O'Connell Early Settlement Offers: Toward Realistic Numbers and Two-Sided Offers

O’Connell Early Settlement Offers: TowardRealistic Numbers and Two-Sided Offersjels_1182 379..401

Bernard Black, David A. Hyman, and Charles Silver*

In a prior article in this journal, we estimated the effect of an “O’Connell” early settlementoffer program on payouts in medical malpractice litigation. Using Texas data and a base setof assumptions, we predicted that early offers would result in a 16 percent (20 percent)decline in payouts in currently tried (settled) cases. The overall decline came almost entirelyfrom a sharp drop in payouts in cases with small economic damages. We compared our resultswith the estimate by Hersch, O’Connell, and Viscusi (2007) (HOV) of a 70 percent reductionin payouts, reconciled the two estimates, and explained why HOV’s estimate reflected thecompound effects of a series of unreasonable assumptions. In a reply in this journal, Hersch,O’Connell, and Viscusi (2010) (HOV-2) complain that we misunderstand both the early offerproposal and their analysis. Remarkably, they do not dispute our estimates, given ourassumptions. In this rebuttal, we defend our assumptions and provide an alternate analysis ofsettled cases based on insurer allocations, which also produces an estimated 20 percentpayout decline. We also develop further our proposal for two-sided early offers. This proposalwould reduce the predicted payout decline by about 2 percent in both tried and settled cases.We explain in greater detail the problems with HOV’s analysis. If we correct an error theymade in understanding the Texas data set, and leave their other assumptions unchanged,their payout decline estimate drops to 30 percent, not far from ours.

I. Introduction

In a prior article in this journal (hereinafter, BHS),1 we analyzed an early settlementproposal that Professor Jeffrey O’Connell has been promoting since 1982.2 Under hisproposal, 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

*Address correspondence to Bernard Black; email: [email protected]; from the fall of 2010, Black will beNicholas J. Chabraja Professor at Northwestern University, Law School and Kellogg School of Management. Black iscurrently Hayden W. Head Regents Chair for Faculty Excellence, University of Texas School of Laws, and Professorof Finance, University of Texas, Red McCombs School of Business. Hyman is Richard and Marie Corman Professorof Law and Professor of Medicine, University of Illinois; Silver is McDonald Endowed Chair in Civil Procedure,University of Texas Law School.

We thank Hyun Kim for superb research assistance and Vicky Knox of the Texas Department of Insurance for heranswers to our many questions about the TDI database.

1Black et al. (2009). <http://www3.interscience.wiley.com/cgi-bin/fulltext/123214961/PDFSTART>.

2O’Connell (1982).

Journal of Empirical Legal StudiesVolume 7, Issue 2, 379–401, June 2010

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face a large stick in the form of a heightened burden of proof—they must prove grossnegligence beyond a reasonable doubt, making the offer one “that can’t be refused.”3 Ourarticle responded to an empirical study by O’Connell and co-authors Joni Hersch and W.Kip Viscusi (hereinafter, HOV), where they estimated that an early offer program wouldreduce payouts and defense costs by roughly 70 percent.4

In BHS, we estimated that, under a base set of assumptions and using basically the samedata set as HOV, an early offer program would produce a 16 percent (20 percent) overalldecline in payouts in currently tried (settled) cases. We also provided sensitivity analysesshowing how this estimate would vary depending on program details and on changes in ourassumptions. Under no plausible set of assumptions was the estimated payout decline evenclose to HOV’s estimate. We showed: (1) that the overall payout decline would come mostlyfrom large drops in payouts in cases with “small” economic damages of $0–$100,000; and (2)elderly and deceased plaintiffs would experience large payout declines, with much morelimited effects on babies, children, and employed adults in nondeath cases.5

Why do our results differ so greatly from HOV’s? In BHS, we concluded that HOV’spayout decline estimates reflect the compound effects of a series of unreasonable assump-tions, including: (1) only one-third of paid damages are economic; (2) no adjustment ofpayouts for the time value of money; (3) current payouts include full payment of economicdamages; (4) a fee of 10 percent of economic damages (9 percent of gross payout) is amarket-clearing price for the services of plaintiffs’ attorneys; (5) plaintiffs incur no out-of-pocket litigation costs; and (6) no minimum damages offer in many cases.

In a reply in this journal, Hersch, O’Connell, and Viscusi (hereinafter, HOV-2)challenge some of our assumptions and complain that we misunderstood their proposaland “misrepresent[] fundamental aspects of [their] analysis.”6 Remarkably, they do notdispute our estimates given our assumptions. The central question is, therefore: Whoseassumptions are more reasonable—ours or theirs? In this rebuttal, we defend our assump-tions and analysis, provide additional sensitivity tests, and develop an alternate analysis ofearly offers in settled cases, based on insurer allocations of damages. Our alternate analysis,which also produces an estimated 20 percent payout decline in settled cases, responds toHOV’s concern with whether one can reliably extrapolate from tried cases to settled cases.Extrapolating from tried cases and relying on insurer allocations have different strengthsand weaknesses; we consider both approaches to be reasonable. As it turns out, the twoapproaches produce similar results.

We also develop further our proposal for two-sided early offers, which HOV dismiss,and show that it does not have the flaws they attribute to it. Two-sided offers would better

3Hence the title of Professor O’Connell’s initial article, which begins “Offers That Can’t Be Refused.” Id.

4Hersch et al. (2007); see also the similar estimates in O’Connell and Born (2008) and O’Connell and Robinette(2008).

5All amounts in BHS and this rebuttal are in 1988 dollars; to convert to 2008 dollars, multiply by 1.82.

6Hersch et al. (2010:164) (abstract). <http://www3.interscience.wiley.com/cgi-bin/fulltext/123294628/PDFSTART>.

380 Black et al.

compensate plaintiffs for economic damages in some cases where defendants would notmake early offers. Our example two-sided proposal would produce an estimated payoutdecline of 14 percent (18 percent) in tried (settled) cases, only 2 percent smaller than thedecline a defendant-only program would produce.

With regard to the HOV analysis, we show that HOV misunderstand the Texas dataset on which we both rely. Correcting this error reduces their payout decline estimate to 30percent; adjusting this payout decline for the time value of money (which they agree isappropriate), reduces this estimate to 29 percent, not far from ours.

Section II compares the BHS and HOV assumptions, develops our alternateestimate based on insurer allocations, and shows that the two errors noted above by HOVaccount for most of the difference between their estimate and ours. Section III developsthe two-sided settlement program proposed in BHS. Section IV discusses some policyimplications of the HOV early offer program and our two-sided alternative. Section Vconcludes.

