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Tuesday, August 23, 2005
Merck, Juries, and Insurance . . . and Reinsurance
Many have weighed in about the astronomical jury verdict against Merck. The New York Times has found a way to justify it (sort of) in spite of very thin evidence of causation; most are outraged, including Bainbridge and Ribstein, among many others. Gordon Smith at the Conglomerate offers a sober assessment, as always.
Although I'm certainly disturbed to learn that some jurors apparently considered which verdict would get them on Oprah, I'm not really sure what the take home message is. I want to be outraged but I like our jury system too much to use this as an opportunity to disrespect the institution more generally (though I suppose I'm open to the abolition of the jury in certain kinds of cases). One thing, however, gives me some peace in the face of the talk about Merck going out of business over this and the hyperbole invoked by those worried about the future of Big Pharma in America: Merck won't likely be paying for the entire verdict out of its own pocket. Layers and layers of insurance cover these sorts of cases: Merck undoubtedly has insurance, and the insurance company probably has reinsurance. To be sure, premiums may rise for the industry (though don't forget that the insurance industry is itself a competitive marketplace) and litigation will ensue between Merck and its insurer and reinsurers. But let's not overstate the case against the astronomical award: it isn't going to put Merck out of business.
Posted by Ethan Leib on August 23, 2005 at 02:08 PM in Blogging | Permalink
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Comments
While I tend to agree that the verdict in cases like this and the State Farm case out of Utah are not a good thing, and reek of a stick-it-to-the-rich mentality, I also think that the sky is not falling. States like Michigan and Virginia have put caps on damages that have thus far withstood constitutional challenges. The states have all of the tools necessary to protect businesses from these kind of verdicts and the businesses have all the resources necessary to both minimize their exposure and to fully litigate the claims.
Again, I think these verdicts are clearly excessive. But I don't think they are a runaway train.
Posted by: MJ | Aug 23, 2005 2:48:39 PM
Ethan, I mostly agree with you; the case seems flimsy, but the system as a whole is workable and working (though there should be changes on the margins and in some kinds of cases, as you allude to). But the suggestion that Merck won't go out of business because it has layers of insurance seems way off to me. Unless you think that the insurance market is anticompetitive such that it charges fixed prices regardless of risk, then you have to believe that the risk of these kinds of verdicts gets factored into the price. That means that the price of manufacturing and inventing drugs goes up. So it might not put Merck out of business, but it may well stop the next drug from being researched and produced. Obviously, one case like this isn't going to do that; but brushing the case aside on the basis of insurance seems to miss the point.
Posted by: Hillel Levin | Aug 23, 2005 5:43:46 PM
Ethan, that was a great idea about insurance! You’ve just discovered how to grow money on trees. Just insure your activities for a huge amount; have someone sue you; lose; have insurance pay, no biggie. Insurance companies have their own reinsurers, and reinsurers have reinsurers, and it’s all reinsurers all the way down.
Nobody actually pays at the end. Insurance premia won’t increase to compensate for risk. To the extent insurance companies can't pass the entire increase in exposure to the insureds, they won't exit the market, creating lots of underinsured firms.
And then, insured firms won’t pass increased premia down to consumers via higher prices. To the extent insured firms cannot pass entire increased premia to consumers, investors won’t pull out of high-risk firms, increasing the cost of capital. Higher cost of capital won’t hurt innovation and the development of new drugs. Oh no. It’s reinsurers all the way down.
Priceless. I mean, costless.
Posted by: Kate Litvak | Aug 23, 2005 6:52:00 PM
Of course it isn't reinsurers all the way down. My claim was fairly modest: Merck won't be put out of business over a few jury verdicts that they have already insured against. I'm well acquainted with the idea that premia then increase (that's in the original post, of course)--and that there can be some indirect consequences that are worth noting. But I don't think we should overstate what a single large punitive verdict does in the grand scheme of things. I can't see how that "miss[es] the point," as Hillel likes to say. I'm hardly "brushing the case aside," just trying to get add a drop of perspective.
Posted by: Ethan Leib | Aug 23, 2005 7:25:00 PM
First, to the extent insurers adjust premia to reflect risks of the insured, Merck’s expected spike in premia should be roughly equivalent to the insurer’s payment in litigation. So, instead of seeing insurance as a cushion reducing the blow, we should see it as an instrument that merely stretches the blow in time. In effect, Merck paid a part of today’s verdict via earlier insurance premia, and will pay the remainder via tomorrow’s premia. In the long run, the financial consequences of the Vioxx litigation will be mostly born by Merck’s investors.
