This article is from Cal-Tax Digest, published
by the California Taxpayers' Association.
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December 1999

California voters will shortly be asked to resolve a two-decade old controversy over handling of insurance claims. They will be asked to reject or to approve legislation enacted at the bidding of the trial bar allowing third-party lawsuits against insurance companies. Voters will do themselves a big favor by rejecting this legislation.

Senate Bill 1237 and Assembly Bill 1309, enacted last fall, restore an arcane part of California law known as "third-party liability." Accident victims have always had the right to sue the parties responsible for their losses, but these bills extend liability beyond the principal parties by authorizing a plaintiff to file an additional lawsuit against the responsible party's insurance company over the manner in which it dealt with the claim.

Third-party liability tilts the legal system very much in favor of not only the plaintiff, but more importantly, the plaintiff's contingent fee attorney who has a new tool to leverage much higher settlements in tort cases. The third-party liability doctrine is also unique in America. Only six states allow any kind of third-party liability, and only one state, Kentucky, goes as far as the new California law.

Years ago the California Supreme Court outlawed these third-party lawsuits, because they were leading to fraud, runaway litigation, and higher insurance premiums. Personal injury lawyers always want to reach into the deepest pocket, so when they're not satisfied with a settlement offer - often the case - they want to sue not only the defendant, but also the defendant's insurance company.

The court said no; an insurer should not be liable in a lawsuit for aggressively defending its client and refusing to pay a bloated settlement demand. The court noted that the public suffers undesirable social and economic effects from frivolous lawsuits, including fraudulent settlement demands from plaintiffs, with insurance companies coerced to accept these settlements to avoid further litigation.

Consider the following example: A hot dog vendor trips on a curb and breaks an arm following a Friday night high school football game. He hires a personal injury lawyer who sues the school for not providing enough light to see the curb in the dark. The school's insurance company determines that the cost of treatment is $3,000, and offers to pay the vendor that amount.

Under current law, he can accept the $3,000 settlement offer, or reject it and go to trial or arbitration. Under third-party liability, however, the trial lawyer - who will usually get up to 40 percent of the settlement as his fee - will refuse to settle and demand more.

The school district then has three choices: (1) take the case to binding arbitration for resolution, which may inoculate the district against a third-party lawsuit but which involves thousands of dollars in legal fees to prepare and present the case to an arbitrator; (2) refuse to settle and demand a trial, but that opens the district to a second lawsuit with sky's-the-limit damages; (3) settle for more than the case is worth - essentially allowing the plaintiff's attorney to dictate the settlement - to avoid the expense of a binding arbitration hearing or the risk of a multi-million dollar lawsuit later.

Many defendants would be left with no realistic alternative but the latter course, and during the years when California allowed third-party lawsuits, insurance costs and prices rose dramatically, driven by third-party leveraged settlements. In this case, the school's insurance company would have little choice but to pay more than it thinks is fair.

Tony Quinn is vice president of Goddard Claussen Porter Novelli, and has written extensively on state government issues.

The insured defendant could be a local government, it could be a small business, it could be anyone who insures an automobile. It could even be an entity that self-insures because the third-party lawsuit would be aimed at the insurer of a contractor or someone else not directly covered by self-insurance.

This is where the taxpaying and consuming public is harmed. A study by former state Legislative Analyst Dr. William Hamm estimates that allowing third-party lawsuits will increase automobile insurance liability premiums by up to $1.3 billion, and other business and government agency insurance by $200 million.

The state Department of Finance estimates a $25 million increased burden on the state's trial courts to handle the additional lawsuits. Government service contract costs will rise and insurance rates for schools and government agencies will increase as agencies try to inoculate themselves against third-party lawsuits. These additional costs will impact various insurance policies local governments purchase to cover such things as law enforcement training and school sports programs. Both government officials and private vendors will be forced to include added liability protection in contracts, which could impair further privatization of government services.

Small businesses and government agencies need liability insurance to cover "slip and fall" lawsuits, if nothing else. Under SB 1237 and AB 1309, these liability rates will go up. Ultimately, businesses will have no choice but to pass on these higher costs to their customers, and government bodies will have to devote more of their budgets to liability insurance.

A coalition of taxpayers and insurance consumers, as well as major insurers, have mounted a referendum campaign to allow the people to reject these new laws. A referendum allows the people to reject a law passed by the legislature. It works like an initiative, in that a yes vote favors the proposed law, and no vote rejects it. In a referendum election, voters are asked to vote yes or no on the statute, and if they vote no, it is rejected and does not go into effect.

The referendum is the voters' ultimate weapon to stop a bad law. It is part of the toolbox of direct democracy Hiram Johnson gave us in 1911, along with the initiative and recall. The last referendum election occurred in 1982. The reason there are so few referendum elections is that it is very difficult to qualify a referendum. After the governor signs a bill into law, opponents have only 90 days to gather more than 400,000 valid signatures.

The important lesson is that a legislative reach for advantage by personal injury attorneys has left the consuming public at risk for much higher insurance costs. The insurance marketplace is very elastic; price is driven by cost, and third-party liability is a proven cost driver.

When this referred legislation goes before the voters in 2000, taxpayers and consumers should vote to reject these self-serving trial lawyer statutes.