State legislatures are still passing tort reforms, but survival in the courts is another matter. Will US tort reforms ultimately help insurers and reinsurers? Mindy Pollack, with assistance from William P. Walsh and Christopher L. Gallagher, discusses recent tort reform developments and their impact on the industry.

Once I reviewed a professional liability account in a state where tort reforms had just been enacted. The new law imposed caps on non-economic damages, and the discussion between reinsurer and client centered on how - or if - those damage limitations would affect insurance rates. Policyholders expected immediate relief. The insurer, aware that previous reforms had been invalidated in the courts, gave the new version no more than a 50-50 chance of surviving the certain challenge. The insurer opted to postpone major changes until the state high court ruled; two years later the law was held unconstitutional.

Tort reform scenes like this one are playing out across the states to varying laws and judicial outcomes. Punitive damage proposals languish in Alabama legislative committees; the Florida governor vetoed a bill modifying joint and several liability. The Illinois comprehensive tort reform measure became law only to be overturned by the state supreme court; Florida medical malpractice legislation survived judicial scrutiny and remains the law of that state. The proposals range from broad liability and damage reforms to single issue solutions, and all combinations in between. Relatively few become and stay enforceable laws.

This diversity of state reforms and uncertainty of outcome may be frustrating to companies unfamiliar with the US legal system, but we see several positive trends in the confusion. First, the tort reform movement is alive and well in the states, where bills are introduced and passed almost every day. Second, many of the enacted reforms contain strong provisions, like damage caps, that revamp the tort regime; legal challenges should be expected and in a way confirm how far reaching some reforms are. Finally, rather than concede defeat after reforms lose in the courts, state lawmakers are responding with new and better proposals. The health of tort reform is good, and occasional legislative and judicial setbacks have not weakened its pulse.

The challenge for insurers and reinsurers is factoring new tort reforms into today's business decisions. Companies should know the content and status of legislation and judicial challenges, and then put this information into the context of past reform history and political realities. Even when armed with this intelligence, underwriters find it difficult to quantify the benefits of reform and risky to do so before the highest court has had its say. We provide a snapshot of this moving target, with some constant underwriting insights on how tort reforms affect the insurance industry.

Different reforms, different results

Tort reforms come in all sizes and packages, and the exact content is important to evaluating its prospects for survival and impact on insurance. A state may aim reform at a single problem or line of business, like a release from recreational liability for inherent risks or immunity for volunteer health workers. In some cases the legislation focuses on one broad issue, like joint and several liability, but legislators may also sweep a wide range of changes into one comprehensive package that rewrites the entire area of law. New standards and limits for compensatory and punitive damages are examples of such dramatic changes.

For an overall picture, consider that from 1986-1996, just about every state passed at least one type of tort reform. During this time, 34 states restricted or eliminated joint and several liability; 10 enacted caps on non-economic damages and 31 limited punitive damages; 21 reduced compensatory awards by collateral sources; and an equally large number addressed prejudgment interest, comparative fault or product liability defenses. In the medical malpractice arena, 19 passed caps on non-economic damages, and a few were repeats after the first reform was declared unconstitutional.

Damage caps provide a revealing study of the variety in reforms and vagaries of the legal process. As of mid-1998, caps on non-economic damages had been passed in 13 states. No two are exactly alike; these dollar limitations on "pain and suffering" recoveries range from $250,000 on up to $1 million in cases of serious injury or circumstances justifying the higher figure. The supreme courts in 5 of these states struck down the laws on one or more constitutional grounds, including due process, right to trial by jury and equal protection. Illinois was the most recent state to lose its reforms, but Alabama, Florida, New Hampshire and Washington experienced the same defeat. Of the eight damage cap states still valid, Ohio law is now before the state high court and we expect the recently enacted Alaska package to reach that level, too.

There is a connection between the scope of the law and judicial outcome. More focused tort reforms tend to fare better in legislatures and courts than broader reforms, because the problems are often well documented and tied to the specific fixes. Medical malpractice and punitive damage limitations are more common than general damage caps; 23 medical malpractice damage caps have passed and 18 are still in effect, including the older California and Indiana laws. A more fundamental explanation is that comprehensive laws garner more trial lawyer opposition and legal challenge. In the end, all reforms are susceptible to attack and defeat.

Clearly "tort reform" has many meanings and outcomes. The significance of any reform depends on how the law - be it punitive damage caps, shorter statutes of repose in product liability suits or certificates of merit for professional liability claims - affects the class of risks and territory of the particular insurer. There seems to be a tort reform for just about every type of risk, a few of which overcome the obstacles on the way to enactment and enforcement.

