The Collateral Source Rule

One of the more subtle but key underpinnings of the tort law system for compensating people for accidents is the collateral source rule. 

While it is somewhat more involved, the basic idea is that when your own insurance covers you for an injury, for example, for medical bills, or to replace your damaged car or house, or paying you disability payments when you lose income for a period of time, that you can sue for the full amount of the harm without deducting insurance covered losses.

Closely related are the doctrines that say that medical providers have a lien against what you recover in a lawsuit to recover damages that they paid for, and the right of an insurer to bring a lawsuit, called a subrogation claim, against someone whose tortious actions gave rise to the insurance claim to get back what it paid to the insured for that loss, if the insured doesn't sue.

As a practical matter, subrogation claims are uncommon and the lawyers who usually defend insureds who are sued hate bringing them, because the dollar amounts are often modest and they are loss motivated to bring them (and have less of the relevant information in many cases) than an insured who actually suffered the loss.

In substance, a very large share of personal injury and property damage tort cases are cases where the defense lawyers and defense judgment are paid for by one insurance company, and where the medical expenses and property damage claims were mostly paid by another another insurance company or credit extending medical provider with a lien on what was paid for those damages, and where a large share of the non-economic damages awarded go towards paying a contingent fee of the Plaintiff's attorney.

The system provides rough justice, but the benefits of this convoluted system that arises from the collateral source rule, over the system that would evolve without it, are dubious. 

A variety of reforms have been proposed and tried to rework this arrangement, but they're beyond the scope of this post.

Abuse In Orphanages

New Zealand's government is hardly the most corrupt or ill-intentioned in the nation. But there, as is the case almost everywhere, going back to at least as far as the Old Testament, orphans get a raw deal and are frequently abused. 

More than 30% of people in care in New Zealand from 1950 through 2019 were abused and many more were neglected. I suspect that as horrible as this is, that it is worse in many other countries (probably including the U.S.).

The mix of problems in New Zealand is multi-faceted. 

Most children in care were Maori (i.e. indigenous Polynesian), even though New Zealand is currently only about 18% Maori, usually in cases where they were removed from their families, putatively, for abuse or neglect. It is a fair guess that Maori children were also on the receiving end of a disproportionately share of the abuse suffered by children within the system. This has echoes of the notorious residential schools in Canada and the U.S., long ago, in addition to the other issues with abuse in orphanages without ethnic bias and issues of the treatment of indigenous people thrown in.

The culpability of New Zealand’s Catholic, Methodist and Anglican churches is also predictable and has been mirrored in Canada, the U.S., and the U.K., as well as many other places. Partially related is the religious affiliation of Maori people, of whom there are about 1,075,000 in the world (mostly in New Zealand, but with about 1/6th in Australia and about 21,000 elsewhere):

Given the total population, 0.1% corresponds to about 500 to 1500 people, and 0.2% corresponds to about 1500 to 2500 people.

Of course, while this is dismal, surely a large share of children in care in New Zealand genuinely were victims of abuse and neglect before the government stepped in and removed them from their families.

New Zealand deserves credit, at least, for a thorough investigation, for apologizing, and for resolving to take action. It is also worth noting that New Zealand apparently has a "no-fault accident compensation system" that makes sense as basically a more seamless version of a system where everyone has casualty insurance (it is discussed at the end of this post).

More than 200,000 people are estimated to have been abused by state and religious organizations in New Zealand that had been entrusted with their care, according to the final report from a landmark independent inquiry released on Wednesday.

The abuse included sexual assault, electric shocks, chemical restraints, medical experimentation, sterilization, starvation and beatings, said the report from the Royal Commission of Inquiry Into Abuse in Care. Many of the victims were children who had been removed from their families and placed in state, religious or foster care.

“For some people this meant years or even decades of frequent abuse and neglect,” the report said. “For some it was a lifetime; for others it led to an unmarked grave.” . . .

The inquiry, established in 2018 by the New Zealand government, involved interviewing nearly 2,500 survivors as it examined orphanages, foster care systems, mental health facilities and other forms of care that were charged with supporting 655,000 people from 1950 through 2019. The inquiry’s leaders described it as the widest-ranging examination of its kind in the world.

The report noted that most children in care were Indigenous Maori, even though the group makes up a minority of the country’s overall population of five million people, and said that “Maori were often targeted because of their ethnicity.”

Beyond the 200,000 people estimated to have been abused, the report said countless others had suffered neglect. . . .

The inquiry found that even when abuses by government and religious leaders were discovered, the leaders “were rarely held to account for their actions or inactions, which emboldened them to perpetrate further abuse.”

Among the inquiry’s 138 recommendations were calls for public apologies from the pope, the archbishop of Canterbury, and New Zealand’s police commissioner and its top civil servant. It also urged the government to overhaul the country’s no-fault accident compensation program to provide tailored support for survivors of abuse.

The report prompted New Zealand’s Catholic, Methodist and Anglican churches to promise change. “We will ensure that action follows our review of the inquiry’s findings,” Steve Lowe, president of the New Zealand Catholic Bishops Conference, said in a statement. “We owe it to survivors,” the Anglican Church said in another statement.

The report follows decades of complaints from survivors. “Survivors repeatedly called for justice but were unheard, disbelieved, and ignored,” according to the report. “Significant resources have been used to deny survivors their voice and to defend the indefensible. This must stop.”

From the New York Times (July 24, 2024).

The core forward looking recommendations of the report are here and focus on creation of a single national regulatory system for both secular and religious care systems.

National No Fault Accident Compensation

According to an article in a medical journal that is very opposed to the tort system of medical malpractice:

In 1974 New Zealand introduced a publicly-funded accident compensation scheme with the goals of minimising the incidence and impact of injury. 

The scheme provides assistance with the cost of treatment and rehabilitation for all personal injuries, regardless of fault, and in exchange bans suing for compensatory damages. Medical injury has always been covered under the scheme. Consequently, in New Zealand there is no culture of suing doctors for damages and doctors pay comparatively low medical indemnity fees of around £790 per annum. Doctors are held to account under separate processes including the Medical Council of New Zealand’s competence and fitness to practise processes, an independent patient complaints system, and a separate disciplinary process. 

