Early Offers in Medical Malpractice Case Law

Transcription

1 Journal of Empirical Legal Studies Volume 6, Issue 4, , December 2009 The Effects of Early Offers in Medical Malpractice Cases: Evidence from Texasjels_ Bernard Black, David A. Hyman, and Charles Silver* Medical malpractice litigation is costly and time consuming. Professor Jeffrey O Connell, with various co-authors, has long advocated early offer rules that would encourage defendants to offer to settle for economic damages plus attorney fees, and punish plaintiffs who refuse such offers. Using detailed closed claims data from Texas for , we simulate the effects of these early offers. Under a base set of assumptions, early offers will sharply reduce payouts in cases with small economic damages (under $100,000, all amounts in 1988 dollars); will moderately reduce payouts in currently tried cases with economic damages from $100,000 $200,000 and would normally increase payouts (and therefore will not be made) in tried (settled) cases with economic damages over $200,000 ($100,000). Overall, we predict that early offers will be made in 72 percent of all cases, and will result in a 16 percent (20 percent) decline in payouts in tried (settled) cases. Almost all this effect comes from the sharp decline in payouts in cases with small economic damages. Defense costs will drop by roughly 60 percent (20 percent) in currently tried (settled) cases in which an early offer is made, and by about 13 percent overall. An early offer program will have very different effects on different types of plaintiffs, with especially large payout reductions for elderly and deceased plaintiffs. An early offer program also overlaps substantially in its effects with a statutory cap on noneconomic damages (which 26 states already have). Defendants in many of these states have already realized large reductions in payment of noneconomic damages; the additional reductions from an early offer program are modest and would often affect plaintiffs whose recoveries were already limited by damage caps. Our mixed results contrast sharply with dramatic claims by O Connell and co-authors, who predict 70 percent reductions in both payouts and defense costs. Their estimates reflect the compound effects of a series of unreasonable assumptions. I. Introduction Critics of medical malpractice (med mal) litigation assert that it is slow, expensive, and levies an unjustified tort tax on defendants. Similar criticisms apply to personal injury *Address correspondence to Bernard Black; bblack@northwestern.edu. Black is Hayden W. Head Regents Chair for Faculty Excellence, University of Texas Law School, and Professor of Finance, University of Texas, Red McCombs School of Business; Hyman is Richard and Marie Corman Professor of Law and Professor of Medicine, University of Illinois; Silver is McDonald Endowed Chair in Civil Procedure, University of Texas Law School. We thank Jill Horwitz and participants in the 2008 Conference on Empirical Legal Studies, 2008 Midwest Law and Economics Association Meeting, and workshops at Northwestern and University of Michigan Law Schools for helpful comments, and Hyun Kim for superb research assistance. 723

2 724 Black et al. litigation more generally. Because the overwhelming majority of cases settle, rules that encourage faster settlement are an obvious strategy for improving the performance of the tort system. In this article, we analyze one important early settlement proposal, first made by Professor Jeffrey O Connell in Under the current version of this early offer proposal, defendants can offer to settle for full economic damages plus attorney fees, possibly with a minimum damages offer in some cases. Plaintiffs who refuse the offer face a large stick in the form of a higher burden of proof; the defendants are making offers that can t be refused. 2 Recent studies by O Connell and co-authors estimate huge payout reductions from such a program on the order of a 70 percent drop in both payouts and defense costs. 3 We simulate the impact of an O Connell early offer program on payouts. We use a data set of all closed medical malpractice claims in Texas from with payouts over $25,000 (1988$). 4 We study both tried and settled cases, and find similar results for both sets of cases. All amounts in this article are in 1988 dollars; multiply by 1.82 to convert to 2008 dollars. Under a base set of assumptions, we estimate that an early offer program could produce a 16 percent overall decline in payouts in currently tried cases, and a 20 percent decline in settled cases. We explore sensitivity analyses how this estimate will vary depending on program details and one s assumptions. This decline in payouts will result primarily from large payout reductions for plaintiffs with limited or no economic damages ($0 $100,000). There will also be large variation in how an early offer program affects different plaintiff groups, with large payout declines for elderly and deceased plaintiffs, limited effects on employed adults in nondeath cases and on children, and almost no effect on baby cases. There is also substantial overlap between the cases in which an early offer program will reduce payouts and the cases in which a cap on noneconomic damages (adopted by 26 states) already does so. Defendants will make early offers only if they expect to gain by doing so. This means that early offers will be made principally in cases with small economic damages ($0 to $100,000). They may also be made in currently tried cases with economic damages from $100,000 $200,000, depending on likelihood of liability and other case characteristics. Early offers would generally produce higher payouts in tried (settled) cases if economic 1 O Connell (1982). 2 Hence the title of Professor O Connell s initial article, which begins Offers That Can t Be Refused. Id. 3 Hersch et al. (2007); O Connell and Born (2008); O Connell and Robinette (2008). 4 This article is one of a series using the Texas closed claims database to explore different aspects of medical malpractice and personal injury litigation. Other pieces of this project include Black et al. (2005) (trends in overall payouts); Hyman et al. (2007) (comparing jury verdicts with actual payouts); Zeiler et al. (2007) (physician policy limits and out-of-pocket payments); Black et al. (2008) (analyzing defense costs in medical malpractice claims); Hyman et al. (2009a) (estimating effect of various damages caps); and Hyman et al. (2009b) (analyzing effect of insurer duty to settle).