Reading the legal fine print

An insurer spotting favorable tort reform must read beyond the headlines before acting on first impressions. Each unique tort reform holds small details that can make a big difference. The Maryland volunteer protection law passed last year applies only to professional engineers who, at the request of the state, assist at the scene of an emergency or disaster; the Arkansas volunteer statute of 1997 grants immunity only to physicians providing services in low-cost medical clinics. The scope of the law determines its value to insurers, so the fine print cannot be ignored.

Damage caps in Alaska provide a good example of how details, particularly exceptions, can shape the benefit for a large class of risks. First, the comprehensive reform measure contains two different caps on damages. Punitive damages are limited to the greater of three times compensatory damages or $500,000; in contrast, non-economic damages are capped at the greater of $400,000 or the injured person's life expectancy in years multiplied by $8,000. The law confirms the importance of reading all exceptions in the law. In the case of severe permanent impairment or disfigurement, the non-economic damage cap jumps up to $1 million and the multiplier is more than three-fold higher. Similarly, caps and multipliers are higher for punitive damages when the defendant's action is motivated by financial gain. Finally, in the case of employment suits, a completely different set of punitive caps is based on employer size.

State laws may except an entire class of risks from the scope of all reforms. The 1995 New Jersey reform law caps punitive damages at the greater of two times compensatory damages or $250,000, but exempts various employment, sexual abuse and drunk driving claims. Nevada punitive caps do not apply to product liability, insurer bad faith or environmental claims, among others. In many municipal liability reforms, caps are waived or disappear when the policyholder purchases insurance coverage. There are often good reasons for "carve outs" within tort reform laws; the only point is that insurers should know the details relevant to the auto, municipal, general or specialist lines they write.

Even after laws are upheld, the courts have a powerful influence on reforms by how broadly or narrowly they interpret the provisions and insurers need to read the judicial fine print in legal opinions. California appellate courts have been asked whether blood banks, research laboratories, nursing homes and other entities fall within the definition of health care providers under the "MICRA" medical malpractice damage caps. The answers hinge on exact wording of the statutes and legislative intent; blood banks meet the California definition but fall outside the medical malpractice laws and caps in Florida and Wisconsin. Even well-worded statutes like MICRA have their share of questions and case law.

Any change in the composition of the state legislature or appellate courts can turn around the most established tort reforms. It may only take one new judge on a state supreme court to alter an interpretation of the law or its chances for surviving constitutional attack; a shift of legislative control at the state or federal level can spell repeal or reduction of prior tort reforms. The point is that the fine print of laws and court rulings is not static, and insurers must keep attuned to the broad political scene as well as the little details when tort reforms are a part of their business plans.

A tale of two states

The most instructive tort reform dramas played out in two crucial insurance states - Florida and Illinois - to very different results. Each state provides its own lessons in predicting tort reform outcomes and insurance effects that can be applied to any other state laws.

Florida. In response to the insurance and liability crisis of the mid-1980s, the Florida legislature enacted a comprehensive reform package in 1986 that capped non-economic as well as punitive damages and limited joint and several liability, subject to a 1992 sunset date. The Insurance Department issued complementary rate regulations freezing and later reducing insurance premiums to their low 1984 levels. The statutory scheme was challenged almost immediately and the most pivotal part - the non-economic damage cap - was declared unconstitutional in Smith v Department of Insurance, 507 So.2d 1080 (Fla. 1987), leaving the joint liability and other provisions in effect. With an insurance crisis still underway and public support behind them, Florida lawmakers took another but more targeted run at tort reform. A highly visible Florida Academic Task appointed by the legislature to study reform options held numerous hearings and ultimately recommended a broad medical malpractice reform law with new damage caps. To overcome constitutional "right to court access" infirmities in the first cap, a lower damage limit applied where both parties agree to a no-fault arbitration but a higher limit was available should they proceed to trial without no-fault benefits. The medical malpractice regime was challenged, but seven years and a different law later, the Florida Supreme Court upheld the statute. University of Miami v Echarte, 618 So.2d 189 (Fla. 1993). Even with punitive damage caps and other early reforms remaining in place, along with the medical malpractice limitations, the tort reform movement is still active. This year the legislature passed bills to prohibit multiple punitive damage awards, further limit joint and several liability and establish a 12 year statute of repose on product defect suits, but Governor Chiles vetoed the package. If a Republican governor is elected in the fall to join a currently Republican legislature, a different outcome is likely.