The patient complaints system was introduced in 1994 on recommendation of a 1988 government report that found wanting the prior accountability processes in an environment where patients were unable to sue. In New Zealand, patient complaints are not a demand for financial recompense but a demand that an individual be held to account for perceived wrongdoing. A patient may lodge both a claim for treatment injury compensation and, regardless of injury, a complaint against a practitioner.

Although medical injury has always been covered under the scheme, the compensation of medical injury has not always been without fault for doctors. Prior to 2005, patients could obtain compensation by proving medical error. Because all findings of error were reported to the Medical Council, compensation could bring disciplinary repercussions for doctors. Fear of punishment and/or reputational damage discouraged some doctors (and some patients) from participating in the compensation claims process, unfairly restricting access to compensation for injured patients. This situation was rectified in 2005 under the ‘no-fault’ legislative reforms. The reforms extended eligibility to all injuries caused by treatment and replaced the prior reporting duties with a new duty to report ‘risk of harm to the public’ to the ‘authorities responsible for patient safety’. These changes freed doctors to participate in the compensation claims process with little fear, and improved information flows within the system.

The program explains itself here:

Our no-fault scheme covers everyone, including visitors, who are injured in an accident in Aotearoa New Zealand. It can include events that result in mass casualties, and covers children, beneficiaries, and students. You’re covered if you’re working, unemployed, or retired.

There are some limits to the support we can provide. These limits are set by Parliament, which makes laws about what we can and can’t support.

If you're injured in an accident, make sure you go and see your doctor or health provider first. They can make a claim for you. Claims can be made up to 12 months after your injury. We may still consider claims made after this time if there’s a good reason for the claim not being made sooner. 

What is no-fault cover?

No-fault cover means it doesn't matter what you were doing when you were injured or who was at fault. We'll cover you, as long as the injury falls within our legislation.

The cover we provide helps pay for costs to support your recovery and get you back on your feet. It includes payment towards medical bills, treatment, help at home and work and help with your income. 

Physical injuries we cover

A physical injury is when there is actual damage to your body. This includes: 

• sprains or strains - such as the ankle, back, knee or shoulder sprains
• wounds - cut, broken or bruised skin
• burns
• fractures
• dislocations
• dental injuries
• hearing loss
• concussion and loss of consciousness
• maternal birth injuries which occurred on or after 12:00am on 1 October 2022.

We cover most physical injuries if they're caused by: 

• an accident
• sexual violence

We can cover injuries or conditions that happen over time and are caused by the type of work you do. This is known as gradual process conditions. We have to establish if your work tasks or workplace environment are causing your condition.

We can also cover injuries that are long-term, permanent or that happened at birth. 

Injuries caused by treatment

Sometimes getting treatment can cause an injury. We can cover a treatment injury if: 

• the treatment directly caused your injury
• a registered health professional was treating you
• it's not a normal side-effect of your treatment.

We can also cover injuries caused by treatment for an injury we've already covered. 

Conditions that come on gradually from work

We can cover injuries or conditions that happen over time and are caused by the type of work you do. This could be things like: 

• tendonitis from overusing muscles or heavy lifting
• deafness caused by noise at work
• infections or diseases from exposure to certain environments. 

Serious injuries and disabilities

We can cover injuries that cause long-term effects and disabilities including spinal and traumatic brain injuries (TBI), such as concussion.

Find out how we're working to reduce the number, severity, and impact of TBIs:

Reducing traumatic brain injuries 

Mental injuries we cover

If we accept your claim for a physical injury, we can also cover mental injuries resulting from that injury. For example, post-traumatic stress disorder after a physical assault.

If your physical injury is caused by medical treatment we may also be able to cover a resulting mental injury, even if the physical injury isn’t covered.

We also cover mental injuries if you've experienced, seen or heard a traumatic event at work such as working in a retail shop when a robbery takes place. This is even if you haven't been physically injured. 

Sexual abuse

We provide support for anyone in Aotearoa New Zealand, including visitors to the country, who has experienced sexual abuse and assault. We may also be able to help if you're an Aotearoa New Zealand resident and have experienced sexual abuse while travelling overseas. It doesn't matter if the event happened recently or a long time ago.

If you've experienced sexual abuse, use the Find Support website to see the organisations that have therapists who can support you. This support is fully funded and you can start whenever you're ready. There are also services available for your family.

If you're having trouble getting in touch with the right therapist, contact us. We'll help you to make an appointment. 

Dental injury

We can pay for dental injuries caused by: 

• an accident
• sporting injury
• as a result of medical or dental treatment.

We don’t pay for: 

• damage to your teeth or dentures due to normal wear and tear, eg chewing or biting
• damage to your teeth due to decay or gum disease
• damage to your dentures while you were not wearing them
• treatment that was done by someone that’s not a registered dentist, eg a dental technician.

Your dentist will help you to make a claim if you have an injury we cover.

Injuries causing death

We give financial help if someone dies as a result of: 

• an accident
• a work-related disease or infection
• a treatment injury we're covering
• a self-inflicted injury (in some circumstances). 

Maternal birth injuries

If you have experienced an injury while giving birth on or after 1 October 2022, we may be able to help with your recovery. We have guidance on what's normal and what's not.

This is essentially "no-fault" automobile insurance and worker's compensation on steroids and has a lot to be said for it in some form. The tort system does a poor job of compensating people with smaller injuries, and people who have suffered from bad outcomes and accidents when fault is less clear cut. The tort system is also slow, uncertain, and involved immense transaction costs.

The Economics and Political Economy of Trade Credit Insurance

It is widely understood in the investment world that bondholders and long term secured creditors of publicly held companies are financial creditors making a long term investment who need to consciously consider the creditworthiness of the company during the life of a bond when they make their investment and bear the risk of loss upon a default.  Also, there may be hundreds of thousands of bondholders in a typical publicly held company, but typically, the bondholder's interests are managed by a trustee for the bondholders and the total number of trustees for bondholders for a publicly held company is rarely more than a couple of dozen, and often there are just a handful of them.

