Research Handbooks in Law and Economics series
Edited by Daniel Schwarcz and Peter Siegelman
Chapter 13: Basic economics of the defense of covered claims
Liability insurance arrangements generate wealth by transferring risks from policyholders to insurers, who can bear them more cheaply. One such risk attends the defense of covered claims. The cost of defending claims has considerable potential to vary, and the manner of conducting the defense can affect the amount paid to a claimant. It is therefore important to deploy resources efficiently when defending claims. The standard law and economics approach to contracting suggests that suitable arrangements will evolve when liability coverage is sold in competitive markets, because carriers and policyholders should prefer arrangements that maximize their joint wealth. This chapter describes the basic economics of the defense of covered claims. It also discusses contractual arrangements and other devices that insurers and policyholders use to defend liability claims. Although these working arrangements are imperfect, they have obvious and strong efficiency justifications.
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