Illinois. Before the 1980s liability crisis were medical malpractice and product liability problems of the 1970s, which spawned an Illinois medical malpractice statute later declared unconstitutional. Fast forward to 1995, when Illinois revisited tort reform to enact one of the most sweeping packages of any state. The Illinois Civil Justice Reform Amendments capped non-economic damages, abolished joint liability in most tort actions and limited punitive damages, for starters. In late 1997, the state supreme court invalidated the entire statute because its major provisions - the damage cap, for one - failed state constitutional tests for separation of powers and special legislation. According to the court, the tort reform statute contained arbitrary classifications that had no reasonable connection to the stated legislative goals. Best v Taylor Machine Works, 1997 WL 777822 (Ill. Dec. 18, 1997). For example, a flat cap affected severely injured people more than slightly injured ones unlikely to trigger the limit, and greater ease of damage calculations did not justify this disparity. In the decade between failure of the medical and general damage caps, Illinois appellate courts upheld a dram shop liability statute and very low $40,000 cap. Stevens v Lou's Lemon Tree, 543 N.E.2d 293 (Ill. App. 1989). The different result can be explained by the fact that the legislature created alcohol server liability and hence can limit the remedy in any way it chooses; in contrast, common law tort rights merit constitutional protection. We do not foresee another round of tort reform in Illinois for some time but wonder if the experience will influence Ohio events. The 1996 Ohio tort reform laws are now before the state supreme court, which only four years ago struck down key portions of a landmark 1987 tort reform law. The Ohio legislature bolstered the new law with citations to successful reforms. Will it be enough?

Many would prefer more unified federal tort reform but years of product liability and more recently health reform effort have generated more press than results. As with state legislation, more narrowly focused federal proposals have emerged from committees and the White House while broader reforms have not; product liability measures aimed at aircraft manufacturers are now law while general product liability reform bills have failed repeatedly. Compromise proposals may win enough support to pass but often lack meaningful reform. The current product liability proposal has been watered down to appease opponents and lost some insurance industry backers as a result. Absent a strong Republican alignment in Washington, significant tort reform is likely to remain a state affair.

Risk Capital Re's perspective

There are many insurance lessons learned from watching tort reforms and working through the aftermath. Each insurer has its own views and reactions. As our underwriters have considerable insurance and reinsurance experience, these observations tend to cut across several types of reforms and lines of business. My perspective is shaped by years as a lobbyist and claim manager. A few thoughts:

* An insider view is worth a thousand outside opinions. Scan the news reports and draft legislation for the lay of the land, but then call the insurance industry trade association representative in that state for the reality check. I recall one lobbying experience where a bill had all the earmarks of success - easy passage in the insurance committees and the Governor's support - but the senator chairing the Rules Committee killed the measure. Only the local industry lobbyists predicted this result; call them.

* In predicting which caps will withstand judicial challenge, place your bets on limitations with inflationary adjustments rather than fixed dollar amounts. RCRe underwriter Bill Walsh would rather see upward adjustable caps that retain fairness and flexibility. A permanent dollar cap may seem ridiculously low in five or 10 years, making it more susceptible to repeal or overturn.

* Be prepared for substantial rate rollbacks after major reforms. While rate changes may ultimately be justified, the dilemma for insurers is that rollbacks can be implemented before the courts have approved the laws and always before loss experience has emerged. Mr Walsh notes that the worst possible scenario is significant rate rollback with tort law later invalidated.

* Damage caps present rating challenges, particularly for insurers writing general lines on a national basis. Bill Walsh asks how a regional umbrella writer can quantify an Ohio cap in rates drawn from multistate experience. The lesson here is that insurers cannot always generate more accurate rates than regulators. The difficulty is greater for reforms like abolition of joint liability. From our underwriting and claim perspectives, Mr Walsh and I doubt that insurers capture any credible joint liability data. Waiting for experience under the new law may be an "insurance correct" but not "politically correct" answer.

* In workers' compensation and other lines where reforms are more closely linked to rates, insurers may still find that experience modification calculations are problematic. RCRe underwriter Chris Gallagher suggests that carriers are as likely to underestimate the impact of reforms as overreact to them. Any imbalance is soon corrected by new entrants attracted to a favorable rate environment, so much so that the rates are often driven below levels supported by reform. Timing is almost everything.

Both Mr Walsh and Mr Gallagher conclude that time can work for or against insurers acting on tort reforms, but that knowledge plays a larger role. The insurer most informed about the exact content of tort reform and its prospects for judicial approval is surely the insurer most able to make - and time - the right moves.

William P. Walsh is senior vice president of casualty underwriting at Risk Capital Reinsurance Company in Greenwich, Conn- ecticut, and Christopher L. Gallagher is vice president in that casualty underwriting unit. Mindy Pollack is an attorney and manager, client service and communication, at Risk Capital Re. We express our appreciation to the American Tort Reform Association, an excellent and helpful resource on the tort reform legislation discussed in this article; ATRA is located in Washington, D.C.