Kyle D. Logue

Outsourcing Regulation: How Insurance Reduces Moral Hazard

This article explores the potential value of insurance as a substitute for government regulation of safety. Successful regulation of behavior requires information in setting standards, licensing conduct, verifying outcomes, and assessing remedies. In some areas, the private insurance sector has technological advantages in collecting and administering the information relevant to setting standards, and could outperform the government in creating incentives for optimal behavior. The paper explores several areas in which regulation and other government-oriented forms of control are replaced by private insurance schemes. The role of the law diminishes to the administration of simple rules of absolute liability or of no liability, and affected parties turn to insurers for both risk coverage and safety instructions. The paper illustrates the existing role of regulation-through-insurance in various areas of risky activity, and then explores its potential application in additional, yet unutilized, areas: (1) consumer protection; (2) food safety; and (3) financial statements.

The Perverse Effects of Subsidized Weather Insurance

This Article explores the role of insurance as substitute for direct regulation of risks posed by severe weather. In pricing the risk of human activity along the predicted path of storms, insurance can provide incentives for efficient location decisions as well as for cost-justified mitigation effort in building construction and infrastructure. Currently, however, much insurance for severe weather risks is provided and heavily subsidized by the government. The Article demonstrates two primary distortions arising from the government’s dominance in these insurance markets. First, the subsidies are allocated differentially across households, resulting in a significant regressive redistribution, favoring affluent homeowners in coastal communities. The Article provides some empirical measures of this effect. Second, the subsidies induce excessive development (and redevelopment) of storm-stricken and erosion-prone areas. While political efforts to scale down the insurance subsidies have so far failed, by exposing the unintended costs of government-subsidized insurance this Article contributes to reevaluation of the social regulation of weather risk. * Ben-Shahar is the Leo and Eileen Herzel Professor of Law at the University of Chicago Law School. Logue is the Wade H. and Dores M. McCree Collegiate Professor of Law at the University of Michigan Law School. We are grateful to Kevin Jiang, Michael Lockman, and John Muhs for research assistance and to Jim Hines, William Hubbard, and Ariel Porat for helpful comments. Ben-Shahar acknowledge financial support from the Coase-Sandor Institute for Law and Economics at the University of Chicago Law School.

Tax Transitions, Opportunistic Retroactivity, and the Benefits of Government Precommitment

What if the current federal income tax laws were repealed and replaced with a simple flat tax? What if the entire Internal Revenue Code (with its graduated rates and countless deductions, exclusions, and credits) were scuttled in favor of a broad-based consumption tax? Only a few years ago, such proposals would have seemed radical and extremely unlikely to be adopted. But times are changing. Calls for a drastic overhaul of the Internal Revenue Code have become commonplace, even at the highest levels in the tax-policy community.3 In addition, proposals that would replace the income tax with a flat-rate broad-based consumption tax have received substantial bipartisan support in Congress.4 And many

Genes as Tags: The Tax Implications of Widely Available Genetic Information

Advances in genetic research promise to loosen the tradeoff between progressivity and efficiency by allowing tax liability (or transfer eligibility) to be based in part on immutable characteristics of individuals (“tags”) that are correlated with their expected lot in life. Use of genetic tags would reduce reliance on tax bases (such as income) that are subject to individual choices and, therefore, subject to inefficient distortion to those choices. If genetic information can be used by private employers and insurers, the case for basing tax in part on it becomes more compelling, as genetic inequalities would be exacerbated by market forces.