Second, Merck holds some amount of insurance, but it is not infinite, and I bet it doesn’t come close to Merck’s potential exposure in Vioxx litigation. Today, we have a $23M verdict for a single plaintiff (and this is not counting punitive damages, which are fortunately unenforceable in TX, but might be enforceable elsewhere). Add defense costs. Add the costs of interrupted business. Multiply this by the number of potential cases, and you'll see how this drop in a bucket grows into a hefty sum. Whether Vioxx litigation will actually bankrupt Merck is not clear, but it's pretty clear that it will have grave consequences for consumers (current and potential) of pharma products.
Posted by: Kate Litvak | Aug 23, 2005 8:17:54 PM
Do you think it is possible that one of those "grave consequences" might be that Big Pharma will be a bit more careful about what goes on the market when and to whom its drugs are peddled?
Look, I'm troubled by the verdict. I made that clear. I just don't mind when insurance companies actually have to shell out some of the money we give them once in a while.
Posted by: Ethan Leib | Aug 23, 2005 8:37:16 PM
Last attempt: because insurers have a way of pricing their products on the basis of an insured’s liability history, in the long run, the only people who will “shall out” anything will be investors of pharma companies. Which, in turn, means consumers.
Posted by: Kate Litvak | Aug 23, 2005 8:55:34 PM
I understand how this is all supposed to work in theory, Kate. I really do.
But there are so many little causal arrows in the story about how this verdict spells the end of Big Pharma that I can't help finding it all very speculative.
I agree that we should give some serious thought to how to administer our mass tort system in a better manner; I've never said otherwise. This verdict is as good an opportunity as any to do so. Indeed, it is better than a run-of-the-mill case because it seems the evidence of causation was extremely thin. Shall we just leave it at that?
Posted by: Ethan Leib | Aug 23, 2005 9:21:36 PM
(Warning: rant follows.)
Deterrence, people. Deterrence. Frankly, I could give a damn about liability in terms of the actual causal connection between the danger and the death. It seems like mass tort litigation is the only thing that can deter coverups, biased science, etc. In an ideal world, of course, there would be real and enforced criminal penalties to stop that kind of antisocial behavior. We don't live in an ideal world, however. We live in a world where the politicians that pass the laws and the politicians that initiate the prosecutions are, for the most part (Spitzer excepted) entirely in the pockets of monied interests.
In the absence of things like jail, charter revocation, and/or real bottom-line impacting criminal fines, one of the few tools that is available to deter corporate misconduct is the private suit. And frankly, in that context, whining about causation and/or the poor investors brings the phrase "cry me a river" to the tip of my tongue. Where's billion dollar Charlie when we need him?
I also note that Kate's argument proves far, far, far too much. One simply can not, can not simply appeal to the poor non-malfeasants that will have to pay in the long run any time corporations are charged for their misconduct. That is a consequence of the nature of corporations. If we are to be able to punish corporations at all for their misconduct, we must be willing to say that their poor investors (who benefit from things like limited liability in the first place), insurers, consumers, etc. will have to suffer a little. If we were to invalidate any punishment of a corporation that caused collateral harm to innocent investors etc., we would have to forbid all punishment of any corporation for anything, because the nature of the corporate entity is that it is comprised of an amalgation of bunch of people's interests, and many of those individual people may be completely innocent.
Presumably, Kate, you don't think that corporations should all be exempt from punishment? So can you give a principled reason why sometimes we should take the poor innocent investors, consumers, etc. into account in giving financial punishment to malfeasant corporations and sometimes we shouldn't?
Posted by: Paul Gowder | Aug 23, 2005 9:57:21 PM
Ethan:
Obviously this case isn't going to bankrupt the company; and I think that our system works well over all. But NO ONE (serious) is arguing that this will bankrupt the company. To the extent that's your point, it is a stawman argument.
I don't know enough about the case (I was on vacation and didn't bother to read many papers) to pronounce judgment on the absurdity of the verdict. But to the extent you think the verdict is mostly baseless (which I gather from your post), while it is true that we shouldn't declare that the sky is falling, if it isn't falling it is because the system as a whole works and can sustain bad verdicts (as any system must)--not because of this magical thing called insurance.
That's the point.
