Does Tort Reform Reduce Health Care Costs?

With the U.S. Congress actively debating health reform bills that could extend insurance coverage to millions of Americans, the need to identify strategies to contain health care costs has become an ever more pressing issue. Tort reform has been proposed by leaders of both political parties as one possible strategy to reduce health care costs.

In The Impact of Tort Reform on Employer-Sponsored Health Insurance Premiums (NBER Working Paper 15371), researchers Ronen Avraham, Leemore Dafny, and Max Schanzenbach exploit state-level differences in tort laws to explore the potential cost savings associated with tort reform.

The authors begin by observing that tort reform must have an impact on medical practice - as opposed to solely on medical malpractice - in order to yield nontrivial reductions in healthcare costs. Direct costs of malpractice, which include premiums, damage awards in excess of premiums, and associated litigation costs, represent no more than two percent of health care costs. Thus, tort reforms can have a substantial effect on health care costs only if they affect the amount of healthcare services provided.

The authors explain that the effect of tort reform on health care costs is theoretically ambiguous. On the one hand, providers' sensitivity to liability may lead them to provide excessive care, resulting in higher health care costs. Eliminating this practice of "defensive medicine" is a primary justification for tort reform. On the other hand, however, liability creates incentives for providers to take greater precautions and avoid unnecessary risks. By this logic, reducing liability could increase costly medical errors and encourage providers to recommend profitable but unnecessary and even risky treatments, increasing health care costs and lowering the quality of care. Thus the effect of tort reform on costs is an empirical question.

The previous literature on this topic has largely focused on the effect of tort reform on treatment intensity for particular medical conditions with a large number of malpractice claims, such as pregnancy. These studies may not be representative of the effect on health care at large and have led to wide variations in the estimated impact of reform. The current study is the first to look at the aggregate effect of reform on costs.

To do so, the authors use a database of employer-sponsored health plans covering over 10 million non-elderly Americans annually for the period 1998 to 2006. The authors focus on four types of reforms-caps on non-economic damages (such as for pain and suffering), caps on punitive damages, collateral source reform (which reduces plaintiffs' awards if they receive public or private insurance benefits), and joint and several liability reform (which limits plaintiffs' ability to go after those parties with "deep pockets").

The authors basic approach is to make use of differences in the timing of adoption of these reforms by the states to identify the effect of reform on premiums. In their first key set of results, they find that each of the reforms except for the cap on punitive damages lowers health insurance premiums by 1 to 2 percent. This result applies to self-insured plans, those health plans for which the sponsoring employer directly pays realized health care costs of enrollees rather than paying an insurance carrier to bear this risk.

By contrast, the authors find that tort reforms have no effect on premiums of fully-insured plans. Since almost ninety percent of fully-insured plans in their data are managed by Health Maintenance Organizations (HMOs), this finding suggests that HMOs may reduce defensive medicine without tort reform through monitoring of care. The authors test this hypothesis directly by comparing the effect of the reform by insurance plan type within the sample of self-insured firms. They confirm that responses to the reforms are concentrated among plan types other than HMOs, such as Preferred Provider Organizations (PPOs).

Another interesting hypothesis the authors test is whether post-reform premium reductions are steeper in more competitive insurance markets, as measured by the number of insurance carriers. They find that this is the case. This suggests that when insurers possess market power, the pass-through of cost reductions due to tort reform will be incomplete.

A potential concern with the authors' analysis is that tort reforms may be adopted by states that are experiencing a rapid increase in health insurance premiums, generating a correlation between reforms and premiums that may not represent a true causal effect. When the authors test whether the implementation of a reform is associated with any change in premiums prior to the reform, however, they fail to find any evidence of this. They also find that the effect of reforms strengthens slightly with time.

In sum, the authors find that caps on non-economic damages, collateral source reform, and joint and several liability reform reduce self-insured premiums by 1 to 2 percent each. These findings indicate that tort reform reduces treatment intensity, as the drop in premiums is larger than the savings that would arise from reduced direct liability costs. These reductions are concentrated in PPOs rather than HMOs, suggesting that HMOs can reduce "defensive medicine" even in the absence of tort reform.

The authors observe that their findings "constitute the first evidence that tort reform reduces healthcare expenditures broadly (albeit not in a managed-care environment)." However, they caution that "to understand the social welfare implications of these reforms... additional research on health outcomes and long-run costs is needed."

The authors acknowledge funding from the Searle Center on Law, Regulation, and Economic Growth at the Northwestern University School of Law.