II. Comparing the BHS and HOV Assumptions

In this section, we review the main differences between the BHS and HOV assumptions andrespond to the rejoinders in HOV-2. Table 1 summarizes the key common and differingassumptions we each make.7 For settled cases, the BHS column is updated to include bothour original method based on extrapolation from tried cases to settled cases, and thealternate method developed here, based on insurer allocations.

A. Ratio of Paid Economic Damages to Total Payout (Econ Payout Ratio)

HOV Estimate: Only one-third of paid damages are economic.

BHS Estimate: In tried cases, 58 percent of paid damages are economic. In settled cases, either 46 percentof paid damages are economic (extrapolation method) or 72 percent of paid damages are economic(insurer allocation method).

A critical factor in estimating payout under an early offer program is the ratio of paideconomic damages to total payout (econ payout ratio). The smaller this ratio, the larger thepayout reduction from an early offer. This proportion can be computed in tried casesbecause the jury divides the overall award into economic, noneconomic, and punitivedamages. HOV do not object to the BHS methodology for computing this ratio for triedcases.

For settled cases, the econ payout ratio must be estimated. BHS do so by extrapolat-ing from tried cases to settled cases with similar case characteristics. One can also rely oninsurer estimates of this allocation. This is what HOV claim they do, but not what they

7HOV-2 do not contest two of our methodological choices. First, when separating paid damages into economic,noneconomic, and punitive components, we allocate interest to damages. Second, when payout < damages, weassume that economic damages are paid before other damages. Below, for simplicity, we often combine noneconomicdamages and punitive damages and treat both as noneconomic damages.

O’Connell Early Settlement Offers 381

actually do. What they actually do reflects a misunderstanding of the Texas Department ofInsurance (TDI) data set on which we both rely.

To explain how HOV go wrong, we must delve into the details of the Texasclosed claim database reporting form. TDI asks insurers to report and allocate settlementpayments through a two-step process. It first asks insurers whether they believe the settle-ment “was influenced by a demand for or possible award of non-economic or exemplaryedamages or pre-judgment interest” [answer “Yes” or “No”] (TDI Question 11.e.2).8 If the

8TDI Long Form Question 11.e.2. The long claim reporting form covers claims with payouts > $25,000 (nominal).The short form, which covers claims with $10,000 < payouts < $25,000, asks only whether the settlement was

Table 1: Comparison of BHS and HOV Assumptions

Common Assumptions

Early offer is made 6 months after suit is filedDefendants choose whether to offer to settle for full economic damages plus a fee percentageDefendants make offer only when they expect to reduce payouts by doing soIf an offer is made, it is accepted

Differing Assumptions HOV BHS

Estimated mean ratio ofeconomic to total damages

33% Tried cases: 58%Settled cases: 46%(extrapolation method);72% (allocation method)

Discount current payouts topresent value

No Yes (Texas statutory rate)

Current payouts include fullpayment of economicdamages, in both tried andsettled cases

Yes No

Fee percentage (covers plaintifflegal fees plus out-of-pocketexpenses)

9% of gross payout 30% of gross payout

Minimum damages offer No (principal analysis) or onlyif “serious” harm (alternateanalysis)

Yes ($50,000)

Reduction in defense fees andcosts

70% 60% (20%) in tried (settled)cases

Ability to estimatenoneconomic damages

Insurers have perfect foresighton noneconomic damages ineach case

Insurers can predict econpayout ratio for group ofcases, not case by case(extrapolation method);Same as HOV (allocationmethod)

Data set Texas closed claims, 1988–2002,with payout > $10,000(nominal)

Texas nonduplicate closedclaims, 1988–2005, withpayout > $25,000 in 1988dollars

382 Black et al.

answer is “Yes,” TDI asks the insurer to allocate the payout among economic losses,noneconomic losses, exemplary damages, and interest (TDI Question 11.e.3). If the answeris “No,” TDI instructs the insurer to skip the allocation question.9 In 35 percent of claims,insurers answer “Yes” and allocate damages. For the remaining 65 percent of claims,insurers answer “No” and do not allocate damages. A “No” answer to Question 11.e.2 meansthat, in the insurer’s judgment, the entire payout is attributable to economic damages.Table 2 shows the breakdown of paid damages in settled cases based on insurers’ alloca-tions. The econ payout ratio is 35 percent in cases where the insurer allocated damages and72 percent across all cases.

Is it plausible for insurers to report no paid noneconomic damages in almost two-thirds of settled cases? We think so. If a case settles for economic damages or less, an insurercould reasonably answer “No” to Question 11.e.2. To be sure, insurers might sometimesanswer “No” to Question 11.e.2 to avoid having to allocate damages. If so, the true per-centage of cases with zero paid noneconomic damages might be less than 65 percent—though how much less, one could only guess.

How did HOV get from the insurers’ allocations of 72 percent of payouts to economicdamages to their own estimate of a 33 percent overall econ payout ratio? When the insureranswered “Yes” to Question 11.e.2, thus reporting that noneconomic damages were posi-tive, HOV used the insurer’s allocation (on average, 35 percent). Where the insureranswered “No,” thus reporting that only economic damages were paid, HOV ignored theinsurer’s report and instead used Florida data to impute an econ payout ratio between 15percent and 36 percent, depending on plaintiff demographics (on average, 22 percent).Thus, HOV assumed that the econ payout ratio is lower in cases where insurers reportedpaying only economic damages than in cases where insurers reported paying both economicand noneconomic damages. This cannot be right.

“influenced by a demand for or possible award of exemplary damages.” TDI Short Form Question 11.e.2. Ourdiscussion in the text and our analysis in BHS use only long-form claims. HOV use both long-form and short-formclaims, but short-form claims account for less than 1 percent of payouts, so how one handles them will not significantlyaffect the overall results.

9The instructions to Question 11.e.2, printed in the margin next to the question, state: “If item 11.e.2 is ‘N’, do notrespond to item 11.e.3.”

Table 2: Insurer Allocations of Paid Damages in Settled Cases

No ofCases

EconomicDamages

NoneconDamages

PunitiveDamages Total

Insurer allocates damages 5,173 35% 57% 8% 100%Insurer does not allocate damages 9,507 100% 0% 0% 100%All cases 14,680 72% 25% 3% 100%

Note: Insurer allocation of settlement payments, for 14,680 nonduplicate cases settled before verdict included in medmal data set of claims closed from 1988–2005 with payout �$25,000 in 1988 dollars. See text for details on insurerallocations.