3 Early Offers in Medical Malpractice Cases 725 damages are over $200,000 ($100,000), and thus will normally not be made in these cases. Overall, we predict that early offers will be made in 72 percent of all cases, which represent about 42 percent of current payout. The 70 percent payout reductions estimated by O Connell and co-authors reflect the compound effects of a series of unreasonable assumptions. These include: (1) assuming no minimum damages offer in many cases; (2) assuming that two-thirds of paid damages are noneconomic (we estimate that noneconomic damages represent 40 percent (52 percent) of payout in tried (settled) cases); (3) assuming that current payouts include full payment of economic damages (they do not in many tried cases and are unlikely to in settled cases); (4) treating a fee of 10 percent of economic damages as a market-clearing price for the services of plaintiffs attorneys (it isn t close); (5) ignoring plaintiffs out-of-pocket costs; (6) ignoring the time value of money; and (7) assuming that liability is certain. Defense costs will decline moderately. We estimate that defense costs will drop by roughly 60 percent (20 percent) in currently tried (settled) cases that are resolved with an early offer, or about 13 percent across all cases. This contrasts with O Connell s assumption that defense costs will drop by 70 percent in both tried and settled cases. Our approach and data set have important limitations. Our data come from a single state, albeit a large one. Our simulations require a series of assumptions. For tried cases, these include assumptions about how to allocate payouts to different components of damages, equilibrium fee levels, and plaintiffs ex ante chances of winning at trial in cases that they actually win ex post. For settled cases, we also need to estimate the economic and noneconomic components of payouts. We believe, however, that our assumptions for both tried and settled cases are far more realistic than O Connell s. Our simulation approach ignores how an early offer program might affect which cases are brought, which are taken to trial, and how they are tried. Note, too, that any payout reductions from an early offer program are a wealth transfer, and not a direct social savings. We do not evaluate here the efficiency implications of a change in payouts. Section II provides background on the pretrial settlement process, and describes the Texas medical malpractice data set and our simulation methodology. Section III discusses our data set, and Section IV describes our simulation methodology for tried cases. Section V analyzes how an early offer program will affect tried cases. Section VI extends the analysis to settled cases. Section VII examines how an early offer program will affect different types of plaintiffs. Section VIII examines how such a program will affect defense costs, total defendant costs, plaintiff s net recovery, and system efficiency. Section IX compares our early offer results to those found by O Connell and co-authors. Section X discusses some implications of our findings. Section XI concludes. HOV reply to this article in the next volume of this journal, and we then respond to their reply. 5 We urge those interested in fully understanding the differences in assumptions and analysis that drive the differences in results to read those two articles, as well as this one and the original HOV article. In particular, our response contains a more extensive statement of our assumptions, and how they differ from HOV, than is offered below. 5 Hersch, O Connell & Viscusi (forthcoming); Black, Hyman & Silver (forthcoming).

4 726 Black et al. II. Background A. Settlement and the Pretrial Process In standard litigation models, cost savings and risk aversion drive the parties to settle most cases. Cases go to trial when the parties settlement ranges do not overlap because they disagree on the plaintiff s chances of prevailing, on expected damages, or both. Other factors can enter into the decision whether to settle, such as concern about showing weakness, conveying information about one s reservation amount by being the first to offer settlement, or concern with the implications of a settlement for other cases. 6 Several voluntary programs encourage early settlement. In 2004, the U.S. Department of Health & Human Services (HHS) began a program covering Federal Tort Claims Act claims against HHS. 7 Both sides have 90 days from claim filing to send a settlement offer to a neutral intermediary (the Settlement Depository). Neither side knows if the other side has submitted a settlement offer or the amount of that offer, unless the case is resolved through the program. No data on the results of this program are available. We are also aware of early offer/apology programs run by a major malpractice insurer in Colorado (COPIC), the Universities of Illinois and Michigan, and a Veterans Administration hospital in Lexington, Kentucky. There are reports suggesting that these programs are associated with reduced payouts. However, there has been no peer-reviewed study of these programs, and informal reports suggest that formal apologies alone, plus willingness to settle after admitting wrongdoing, can also reduce payouts (Sack 2008). In separate work, we explore the effect of insurer liability for unreasonable refusal to settle within policy limits on case duration and defense costs. 8 B. O Connell Early Offers In 1982, Professor Jeffrey O Connell proposed an early offer program in a law review article. 9 In the intervening years, in numerous venues, and with numerous co-authors, Professor O Connell has promoted the virtues of early offers. 10 Although the details of the proposal have evolved over time, the general idea is that defendants can offer to settle by paying full economic damages plus a statutorily determined attorney fee, computed as a percentage of economic damages. If no offer is made, the usual tort recovery rules apply. 6 Weise (2001) ( How many times have you heard from outside litigation counsel that... wecan t raise settlement now; it would show weakness. ). 7 Department of Health and Human Services (1994). Hyman is the Settlement Depository for this program. 8 Hyman et al. (2009b). 9 O Connell (1982). 10 O Connell and Robinette (2008) list the full series of articles.

5 Early Offers in Medical Malpractice Cases 727 If the plaintiff rejects an early offer, then to recover anything, the plaintiff must either receive an economic damages award at trial that exceeds the offer, 11 or else face both a higher burden of proof (either clear and convincing evidence or beyond a reasonable doubt) and a lower standard of care (such as gross negligence). 12 Most recently, O Connell, with Joni Hersch and W. Kip Viscusi (HOV), estimated huge payout reductions in medical malpractice cases from implementing his proposal roughly a 70 percent drop in total payouts and a similar drop in defense costs. 13 We discuss this paper in detail below. O Connell then wrote a second article (with Patricia Born) extending the empirical claims to other types of personal injury litigation, and a book (with Christopher Robinette) further developing the early offer proposal. 14 Because the O Connell and Born article and the book largely replicate and extend the analysis in HOV, we focus on HOV in this article. We know of no early offer programs in existence comparable to the O Connell proposal, nor of efforts by other researchers to estimate their effects. 15 III. Data on Medical Malpractice Claims Our data come from the Texas Closed Claims Database (TCCD), a publicly accessible database maintained by the Texas Department of Insurance (TDI). This database contains individual reports of closed personal injury claims covered by mono-line general liability, commercial auto liability, commercial multiperil, medical professional liability, and other professional liability insurance involving payouts by all defendants of more than $10,000 in nominal dollars, closed from 1988 on. When we completed work on this article, data were available through TDI checks the reports for internal consistency and reconciles them against aggregate annual reports filed by each insurer. 11 Or so we infer. Neither Hersch et al. (2007) nor O Connell and Robinette (2008) discuss what happens if the plaintiff can prove larger economic damages than the defendant s offer. O Connell and Robinette (2008) are also silent on this issue. O Connell, Kidd, and Stephenson (2005) state that the higher proof standard would not apply if the plaintiff can show economic damages that exceed the defendant s offer. O Connell has not explained how one would, in practice, handle a jury trial in which the burden of proof and degree of culpability depend on the level of damages. 12 Hersch et al. (2007) state that the plaintiff must show gross negligence beyond a reasonable doubt; O Connell and Robinette (2008:124) suggest that a legislature might choose a clear and convincing evidence standard instead. 13 Hersch et al. (2007). 14 O Connell and Robinette (2008); O Connell and Born (2008). 15 The early offer proposal also allows defendants to reduce their offers by the amount of any collateral source coverage (such as coverage of medical expenses through health insurance). O Connell and Robinette (2008:124). Neither we nor HOV examine this aspect of the proposal.

