COMPARATIVE ANALYSIS OF ECONOMIC DAMAGES IN PERSONAL INJURY CASES IN THE UNITED STATES AND AUSTRALIA
James R. Eck
Professor of Insurance
Washburn University
Topeka, Kansas 66621
Personal injury liability insurance has been a problem in the
United States for more than two decades. The degree of severity has
varied over the years with it reaching crisis proportions on some
occasions. In recent years the symptoms of the problem appear to be
somewhat less severe but the underlying problems continue to exist.
In Australia such liability insurance has not been a major concern
over the same time period but it now appears to be evolving into a
more serious problem. Is this seemingly reversal of conditions
simply a matter of evolution? Is the problem in Australia to run
the same course over the next 20 years as it did in the United
States, or are there basic differences which exist within the two
countries which will prevent a recurrence of the American problem?
There are numerous differences which exist between the two
countries which might allow Australia to escape the problem which
have been faced in the United States. These would include the
differences in the social programs in the two countries; the
providing of certain types of insurance protection in the U.S. by traditional insurance companies; the methods employed in estimating
economic loss; the collateral source rule; the contingent fee
system versus the loser pays system for compensation of lawyers;
and attitudes.
DIFFERENCES IN SOCIAL PROGRAMS
At the present time the United States does not have a national
health program similar to that which exists in Australia. It is
often said that one of the reasons for litigation being more common
in the U.S. is the lack of such social programs. In Australia
virtually everyone has access to the public health care from both
medical providers and hospitals. While the basic health insurance
provided by the government is not all inclusive it does provide for
the basics. Supplemental insurance is available but it is now
subscribed to by less than half of the population because of the
increasing cost of such additional protection.
While there is no government sponsored health insurance
available in the U.S., the vast majority of the population is
covered by private health insurance. Approximately 80 to 85 percent
of the people have such private insurance, but, this figure is
misleading. Many of the persons with private health insurance are
underinsured. Someone with a health insurance policy which contains
a maximum benefit of $20,000 is considered to be insured, but this
minimal amount of coverage is obviously inadequate in most cases
involving personal injury. The demographics also distort the
statistics, 98 percent of the people age 45 to 64 with family income of $50,000 or more are insured, while only 57 percent of the
people aged 18 to 44 with family income between $5,000 and $10,000
are insured. These persons in the lower income group are probably
covered by a government insurance program.
While almost everyone in the U.S. is covered for health care,
the protection is often inadequate. In Australia everyone is
covered, and while the majority may not have all of the
supplemental coverage, they all have their basic needs provided. If
the medical expenses of an individual are covered by insurance,
either public or private, there is no need to resort to litigation
to be reimbursed for these expenses. In Australia it is not
necessary to sue the defendant for such reimbursement, while in the
U.S. such action is often the only way the injured person might
have the medical expenses paid.
PROVIDERS OF MEDICAL PROFESSIONAL LIABILITY PROTECTION
Medical professional liability protection in the United States
had previously been provided by the traditional casualty companies.
In the past decade there has been an increase in the market share
held by the direct writers, these insurers now account for slightly
more than one half of the total premium volume. In Australia the
protection is provided by the defense unions rather than by
insurance companies. It appears that the legal expenses are higher
with the defense unions than with the insurers in the U.S. The
defense unions allocate 36 percent of the combined loss and loss
adjustment expenses to legal expenses, while the U.S. carriers allocate only 30 percent. The administrative expenses of the
defense unions are also higher than those of the insurance
companies. The result is approximately one half of the premium
dollar goes to the claimant in the U.S. with only about 40 percent
going to the claimant with the defense unions. From these facts it
does not appear that the efficiency of the defense union is the
reason for the lower cost of medical malpractice in Australia.
While the defense and administrative costs are higher relative
to indemnity payments in Australia than the U.S., this may result
in, or be the result of, lower settlements and awards. Perhaps if
the insurance companies in the U.S. were to resist the claims more
vigorously, the total payout would be reduced. It is not possible
to determine what the impact would be on the total cost of medical
professional liability insurance.