BHS pointed out these problems with the HOV analysis.10 HOV-2 reply that theyneeded to impute an econ payout ratio for cases where insurers reported no breakdownbecause, for these cases, TDI reports zero values for all damage components in Question11.e.3, and “it is impossible that all damages components are zero, as that would have ledto a zero payment amount in these cases.”11 The reply shows that HOV misunderstand theTDI database. The responses to Question 11.e.3 are zeroes not because “all damagescomponents are zero,” but because the insurer answered “No” to Question 11.e.2 and thenskipped Question 11.e.3, in accordance with TDI’s instructions.12 The consequences of thismisunderstanding are huge. For the 65 percent of settled cases where they impute econpayout ratios, HOV estimate an average 76 percent payout decline. Yet, if one credits theinsurers’ reports that only economic damages were paid, early offers would increase payoutsin these cases, and thus would not be made.

How best to estimate the econ payout ratio for settled cases is a hard question. InBHS, we extrapolated from tried cases, where the allocation is known, to settled cases withsimilar plaintiff demographics and type of harm. We used a bootstrap approach to estimatethe econ payout ratio in each settled case, in which we picked a ratio at random, withreplacement, from tried cases with similar demographics and type of harm.

HOV argue that extrapolation is suspect because settled cases likely differ from triedcases in ways not observable from the data.13 We agree, said as much in BHS, and warnedthat we “have less confidence in the results for settled cases.”14 Prompted by HOV’scriticism, we develop here an alternate approach based on insurer allocations. Thisapproach has the weakness of relying on insurer estimates rather than actual awards, butthe strength of not assuming that tried and settled cases have similar econ payout ratios.The key assumptions we make when using insurer allocations are that insurers: (1) answerno to Question 11.e.2 if payout is less than economic damages; and (2) assign payout inresponse to Question 11.e.3 first to economic damages.15

10See Black et al. (2009:747).

11Hersch et al. (2010:169–70) (“For cases in which there was a positive payment amount but the insurer did not reportthe breakdown of the damages components, the TDI recorded zeros for all the values that would otherwise containthe damages components. However, as the minimum payment for inclusion in the TDI sample is $10,000, it isimpossible that all damages components are zero, as that would have led to a zero payment amount in these cases.”).

12For this and many other questions, when releasing the closed claim database in spreadsheet form, TDI codes missinganswers as zeros. TDI personnel explained that they do so because their software routines “which check formathematical errors could not be run [with missing values].” Email from Vicky Knox at TDI to Bernard Black (Oct.20, 2009).

13Hersch et al. (2010:167).

14Black et al. (2009:740).

15More specifically, these assumptions imply that (1) insurers interpret TDI Question 11.e.2, which asks whether thesettlement was influenced by a demand for noneconomic damages, as asking whether the settlement exceeds fulleconomic damages, and answer no if payout < full economic damages; and (2) insurers answer the allocationquestion, Question 11.e.3, by allocating payout first to economic damages until fully paid, then to other categories.

384 Black et al.

As Table 2 reflects, using insurer allocations, we obtain a mean 72 percent econpayout ratio in settled cases. This is substantially higher than our extrapolation-basedestimate of 46 percent, but that is largely because the two ratios measure different things.In tried cases, liability is known, so our extrapolation approach gives an estimated econpayout ratio, if liability were certain. This estimate must be adjusted upward to reflectuncertainty about liability (see Section C below). In contrast, insurer allocations provide theecon payout ratio given actual uncertain liability.

The next step when using insurer allocations is to estimate payout reduction. Weassume a $50,000 minimum damages offer. We also assume that insurers can correctlyassess, case by case, what they could settle for under current law, and thus which caseswarrant early offers. The minimum offer aside, with a 30 percent fee, defendants break evenby making an early offer if the econ payout ratio is 70 percent and gain if this ratio is below70 percent. Thus, they gain in 22 percent (3,182/14,680) of the settled cases in our sample.The mean payout decline in these cases is 56 percent, and the overall mean across all settledcases is 20 percent. This turns out to be the same—to the nearest 1 percent—as ourextrapolation-based estimate. We caution, however, that the two approaches make differentassumptions, and that both estimates are rough. They produce quite diffferent predictionfor the fraction of cases in which defendants will make early offers. Thus, their closeness toone another is partly coincidence.16

Table 3 shows estimated econ payout ratios and overall payout declines in tried cases,together with settled case estimates from the BHS extrapolation, our new insurer-allocationmethod, the estimate in a recent article by Studdert et al.,17 the HOV estimate, and an“HOV-corrected” estimate that uses insurer allocations correctly but maintains the otherHOV assumptions. Correcting this error in HOV’s analysis cuts their estimated payoutreduction from 70 percent to 30 percent. This is not far from the BHS estimates. Thus, mostof the difference between the BHS and HOV estimates derives not from the differentassumptions discussed below, but from HOV’s misunderstanding of the TDI instructionsand imputing a low econ payout ratio from Florida data for no-allocation cases.

B. Time Value of Money

HOV Implicit Calculation Error: Not adjusting for the time value of money when estimatinginsurer savings.

16In the extrapolation approach, we assumed that insurers either make early offers in all cases within a given rangeof economic damages or none. We estimated that they gain from making early offers in settled cases with economicdamages < $100,000, and thus assumed they would make offers only in those cases. When we switch to the insurer-allocation approach, this restriction on early offers no longer seems appropriate to us. We instead assume (as HOVdo) that insurers can assess what they could settle each case for under current law, and will make an early offer if theoffer will be less than current payout, whatever the level of economic damages. If we assumed that insurers make earlyoffers in all 5,173 cases with < 100 percent allocation of payout to economic damages, the estimated payout declineusing insurer allocations would be 18 percent. Conversely, the extrapolation-based estimate would be higher than 20percent if we assumed greater insurer ability to cherry-pick which cases warrant early offers.

17Studdert et al. (2007:online technical appendix).


BHS Approach: Compare payouts with and without an early offer program by bringing both to presentvalue at the same time, relative to when the case is brought.

In estimating insurer savings, HOV subtract early offer payouts from current payouts withoutadjusting for differences in when payments are made. This implicitly ignores the time valueof money. In BHS, we criticized this omission and adjusted for the time value of moneyusing the Texas statutory rate for prejudgment interest (10 percent simple interest for mostof our sample period; 5 percent after September 1, 2003) as the discount rate.

HOV-2 agree that discounting is appropriate, and state that they adjusted payouts forthe time value of money.18 We rechecked our replication of the HOV results and areconfident that they did not discount payouts when estimating insurer savings (theirTable 3).19 But the key point is not what HOV did or did not do; we both agree thatdiscounting is appropriate. If we take the HOV-corrected estimate above of a 30 percentpayout decline, and adjust for the time value of money using their proposed 3 percent realinterest rate, their estimated payout decline is 29 percent, versus 20 percent for BHS.