6 728 Black et al. A. Med Mal Data Set We construct a med mal data set, which includes the following cases. 16 Payout by all defendants is at least $25,000 in 1988 dollars (roughly $45,000 in 2008 dollars). We convert payouts to 1988 dollars using the Consumer Price Index for All Urban Consumers (CPI). 17 The claim meets two of the following three criteria: It was paid under medical professional liability insurance; It was against a physician, hospital, or nursing home; It involved injuries caused by complications or misadventures of medical or surgical care. 18 A claim is an incident causing bodily injury and resulting in a request to an insurer by a policyholder for coverage. An insurer must file a report with the Texas Department of Insurance (TDI) in the year a claim closes when the insurer has made all indemnity and expense payments on the claim. 19 Many med mal cases involve multiple defendants. We reviewed all claim reports to identify duplicate reports. When duplicate reports exist, we treat the last-filed report as the primary report. This report should capture any prior payouts by parties that were not required to file closed claim reports, such as self-insured hospitals. Our sample includes 15,038 distinct cases involving total payouts over of $4.81 billion. The sample includes 358 tried cases with plaintiff verdicts involving allowed verdicts (allowed damages after remittitur and applying damage caps, plus pre- and postjudgment interest) of $468 million and payouts of $255 million For a fuller discussion of the TCCD, the med mal data set, and data set limitations, see Black et al. (2005) (overall data set); Hyman et al. (2007) (jury verdict cases). The Texas Department of Insurance (TDI) Closed Claim Reporting Guide (2004) (containing reporting instructions), the long and short forms, summary Closed Claim Annual Reports, and the data on which we rely are available at 17 Cases with payout of at least $25,000 are reported on a Long Form, which contains the nature of the injury, which we require to classify a claim as involving medical malpractice. The reporting thresholds are not inflation adjusted. Thus, some claims that are reported on the Long Form in later years would have been reported in earlier years on the Short Form used for smaller claims. To address this bracket creep, we limit the sample to cases with payout of at least $25,000 in 1988 dollars. 18 Other types of health-care providers (e.g., nurses and free-standing medical clinics) are not separately listed in the Long Form. We also include cases that meet one of these three criteria and otherwise seem likely to involve medical malpractice. For example, we include cases against nursing homes that were paid under other professional liability rather than under medical professional liability insurance. We exclude cases that meet two of these criteria, but seem unlikely to involve medical malpractice. Thus, we exclude cases paid under automobile liability insurance even if they meet the other two criteria. In identifying duplicate reports, we sometimes exercised judgment when claim reports were similar but not identical. Insurers also make some reporting errors that TDI does not catch. In a few cases when both the error and the correction were apparent, we corrected the underlying data. Details on the procedure we used to identify duplicates, the data adjustments we made, and our inclusion rules are available from the authors on request. 19 TDI, Closed Claim Reporting Guide (2004:18). 20 Our data set also includes 51 cases with a defense verdict followed by a payout $25,000. Most of these payouts appear to reflect high-low agreements. See Hyman et al. (2007). We exclude defense verdict cases from our analysis, since there is no basis on which to allocate the payout to economic versus noneconomic damages.

7 Early Offers in Medical Malpractice Cases 729 B. General Data Set Limitations The TCCD includes only insured claims. We lack claims against pure self-insured providers (which do not rely on captives or risk pooling). Most physicians carry malpractice insurance, but many hospitals do not. We lack data on claims against the University of Texas (UT) hospital system and UT-employed physicians. Thus, our data set likely captures most trials in which physicians make payments, but a smaller and unknown fraction in which the payers are hospitals and other providers. We have data on plaintiff age, employment status, and county of injury, but not injury severity, gender, or county of residence. We lack data on cases with zero or small payout. We have data on tried cases with defense verdicts only when they result in a payout. IV. Simulation Methodology for Tried Cases We now turn to estimating the effects of the O Connell early offer program. Our basic approach is to simulate the effect by applying the early offer rules (payment of full economic damages and attorney fees, but not noneconomic or punitive damages) to the cases in our data set. For tried cases, we have many of the data we need to simulate the program s effect. Where we lack data, we make explicit assumptions, and then vary the assumptions to test the sensitivity of our results to those assumptions. For settled cases, we have fewer data and thus must make stronger assumptions. This simulation approach builds on a similar approach that we developed in prior work to estimate the effect of damages caps on payouts. 21 Texas had caps on punitive damages, and on the sum of economic damages, noneconomic damages, and prejudgment interest in death cases throughout our sample period. We refer to these caps, together with remittitur, as other caps. The payouts we observe, and thus our estimate of how an early offer program would affect payouts, are after the effect of these other caps. Our sample period largely precedes Texas s adoption of a cap on noneconomic damages (nonecon cap). We simulate below how the Texas nonecon cap would affect our results. Our data set includes 358 tried med mal cases with damage awards. The TCCD reports the amount awarded by the jury as economic, nonecon, and punitive damages, and the lump sum paid to resolve the case. To estimate the impact of an early offer program, we first determine for each case the allowed damages of each type, after other caps. We then gross-up the awarded and adjusted damages of each type by adding prejudgment and postjudgment interest to each. This approach treats interest as compensating for the time value of money, beginning as of the time when prejudgment interest begins to accrue, generally 180 days after suit is filed. We refer to the sum of awarded damages (allowed 21 Hyman et al. (2009a).