The same cannot generally be said of the legion of trade creditors of a typical publicly held company.  These may number in the tens of thousands, have claims that range from tiny to substantial, they are not organized collectively outside of bankruptcy, and they almost always predominantly get paid in full in the long run during a Chapter 11 reorganization bankruptcy.  For those not familiar with the term, "trade credit" generally refers to willingness of a vendor or customer doing business with a company in the course of its day to day operations to defer payment for a short period of time (typically thirty to ninety days) without interest.  It wouldn't be unusual for trade credit (also known in accounting terms as "current liabilities") to be 10%-20% of the book value of a firms assets at any given time.

I've proposed in the past that trade creditors of companies formally be given priority in bankruptcy so as to recognize the economic reality that manifests in Chapter 11 reorganizations, and for reasons described below for an alternative approach involving insurance and/or bonding of companies by private (but perhaps, if necessary, government chartered) insurance companies.

But, there is another approach, which borrows from the area of deposit insurance in financial institution insolvencies that has been very effective in preventing financial institution insolvencies from causing wider damages to the economy.

What if publicly held companies, either to secure favorable terms with trade creditors in the marketplace, or as a matter of regulatory mandate, secured "trade creditor insurance" from a suitably regulated insurance company with adequate reserves and financed this system by paying premiums for this insurance, which would guarantee payment of the company's trade debts (but not its financial debts) in the event of its insolvency, just as comprehensive general liability insurance (which is not legally required, but is universally maintained by publicly held companies presumably to reassure investors) is routinely secured to finance a company's tort debts.

The company providing the trade creditor insurance would in turn have a priority claim in any insolvency proceeding similar to that of the FDIC, to be indemnified for the claims it paid.

Alternately, the trade creditor insurance company could simply take a security interest in all of the company's assets (subject only to purchase money security interests in select individual purchases), as a condition of granting the insurance, which would afford the company priority without having to change the bankruptcy law.  It would be necessary, however, for existing standard stock exchange regulations and bond covenants to be amended to permit firms to do this, because these regulations and covenants currently prohibit publicly held companies from granting these kinds of blanket security interests because that would impair the priority of bondholders and stockholders, thereby making insolvencies more complex in a Red Queen style battle of investors and creditors to position themselves to have priority in any bankruptcy.

Thus, in a typical publicly held company bankruptcy under this regime, there would be only a couple dozen of so creditors who would participate in the bankruptcy phase of the proceeding after the insurance company paid off and settled all of the remaining claims, greatly simplifying this part of the litigation in a way that does not prejudice any creditor's rights.  This is how bankruptcy proceedings for insolvent financial institutions work now.

Thus, trade creditors of a bankrupt company would not need to panic because they would be assured immediate prompt payment of their claims in full almost as quickly as they would have been paid by the company had it been solvent, and only trade credit insurance companies and financial creditors of firms would have to seriously investigate a publicly held company's creditworthiness.

If this sounds familiar, it should.  This kind of arrangement is routine in the construction industry, and is almost universal among government entities employing contractors to do doing construction work, and is called 'bonding", as in the familiar phrase "licensed, bonded and insured."

If publicly held companies and privately held companies seeking to compete in the same markets with them, were routinely bonded, this would reduce the transaction costs involved in dealing with such firms, would produce more prompt and dramatically simplified resolutions of insolvencies of bonded companies, and would greatly reduce systemic risk in the economy at large, making it more robust during economic downturns.

But, because the risk that a publicly held bonded company would be unable to pay trade creditors in the long run would already be so low (perhaps 1% of outstanding trade credit or less), in part, because of debt to equity ratios mandated by stock exchanges in order for a company to be listed, and by corporate bondholders as loan covenants, typically limiting debt to something like 50% of assets in non-financial companies, the premiums that a publicly held company would have to pay for this kind of bonding would probably be quite modest. They would be lower still if trade creditor insurance indemnification claims were given priority in bankruptcy.  And, they could be lowered even further if bonding companies imposed their own covenants upon companies that would mitigate the risk of defaults on trade credit in advance.

We can be reasonably certain that requiring these companies to be bonded as to trade creditors would not led to a parade of horribles, because in the many circumstances like deposit insurance, security registration insurance, government project bonding, and construction contractor bonding, to name a few, where these kinds of regimes are in place, they do not appear to pose a significant impediment to the profitability of these sectors of the economy.  If anything, the increased trust that these arrangement engender make these sectors of the economy work more efficiently.

Indeed, the creation of an industry with an institutional and lobbying interest is controlling systemic risk in American's big business sector, and powerful tools through insurance underwriting to accomplish those ends, might arguably, in the long run, be as important for the American political economy as the direct benefits of the policy itself.

One of the problems that led to the financial crisis was that credit rating firms, which have immense impact on insolvency risk management in the big business sector, had no skin in the game to temper the small dollar incentives created by fees charged to firms to have their credit rated so that they could obtain bonds.  The harm caused by inaccurate credit rating assignments by these firms far outweighed any capacity those firms had to compensate people harmed when those inaccurate credit rating assignments were the result of negligence or outright fraud.  They were judgment proof.

In contrast, firms providing bonding and/or trade credit insurance (to the extent that the two are distinguishable) would have substantial financial reserves which would give these firms a powerful economic incentive to set premiums accurately relative to risk for particular publicly held businesses or for privately held businesses seeking to participate in the marketplace with those publicly held businesses on an equal footing.  By collectivizing trade creditor credit risk, bonding firms would overcome the collective action problems faced by trade creditors pre-default, because they would have the means and the incentives to aggressively ferret out major securities fraud, which they would bear much of the brunt of the risk if that fraud was not stopped in a timely manner.  This is something that is much less true of the far less deep pocketed firms that audit publicly held company financial statements now.