HOV-2 also argue that the Texas statutory rate is too high, and that a better ratewould be 3 percent real (or about 6 percent nominal on average over our sample period).We agree that a 3 percent real rate is also reasonable.20 If we had used it in place of the

18Hersch et al. (2010:164) (abstract) (BHS claim incorrectly that our analysis does not discount deferred payments,whereas in fact it does) (2010:168); (we “discount deferred payments using a 3 percent real (i.e., inflation-adjusted)interest rate”).

19HOV say that they adjust for the time value of money in their Tables 5 (defense cost savings) and 6 (effect onplaintiff recoveries), but do not so state for Table 3 (insurer savings). See Hersch et al. (2007:S251) (first mention ofdiscounting in section on “Litigation Cost Savings”). We replicated their results for Table 3 without discounting andtheir results for Tables 5 and 6 with the discounting they say they use for those tables. The disagreement between usinvolves only whether they discounted in Table 3. Our HOV-replication analysis is included in our overall replicationStata data set and do file, see note 46 below.

20One might prefer the 3 percent real rate in assessing payout decline for defendants, but the generally higher Texasstatutory rate for plaintiffs. See Knoll (1996) (discussing plaintiff and defendant discount rates).

Table 3: Comparison of Methods: Econ Payout Ratio and Early Offer Impact

ApproachMean Econ

Payout RatioPayoutDecline

Tried cases: BHS results 58% 16%Settled cases:

BHS Method 1 (extrapolate using subsample bootstrapping) 46% 20%BHS Method 2 (insurer allocations) 72% 20%Studdert et al. survey 60% n.a.HOV 33% 70%HOV-corrected 72% 30%

Note: Table shows different estimates of ratio of paid economic damages/total payout (econ payout ratio) for 14,680nonduplicate cases settled before verdict included in med mal data set of claims closed from 1988–2005 withpayout �$25,000 in 1988 dollars. Top row shows BHS results for tried cases; next two rows show BHS results underextrapolation and insurer-allocation approaches; next row shows the Studdert et al. (2007) estimate; last two rowsshow HOV’s reported results and their results after correcting the econ payout ratio as described in the text.

386 Black et al.

Texas statutory rate, our estimated payout reduction would become 17 percent (21percent) in tried (settled) cases, instead of 16 percent (20 percent).

C. Going from Paid Economic Damages to an Estimate of Full Economic Damages

HOV Assumption: Current payouts include full payment of all damages, including economicdamages.

BHS Analysis: Settlements often involve less than full payout of economic damages. One must account forthis in estimating full economic damages and thus early offer payout.

An early offer is equal to full economic damages * (1 + fee percentage), and the payoutdecline from an early offer is [current payout] – [full economic damages * (1 + fee per-centage)]. Full economic damages are known in tried cases, but must be estimated insettled cases. An advantage of the insurer-allocation approach, if used in all cases, is that theinsurer allocations provide enough information to let one avoid this difficult estimation.

If the insurer allocates less than 100 percent of payout to economic damages, we inferthat economic damages were fully paid, and therefore can compute what they are [eco-nomic damages = payout * econ payout ratio]. If the insurer allocates 100 percent of payoutto economic damages, we know only that payout � economic damages, but that is all weneed—because we then also know that the insurer would not make an early offer in thesecases.

If, however, one imputes an econ payout ratio from another source—as BHS do inour extrapolation approach, and HOV do when they impute this ratio from Florida cases—the need to estimate full economic damages, in order to estimate early offer amounts,cannot be avoided. It is tempting to estimate full economic damages by multiplying theimputed econ payout ratio by the payout. For example, if one observed a settlement for$200,000 in a case with a 50 percent imputed econ payout ratio, one would infer that fulleconomic damages were $100,000. This is what HOV do. This is, however, a mistake. Weprovide an informal explanation here, and a more formal analysis in the Appendix.

Assume a set of cases has an average settlement payment of $200,000, and a 50/50split of the total loss between economic and noneconomic damages. On average, across thisset of cases, full economic damages will be higher than $100,000 (and, correspondingly, theecon payout ratio will be higher than 50 percent) for two reasons. First, we know thatplaintiffs who win at trial often recover less than full economic damages.21 Assume thatplaintiffs in this class of cases who go to trial and win would recover 90 percent of economicdamages on average. Because settlements are negotiated in the shadow of expected trialoutcomes, settlement payouts will reflect these discounts and must be adjusted upward torecover an estimate of full economic damages. Second, settlement payments are discountedto reflect plaintiffs’ risk of losing at trial. Ignoring other considerations, if the plaintiff hasa 75 percent chance of winning, the case should settle for 75 percent of total damages. Toestimate full economic damages correctly, one must adjust settlement payments upward asecond time to offset this discount.

21Hyman et al. (2007); Zeiler et al. (2008).


Under our assumed facts, for a set of cases with, on average, payout of $200,000, 50percent of damages are economic, 90 percent of economic damages are paid after trial, and75 percent plaintiff chances of success, full damages would be:

d full = ∗( )∗( ) =$ $200 0001

0 901

0 75296 296,

. ., .

Full economic damages would be half this amount, or $148,148, and the correspondingecon payout ratio would be 74 percent—rather than $100,000 in economic damages, anda 50 percent econ payout ratio, as suggested above.

BHS take these effects into account when estimating early offer payouts. HOV do not.In effect, they assume, for the cases where they impute an econ payout ratio from Floridadata, that observed settlement payments cover all damages in full. This error causes HOVto underestimate early offer payouts, even if one treats the imputed Florida ratios as correctfor the Texas cases (which, as we discuss above, they are not).

HOV respond to our objection by saying that we ignore their use of insurer reservesas a baseline estimate of current payouts and that reserves and payouts take into accountsettlement discounts, relative to full economic damages.22 This misunderstands theproblem. The payout decline from an early offer program is the sum, across early offersuitable cases, of (payout under current rules) – (early offer payout). We agree that theirbaseline—their estimate of payout under current rules—reflects plaintiffs’ less-than-100-percent chance of success. This is true whether this baseline is measured using insurerreserves or current payouts. However, their estimate of early offer payout does not reflectplaintiffs’ less-than-100-percent chance of receiving full damages. It needs to do so in caseswith imputed econ payout ratios.

D. Fee Percentage

HOV Assumptions: A contingent fee of 9 percent of gross payout is a market-clearing wage forplaintiffs’ counsel. Out-of-pocket expenses can be paid out of this.

BHS Estimate: A market fee percentage under an early offer program will be around 30 percent of grosspayout, including around 4 percent for out-of-pocket expenses in cases which plaintiffs win.

