Executive SummarySupporters of capping court awards for medical malpractice argue that caps will make health care more affordable. It may not be that simple. First, caps on awards may result in some patients not receiving adequate compensation for injuries they suffer as a result of physician negligence. Second, because caps limit physi-cian liability, they can also mute incentives for physicians to reduce the risk of negligent inju-ries. Supporters of caps counter that this deter-rent function of medical malpractice liability is not working anyway—that awards do not track actual damages, and medical malpractice insur-ance carriers do not translate the threat of li-ability into incentives that reward high-quality care or penalize errant physicians. This paper reviews an existing body of work that shows that medical malpractice awards do track actual damages. Furthermore, this paper provides evidence that medical malpractice insurance carriers use various tools to reduce the risk of patient injury, including experience rating of physicians’ malpractice premiums. High-risk physicians face higher malpractice insurance premiums than their less-risky peers. In addition, carriers offer other incentives for physicians to reduce the risk of negligent care: they disseminate information to guide risk-management efforts, oversee high-risk practi-tioners, and monitor providers who offer new procedures where experience is not sufficient to assess risk. On rare occasions, carriers will even deny coverage, which cuts the physician off from an affiliation with most hospitals and health maintenance organizations, and pre-cludes practice entirely in some states. If the medical malpractice liability insurance industry does indeed protect consumers, then policies that reduce liability or shield physicians from oversight by carriers may harm consum-ers. In particular, caps on damages would reduce physicians’ and carriers’ incentives to keep track of and reduce practice risk. Laws that shield gov-ernment-employed physicians from malpractice liability eliminate insurance company oversight of physicians working for government agencies. State-run insurance pools that insure risky prac-titioners at subsidized prices protect substan-dard physicians from the discipline that medical malpractice insurers otherwise would impose. Could Mandatory Caps on Medical Malpractice Damages Harm Consumers?by Shirley SvornyNo. 685 October 20, 2011Shirley Svorny is an adjunct scholar at the Cato Institute and professor of economics at California State University, Northridge.IntroductionSupporters of capping court awards for medical malpractice argue that caps will make health care more affordable. It may not be that simple. First, caps on awards may result in some patients not receiving adequate compen-sation for injuries they suffer due to physician negligence. Second, because caps limit physi-cian liability, they can also mute incentives for physicians to reduce the risk of negligent injuries. Supporters of caps counter that this deterrent function of medical malpractice li-ability is not working anyway—that awards do not track actual damages, and medical mal-practice insurance premiums do not reward high-quality care or penalize errant physicians with higher premiums. This paper proceeds as follows. I begin with a review of the structure and regulation of the medical professional liability insurance indus-try. Next, for those unfamiliar with studies of the tort system and concerned that it fails to identify malfeasant physicians, I review the empirical literature that has found malprac-tice awards generally track injuries resulting from negligence. The next section reviews the conventional wisdom that says medical malpractice insurance companies do not “ex-perience rate” (i.e., charge higher premiums to physicians who are more likely to injure patients). Drawing on interviews with under-writers and brokers, published sources, and an extensive review of state insurance company rate filings in California and elsewhere, I ex-plain how the malpractice insurance industry uses underwriting and other tools to provide oversight and reduce adverse medical events. I conclude that important consumer protec-tions could be lost were caps on economic and noneconomic damages to reduce insurance industry incentives to evaluate and minimize risk associated with the practice of medicine. The findings in this paper have implica-tions for several other public policies, includ-ing laws that shield government-employed physicians from malpractice claims, state malpractice insurance subsidies for high-risk physicians (via state joint underwriting associations), and state licensing of medical professionals. The Medical MalpracticeInsurance IndustryMedical professional liability insurance is commonly referred to as malpractice insur-ance. State governments regulate medical malpractice insurance. Companies approved by state insurance departments are called ad-mitted carriers. Admitted carriers must dem-onstrate financial stability and adhere to state regulations. They must seek state department of insurance approval for rates and forms. State guarantee programs protect injured pa-tients against insurer insolvency. Since the mid-1970s, the share of the medi-cal professional liability insurance market held by traditional, for-profit, commercial insur-ers has declined as not-for-profit, physician-owned insurers’ share has grown. Other risk-transfer entities provide insurance to medical societies or physician groups.1Physicians denied coverage or dropped by admitted carriers turn to surplus-lines carriers. This includes physicians who have lost hospi-tal privileges, those with a history of medical malpractice claims or drug or alcohol abuse, and physicians sanctioned by state medical boards. Medicare or Medicaid fraud can also be a ticket to the surplus-lines market.2 Doc-tors with clean clinical records may be in the surplus-lines market because they practice in more than one state, have gone without insur-ance coverage for a time, or are using a new procedure not yet widely in use. For the most part, surplus-lines carriers are not as heavily regulated as admitted carriers nor backed by a state guarantee fund.3 Because they are not required to file forms and rates, they may change rates or policy terms as con-ditions warrant. This allows them to design insurance products for nonstandard risks.4 The number of physicians in the