Jan 1, 2001
In its 1979 decision in Royal Globe Insurance Company v. Superior Court, the California Supreme Court gave an accident victim the right to bring a claim for punitive damages against another person's liability insurer if the victim felt that the insurer had engaged in unfair claims settlement practices. Although the California Supreme Court reversed this decision in 1988, so-called third-party, bad faith suits continue to be debated nationwide. Since the 1988 reversal, several states have subsequently considered or enacted legislation to allow such claims. In 1999, California passed legislation reinstating these suits, but the legislation was overturned by statewide referenda before being put into effect. Nonetheless, about a dozen other states are now considering whether to allow third-party, bad faith claims.
The crux of the debate relates to the shift in the negotiating environment that occurs when third-party, bad faith claims are permitted. Two central questions are involved. First, does the desire to avoid potentially costly punitive lawsuits make insurers and their claims adjusters more likely to increase settlement offers on bodily injury claims or to pay claims they would otherwise deny? Second, does a Royal Globe doctrine increase attorney representation in bodily injury claims, and if so, how are insurer costs and compensation affected?
In an effort to inform the policy debate, researchers at RAND's Institute for Civil Justice examined the effect of the adoption and subsequent rejection of the Royal Globe doctrine on the compensation and costs of bodily injury claims related to automobile accidents in California. The researchers found that the adoption of a Royal Globe doctrine affected both the severity and the frequency of bodily injury claims. Moreover, the "shadow effects" from a potential Royal Globe suit led insurers to make higher compensation payments than they otherwise would have, while increased attorney representation in bodily injury claims affected both compensation payments and claims of economic loss.
The study compared trends in average compensation from 1975 to 1999 for bodily injury claims in California to corresponding trends in the 31 other states allowing unimpaired access to the tort system and having essentially the same legal system as California. The analysis focused on automobile accident claims, which provide the best data available.
The adoption and subsequent reversal of the Royal Globe doctrine were found to affect both the severity and frequency of bodily injury claims. Before Royal Globe, trends in average bodily injury compensation and the relative frequency of claims in California were similar to those in the 31 other tort states. However, after Royal Globe was adopted in 1979, both the average compensation payment and the frequency of claims increased significantly in California, at a rate exceeding those in more than three-quarters of the other tort states.
The elimination of Royal Globe reversed these trends. After 1988, the average bodily injury compensation payment in California fell relative to that in 29 of the 31 other tort states. Moreover, the frequency of these claims declined relative to every other tort state.
The researchers analyzed payments for closed personal injury claims in California and the other tort states while controlling for state-specific effects and claim characteristics. Three years were chosen for analysis: 1987 (when Royal Globe was in effect), and 1992 and 1997 (both after Royal Globe's elimination). As expected, the amount of a claim was found to depend on its characteristics. Claimants obtained greater compensation if they incurred more-severe injuries or greater economic losses, were less responsible for their injury, or were represented by an attorney. Claims that took longer to close also resulted in greater compensation.
The results demonstrated the shadow effect created by the threat of potential third-party, bad faith lawsuits. In the Royal Globe environment, compensation payments in California were much higher than the amounts paid on similar claims in the other tort states. This pattern changed dramatically after Royal Globe was eliminated.
These estimates do not take into account the effect of Royal Globe on either attorney representation or claimed economic losses. The Royal Globe doctrine also appears to have increased the value of smaller claims in California, which in 1987 received on average 32 percent higher compensation than did similar claims in other tort states.
The presence of a Royal Globe doctrine was found to have a significant effect on the likelihood that claimants would be represented by an attorney, and this "representation effect" was associated with increased compensation. Controlling for claim characteristics other than attorney representation and economic loss, the analysis found the following:
All things being equal, the likelihood of representation was significantly higher under Royal Globe in California than in the other tort states or in California after Royal Globe was reversed. Attorney representation was associated with larger economic losses being claimed. When controlling for injury and other case characteristics, economic losses presented under attorney-represented claims were 270 percent larger than similar claims without representation. By 1992, when Royal Globe was no longer in force, the likelihood of representation had begun to decrease, and by 1997 it was dramatically reduced, with a similar decline in the average economic loss claimed.
|Effect||Change in Value of Closed Claims (%)|
The adoption and subsequent reversal of Royal Globe clearly affected the severity and frequency of bodily injury claims, triggering sharp increases in compensation payments. The elimination of Royal Globe reversed these trends. The table provides a credible range of effects of Royal Globe on compensation costs in California, shown as a percentage change in the value of closed claims in California from 1992 to 1997.
Disregarding the effect of Royal Globe on attorney representation and economic loss, the value of a given claim in California from 1992 to 1997 ranged from 29 percent to 35 percent less than it would have been had compensation costs in California changed in the same way as they did in the other tort states. When the representation effect is also considered, the total effect of the Royal Globe doctrine on compensation ranges from 40 percent to 65 percent.
How might the Royal Globe doctrine have affected policyholders' premiums? In California in 1997, the most recent year for which data are available, bodily injury premiums accounted for 54 percent of the total liability premiums, leading the researchers to draw these conclusions:
In sum, the researchers conclude that the introduction of a Royal Globe–like doctrine will likely result in substantial increases in the amounts that insurers spend in compensating auto accident victims.