas. "We're getting to the point where as a society we're realizing there is a limited amount of resources going around, and we have to draw distinctions and prioritize who is worthy of compensation," she says.
Head of the Class
The industry's one bright hope for federal tort reform is class-action legislation, which passed the House of Representatives in June. A similar version of the so-called Class Action Fairness Act, which would make it easier to get class actions into federal courts, where judges often put the interests of the class members ahead of those of trial lawyers, is now in the Senate.
"This is the one with the best chance of passing at the federal level," says Hartwig. "Among other things, the bill would reduce the abusive practice of forum shopping, where plaintiffs' attorneys form classes of individuals with dubious injuries who have essentially suffered no economic damage and find a sympathetic venue that is likely to hear the case and grant in favor of the plaintiffs. While class actions make sense intuitively, they have been perverted by the trial bar to the point where they do more harm than good. The lawyers often rake in millions, while the class members receive coupons for products or a couple dollars and change."
Plaintiffs' attorneys bristle at such charges. "The civil-justice system in the United States...not only is laudatory, it's the envy of the world," asserts David Boone, past president of the Georgia Trial Lawyers Association and a partner at Boone & Stone, in Atlanta, who adds that "we must have an unfettered system for holding wrongdoers responsible and accountable for their actions. If that results in higher insurance premiums, then that should serve as an incentive for companies to make their products safer and for doctors to be more careful."
Even some high-ranking insurance executives agree that victims must not be shoved aside in the zeal to effect meaningful civil-justice reforms. "I've been a runner for 28 years, and if I were to be hit by a car and require the amputation of my leg, I would not want my case to be limited to my economic losses and $250,000 for pain and suffering," says Dennis Connolly, a managing director at Marsh Inc. "The pain and suffering may not be that severe physically...but in terms of the emotional impact, well, my whole life would change."
As insurers pack up their lobbying kit, Chubb's Degnan is pessimistic that tort reform will receive the same attention in the future. "Next year is a Presidential election year, and that is unlikely to produce any controversial legislation," he says. "It's either this year or maybe 2005."
But Post of Fireman's Fund says tort reform will not fade away. "Some people believe the industry had a rare window of opportunity to effect reform this year, and that window is either shutting or has closed," he says. "I'm not among them. Insurance is the oil for the engine of this economy. If more insurers pull up stakes or go out of business, the oil drains out and the economy sputters. My sense is that the American public, as it becomes more apprised of the legal system's inequities, will insist on a system that provides appropriate financial recourse to victims, does not impose undue burden on corporations and insurers, and limits the transactional costs involved."
Russ Banham is a contributing editor of CFO.
Where the tort dollar goes.
% of Tort Dollar
|Awards for noneconomic loss||24%|
|Awards for economic loss||22%|
|Claimants' attorney fees||19%|
|Source: Tillinghast-Towers Perrin|