It is even conceivable that this kind of regime could become almost universal without any legislative change at all, if the markets found that bonding made firms more attractive to deal with (and hence more profitable and a better investment at little additional cost), and stock exchanges and bond investors acquiesced to it.  After all, firms already almost universally secure comprehensive general liability insurance without any express legislative mandate to do so, and the incentives associated with this reform would be similar.

Even before securities laws were enacted, economic realities pushed the investment banking industry to establish creditable assurances, like independent auditing of financial statements in accordance with generally accepted accounting standards, due diligence investigations by law firms offering public securities for sale, stock market exchange listing rules governing the structure and capitalization of firms traded on these exchanges, and so on.  Many of these measures don't appear in any statute, or were only codified as law long after they became universal.  There is no reason to think that the investment banking industry's continuing process of structuring corporate America in a way to provide credibility to its participants is complete now.

Indeed, one of the "cultural" factors that distinguishes economies that operate well from those that do not, is the internalization of these kinds of business practices which often get lost in translation when a developing company simply tries to copy another country's statutes without assimilating the business practices in which those statutes were intended to operate.  Even the best tools don't work well when the people trying to build a house with them don't have an architect's plans and have never built a house before themselves.

Paranormal Insurance

From Saturday Morning Breakfast Comics.

Selling people insurance with no intent to pay claims is fraudulent.  But, what if, instead, you formed an insurance company that paid claims in every case where the insurance company couldn't prove that it was a hoax (essentially the premise of a contemporary fantasy Downside Ghosts series by Stacia Kane).

One could set rates simply from actuarial experience and if one was interested in locating potential paranormal events, what better way to do so than to use the device of people making claims on the paranormal insurance coverage.  Even if the business operated at a loss, the anthropological or metaphysical research payoff (depending upon what the research investigating claims revealed) might very well be a small cost to subsidize in order to secure the research tool.

Assurant Health Has A Policy Of Cheating Insureds

Assurant Health, a.k.a. Time Insurance, is one of the leading providers of health insurance to people who don't receive health insurance through their employers. It has been rebuked by the President, Congress and courts for the way it conducts business.

In Congressional testimony, its CEO told Representatives that its application forms "are written in simple, easy-to-understand, straight forward language," then admitted that he didn't know what many of the terms on his company's own forms meant. He also told Congress that he would not commit to rescinding people's policy's only in cases of "intentional fraud."

Latham v. Time Insurance

Alan Prendergast nailed the fact that make it clear that Assurant Health has earned its bad reputation in a story in this week's Westword. The story discussed a $37 million judgment entered against the company in a bad faith case by a Boulder jury. In the case, Assaurant Health refused to pay her bills and retroactively rescinded the five months old health insurance policy of a woman badly injured in a car accident.

The investigation Assurant Health did wasn't begun until the accident claims started to arrive. Assurant Health didn't follow its own rules or Colorado insurance division rules in the process it used. The insurance company made the decision in about 68 seconds. The insurance agent who sold the policy pretty clearly lied about the process by which the insurance application with pre-existing condition data was gathered in open court. Testimony of the top manager at Assurant Health in charge of the decision makes clear that Assurant Health also lied to the woman injured about what it was doing to handle her case in its written communications with her.

The companies lawyers, led by Robert Walker and Walter Wilson, from a law firm based in the state of Mississippi, where reprimanded by federal judge Richard Matsch was abuses in the litigation.

Of the three items allegedly misrepresented by the woman injured on her insurance application, one involved an alleged pre-existing condition that wasn't covered anyway. Another involved an incorrect interpretation of a medical record that was alleged to say that a particular drug was used and that the woman was diagnosed with a particular problem, when in fact the medical record said that the drug in question was not used and that the woman was told that she didn't have the problem she had feared that she might have. None of the alleged misrepresentations had anything to do with the accident claims that Assurant Health was asked to pay.

The case is in the post-trial review phase now and I assure you that every actively litigated $37 million plus trial court loss is appealed. It is a good example of one of important unwritten rules of trial practice. A clear wrong is punished much more seriously than ambiguous but economicaly more serious wrongs. Clarity and doubt drive damages, even though theoretically, they shouldn't.

I would be surprised if the verdict was reduced on appeal, but would be surprised if some aspect of the damages award (which went well beyond what the attorney for the woman injured asked for in the case) were not adjusted in post-trial motions or on appeal. The lawyer asked for $2 million in economic damages and $5 million in punitive damages. The jury awarded $183,551 for medical expenses incurred an not paid (even though an automobile insurer for the party at fault ultimately did pay those), $2,000,000 in economic damages on the theory that the woman and her children might never be able to get health insurance again because of Assurant Health's wrongly determination that the woman lied on her health insurance application, $7.3 million for emotional distress, and the balance, about $27.8 million, in punitive damages.

Juries can award whatever they want in damages, but Colorado has a dollar cap on damages for emotional distress. In practice, in a case like this one, the cap on non-economic damages is about $2.8 million at most ($936,030 each for mother and each of the two children with a judicial finding of justification with clear and convincing evidence) and there is some argument for limiting non-economic damages in the case to a lower amount. Thus, non-economic damages are likely to be reduced by at least $4.5 million.

Thus, total non-punitive damages in the case are likely to be reduced to about $5 million.

Colorado has limited punitive damages to the total amount of non-punitive damages awarded, unless there a judge finds that the conduct is ongoing (a plausible possibility in this case) in which case punitive damages up to three times the economic damage award (i.e. $15 million) could be imposed.

Normally, interest at 8% per year from the time of the wrongful act on the non-punitive part of the award (probably close to 50% which is about $2.5 million by the time that post-trial motions are over and the judgment is finalized), and out of pocket costs incurred in connection with the lawsuit other than attorneys' fees (almost certainly no more than a few hundred thousand dollars). There are also frequently attorneys' fees awards in bad faith cases, usually based upon a hypothetical hourly rate and the number of hours worked. My guess is that an award for attorneys' fees would probably be less than $700,000 in a case like this one.