ESTIMATING ECONOMIC LOSS
In the U.S. the estimate of damages is typically performed by an
academic economist and the analysis is usually based on economic
theory. In Australia the analysis is typically performed by an
actuary or an accountant in private practice and economic theory is
disregarded, a system which is mandated by the courts is employed.
A simplified example will illustrate the differences. To estimate
the economic loss it is necessary to discount the lost future
earnings and future medical expenses to the present, that is,
determine the present value of these future flows of funds. In the
U.S. the before income tax discount rate is usually between 1.5 and 2.5 percent. This rate is based on the spread between the rate of
inflation and the rate of interest which may be earned on a "risk-free" investment. The spread is determined by the historic
relationship between these two rates. In Australia the court
mandated after tax discount rate is 3.0 percent. This mandated rate
is not based on any historic or projected future relationship. It
was established more than a decade ago to expedite matters and to
minimize the magnitude of awards. It is not possible in Australia
to obtain a real after tax return of 3.0 percent without assuming
a substantial degree of risk. The real after tax return on "risk-free" investment is zero, or negative, in Australia just as it is
in the U.S.
A second difference between the two countries is the expected
retirement age. The U.S. "normal" retirement age is 65, with
younger persons it is age 67. In Australia the "normal" retirement
age is 55. This difference may make a substantial difference in
the resulting estimate of damages, especially for the middle aged
person.
To illustrate, assume the 40 year old claimant is permanently
and totally disabled and was earning $40,000 annually at the time
of injury, further assume the after tax income in Australia would
be $28,000. The present value of the lost pretax income in the
U.S., employing a 2.0 percent discount rate, would be $780,938. The
present value of the after tax income in Australia, employing a 3.0
percent discount rate, would be $334,262. The Australian
methodology results in a 57 percent reduction in the present value of the lost income.
If there were medical expenses the discount rate would probably
be negative, depending on the composition of the medical expenses.
The overall cost of medical care has increased at a rate much
greater than the rate of inflation, with some of the components of
the medical care index greater than the inflation rate and others
less than the inflation rate. For the sake of simplicity it will
be assumed that the expected rate of increase of this particular
composition of medical expenses will not increase as rapidly as the
overall cost of medical care, and the resulting net discount rate
will be zero rather than negative. It is further assumed that the
individual will have a life expectancy of 35 years, and the medical
expenses are $50,000 this year. The present value of the medical
expenses in the U.S. would be $1,750,000, in Australia the estimate
would be $1,074,361. The Australian settlement for medical expenses
would be 38 percent less than in the U.S. The total settlement in
the U.S., excluding pain and suffering, would be $2,530,938, in
Australia it would be $1,408,623. The U.S. settlement being 80
percent greater than the Australian settlement. This is assuming
that the injured person will be reimbursed for the total medical
expense in both countries. In Australia much of the medical care
would probably be provided by the national health program. If all
of the medical care was provided at no additional cost to the
injured person the total loss in Australia would be $334,262 versus
$2,530,938 in the U.S. The settlement in the U.S. would be 7.5 time
the award in Australia.
THE COLLATERAL SOURCE RULE
The collateral source rule has been in effect in the United
States but is being repealed in many states, such a rule does not
officially exist in Australia. With a collateral source rule it is
not possible to consider recovery from collateral sources such as
medical insurance, disability income protection, or life insurance.
This allows the insured to collect more than once for the same
damages more than, and receive a windfall profit. This situation
not only increases the magnitude of the settlements and awards, it
also probably increases the number of cases filed. If persons are
unable to collect twice for the same injury, and they have already
had their medical expenses paid by the health insurer, there would
be less reason to file a claim against the negligent provider. In
Australia it is not legally possible for the injured person to have
the medical expenses paid by insurance and then recover from the
liability carrier. While it is not legal to do so, it has been
fairly common for such double collection to occur in the past. At
the present time it appears that there is an attempt to police this
area and reduce the illegal activity. It is impossible to prevent
such activity especially when the case is settled out of court. The
out of court settlement will often be in the form of a lump sum
payment with no itemization of the expenses included in the
settlement. If the settlement does not specify that a certain
portion of the payment is for medical expenses it is not possible
to prevent the double collection.