The early offer program requires defendants to pay a market-clearing fee for plaintiffs’counsel. HOV assume that a market-clearing fee is 10 percent of the damages payment (9percent of gross payout) in cases that plaintiffs’ counsel win and (implicitly) 0 percent incases they lose. In BHS, we argue that this is far below an appropriate market rate and thatHOV ignore out-of-pocket expenses, which we estimated at 4 percent of payout. HOV replythat a fee equal to 9 percent of gross payout is only an “illustrative assumption” but defendthis assumption because an early offer program will require plaintiffs’ counsel to do less

22Hersch et al. (2010:170) (italics in original, footnote omitted) (BHS object that “[c ]urrent payouts do not fully payeconomic damages: This BHS claim is not relevant to our model. . . . The initial reserve and final reserve analysesincorporate the insurer’s expectation of whatever damages will be paid, which will fully account for expectations thatjury awards may be reduced [after trial]. Similarly, for our . . . calculations based on the actual settlement or courtaward, the TDI data reflect the actual amounts paid by insurers.”).

388 Black et al.

work.23 In response to our concern with out-of-pocket expenses, they contend that expensescan be taken out of the 9 percent fee, reducing it, on average, to 5 percent.24 HOV offer noempirical support for these assumptions.

We agree that an early offer program will reduce fees and expenses, but find a 9percent rate to be implausible. In BHS, we used data on defense costs and estimated thatif plaintiff-side costs behave similarly, the sum of plaintiff legal fees and expenses couldplausibly decline to 30 percent of gross payout under an early offer regime, from thecurrent 36 percent or so. This estimate is a blend of a substantial decline in plaintiff-sidecosts for cases that receive early offers (20 percent in settled cases; 60 percent in currentlytried cases), but no decline in cases that do not, including zero-recovery cases. Even ifplaintiff costs drop by 60 percent in both tried and settled cases that receive early offers, feesplus expenses would only decline to about 25 percent of gross payout.

If we adjust the HOV-corrected payout decline estimate for a 25 percent gross fee(the lower end of the range we consider plausible), their estimate becomes 26 percent,compared to the BHS extrapolation-based estimate of a 22 percent decline in settled cases,using the same 3 percent real discount rate and a 25 percent fee.

E. Minimum Damages Offer

HOV Assumption: Either no minimum offer (for their base analysis) or a minimum offer only in“serious” cases (roughly half of all cases).

BHS Assumption: $50,000 minimum damages offer in all cases.

HOV’s base analysis does not assume a minimum damages offer. Thus, they assume that ifeconomic damages are zero, the defendant would make, and the plaintiff would accept, a$0 offer. In an alternate analysis, HOV assume a minimum offer ranging from $100,000–$500,000 for what they term “serious cases” (death, brain damage, spinal cord injury, andamputation; roughly half of all cases), but no minimum offer for other cases. We wrote inBHS that “we can imagine a minimum offer that varies based on type and severity of harm,but a minimum offer of $0 seems implausible as a legislative judgment on fair compensa-tion.”25 Our base assumption was a $50,000 minimum damages offer (in 1988 dollars, thecurrent dollar equivalent is around $90,000).

HOV-2 respond that our assumed minimum might be too high in some cases. Weagree; our assumed minimum reflects our judgment about what a politically determinedminimum offer might be on average. Our judgment is that a $50,000 minimum is a reasonableaverage across all cases and a $0 minimum in either all or half the cases is not.

To assess the effect of our minimum damages assumption, we conducted a sensitivityanalysis in which we reduced the BHS minimum damages offer to $25,000 in nonserious

23Hersch et al. (2010:171).

24Hersch et al. (2010:170) (“If there is an early offer payment, presumably the parties can negotiate sud out of pocketexpenses to come out of the 10 percent fee.”).

25Black et al. (2009:747).


cases, but left it at $50,000 in serious cases, and add a similar minimum offer to theHOV-corrected estimate from the previous subsection, using a 25 percent fee and 3 percentreal discount rate in both approaches. The HOV-corrected estimate drops from 26 percentto 25 percent; the BHS estimate rises to 24 percent.

F. Defense Costs

HOV Assumption: A 70 percent drop in defense costs.

BHS Estimate: Defense costs will decline by 60 percent (20 percent) in tried (settled) cases.

HOV assume that defense costs will drop to 10/33 of their current level, to reflect theassumed cut in plaintiff legal fees to 10 percent from 33 percent.26 They offer no other basisfor this assumption. In BHS, instead of assuming a particular level of defense cost savings,we used the Texas defense cost data to estimate the effect of faster settlement on defensecosts. We estimated that these costs would decline 53 percent (15 percent) in currently tried(settled) cases. In our analysis of overall system costs, we use somewhat larger estimates of60 percent (20 percent) in tried (settled) cases that would receive early offers.

HOV-2 reply that they are making an assumption, not an estimate. But assumptionsshould be consistent with the available data. HOV-2 do not explain why their assumption isreasonable, given the data and our analysis HOV-2 assert that under an early offer regime,insurers will be able to handle most cases using only claims adjusters, without hiring eithrecounsel or expert witnesses.27 This seems like wishful thinking to us. If liability is so clearthat one doesn’t need an expert to assess it, then insurers should often be able to foregoexperts today. In most cases, liability will be uncertain, and experts will be needed, earlyoffer regime or not. As for counsel, we can imagine some easy early offer cases, in whichinsurers could dispense with counsel entirely. But most claims will still involve lawsuits, andcounsel will be needed.

G. Data Set Comparison

BHS study med mal claims closed from 1988–2005, with payout by all defendants of at least$25,000 in 1988 dollars. HOV-2 offer two complaints about our use of this data set. First,they note that we include claims closed from 2003–2005, even though Texas cappednoneconomic damages in 2003 (non-econ cap). Second, they complain that we limit ouranalysis to claims with payout over $25,000 in 1988 dollars, while they include all claims withindividual reports in the data set, which goes down to $10,000 in nominal dollars. Neitherobjection is significant.

The non-econ cap applies only to cases with suit filed after September 1, 2003. Onlythree tried cases in our data set were subject to this cap, and in all three, the actual awardednoneconomic damages were below the cap. Thus, there is no bias introduced by using tried

26As we noted above, HOV actually want to cut plaintiff legal fees from 33 percent to 9 percent (of gross payout).

27Hersch, et al. (2010:166).

390 Black et al.

cases through 2005.28 Our sample includes a larger number of settled claims that weresubject to the non-econ cap—2 closed in 2003; 56 closed in 2004; and 164 closed in 2005.Taken together, these claims are 8 percent of the claims that closed in these three years butonly 1.5 percent of all settled claims in our data set. If we exclude these claims, our estimatesbarely change.29 As for claims between $10,000 (nominal) and $25,000 (real), these accountfor 15 percent of all claims with payout of $10,000 nominal or more, but only 0.9 percentof all payouts. Thus, including them would have a minimal effect on our estimates.