Mandatory Rules and Default Rules in Insurance Contracts

The economic analysis of contract law can be organized around two general questions: (1) what are the efficient or welfare-maximizing substantive rules of contract law; and (2) once those rules have been identified, when if ever should they be made mandatory and when should they be merely “default rules” that the parties can contract around if they wish? Much of contract theory over the past twenty years has been devoted to developing answers to those two questions. The same two questions can be posed with respect to the rules of insurance law. Although previous scholars have examined particular substantive doctrines of insurance law (such as contra proferentem and the “duty to settle”), insurance law scholars as well as courts and legislatures have largely ignored whether and under what circumstances rules of insurance law generally should be mandatory. This article begins to fill that gap in the literature. The article articulates a straightforward efficiency-based approach to drawing the line between which rules in insurance law should be considered mandatory and which should be changeable by agreement of the parties. Specifically, the article suggests drawing the line in a way that is consistent with the market-failure rationale that justifies making contract rules mandatory in the first place. This same principle would apply to all contracts, not only insurance contracts. The article describes how insurance law currently draws the line between mandatory rules and default rules and evaluates whether those boundaries are consistent with the applicable market failure rationales. In addition, the article takes into account the unique role that state insurance regulators can play in helping courts decide which rules of insurance law, or terms in insurance contracts, are mandatory and which are defaults. Finally, the article explains how the rules/standards distinction must be considered in the design of the optimal mandatory/default-rule boundary.

NFIB v. Sibelius and the Individual Mandate: Thoughts on the Tax/Regulation Distinction

Should Congress’s taxing power be broader than its regulatory power? Put differently, should the courts, on federalism grounds, be more willing to strike down federal laws that are adopted under the Commerce Clause than federal laws that are adopted under the taxing power? The Supreme Court thinks so. While the Court has on occasion held that Congress’s has exceeded its regulatory power by unconstitutionally encroaching on the regulatory domain properly reserved to the states, the Court has never found that Congress has exceeded its taxing power. Moreover, the Court recently (and famously) doubled-down on the position that Congress’s taxing power exceeds it regulatory power in the landmark case of National Federation of Independent Businesses v. Sebelius [“NFIB”], which upheld the Affordable Care Act’s “individual mandate” on taxing-power grounds. Whether it makes normative sense for the Court to treat Congress’s taxing-power as being broader than its regulatory power is the question this Article explores. The Article concludes that the way the Court has drawn the distinction between taxes and regulations, or between taxes and penalties (which, as I will point out, are a type of regulatory provisions), is both counter-intuitive and could create incentives that inefficiently alter Congress’s choices among various policy instruments. The Article also provides an alternative way of drawing the tax/regulation distinction that does not suffer from this problem. The Article ultimately concludes, however, that the tax/regulation dichotomy should probably be abandoned; and it concludes that the Supreme Court was right to uphold the Affordable Care Act’s individual health-insurance mandate, though for reasons different than ones the Court offered.

Encouraging Insurers to Regulate: The Role (If Any) for Tort Law

Insurance companies are financially responsible for a substantial portion of the losses associated with risky activities in the economy. The more insurers can lower the risks posed by their insureds, the more competitively they can price their policies, and the more customers they can attract. Thus, competition forces insurers to be private regulators of risk. To that end, insurers deploy a range of techniques to encourage their insureds to reduce the risks of their insured activities, from charging experience-rated premiums to giving special premium discounts to insureds who make specific behavioral changes designed to reduce risk. Somewhat paradoxically, however, tort law discourages insurers from engaging in the direct regulation of their insureds’ behavior. Under longstanding tort principles, if an insurer “undertakes” to provide serious risk-reduction services to an insured, the insurer can be found to have a duty of reasonable care and, should that duty be breached, held liable for any harms caused to third parties. This application of tort principles to insurance companies could be contributing to the moral hazard problem often associated with insurance — the tendency of insurance to cause risk to increase rather than decrease. This Article explores this problem and analyzes a number of ways to encourage insurers to regulate — from insurer-specific Good Samaritan statutes (which we might call a “carrot”) to the expansion of tort principles to create an affirmative duty on the part of insurers to regulate (which would definitely be a “stick”). What combination of carrots and sticks produces the optimal insurer incentives to regulate their insureds’ behavior? That is the question the Article addresses.