Thus, the $37.3 million verdict is likely to be reduced to $23.5 million or less depending upon the legal decisions made by the judge. This is still substantial, of course, and if the insurance company wants to appeal it will have to post a bond in that amount (more or less) which will make collecting the judgment easy (collecting from insurance companies is never very hard because they are required to maintain cash reserves under insurance regulations so they always have cash on hand to pay).

The case could also hurt Assurant Health in other cases by binding it to factual findings made in this case in other similar cases brought against it, and through the evidence of general applicability that the trial transcript could make available in other cases, making copycat bad faith cases cheaper to litigate.

If there is an appeal and a bond is posted, neither the woman nor her lawyer will see any of that money until the appeal is finally resolved, although interest will continue to accrue.

The lawyer will get a significant contingency fee (a third is the rule of thumb but there is considerable variation in actual agreements based upon whethere cases go to trial or appeal and sometimes with tiers with different percentages based upon the amount of the recovery). And, some portion of the damages may go to taxes (the tax implications of an award like this one for both the plaintiff and the defendant would take a post all its own).

A Policy And Practice That Is A Menance To Consumers

It was clear from the case that this was not simply a mistake. It was a direct consequence of a policy and practice of the firm. It rescinds about one in two hundred insurance policies. This may not sound like many, but an insurance company can only rescind a policy in the first year or two it is in force (the time period varies from state to state), and Assurant Health has a policy of investigating the accuracy of insurance applications only after big claims are submitted. Big claims in the first year or two of a policy are made by only a small percentage of an insurance company's outstanding insureds.

An analysis done here calculates that the percentage of insureds with big claims whose policies are rescinded by Assurant Health is on the order of 10%-50%, probably around one in six, with rescission becoming increasingly likely as the amount claimed rises.

You buy health insurance for just these kind of catastrophes and Assurant Health makes it its policy to lie and cheat in an effort to take advantage of you, at a time when you have suffered a very severe health problem, in these cases.

Companies like Assurant Health deserve to be wiped out by big jury awards and no consumer interested in having the promises in their insurance contract honored should consider doing business with them.

Is It Racketeering? Should It Be?

The only hard question, in my mind, is whether the company and a good share of its senior executives should be prosecuted for racketeering. It wouldn't take much beyond the Westword story and the transcript of the trial it discusses to show probable cause to bring criminal charges against the company and its executives. The U.S. Supreme Court permitted civil RICO class action lawsuits against health insurance companies alleging mail and wire fraud as a predicate act in a unanimous 1999 decion, so presumably a pattern and practice of mail and wire fraud could also be a basis for a criminal RICO prosecution.

Assurant Health is a good example of a case where there is considerable evidence of a business organization carrying out intentional fraud towards vulnerable people in a collective and coordinated manner, and also a good example of a case where bad acts are systemically underpunished which suggests that harsh punishments in selective cases that are tried would not be unjustified. This company is the health insurance equivalent of the pervasive but small time economic crimes like loan sharking and con schemes that made the mob profitable and inspired Congress to adopt RICO in 1970. Indeed, a RICO case based on its practices would be well within the heartland of the white collar cases most commonly prosecuted both civilly and criminally, under the statute today.

This said, I have no great love of the RICO statute. Like most laws with harsh penalties, its heaviest use has come from the most marginal of the kinds of cases it covers, cases that miss a critical element of that drove its harsh penalties.

What makes the mob the mob? It isn't just that the mob and drug gangs and other criminal enterprises engaged in a pattern of organized, profitable criminal activity, although all of that is part of what makes the mob the mob. But, what distinguishes the organized crime that we are really afraid of, and the organized crime that is usually prosecuted in civil and criminal RICO cases is violence and the threat of violence as a component of the criminal enteprise's activity.

I am a believer in private civil remedies against individuals enterprises that engage in organized non-violent economic crime. I am a believer in aggressive enforcement of criminal laws against individuals and entities that engage in organized non-violent economic crime. The problem is not that the conduct at the fringe of the kind of activity that spawned RICO should not be subject to serious civil and criminal sanctions.

The problem is that these fringe cases involve conduct that doesn't justify sanctions that were calculated to cover violent organized crime, not merely organized economic crime.

Under RICO, a person who is a member of an enterprise that has committed any two of 35 crimes—27 federal crimes and 8 state crimes—within a 10-year period can be charged with racketeering. Those found guilty of racketeering can be fined up to $250,000 and/or sentenced to 20 years in prison per racketeering count. In addition, the racketeer must forfeit all ill-gotten gains and interest in any business gained through a pattern of "racketeering activity." RICO also permits a private individual harmed by the actions of such an enterprise to file a civil suit; if successful, the individual can collect treble damages.

Still, it is less disproportionate than many other criminal statutes and certainly isn't at the top of my list of criminal sentencing regimes that need to be reformed. The United States Sentencing guidelines and jury discretion in civil case also mitigate some of the excesses that might otherwise be possible in these cases.

Full disclosure: I do no business with Assurant Health personally, and never have (although I once priced but did not buy a policy from them) and have no financial interest whatsoever in any person with a business or insurance relationship with them. I have never represented anyone in a dispute with Assurant Health. I know none of the parties or lawyers involved in the Westword story. I have no ax to grind them them personally, either directly or indirectly. I have litigated cases both as an insurance defense lawyer and a plaintiff's personal injury lawyer, and I am not currently either an insurance defense lawyer, or a personal injury lawyer. I have represented parties in bad faith cases not involving health insurance, and I have provide legal advice to insurance companies concerning bad faith issues that do not involve health insurance. Assurant Health owes me nothing and I am not asking anything of them, and I owe nothing to Assurant Health. I have no influence other than this blog (if any) with either state or federal prosecutors.

Denver's Emergency Room Scene

George in Denver offers his detailed impressions of a recent emergency room visits to Lutheran and St. Joseph's hospitals, that says as much about our health care system as it does about his own moment of personal distress.