III. Two-Sided Early Offer Proposal

If early offers by defendants are desirable, one might also want to give plaintiffs incentivesto make early offers to settle for economic damages plus fee percentage, and penalize insome reasonable way defendants who refuse qualifying offers and then lose at trial. BHSproposed a two-sided early offer program, analogous to the bilateral offer-of-judgmentrules that already exist in Texas and several other states.30 One proposed “stick” wasmaking defendants liable for the fee percentage on all damages (not just economicdamages) if they refuse a plaintiff offer and lose at trial. HOV-2 dismiss this idea out ofhand, writing that “claimants and their counsel lack sufficient incentives to weed outnon-meritorious claims if they have the power to unilaterally bind defendants in some wayby their claims.”31

We find this response puzzling. Plaintiffs can make offers, but cannot compel defen-dants to accept them. The misunderstanding may arise because BHS only sketched thetwo-sided offer proposal. We develop it more fully here.

A. Effects of Plaintiff Offers on Settlement Value

Consider, for simplicity, three types of claims—invalid claims (clearly or nearly so), validclaims (clearly or nearly so), and claims that are neither clear winners nor clear losers. If aclaim has little merit, defendants will refuse the plaintiff’s offer to settle. The plaintiff willeither drop the case or proceed to trial, where the defendants will (by assumption) have

28Black et al. (2009:738 n32). If we exclude the three tried cases that were subject to the cap on noneconomicdamages, our results change only trivially (as one would expect).

29If we exclude claims filed after September 1, 2003, the payout reduction is the same to the nearest 1 percent (whichis how we reported all results). The point estimate increases by 0.3 percent. We can think of no reason to exclude casesclosed during 2003–2005, but filed before September 1, 2003.

30See Texas Rules of Civil Procedure, Rule 167 (Offer of Settlement) (providing for the shifting of certain “litigationcosts” when an offer to settle is rejected and the ultimate judgment is less favorable to the offeree by 20 percent ormore.) See also Yoon and Baker (2006); Carson (2005).

31Hersch et al. (2010:172).


excellent chances of prevailing. Plaintiff-side offers will make defendants only marginallyworse off than the status quo.32

Next, consider clearly (or nearly so) valid claims. Litigation cost savings aside, defen-dants will make early offers whenever early offer payout is less than expected payout undercurrent law. Plaintiffs, in turn, will make early offers in all cases in which the early offerpayout equals or exceeds the expected value under current law. The risk to a defendant ofhaving to pay the fee percentage if the defendant refuses the offer and loses at trial should,one hopes, induce settlement where the plaintiff has a strong case. This implies that allmeritorious cases should be resolved through an early offer. If collectability is limited, due,say, to policy limits, both sides will presumably realize this and settle for what the plaintiffcan realistically expect to collect.

Finally, consider claims that are neither clear losers nor clear winners. Plaintiff-sideoffers will increase settlement values for cases in which defendants do not make early offers.By how much will depend on the expected cost to defendants who refuse a plaintiff offer.Let the fee percentage be y, the probability of liability be z, the maximum collectibledamages be L (for policy limits), and, for simplicity, ignore litigation costs, damage caps,plaintiff ability to collect more than policy limits, and sources of “haircuts” (in whichplaintiffs receive less than full payout even if liability is certain) other than policy limits.

As before, the defendant (plaintiff) will make an early offer if the offer amount is less(more) than current payout, so an offer will be made in all cases.33 The settlement value ofcases in which plaintiffs make early offers should equal the expected payout if the case goesto trial:

Settlement value with plaintiff early offer L total damages= ∗z min , ∗∗ +( ){ }1 y .

In contrast, under current law:

Settlement value L total damages= ∗ { }z min , .

Thus, settlement value will not change for claims that currently settle at limits. Settlementvalue will increase by a factor of (1 + y ) if the with-early-offer settlement value is below orat limits, and by a factor of less than (1 + y) if the full increase would take the settlementamount above limits.

32Plaintiffs’ counsel will presumably take some weak cases to trial because they believe there is some chance to win(perhaps correctly, since juries sometimes err). The prospect of recovering fees could, at the margin, persuadeplaintiffs’ counsel to take to trial some weak cases that they would today abandon. This would increase defendants’defense costs and could lead to an occasional loss at trial. However, the dollars involved are likely to be small. Forexample, Studdert et al. (2006) report that of 117 med mal trials in which independent review of the claim file foundno or only some evidence of negligence, only 11 produced plaintiff verdicts.

33A caveat. The statement in the text assumes that the plaintiff and defendant agree on damages and chance ofliability. If not, there can be cases where neither side will make an early offer. A plaintiff will make an early offer whenecon payout ratio * (1 + y ) � z; a defendant will make an early offer when the inequality is reversed; in each case withall values as perceived by their counsel.

392 Black et al.

B. Effects on Overall Payouts in Tried Cases

HOV also object that a two-sided offer program is not politically viable because it wouldincrease overall payouts.34 This is not the case, at least for the example program developedabove. As we note in BHS, Table 2, if early offers were made and accepted in all tried cases,payouts would fall (rise) in cases with small (large) economic damages. Overall, payoutswould increase by 17 percent. But this is unrealistic. Plaintiffs already often collect less thanfull damages, with haircuts increasing as damages increase.35 An assessment of how plaintiffearly offers would affect payouts must account for limits on collectability.

A full analysis of how policy limits (and other factors that lead to posttrial haircuts)would affect the choice of cases in which defendants or plaintiffs would make early offers,and how much the plaintiff might collect, is complex. We offer here only a rough cut, basedon some simplifying assumptions.

Consider tried cases first. Recall from BHS Table 2 and Figure 3 (which ignorepolicy limits) that defendants gain from making early offers in currently tried cases witheconomic damages under $200,000, and roughly break even if economic damages are from$200,000–500,000. Let us therefore assume that defendants will make early offers if eco-nomic damages are $500,000 or less. This changes slightly the BHS assumption thatdefendants make offers if economic damages are $200,000 or less, but leaves almostunchanged the predicted payout decline from defendant-only offers. For simplicity, we alsoassume 100 percent plaintiff chances of success, but otherwise retain the base BHS assump-tions. Defendants will then make early offers in 293/358 tried cases (82 percent); overallpayouts will decline by 20 percent.