8 730 Black et al. Table 1: Allowed and Paid Damages in Tried Cases Economic Damages Nonecon Damages Punitive Damages Total Adjusted verdict $202,743 $283,384 $32,103 $518,230 Allowed verdict $198,974 $247,197 $22,207 $468,377 Payout (before payout bonus) $146,554 $102,638 $5,815 $255,006 Present value of allowed verdict $161,090 $192,241 $16,328 $369,660 Present value of payout $118,341 $80,784 $4,103 $203,228 Mean (median) PV of payout $398 ($78) $306 ($151) $256 ($113) $568 ($220) Column as % of total payout 58.2% 39.8% 2.0% 100% Payout as % of allowed verdict 73.5% 42.0% 25.1% 55.0% Note: Adjusted verdict, allowed verdict, and total payout for tried cases. Present value is measured at six months from date of suit. Data set is 358 nonduplicate cases with plaintiff verdicts included in the med mal data set of claims closed from with payout $25,000 in 1988 dollars. Allocation rules for payout are stated in the text. Total payout excludes payout bonus of $5.9 million (present value). Mean and median for each type of damages are for cases with nonzero awards of this type. Four outlier punitive awards are winsorized at level of next highest punitive award ($2.76 M). Amounts in thousands of 1988 dollars. damages), including the gross-up for interest, as the adjusted verdict ( allowed verdict ). We compute paid damages by allocating the payout to allowed damages as follows: 22 First, to allowed economic damages until payout is exhausted or these damages are fully paid (paid econ damages); Second, to allowed nonecon damages until payout is exhausted or these damages are fully paid (paid nonecon damages); Third, to allowed punitive damages until payout is exhausted or these damages are fully paid (paid punitive damages). 23 This approach assumes that the parties have lexical priorities in allocating payout to damages, with economic damages paid first, nonecon damages second, and punitive damages third. This assumed priority is consistent with the policy premises underlying the early offer concept, and with our interviews of plaintiff s attorneys. 22 About one-third of claim reports do not include prejudgment interest. For these cases, we estimate prejudgment interest based on the statutory rates in effect during different periods. For most of our sample time period, prejudgment interest was set by statute at 10 percent simple annual interest, postjudgment interest was 10 percent interest compounded annually, and there was no prejudgment interest on punitive damages. Under Texas law, prejudgment interest is generally computed from 180 days after the earlier of when the suit was filed or written notice of the claim was received. We lack information on when plaintiffs provide written notice to defendants, so use the lawsuit filing date as the starting date. For details on the Texas rules and how we computed pre- and postjudgment interest, see Hyman et al. (2007). Our data set includes nine cases tried to a judge, rather than a jury. In robustness checks, we obtain similar results if we exclude these cases. Four cases involve large punitive damage awards ($6.9 M, $7.3 M, $16 M, and $41 M), most of which exceeded the Texas cap on punitive damages, and none of which were paid. We winsorize the punitive damages in these cases at the level of the next largest punitive award ($2.76 M). 23 In some cases, defendants pay more than the adjusted verdict. We exclude this payout bonus from our analysis, since we cannot predict how an early offer program would affect it. There is a payout bonus in 37 cases, with a mean (median) of $161,000 (45,000).

9 Early Offers in Medical Malpractice Cases 731 Table 1 shows the results for the tried cases in our data set. Of the total payouts in tried cases, 58 percent reflect economic damages, 40 percent reflect nonecon damages, and 2 percent reflect punitive damages. On average, 73 percent of allowed economic damages are paid, but only 42 percent of allowed nonecon damages, and 25 percent of allowed punitive damages. We discuss the reasons for the gap between allowed and paid damages in prior work. 24 Our simulation approach holds constant the manner in which cases are chosen and brought and applies a hypothetical early offer program to cases that were brought without the program in place. An actual early offer program will affect plaintiff s lawyers choice of which cases to bring, which to take to trial, and how cases are developed and tried. We cannot address those effects. 25 We also do not study how an early offer program will affect total payouts in all cases, or insurance premiums. Those effects will depend in part on endogenous changes in case selection and handling. V. Early Offers in Tried Cases To determine the impact of an early offer program, we must specify its rules in a form that we can simulate with our data set. We assume that the program would work as follows. Plaintiffs and defendants agree on the level of economic damages. Defendants may make a settlement offer equal to 100 percent of economic damages plus a specified percentage meant to cover reasonable attorney fees and litigation-related expenses (we will refer to this loosely as the fee percentage ). The fee percentage must be enough to cover the value of the attorney s time and expenses, both in cases that result in a payout and those that do not. Below, we make various assumptions as to whether defendants will make qualifying offers in all cases, or only in specified subsets of cases. To address cases with zero or low economic damages, the program may require a minimum offer, regardless of the level of economic damages. If the defendant makes a qualifying offer, the plaintiff must either accept the offer or face a large penalty for rejecting the offer. That penalty could involve limits on collecting damages above the offer, a higher burden of proof for some or all damages, a fee-shifting rule, or other possibilities. We follow HOV in assuming that the stick is large enough so that the offer, if made, will be accepted. We also follow HOV in assuming offers will be made six months after suit is filed. The timing of offers is not critical to our analysis, as long as offers made later than this must include prejudgment interest. The starting place for analysis is to recognize that under the current system, defendants often pay less than the jury award, and do not pay the plaintiff s attorney fees Hyman et al. (2007). 25 In most states, jurors are not told of the existence of damage caps. If jurors were told of the existence of the O Connell early offer program, it is unclear how that would affect damage awards. 26 Id. See also Hyman et al. (2007).

10 732 Black et al. Whether an early offer program will affect payouts turns on whether fast payment of 100 percent of economic damages plus attorney fees is larger or smaller in present value than the status quo (slower payment of less than 100 percent of economic, noneconomic, and punitive damages). In algebraic terms, if paid economic (noneconomic) damages are E (NE), full economic damages are E full, and the fee percentage is y, an early offer is appealing to defendants if: ( E+ NE)> E full ( 1+ y ). A. Graphical Overview of Payout Changes Our base case assumes that the fee percentage is 30 percent of gross payout. 27 References to fee percentage are to percentage of gross payout, unless otherwise specified. This compares to a current norm of a one-third attorney fee plus out-of-pocket costs. Given typical out-of-pocket expenses, the current norm involves mean fees and expenses of about 36 percent. Thus, our base case assumes about a one-sixth reduction in plaintiff-side litigation costs. Below we discuss why a 30 percent fee is reasonable and examine how varying this percentage affects our results. We initially assume that liability is certain, but relax this assumption below. We discount all payouts back to present value as of six months after suit was filed, using the statutory rate for interest (both prejudgment and postjudgment) for these periods. This puts these actual payouts on the same time footing as early offers, which we assume (following HOV) occur six months after suit is filed. Suppose, for example, that the prejudgment interest rate is 10 percent simple interest, as it was for most of our sample period, a trial was held three years after suit, and a payout of $125,000 is made soon thereafter. We would discount this payment back to six months after suit. It would be equivalent in present value to an $100,000 early offer. In Figure 1, we show how the early offer program affects payouts, under different assumptions about the details of the program. Each bar includes stacked subbars, with each subbar reflecting payout components (i.e., economic, noneconomic, and punitive damages, minimum offers, and attorney fees). The first bar shows the actual payout in the 358 plaintiff verdict cases in our data set. The second bar, labeled no minimum offer, shows the expected payout under an early offer program, assuming (unrealistically) that there is no minimum amount for a qualifying offer; an offer is made in all cases; and liability is certain. Compared to the first bar, economic damages rise, to reflect full payout of these damages. A new area for attorney fees also appears, but noneconomic and punitive damages drop out. The rise in paid economic damages and the payout of attorney fees 27 If the fee as a fraction of gross payout is y, the fee will equal x = y/(1 - y) as a fraction of the plaintiff s net recovery after the fee. So, if the gross fee fraction is 0.30, percentage is 30 percent, the fee as a fraction of economic damages would be For example, if economic damages are $100,000, attorney fees plus expenses will be $42,857, the gross payout would be $142,857, and (fees + expenses)/gross payout will be $42,857/$142,857 = 30%.