I come away with the same conclusion that I had after my dad's experience at Mayo Clinic in Rochester, Minnesota, and a lot of studies I've read about health care quality. Health care quality and efficiency have as much to do with the quality of the administrative side of the operation and a lack of good systems as it does with technology or the skills of particular practitioners. The quality of the administration of our hospitals and doctor's offices is often mediocre. And, the way health insurance companies are run is an important contribution to this mediocrity.

The Blueprint for Regulatory Reform

In what quite possibly is the last major domestic initiative of the Bush Administration, the Treasury Department has announced a Blueprint for Regulatory Reform. Here is what is proposed and what I think of these proposals:

New Powers For the Fed

[T]he Federal Reserve's market stability role would continue through traditional channels of implementing monetary policy and providing liquidity to the financial system. . . .

[A new] role would replace the Fed's more limited role of bank holding company supervision because we recognize the need for enhanced regulatory authority to complement market discipline to deal with systemic risk. . . . the Fed would have to be able to evaluate the capital, liquidity, and margin practices across the entire financial system and their potential impact on overall financial stability. . . . the Fed will collect information from commercial banks, investment banks, insurance companies, hedge funds, commodity pool operators, but rather than focus on the health of a particular organization, it will focus on whether a firm's or industry's practices threaten overall financial stability. It will have broad powers and the necessary corrective authorities to deal with deficiencies that pose threats to our financial stability.

To illustrate . . . systems requiring the attention of our market stability regulator would include the interconnected OTC derivatives markets with their lack of a cohesive design for clearing, settlement, and novation protocols. Similarly, a market stability regulator would have the authority to review certain private pools of capital, such as hedge funds and private equity, which have the potential to contribute to a systemic event.

Analysis: Good ideas implemented with the wrong agency. It is a good idea to have a federal regulator in charge of gathering the information necessary to evaluate systemic risks including those that arise from privately held companies and private transactions that impact public securities markets. Liquidity practice, margin practices and settlement practices all have these effects. Adequate regulation of these practices could greatly mitigate future financial crisises.

The Fed is the wrong institution to carry out this role. We already have regulatory agencies who are charged with carrying out these functions. They are the SEC and the CFTC. They have boards appointed in a more politically legitimate method (pure Presidential appointment with Senate confirmation) than the Fed (Presidential appointment with Senate confirmation from a pool of bank president's chosen by directors chosen by directors of for profit banks). The SEC and CFTC also have experience regulating and gathering information from many key players in these industries. When consolidated, the SEC and CFTC will be in a particularly good position to refocus on looking at systemic risk as opposed to only firm and individual transaction level risks. But, instead of strengthening the hand of the SEC, the plan would take power from the SEC and give it instead to the Fed.

If the SEC and CFTC lack the powers to gather this information from all players and to impose regulation on non-publicly held firms or private transactions, the combined agency's powers should be revised to reflect this need.

Near Term Recommendations

* President's Working Group Executive Order

The President's Working Group on Financial Markets, the PWG . . . was developed to coordinate across the current US structure. . . . We should formalize the current informal coordinating practice among the US regulatory community by amending and enhancing the Executive Order which created the PWG.

The new executive order will emphasize the importance of coordination and communication. It will clarify the PWG's mission of attempting to mitigate systemic financial risk, enhancing financial market integrity, promoting consumer and investor protection, and supporting capital markets efficiency and competitiveness. It will also increase the PGW membership to include all federal financial regulators so that information is shared in an appropriate, timely and efficient manner.

One thing that the PWG will work on immediately is determining whether the government has all the tools and powers it needs to deal with a financial crisis. As part of this, as I mentioned in my remarks last week, the PWG should examine the lessons of the current temporary liquidity facility the Fed has established for investment banks, and examine a number of issues regarding the proper level of oversight that should apply.

Analysis: Indifferent. Mostly harmless. A talk shop and federally sponsored think tank on preventing financial crisises doesn't hurt, and since it lacks the power to act on its own, can't do harm on its own.

* Create "a new federal-level commission, the Mortgage Origination Commission. This commission, the MOC, would be led by a director appointed by the President. The Commission membership would include federal banking regulators and appropriate state representation." It would "establish minimum standards which should include personal conduct and disciplinary history, minimum educational requirements, testing criteria and procedures, and appropriate licensing revocation standards . . . . [and] would evaluate, rate, and report on each state's adequacy for licensing and regulation of participants in the mortgage origination process."

Analysis: Bad idea. Potentially harmful and unlikely to be helpful. States are capable of regulating this field and mostly have done in the wake of the mortgage crisis. A federal government body in charge of telling state governments what to do and gathering information about them would not be helpful, and if this body establishes a bad standard which is not fact based, it could be hard to reform and deny credit to people who deserve it.

The private mortgage collateralization market is more than adequate to gather information and evaluate risk, and the players who failed to perform this function adequately are almost all either out of business now as a result or have taken immense losses on this line of business which have taught them a lesson. The part of the subprime market and most of the Alt-A market driven by poor underwriting and excessive funding of collateralized mortgages have been obliterated. New underwriting standards are emerging through the FHA and private mortgage insurance companies.

Intermediate Term Recommendations

* Create a federal charter for systemically important payment and settlement systems overseen by the Federal Reserve.

Analysis: Indifferent. We are 97% of the way there already. As the report notes "There is no crisis." An "if it ain't broke don't fix it" tempers enthusiasm for what seems like a basically sensible idea. Presumably, Colorado based First Data, a few credit card processing companies and a handful of nominee ownership firms and security transfer processing firms would be the primary target of this regulation.

* Merge SEC and CFTC.

Analysis: Good idea. Harmless to slightly positive. Sooner would be better as it would provide a better basis for reducing systemic risks involved in financial market derivatives and hedge funds. Probably bad for the Chicago economy, which is the heart of the commodities industry in the United States, at the expense of the New York City economy, which is the heart of the securities industry in the United States.

* Establish "a federal insurance regulatory structure to provide for the creation of an Optional Federal Charter for insurance companies, similar to the current dual-chartering system for banking. This system would be built on a proven model and we recommend, as in the banking sector, that this federal agency be housed within the Treasury Department." Federal insurance companies would be entitled to ignore state insurance laws.