Good lord, I'm agreeing with Kate! ;-)
Posted by: Hillel Levin | Aug 23, 2005 10:11:46 PM
I largely agree with Paul's result (note the time and date!), although not for the same reason. If courts wish to give out preposterously large punitive damages, provided it doesn't violate any relevant state laws against such awards, I say bravo. BMW, State Farm, yadda, yadda, yadda, and so on and so forth.
Posted by: Simon | Aug 23, 2005 10:16:19 PM
Paul: the original post stipulated that the verdict and the amount of damages were not justifiable on the merits, and only pointed that the gravity of harm might have been overstated. Since we didn’t dispute the merits issue, we didn’t discuss deterrence. A meritless verdict does not improve deterrence; rather, it either over-deters or constitutes an additional tax without deterrence impact, depending on a few factors too complex to discuss here.
Posted by: Kate Litvak | Aug 23, 2005 11:02:17 PM
Kate: a meritless verdict does improve deterrence when that verdict is connected to culpable behavior and the lack of merit merely comes from the lack of a clear causal connection from the culpable behavior to the injury. The ideal deterrence situation would seem to be punishment of all culpable behavior (at an efficient level) without regard to cause of actual harm, because it is the behavior that is to be deterred, not the harm.
Posted by: Paul Gowder | Aug 24, 2005 6:58:30 AM
(P.s. Kate, I'm aware that a L&E person would say that deterrence without proven harm would indeed be overdeterrence, because in the absence of harm the culpable behavior might be utility maximizing. If that's your position, I can't really deal with it in blog comments, but I'm working on a series of papers taking a good hard look at what the L&E notion of "efficiency" really means, which I think will address that argument, so gimme about a year...)
Posted by: Paul Gowder | Aug 24, 2005 7:16:58 AM
Paul: looking forward to your new project overriding 20 years of economics literature, mathematical models, and statistical research on deterrence and damages. Have you already finished that perpetual motion machine?
Posted by: Kate Litvak | Aug 24, 2005 9:26:28 AM
Alas, the laws of physics are rather more scientifically grounded than the laws of law and economics.
Posted by: Paul Gowder | Aug 24, 2005 3:29:56 PM
(Incidentally, before we get into a war of snappy and/or arrogant comments back and forth at each other, and before I'm tempted to do anything rash like compare L&E to astrology, suffice it to say that my new project won't be overriding 20 years of economics, math, statistics, etc. I simply believe I've found some good hard-scientific evidence that is highly relative to the root notion of "efficiency" upon which L&E relies. Like I said, the ETA is a year or more, so I'm not going to make an extravagant promises right now.)
Posted by: Paul Gowder | Aug 24, 2005 3:40:58 PM
Here's another perspective on the insurance matter:
Think of insurance as a casino. Casinos make oodles of money because a lot of people think that the casino will pay out to them eventually. The vast majority of those people are totally wrong. That’s how the casino makes money. As part of doing business, of course, the casino does, from time to time, have to pay out a jackpot. If it never paid jackpots, people really would stop paying in. But after a payout it doesn’t have to then tax everyone and their mother to cover the costs of that jackpot: part of its business model is that it has to pay out sometimes. If it starts raising costs (by making you pay for drinks, say), you can go across the street to the other casino that doesn't.
Insurance can be thought to work that way too. When insuring the drug industry for risks everyone knows about (that drugs go bad sometimes and juries sometimes act badly), these kinds of payouts need to happen occasionally. That is the cost of doing business. It doesn’t mean the costs then have to be absorbed by everyone.
Say insurance company X, which pays out, then raises premia for the drug company that had to claim on its policy. Company Y will be waiting on the sidelines with a policy that is somewhat cheaper. So someone other than the policyholder absorbed some of the cost. And insurance company Y may decide to eat that added cost by paying its executives slightly less, for example. Admittedly, costs are spread not erased.
Kate: tell me why this must be wrong.
Posted by: Ethan Leib | Aug 24, 2005 4:20:58 PM
Does the verdict represent a new risk which hadn't been factored into premiums, or an old, already known and thus anticipated risk which had been factored into premiums?
Is there precedent for a massive award against a drug company, and was it forseeable that such a thing would happen?
The story in which insurers raise rates in the aftermath of this suit is conditioned on them not having factored such an eventuality into their premium calculations.
I'm genuinely ignorant here.
Posted by: Isaac | Aug 25, 2005 12:16:55 AM
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