11 Early Offers in Medical Malpractice Cases 733 Figure 1: Impact of early offer program on payout in tried cases. 120% 100% 80% 60% 40% 20% 0% Actual payout No minimum offer 50k minimum offer Punitive damages Nonecon damages Fees Minimum offer Economic damages 50k minimum, 50k minimum, no offer if no offer if econs > 200k econs > 200k, 75% plaintiff chances Note: Figure shows in percentage terms total actual payout (brought to present value as of six months from date of suit) in 358 nonduplicate med mal cases with plaintiff verdicts, closed from with payout $25,000 in 1988 dollars, and predicted payout under different variants of an early offer program. Second, third, and fourth bars assume an early offer is made in all cases. Second bar shows payout under early offer rule, with early offer = economic damages. Third bar also requires a minimum damages offer of $50,000. Fourth (fifth) bar assumes a $50,000 minimum damages offer and no early offer if economic damages > $200,000. All early offer variants assume attorney fees and expenses = 30% of gross payout. Amounts in 1988 dollars. more than offsets the elimination of noneconomic and punitive damages. Overall, payouts would increase by 11 percent, relative to the status quo. The next three bars of Figure 1 progressively introduce more realistic assumptions. First, a rule that lets defendants settle cases with zero or small economic damages for very low amounts ($0, for the 17 percent of cases with zero awarded economic damages) is not realistic. We cannot imagine any legislature deciding that a fair offer for negligently causing the painful death of a retired person, with no economic damages, is $0. In the third bar, we therefore assume a minimum damages offer of $50,000. Including the fee percentage, the minimum total offer would be $71,400. Of the 358 tried cases in our data set, about half (177) had $50,000 or less in paid economic damages. As the third bar reflects, payouts would then increase by 18 percent, relative to the status quo. (If we were to instead assume a minimum damages offer of $100,000 ($143,000 including the fee percentage), payouts would increase by 25 percent.) Below, we assume a $50,000 minimum damages offer, unless otherwise specified. Second, defendants will not make early offers in all cases. Early offers become progressively less attractive to defendants as economic damages increase. Table 2 shows how the change in expected payout from making early offers varies with the level of economic damages. Payouts drop by 77 percent for cases with zero economic damages (despite the $50,000 minimum damages offer); by 61 percent for economic damages between $1 and $100,000; and by 32 percent if economic damages are from $100,000

12 734 Black et al. Table 2: Early Offer Effect on Payout in Tried Cases, by Level of Economic Damages Allowed Economic Damages Range No. of Cases Allowed Econ Damages Total Payout Early Offer Payout Early Offer % Change in Payout $ ,689 4,357 14, % >$0 but <$100 k 153 5,065 30,346 11,951 18, % $100 k, but <$200 k 42 6,093 12,777 8,705 4, % All cases <$200 k ,159 61,812 25,014 36, % $200 k, but <$500 k 37 11,607 19,769 16,582 3, % $500 k, but <$1 M 30 20,401 22,476 29,145-6, % $1 M, but <$2.5 M 20 31,186 33,746 44,551-10, % $2.5 M 15 86,737 65, ,910-58, % All cases , , ,202-35, % Note: Total allowed economic damages, actual payout (brought to present value as of six months from date of suit), and early offer, for cases with allowed economic damages in indicated ranges, for 358 nonduplicate med mal cases with plaintiff verdicts, closed from with payout $25,000 in 1988 dollars. Early offer = (max(economic damages, $50,000)) + (attorney fees and expenses of 30% of gross payout). Amounts in thousands of 1988 dollars. $200,000. These cases account for 72 percent of tried cases, but only 7 percent of allowed economic damages and 30 percent of payouts. Predicted payouts also decline for cases with economic damages from $200,000 $500,000, but these payout reductions will vanish once we relax the assumption of 100 percent plaintiff chances of success (see Figure 2). Early offers will increase payouts for cases with economic damages over $500,000, dramatically so for cases with economic damages over $2.5 million. The fourth bar in Figure 1 assumes that early offers will be made only in cases with economic damages greater than $200,000. Total predicted payouts now decline by 18 percent. To the extent that defendants can do a more nuanced job of assessing which cases are likely to involve a high ratio of noneconomic to total damages, and hence may warrant early offers, this bar will underestimate the overall payout decline from an early offer program. We address the final bar in Figure 1 below. B. Varying Plaintiffs Chances of Winning at Trial We next relax the clearly false assumption that liability is certain. In fact, plaintiffs lose 75 percent of med mal trials 28 and, overall, about 80 percent of insurer claim files are closed without payment. 29 We have 358 cases with plaintiff verdicts in our sample, and therefore estimate that there were roughly 3 * 358 = 1,074 trials with defense verdicts over our sample period, mostly unobserved. A few of these cases may have gone to trial even though liability 28 We lack data on this proportion in Texas, but 75 percent defense wins is a reasonable national estimate. See Cohen (2004) (plaintiff win rates for 1992, 1996, and 2001; Bureau of Justice Statistics surveys ranged from percent, with mean of 27 percent); Studdert et al. (2006) (21 percent plaintiff win rate). 29 See Black et al. (2005).