Out of the remaining 65 cases, in 11, the early offer amount would be less than theactual payout. In another 47, plaintiffs already collect substantially less than the jury awardand likely could not collect more by making an early offer.36 This leaves only seven caseswhere plaintiffs can expect to gain by making early offers. Table 4 shows how two-sided earlyoffers would affect payouts in tried cases under these assumptions. Payout in the seven caseswhere plaintiffs can gain increases by 17 percent. The overall payout decline across all triedcases is 18 percent, versus 20 percent for defendant-only offers.

C. Effect on Payouts in Settled Cases

We estimate the payout change from a two-sided early offer program for currently settledcases, as follows. We use the BHS extrapolation approach and bootstrap both the econ

34Hersch et al. (2010:173) (“A reformer who goes to the legislature promising to improve things but at a substantiallyhigher cost often faces the response: ‘Who couldn’t?’ A key then is reform that will improve things at no greater oreven lesser costs—which is the goal of the early offers plan we appraised.”). In BHS, we stated that “payouts would belikely to rise under a two-sided program.” Black et al. (2009:758). That statement was incorrect because it did not takeinto account limits on collectability.

35Hyman et al. (2007).

36In 35 of the 47 cases, plaintiffs do not fully collect economic damages. In the other 12 cases, they do, but are ableto collect less than half of allowed noneconomic and punitive damages.


payout ratio and whether the plaintiff can expect to collect damages in full. Results aresimilar using insurer allocations. As for tried cases, we assume 100 percent plaintiff chancesof success, and that defendants will make early offers in cases with economic damages lessthan $500,000 (defendants will either gain or roughly break even from making theseoffers). For cases with economic damages over $500,000, we assume that plaintiffs will makeearly offers if doing so increases expected payout.

Table 5 shows the results. Defendants make early offers in 13,660 cases (93 percent),and payout in those cases drops by 36 percent. In the remaining 1,020 cases, plaintiffs cangain by making early offers in 160 cases, and payout in those cases increases by 33 percent.Overall payout declines by 23 percent, versus 25 percent for defendant-only offers withotherwise similar assumptions.

D. Response to HOV Discussion of Two-Sided Offers

HOV-2 object to our two-sided proposal on the grounds that any reform must ensure thattotal payouts not increase. As we have shown, our proposal would reduce payouts, indeedonly moderately less so than for defendant-only offers. We take HOV-2’s concern thatpayouts not increase to reflect their view of political reality, not their policy preferences.Normatively, HOV think the tort system should “fully insure [victims’] economic losses.”37

37Hersch et al. (2007:S232) (emphasis added). See also id at S233 (arguing that damage caps “may lead to situationsin which claimants are not fully compensated for their economic damages”).

Table 4: Payout Change in Tried Cases from Two-Sided Early Offer Proposal

Early Offer Made byNo. ofCases

CurrentPayout

Payout with2-Sided Program

% Changein Payout

Defendant 293 81,581 41,595 -49.0%No one/no plaintiff gain 58 98,622 98,622 0Plaintiff, with gain 7 23,025 26,991 +17.2%Total 358 203,228 167,209 -17.7%

Note: The table shows estimated change in payout from a two-sided early offer program for 358 nonduplicate caseswith plaintiff verdicts included in the med mal data set of claims closed from 1988–2005 with payout �$25,000 in 1988dollars. Assumptions are stated in the text. Amounts in 1,000s of 1988 dollars.

Table 5: Payout Change from Two-Sided Early Offer Proposal

Early Offer Made byNo. ofCases

CurrentPayout

Payout with2-Sided Program

% Changein Payout

Defendant 13,660 2,769 1,766 -36.2%No one/no plaintiff gain 860 1,115 1,115 0Plaintiff 160 202 268 +32.7%Total 14,680 4,087 3,149 -22.9%

Note: The table shows estimated change in payout from a two-sided early offer program for 14,680 nonduplicatecases settled before verdict included in the med mal data set of claims closed from 1988–2005 with payout �$25,000in 1988 dollars. Estimates are based on extrapolation from tried cases. Assumptions are stated in text. Columns do notsum exactly due to rounding. Amounts in millions of 1988 dollars.

394 Black et al.

Yet the current system undercompensates economic losses for severely injured plaintiffs.Full coverage of those losses could cause total payouts to rise.

Our two-sided early offer program moves toward HOV’s normative goal of fullycompensating economic losses. That a defendant-only program would reduce payouts bymore than a two-sided program should not matter. Both programs would reduce overallpayouts but the two-sided program would better compensate economic losses, and wouldpartly address the undercompensation of severely injured plaintiffs, which defendant-onlyoffers will not. At the same time, plaintiffs gain from a two-sided offer program in only asmall minority of cases. Plaintiffs who today cannot fully collect damages will not bepaid significantly more, even if given the right to make an early offer. To change that,the legislature would need to require minimum policy limits higher than currentnorms.38

With regard to political viability, a two-sided program may have a political advantageover a defendant-only program. Most recent tort reforms have generated political opposi-tion because they limit plaintiffs’ remedies and rights. A two-sided program is more even-handed. It would punish whichever side rejected a settlement offer that, if accepted, wouldhave fully covered economic losses, cut off other damages, and reduce litigation costs.

E. Summary

A two-sided early offer program will resolve more cases through early offers than adefendant-only program. It will also reduce payouts, albeit not as much as a defendant-onlyprogram. The potential gains to plaintiffs are modest because current limits on collectabil-ity will prevent full recovery in many cases. The precise impact will vary depending ondesign details, including how large a stick is applied to defendants.

IV. Discussion

We divided BHS into data analysis, which formed the heart of our article, and a discussionsection where we, in part, offered policy judgments. We do the same here.

A. What Payout Declines are Plausible?

For settled cases, we estimate that a defendant-only early offer program will reduce payoutsby 20 percent in settled cases (using both insurer-allocation and extrapolation methods).HOV, in contrast, estimate a 70 percent reduction. But their estimate shrinks to 29 percentif we correct their errors in understanding the TDI data set and failing to adjust payoutdecline for the time value of money. The remaining gap is modest and can be almostentirely explained by differing assumptions. Using the 3 percent real discount rate sug-gested by HOV, the estimates become 21 percent (BHS extrapolation) versus 29 percent

38We proposed minimum insurance requirements in BHS as part of a two-sided offer program. Black et al. (2009:758).


(HOV). Also using a common fee percentage of 25 percent, the estimates becomes 22percent (BHS extrapolation) versus 26 percent (HOV). Also using a common $25k/$50kminimum damages offer in nonserious/serious cases, the estimates are 24 percent (BHSextrapolation) versus 25 percent (HOV).

One also sees, from these progressive changes to the BHS assumptions, that onecould plausibly estimate somewhat—higher payout declines from an early offer programthan under the BHS assumptions. Conversely, as the sensitivity analysis in BHS shows, otherchanges in assumptions could lower our payout decline estimates into the upper teens.