Analysis: Bad idea. This would gut well developed state regulation of the insurance industry and allow questionable insurance practices to flourish. It would also seriously impair efforts to reform the health insurance system. If this had been done when the industry was in its infancy, it might have been a good approach, but it would do more harm than good to transition from state to dual regulation at this point in time.

* Eliminate the regulatory category of Savings and Loans (also known as thrifts) and convert them to commercial banks regulated by the Comptroller of the Currency. It appears that the FDIC might also be rolled into this agency.

Analysis: Good idea. Mostly harmless, not urgent. The existing regulatory structure was adequate to mitigate most direct harms and abuses in the mortgage crisis in the commercial banking and savings and loan sectors.

Important Omissions

Some key reforms needed to reduce systemic financial risk were omitted from the proposal.

* Pension Benefit Guarantee Reform.

Many defined benefit pension systems are underfunded. The Pension Benefit Guarantee System lacks the resources to handle a major episode of defined benefit pensions that cannot meet their obligations. The existing system also insufficiently protect the pensions of employees and retirees with larger pensions due to them, and provides no protection for retiree health benefits. This system must be improved if we want to avoid another S&L crisis class government bailout of fiscally irresponsible private companies. Funding requirement formulas need to be improved, the scope of coverage needs to be increased, and premiums need to be increased.

* Insurance Benefit Security.

There is no reliable system of federal or state protection to guard against insurance companies growing insolvent and failing to provide promised benefits. Fiscal irresponsibility on the part of a large insurance company that prevents it from paying benefits is an important source of systemic risk in the economy. For example, imagine what would happen if Allstate or State Farm went bankrupt immediately after a hurricane produced a record sized multi-billion loss.

History suggests that this is a particular risk in the case of shareholder owned insurance companies (as opposed to mutual companies like Northwestern Mutual) who have much to gain from leveraging to secure upside gains, but can limit their losses by passing them onto shareholders if bad times strike. Until the FDIC was established, periodic waves of bank collapses for similar reasons were endemic.

The risks are particularly great for policies in which insureds have a long term reliance interest, such as annuities, life insurance, disability insurance and long term care insurance policies, and in casualty policies that involve a high risk of mass claim events, like homeowner's insurance and business comprehensive general liability insurance polices.

This does not require comprehensive federal insurance company regulation or broad pre-emptive legislation at the federal level. While state regulation in most aspects of the insurance business is properly a matter of state regulation, some analog to the FDIC for shareholder owned insurance companies would be appropriate. Like the FDIC's protection, it could be limited to some dollar amount, such as $1,000,000 of benefits per insurance company. Premiums could be low in low risk lines (e.g. automobile insurance and health insurance which are dominated by large numbers of independent small risks) and high in high risk lines (e.g. small annuity and life insurance companies and home insurance companies).

This might also encourage consumer behavior, like spreading high dollar benefit policies across multiple companies, that would reduce systemic risk in the economy.

* Debt-Equity Incentives.

The federal tax code strongly prefers debt to equity in the financing of publicly held companies. Profits allocated to interest payments are not subject to corporate income taxes, while profits allocated to retained earnings or dividends are subject to corporate income taxes. Qualified dividend treatment at the shareholder level and preferential tax treatment for long term capital gains mitigates this effect (interest payments on bonds, in contrast, are ordinary taxable income). But, the existing system does so in an awkward way that still preferences debt.

While not all economic participants can be expected to be rational economic actors, publicly held companies making financing decisions are likely to come close to this model. So, it is fair to assume that tax preferences for debt produce greater leverage within publicly held companies.

There are several sensible ways that the tax treatment of debt and equity can be equalized (e.g. a dividend withholding tax form of corporate income taxation that gives dividend receiving shareholders a tax credit for corporate taxes paid, a dividend paid deduction, a comprehensive shareholder level dividend received exclusion, elimination of the interest paid deduction, or a market capitalization tax in lieu of a corporate income tax). From the point of view of systemic risk, it doesn't really matter which method is used. But equalizing the tax treatment of debt and equity is likely to produce less heavily leveraged publicly held companies.

Companies with less leverage are less likely to go bankrupt, because a company is insolvent when its asset to liability ratio is 1:1 and contractual debt obligations are the principal liability of public companies. Reducing the risk that big businesses will go bankrupt reduces systemic risk in the marketplace.

UPDATE:

Links to additional analysis can be found here and here and here and here. Particularly interesting is this letter from the state securities regulator's association (the NASAA) concerning the plan:

There have been 24 major proposals for regulatory restructuring that have been made (but not acted on) since the bulk of the federal regulatory system was instituted in the early 1930s. Each set of proposed reforms was proclaimed with equal vigor to be “essential,” and the fate of the United States capital markets and/or banks supposedly hung in the balance. Ultimately, our regulatory system—without these reforms—has facilitated the development and growth of the world’s most robust financial markets. . . .

A common argument put forward to justify “regulatory reform” is that our capital markets cannot maintain competitiveness because alternative regulatory structures abroad are more reasonably regulated. . . . This argument is profoundly wrong because it is based on incorrect data. Both 2006 and 2007 to date have been record years for global IPO activity. In 2006, U.S.-based companies generated the largest number of IPOs globally and raised the second-largest amount of capital ($34.2 billion) through November. This was an increase of 14 percent over the $29.9 billion raised during the same period in 2005. The 2006 IPO year through November yielded the largest amount of capital raised by U.S. domiciled companies since 2000. The final year-end reporting shows that U.S. IPO volume increased to $43 billion in 2006a 26% increase over the previous year. . . .

Anyone arguing responsibly for change has an obligation to demonstrate two things: that the current system is inadequate, and that the proffered alternative is better. The advocates of major regulatory reform in securities fall short on both counts. They mischaracterize the nature of the current system. . . . For example, the notion that the United States is solely rules-based and that the Sarbanes-Oxley Act of 2002 is excessive and repellant is simply wrong. In point of fact, the whole of the federal and state securities laws are less voluminous than the laws of many other regulators, including the FSA. And as for the Sarbanes-Oxley Act itself, its passage afforded investors in U.S. securities the most significant protections enacted throughout the globe since the 1930s.