13 Early Offers in Medical Malpractice Cases 735 Figure 2: Early offer programs and different plaintiff chances of winning. 75% 50% % change in payout 25% 0% -25% -50% -75% 100% 95% 90% 85% 80% 75% 70% 65% 60% 55% 50% Plaintiff's chance of winning $0, but < $100k $100k, but < $200k $200k, but < $500k All cases, lesser of payout or early offer Note: Figure shows how percentage change in total payout from early offer program (brought to present value as of six months from date of suit) varies with ex ante plaintiff s chances of winning, for cases within indicated economic damage ranges, for 358 nonduplicate med mal cases with plaintiff verdicts, closed from with payout $25,000 in 1988 dollars. Early offer program includes a $50,000 minimum damages offer and (attorney fees + expenses) of 30 percent of gross payout. Heavy line assumes offers are made only in the payout ranges for which economic damages would decline (see text for details). Amounts in 1988 dollars. was certain or nearly so because the parties could not agree on damages, but more often, liability is uncertain as well. Uncertainty about liability will make early offers less attractive to defendants. Suppose, for example, that the defendant estimates economic damages of $500,000 and noneconomic damages of $300,000. If liability is certain, a $500,000 early offer plus a 30 percent fee ($714,000) reduces expected payout by $86,000. But if the defendant estimates a 75 percent (50 percent) chance of being found liable, the same early offer would instead increase expected payout by $102,000 ($289,000). Using the terms defined earlier, if paid economic (noneconomic) damages are E (NE), full economic damages are E full, and plaintiff chances of prevailing are z, the expected payout from going to trial is (E + NE) * z. If (fees + expenses) as a fraction of economic damages are y, then an early offer of E full *(1+ y) is attractive if: ( E+ NE)> E full ( 1+ y) z. An early offer thus becomes steadily less attractive as the plaintiff s chances decrease. We lack data on the ex ante odds of plaintiff success for the tried cases in our data set, which plaintiffs in fact won, viewed ex post. We address how these odds affect an early offer program using two approaches. First, we use a simple algebraic approach in which we assume that the cases in our data set that plaintiffs won ex post all had the same ex ante chances of plaintiff success. We assume the defendant knows the plaintiff s ex ante chances

14 736 Black et al. on average. We vary that plaintiff win probability from 100 percent down to 50 percent. Second, we use a simulation approach, in which we assume that the cases we observe are draws from a smooth distribution of cases with a specified mean chance of success, which varies from 100 percent to 50 percent, which we again assume the defendant knows. 30 We obtain similar results with both approaches, and present here the algebraic results. Details on how we implement each approach are in Appendix A. Figure 2 shows how the plaintiff s chances of success affect the overall change in payout from an early offer program. The top line in the figure shows the change in payout for cases with economic damages from $200,000 $500,000. Defendants can achieve small payout reductions in these cases if liability is certain. They will break even if there is a 85 percent probability of liability, and pay more if the probability of liability is 80 percent or less. However, as we discuss in Appendix A, it is difficult to construct plausible distributions in which the mean chances of plaintiff success, in cases which plaintiffs win ex post, are greater than 75 percent or, at the most, 80 percent. At a 75 percent success rate, payouts will increase by 12 percent. Thus, we would generally not expect defendants to make early offers in cases with economic damages from $200,000 $500,000. We accordingly so assume in this article, unless otherwise specified. The middle curved line in Figure 2 shows the change in payout for cases with economic damages from $100,000 $200,000. Once again, the percentage payout reduction falls as the plaintiff s chance of prevailing drops, from 32 percent if liability is certain, to about 9 percent if plaintiffs chances of prevailing are 75 percent. Predicted payouts will increase if plaintiffs chances are 65 percent or less. The bottom line in Figure 3 shows how the chances of liability affect expected change in payout for cases with economic damages of $0 to $100,000. Here, early offers are attractive to defendants across the full range of plaintiff chances. In many of these cases, the $50,000 minimum damages offer will exceed the expected value of the damages (which equals full economic damages/plaintiffs chances of prevailing), so plaintiffs chances of prevailing will not affect the expected payout. For such cases, the estimated payout reduction declines gently from 67 percent if liability is certain to 56 percent if plaintiffs mean chances are 50 percent. To summarize these results, we expect defendants will make early offers in all cases if economic damages are less than $100,000; and for plaintiff chances of 70 percent or higher if economic damages are from $100,000 $200,000; and only for plaintiff chances of percent if economic damages are $200,000 or higher. 31 The heavy line in Figure 3 shows how plaintiffs chances affect expected payouts, assuming that defendants will make early offers in all cases where expected payout is thereby reduced. The overall decline in payout varies gently from 20 percent (with 100 percent chance of liability) to 14 percent (with 50 percent chance of liability). 30 For both approaches, defendants will make early offers in some cases that we observe (do not observe) because the plaintiff won (lost) ex post. We also assume that the cases we observe are representative, in damages amounts, damages allocation, and payouts, of all cases in which early offers are made. 31 Most cases with economic damages over $200,000 will still settle, but for lower amounts than a qualifying early offer. The early offer option will not greatly affect settlement dynamics for these cases.

15 Early Offers in Medical Malpractice Cases 737 Figure 3: Fee percentage and payout changes for early offer program. 30% Change in total payout (%) 20% 10% 0% -10% -20% -30% 10% 15% 20% 25% 30% 35% Fee percentage no minumum offer 50k minimum, no offer if econs > 200k 50k minimum offer Note: Percentage change in total payout (brought to present value as of six months from date of suit) under different variants of an early offer program and varying (fee and expense) levels, as a percentage of gross payout, for 358 nonduplicate med mal cases with plaintiff verdicts, closed from with payout $25,000 in 1988 dollars. No minimum offer line shows change in payout for early offer = economic damages + indicated percentages of gross payout. 50 k minimum offer line requires a minimum damages offer of $50,000. Bottom line assumes $50,000 minimum damages offer and no early offer if economic damages exceed $200 k. Amounts in 1988 dollars. Returning to Figure 1, the final bar shows expected payout assuming a 75 percent chance of liability. Overall payout declines by 16 percent (compared to 18 percent if liability is certain). This decline comes almost entirely (96 percent) from cases with economic damages of $100,000 or less. In this scenario, early offers are made in 256/358 (72 percent) of currently tried cases. C. Varying the Fee Percentage Payouts under an early offer program are directly influenced by the fee percentage. Figure 3 shows how varying this percentage from 10 percent (close to the 9 percent level assumed by HOV) to 35 percent (close to current norms) influences payouts. We report results for the first three of the four variations developed in Figure 1; a line for the fourth variation would be very similar to, but slightly above, the third line. Figure 3 reports results for a broad range of fee percentages. However, as we discuss in Section VIII, fee percentages lower than 25 percent are not realistic as market rates. Not surprisingly, a higher fee percentage increases the payout from an early offer program. For the two upper lines in Figure 3 (no minimum offer and $50,000 minimum