CONTINGENT FEE SYSTEM
One of the major differences between the U.S. and Australia is
the procedure for payment of legal expenses. In the U.S. the
contingent fee system is in place, in Australia the "loser pays"
rule is in place. In Australia the party which loses the case is to
pay the legal expenses of both sides. In theory this is correct,
but in practice the defendant pays the legal expenses in almost all
cases. It is estimated that approximately one half of the personal
injury cases in Australia are dropped by the plaintiff at an early
stage of the case. In these instances each side will pay what ever
expenses have been incurred, usually at this stage the expenses are
minor. Approximately 45 percent of the cases are settled with the
defendant making a payment to the plaintiff which would include the
legal fees. Of the remaining five percent of the cases the
plaintiff will win one case with the defendant paying the legal
expenses for both sides. The final four percent of the cases are
won by the defendant, but virtually all of these cases are legal
aid cases and the defendant will pay its own expenses even though
they won the case. It appears that the loser pays rule does not
reduce the legal expenses for the defendant, the savings arise from
the decrease in the number of cases filed. The plaintiff knows that
if the defendant wins the case they will be required to pay all of
the legal expenses which could amount to several hundred thousand
dollars. This is a tremendous risk to assume and one which will be
accepted only if the plaintiff is certain of success. This rule, in
effect, erects a barrier to the legal system for the middle class, the poor person may file suit through legal aid and not risk the
payment of the legal expenses, the wealthy person can afford to pay
the legal expenses if the defendant wins, the middle class person
does not qualify for legal aid, they can not afford to pay the
expenses if they lose, so they drop the case before the legal costs
become unbearable.
While the loser pays rule will reduce the number of legitimate
cases, the contingent fee system will not necessarily increase the
number of frivolous cases. Personal injury cases are extremely
expensive, and a lawyer will not incur this expense if there is not
a high probability of collection. With the contingent fee system
the marginal cases will not be filed, nor will cases which will
result in a small settlement.
ATTITUDES OF THE PUBLIC
The final difference to be discussed is the difference in the
attitudes between the Americans and the Australians. In the U.S.
the people are more litigious, if they are injured they immediately
attempt to decide if there is anyone they can sue. In Australia the
feeling is the opposite, they do not believe that someone should
have to pay for their injury if it was an accident. Why should the
negligent person have to pay, there was no intent to cause an
injury. This attitude appears to result, at least in part, from the
social programs. The Australian expects the government to care for
them if there is a problem, it is the duty of the government not
the duty of their fellow man.
CONCLUSIONS
The cost of liability insurance is higher in the U.S. than in
Australia for several reasons. It appears that fewer claims are
filed in Australia because the injured person may receive health
care at no additional cost without resorting to the legal system as
is perceived to be the only solution in the U.S. The dependence on
these social programs appears to have developed an attitude which
is to rely on the government and not to expect a negligent party to
pay. The collateral source rule has probably increased the number
of claims filed in the U.S., while it is not legal to collect twice
in Australia, it is usually not possible to prevent such a practice
when the case is settled out of court. Virtually all of the
payments of indemnity involve out-of-court settlements, so absence
of a collateral source rule in Australia has probably not had a
major impact on the cost, at least not in the past. A larger
portion of the premium dollar goes to defense costs in Australia
but this could be the result of lower claims, it could be the cause
of lower claims, or it could be the sign of inefficiency on the
part of the defense unions.
While all of these factors have an impact on the cost, it
appears that the major differences between the two countries are
the contingent fee system of paying the lawyer, and the method
employed in estimating the economic loss. The contingent fee system
does not necessarily result in unwarranted cases being filed, but
the loser pays rule results in legitimate cases not being filed.
This barrier to the legal system does reduce the cost of liability insurance, but it does so at the expense of the innocent injured
member of the middle class.
The other major difference is the method employed in estimating
economic damages. In the U.S. the calculation is performed with the
goal of indemnifying the injured person, in Australia the goal is
to expedite the case and to minimize the cost of professional
liability insurance. This is a major cause of the difference in the
magnitude of the awards between the U.S. and Australia.
If it is possible to maintain the unrealistic mandated discount
rate, maintain the barrier to the legal system, and maintain the
aversion to litigation, the cost of liability insurance in
Australia should never reach the levels which have been seen in the
United States.
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