Investors throughout the world revere the Sarbanes-Oxley Act for what it offers them. Furthermore, they have demonstrated a willingness to pay a premium for its protections. The Sarbanes-Oxley Act is a magnet for foreign capital investment in the U.S. The protections of the Sarbanes-Oxley Act are a primary reason why large foreign institutional investors invest in U.S. equities. Currently, the Sarbanes-Oxley Act is being replicated in countries around the world. To the extent it ever posed an actual problem, the issue of the audit requirement for internal controls under Section 404 has been remedied by management guidance and the AS5 standard issued by the PCAOB. As mentioned earlier, the number of foreign IPOs on U.S. exchanges in 2007 will surpass the existing record, which was set just last year.

We also note that European hedge funds have gone public in the U.S. this year. In terms of proceeds, non-US issuers comprised 44% of the total value in the third quarter of this year, up from 18% in the second quarter and up 11% versus the third quarter of 2006. If our regulatory structure is so repellant and punitive, then why is this so? Foreign participants in our markets uniformly report two primary drivers. First, the cost of capital is low. Secondly, they want to demonstrate to investors that they meet the highest standards in the world. Indeed studies consistently show that shares cross-listed in the U.S. will sell at a premium of 15- 30% greater than the shares in home markets. . . .

"Many schemes to defraud investors involve locally generated pyramid schemes, misrepresentations, and scams. Without state regulation accompanied by civil and criminal enforcement of the law in state courts, there would be little hope of redress for many victimized investors. State enforcement is also available when there are fraudulent schemes involving federal covered securities. In effect, Congress and the SEC have acknowledged that federal regulators are unable to cope with all the enforcement that needs to be done."

Also, another important omission is meaningful shareholder participation in selecting members of corporate boards of directors who are now generally elected on the basis of nominations from self-perpetuating boards that hold Soviet style director elections. Shareholder power often discourages reckless actions that could wipe out their interest. Empirical evidence shows that proxy fights won by dissenter increase shareholder value.

Notably, the Blueprint also fails to even mention the important regulatory role played by private securities fraud litigation. A recent study indicates that while "voice" rights in connection with class action securities fraud litigation is ineffectual, that the right to opt out of a securities fraud action and instead bring individual suits in state courts has proven very effective for institutional investors. Regulators have, however, repeatedly failed to recognize the capacity that institutional investors have to recognize risk and take collective action if the regulatory scheme facilitates this kind of action rather than discouraging it.

Easy Case, Bad Law

Washington's State Supreme Court screwed up a really easy insurance coverage case today, reversing a Washington State intermediate court of appeals decision.

At issue: Does an insurance company have a duty to defend its insured under a professional liability or general insurance policy that excluded intentional actions, when the insured intentionally plays a nasty practical joke calculated to humiliate his employee and gets sued?

Easy answer: No. This is precisely the kind of case that insurance customers assume that their insurer is not going to cover under an intentional acts exclusion.

Washington State Supreme Court 5-4 majority answer: Yes. The insurer has to pay.

They explain this in a decision, but like so many decisions, it ultimately comes down to a judgment call. I still come away from it thinking, WTF were they thinking?

I hate stringy insurance companies as much as anybody does. There are plenty of legitimate bad faith cases out there, but this wasn't one of them. The dissent has it right when it notes that this kind of outrageous case fans the fires of the tort reform movement.

Insurance Companies

Not all insurance companies suck.

I got my first renter's insurance and car insurance policies from Allstate, a boring, mildly annoying, major property and casualty insurance firm that charges market rates and has a huge market share. I stuck with them for about 16 years, across four different states, through a number of minor claims. While nothing to write home about, the company did do its job well enough for me not to leave them in disgust, or even think about it very often.

It isn't that I didn't shop around. For example, I called up Geico to see if their claims were too good to be true. They were. While the "standard rate" at Allstate was more than the "standard rate" at Geico, nobody pays Allstate's standard rate. Almost everybody gets multiple policy discounts, good driver's discounts, safety features discounts and the like (even though my car has only standard safety features for its make and model, and my home's most sophisticated safety feature is a battery powered smoke alarm). So, when the dust settled, I couldn't find a better deal.

I could have looked at Allstate's close competitor State Farm, but having done Plaintiff's personal injury cases for a while, it was hard to overcome my distaste for the fact that they have engaged in more systemic bad faith claims handling (some of it technically legal, some not -- maybe their better now after having been sued often enough, but I don't believe it). I didn't want to get sucked into State Farm's strategic litigation strategies the next time I got sued and needed my insurance company to back me up.

One day, I get junk mail piece from Amica and decide to check them out. It turns out that Amica is a truly great insurance company and one of the great undiscovered secrets of the property and casualty insurance market. For one thing, it is a mutual company. That means that it is owned by its policy holders, a bit like a credit union or a cooperative, not by third party shareholders motivated solely by the bottom line. It is fiscally sound, something that is a worry with any insurance company that isn't a household name, because unlike banks, insurance companies aren't federally insured. And, get this, once I sign up for a policy, a month later they actually call up and tell me that due to an underwriting mistake that I should actually get a less expensive product.

All told, switching to Amica is saving me about $800 a year compared to the combined homeowner's and auto premiums I paid at Allstate, and is providing me with better coverages. This is huge considering that my rates weren't stunningly high to start with because I am a low risk driver and have a reasonably modest home. And, no, I have no relationship with Amica to advertise with them, I'm simply a plain old customer writing of my own accord.

One area were Amica has not proved to be a good deal is life insurance. My wife's life insurance is through TIAA-CREF, from the days when she worked at the admission's office of Mesa State College. Mine is through Northwestern Mutual. Again, neither are traditional for profit companies. Both afford us far better rates than we could get from Amica, although this may have something to do with the fact that we got them when we were younger, rather than the company itself.