16 738 Black et al. offer), each 5 percent increase in the fee percentage increases predicted payouts by 6 7 percent. As the bottom line reflects, the slope of the line is far lower if, as we expect, defendants generally will not make offers in cases with economic damages over $200,000. This is simple arithmetic: payouts in cases with early offers will be a small fraction of total payouts (about 15 percent of total payouts with a 30 percent fee percentage). The fee on these payouts is a small fraction of defendants total costs, whatever the fee percentage. D. Interaction with Caps on Noneconomic Damages We have thus far assumed no cap on noneconomic damages. However, 26 states cap noneconomic damages. An early offer program can be understood as a particular type of nonecon cap, available at the defendant s election. For example, if liability were certain, an early offer program with a $50,000 minimum offer and a 30 percent fee can be understood as similar to a cap on noneconomic damages at the greater of (1) ($71, percent of economic damages) or (2) 43 percent of economic damages, conditioned on full payment of economic damages. If a state directly caps noneconomic damages, the early offer program will often largely or entirely affect payment of damages that are already above the cap. This will reduce the impact of the early offer program. In deciding whether to make an early offer, defendants will take into account only the below-cap portion of an expected award of noneconomic damages. Texas adopted a nonecon cap toward the end of our sample period. This cap is not inflation adjusted, is $250,000 (nominal) for an institutional defendant or for one or more individual defendants, but can be as high as $750,000 (nominal) if there are both two liable institutional defendants and one or more liable individual defendants. In prior work examining the effect of this cap, we found that the Texas cap is roughly equivalent to a simple cap on noneconomic damages of $318,000 (nominal), regardless of number and type of defendants. 32 As in our previous work, we model the Texas cap by treating it as constant in real dollars at the equivalent of $250,000 in 2003 dollars for a single defendant (about $161,000 in the 1988 dollars we use in this article). We estimate how an early offer program will affect payouts if applied on top of the Texas nonecon cap by adjusting the methodology described above to include the cap. First, we estimate allowed damages after all caps by applying the nonecon cap to allowed damages after other caps. Second, we estimate paid noneconomic damages and total payout after all caps. Third, we estimate the effect of the early offer program on payouts. Figure 4 shows the results. The first bar shows payout after other caps. The second bar shows the effect of the Texas nonecon cap, which reduces total payout by 22 percent. The third bar in Figure 4 shows predicted payout with a nonecon cap plus an early offer program with a $50,000 minimum damages offer, offers not made if economic damages are greater than $200,000, and 100 percent plaintiff chances of success. Predicted payout with a $50,000 minimum offer declines by 9 percent (compared to 18 percent in Figure 1 without 32 Hyman et al. (2009a). The Texas cap affected none of the 358 plaintiff verdict cases in our data set (only three postcap cases had been closed by year-end 2005, and none involved an above-cap award of noneconomic damages), and applied to only 222 of the roughly 15,000 settled cases in our data set.

17 Early Offers in Medical Malpractice Cases 739 Figure 4: Interaction of nonecon cap and early offers. 100% 80% 60% 40% 20% 0% Actual Payout (after other caps) Predicted Payout (after all caps) 50k minimum, no offer if econs > 200k 50k minimum, no offer if econs > 100k, 75% plaintiff chances Punitive damages Nonecon damages Fees Minimum offer Economic damages Note: Figure shows in percentage terms total actual payout (brought to present value as of six months from date of suit) in 358 nonduplicate med mal cases with plaintiff verdicts, closed from with payout $25,000 in 1988 dollars, predicted payout after applying the Texas nonecon cap, and predicted payout after also applying variants of an early offer program. First bar shows actual payout; second bar shows payout with the nonecon cap; third bars show payout with nonecon cap, early offer equal to economic damages, $50,000 minimum damages offer, and no early offer if economic damages > $200,000 made in all cases. Fourth bar is same as third, except assumes 75 percent plaintiff chances of success and no early offer if economic damages > $100,000. All early offers include (attorney fees + expenses) at 30 percent of gross payout. Amounts in 1988 dollars. the nonecon cap). The final bar assumes a 75 percent chance of plaintiffs winning, and limits early offers to economic damages of $0 $100,000, which is the range over which early offers would reduce predicted payouts with a nonecon cap in place and these plaintiff chances. Predicted payouts decline by 7 percent (compared to 16 percent without a nonecon cap). Of course, the Texas nonecon cap is not the only type of nonecon cap. A more (less) restrictive nonecon cap would leave less (more) room for defendants to gain from making early offers. VI. Early Offers in Settled Cases Cases settled without a full trial (settled cases) represent 98 percent of cases and 95 percent of payouts, so it is important to assess the impact of an early offer program on these cases. In this part, we extend our results for tried cases to settled cases. Our central approach is to extrapolate from tried cases, to estimate the amount of paid economic and noneconomic damages in settled cases. We first divide cases into eight subgroups (Section VII provides details on the groups) with similar demographics (age, employment, and type of harm), but that differ in these ratios. For example, elderly death cases, on average, have a 16 percent

18 740 Black et al. Figure 5: Impact of early offer program on payout in settled cases. 120% 100% 80% 60% 40% 20% 0% Actual payout No minimum offer 50k minimum offer Punitive damages Nonecon damages Fees Minimum offer Economic damages 50k minimum, no offer if econs > 200k 50k minimum, no offer if econs > 100k, 75% plaintiff chances Note: Figure shows in percentage terms total actual payout (brought to present value as of six months from date of suit) in 14,680 nonduplicate med mal cases settled before verdict, closed from with payout > $25,000 in 1988 dollars, and predicted payout under different variants of an early offer program. Second, third, and fourth bars assume an early offer is made in all cases. Second bar shows payout under early offer rule, with early offer = economic damages. Third (fourth) bar also requires a minimum damages offer of $50,000 ($100,000). Fifth bar assumes a $50,000 minimum damages offer and no early offer if economic damages > $200,000. All early offer variants assume attorney fees and expenses = 30% of gross payout. Amounts in 1988 dollars. ratio of total paid economic damages/total payout, compared to 72 percent for baby cases. We then use a bootstrap approach, in which we assign ratios drawn from tried cases in the same subsample to settled cases, at random and with replacement. Appendix B provides details on our methodology and on robustness checks. We have less confidence in the results for settled cases, due to the need to make additional assumptions, including extrapolating from tried to settled cases, even though there are likely to be unobserved differences between tried and settled cases. In robustness checks, the simulated ratio of paid economic damages/total payout ranged from 46 percent (in our actual bootstrap approach) to 52 percent. This compares to 58 percent in tried cases. A lower ratio implies larger payout reductions from an early offer program. Our simulation results for settled cases are broadly similar to those for tried cases. Early offers will substantially reduce payouts in cases with small economic damages. They will have a more moderate impact on cases with economic damages from $100,000 $200,000. Early offers will normally not be made in cases with economic damages greater than $100,000 because payouts would rise if offers were made in these cases. Overall, early offers will be made in 72 percent of settled cases. Figure 5 has the same general format as Figure 1. The first bar shows the estimated breakdown of actual payouts in settled cases. Settled cases are more likely to involve plaintiff demographics that predict a high ratio of noneconomic/total damages, so the mean ratio of noneconomic/total damages is 52 percent in settled cases, compared to 40 percent in tried cases. The second bar shows the impact of an early offer program with no minimum

19 Early Offers in Medical Malpractice Cases 741 offer, a 30 percent fee, and an offer made in all cases. Paid economic damages increase because previously unpaid economic damages now must be paid in full. However, noneconomic and punitive damages drop out. Overall, predicted payouts now rise by 5 percent (vs. 13 percent for tried cases in Figure 1). The next three bars of Figure 5 progressively introduce more realistic assumptions. In the third bar, we assume a minimum damages offer of $50,000. Predicted payout increases by 17 percent (compared to 18 percent for tried cases). In the fourth bar, we also assume that an offer will be made only if estimated economic damages are less than $200,000. Appendix B, Table B-2 confirms that for settled cases, similar to Table 2 for tried cases, this is the damages range in which defendants will gain by making early offers. Predicted payout decreases by 25 percent (compared to 18 percent for tried cases). We also assessed which cases were likely to produce early offers if plaintiffs chances of prevailing are less than 100 percent. Most settled cases likely involve a significant ex ante chance that the plaintiff will lose at trial. This risk will be reflected in a settlement for less than full damages. An early offer, however, must include full economic damages. Thus, the lower the chances of plaintiff success, the less defendants stand to gain by making early offers. 33 Unless plaintiff chances of prevailing are 77 percent or greater, defendants will only make early offers in cases with economic damages less than $100,000. The final bar in Figure 5 assumes a 75 percent plaintiff chance of prevailing, and early offers made in cases with economic damages less than $100,000. Overall expected payouts now decline by 20 percent (vs. 16 percent in tried cases). Early offers will be made in 72 percent of settled cases; these cases represent 8 percent of economic damages and 42 percent of payout. Our results for settled cases are similar to those for tried cases. Overall payout declines somewhat more in settled cases because these cases tend to be smaller, and thus are more likely to involve economic damages in a range that makes early offers attractive to defendants. VII. Distributional Impact So far, we have focused on how an early offer program will affect payouts. We found large payout reductions in cases with small economic damages. In this section, we examine a related question: How will an early offer program affect different plaintiff groups? Prior studies have shown that nonecon caps disproportionately affect some groups, especially the elderly and the unemployed. 34 An early offer program also targets noneconomic damages, so is likely to disproportionately affect the same groups. We confirm that intuition below. 33 The (paid) settlement value of economic damages = full economic damages * chance of liability. Defendants who make early offers must pay full economic damages, which = (settlement value of economic damages)/(chance of liability). For tried cases, we know economic damages but not settlement value; for settled cases, we know settlement value but not economic damages. For both, the algebra is the same: the ratio of (early offer)/(ex ante expected payout) increases as the chance of liability declines by a factor of 1/(chance of liability). 34 Hyman et al. (2009a); Rubin and Shepherd (2007, 2008); Studdert et al. (2004).

20 742 Black et al. To assess how an early offer program will affect different plaintiff groups, we return to tried cases and divide our sample into eight subsamples based on plaintiff age, employment status, and nature of harm. Babies (age 0 1 month); Children (age 2 months 18 years); Adult nonelderly (age 19 64); divided into subsamples of employed plaintiff and nondeath outcome, unemployed nondeath, employed death, and unemployed death; Elderly (age 65+); divided into subsamples of death and nondeath. We chose the subsamples based on characteristics that, for tried cases, predict differences in the ratio of economic/total damages, while requiring a large enough subsample size to make it reasonable to draw conclusions about the subsample. In an earlier paper, we used the same subsamples to estimate the impact of a nonecon cap on payouts in tried and settled cases. 35 Table 3 shows results in tried cases for each group, assuming no offer if economic damages greater than $200,000; a 30 percent fee; and 100 percent plaintiff chances of success. The first part of Table 3 shows results for each subgroup. The second part shows results for different combinations of subgroups. The first three columns of Table 3 show plaintiff age and status and the number of plaintiff verdict cases for each group. The fourth column shows the ratio of total paid economic damages for all cases in a group to total paid damages for that group. This ratio varies widely, from 13 percent in elderly death cases to 75 percent in adult employed nondeath cases. These differences drive differences in how an early offer program affects aggregate payout for all cases within that group (fifth column). Baby cases are scarcely affected (4 percent decline in aggregate payout), but aggregate payouts to elderly deceased plaintiffs decline by 66 percent. More generally, early offers strongly affect death cases (45 percent aggregate payout reduction) compared to nondeath cases (12 percent aggregate reduction). The sixth column of Table 3 shows the mean of the per-case percentage change in payouts for the cases in each group. These percentages are smaller in magnitude than the percentage change in aggregate payout. Some are positive even when the aggregate percentage change is negative. If defendants can cherry-pick the cases in which they make early offers, the aggregate percentage decline in payout will be larger, and the mean of the per-case percentage changes will likely be negative. The final column shows a t test for differences in the means of the per-case fractional changes in payout, for selected pairs of groups. In general, payout reductions are larger in death cases versus nondeath cases; elderly cases versus adult nonelderly cases; and adult nonelderly unemployed cases versus employed cases. Thus, although the early offer program is facially neutral, its impact varies greatly depending on plaintiff demographics, employment status, and type of harm. 35 Hyman et al. (2009a).