B. Response to HOV on Discussion Points

HOV-2 do not object to a number of the BHS discussion points. They appear to agree thatpayout reductions are not social savings, and that there should be a minimum damagesoffer in cases with severe injuries.

We also listed some concerns about how an early offer program would work. Oneconcern involved cases where economic damages are uncertain. We noted that in thesecases insurers might make offers that are less than (economic damages + fee percentage),and plaintiffs might accept those offers given the risks involved in going to trial. Inresponse, HOV-2 complain that we misunderstood their proposal, and state that an earlyoffer should reflect “the expected value of an open-ended commitment to pay periodicallya claimant’s economic losses.”39 A similar concept appears in some of O’Connell’s otherwork, but we did not understand the early offer proposal in HOV to require an insurer tomake such an open-ended commitment in cases with uncertain economic losses. Neitherthe quoted language nor anything similar appears in HOV. We welcome their clarification,which substantially reduces the risk of “low-ball” offers—although it may also discourageinsurers from making early offers in cases in which future economic damages are uncer-tain.40 Fortunately, this clarification does not affect the numerical estimates in BHS or in thisrebuttal.

HOV-2 do not reply to a number of our other concerns. First, if plaintiffs’ lawyers canreceive only a 9 percent fee that must also cover out-of-pocket expenses, lawyers will likelytake only cases with large economic damages and clear liability. Many of these cases will notbe early-offer suitable because in cases with large economic damages, insurers often pay lessthan full economic damages under the existing regime. The likely result might be norecovery of any damages in most early-offer-suitable cases because lawyers will not take thesecases. HOV-2 offer no response. Their suggestion that plaintiffs’ counsel should pay

39Hersch et al. (2010:165).

40The commitment to pay future damage outlined in HOV-2 will create moral hazard problems when future damagesare partly under the plaintiff’s control, increase administrative costs, and create the potential for future disputes overthe amount of these damages. In addition, insurers often prefer to pay a sum certain, rather than remain on the hookfor unknown future costs.

396 Black et al.

out-of-pocket expenses out of the 9 percent fee increases the likelihood that their proposalwill make early-offer-suitable cases nonviable for plaintiffs’ lawyers.41

We also noted that opponents of HOV’s proposal might call it “kill granny cheap” tortreform because of its large impact on elderly claimants. If the proposal were combined withno damages recovery for medical expenses paid by other sources, as HOV propose, thelabel might become “kill granny free.” HOV-2 object to our rhetoric and assert that theytake no normative position on the desirability of an early offer program.42 However, severalsentences later, HOV-2 provide an unflinching normative defense of the early offerprogram, including its impact on the elderly. They write that “BHS assert [that the earlyoffer proposal will] disadvantage people whose economic losses . . . are low. Precisely.Scarce insurance dollars should go to pay for large dollar losses.”43 An early offer opponentmight summarize this position as “too bad for granny.” This is rhetoric, to be sure, but it isrhetoric that has already been deployed by tort reform opponents; a recent proposal to capdamages in nursing home lawsuits in Tennessee was defeated after opponents called it the“Kill Old People Cheap Act.”44 More centrally, the rhetoric reflects a substantive concern,to which HOV-2 provide no answer.

We noted that the O’Connell proposal reduces payouts more sharply in strong suitsthan in weak ones because these are the suits where defendants are more likely to offer topay full economic damages. HOV-2 do not object to our analysis. We noted the consensusamong medical malpractice researchers that med mal litigation substantially underdetersnegligent medical care, which raises questions about the wisdom of reducing what deter-rence now exists. HOV-2 do not address this point.

We noted that much of the payout decline from an early offer program has beenlargely realized by the 26 states that cap noneconomic damages. HOV-2 appear to agree.They respond that states that adopt early offers can safely repeal their damage caps.45 Theconverse is also true: states with damage caps will realize smaller payout reductions froman early offer program. As to whether caps or an early offer program is preferable, ifstates could be persuaded to repeal their damage caps, we would prefer the two-sidedearly offer regime we present above, with a reasonable minimum damages offer and feepercentage.

41HOV recognize that reduced fees will mean plaintiffs’ lawyers will not take some cases. Hersch et al. (2007:S238).They view this as a positive—as a reason to believe that their payout reduction estimates are not overstated. However,if they seek to ensure full payment of economic damages, lawyers’ unwillingness to take cases with economic damagesshould be a negative for their proposal, not a positive.

42Hersch et al. (2010:169).

43Id.

44Vass (2009).

45Hersch et al. (2010:168). (“Thus if an early offer law were adopted, any caps might well be eliminated.”).


C. The Value of Public Data

Tort reform should rest less on the often-heated rhetoric of both sides, and more onempirically grounded predictions about the likely outcomes of proposed reforms. Texasdid those interested in tort reform a great service by creating its public closed claimdatabase. That rich database made possible both HOV’s initial paper and ours. HOV did afurther service by using that database to evaluate O’Connell’s early settlement offer pro-posal. Their effort prompted us to study the same issue, and develop very different esti-mates. We hope that our respective assessments, and the ensuing debate, will inform futureconsideration of ways to speed settlement and reduce litigation costs, O’Connell’s amongthem. For those who are not sure whose assumptions to favor, or who want to try their ownassumptions, we will publicly post a replication data set based on the underlying Texas dataand accompanying Stata do files, from which one can generate both our results and HOV’score tables.46

V. Conclusion

In BHS, we analyzed O’Connell early offers, and then reconciled our estimates to HOV’s.We concluded that HOV made unreasonable assumptions and therefore greatly overstatedthe likely payout reduction. In their reply, HOV stick to their assumptions. They do notconcede even obvious points, like the unreality of a 9 percent combined fees and expensespercentage. We, in turn, show in this rebuttal that most of the difference in estimatesdisappears if we correct the HOV analysis for their misunderstanding of the Texas data setand failure to adjust payouts for the time value of money when estimating insurer savings.We also develop an alternate analysis of settled cases based on insurer allocations that givesresults similar to the BHS extrapolation-from-tried-cases approach.

We also develop payout decline estimates for two-sided early offers. A two-sidedproposal, like its defendant-only counterpart, is likely to modestly reduce litigation costsand speed settlements. At the same time, any early offer program has important costs,including weakened deterrence and payout reductions that disproportionately affect par-ticular plaintiff groups. Early offers also will not reduce either payouts or defense costs by70 percent, or anywhere close—particularly when more than half the states already capnoneconomic damages.

References

Black, Bernard, David Hyman, & Charles Silver (2009) “The Effects of ‘Early Offers’ on Settlement:Evidence from Texas Medical Malpractice Cases,” 6 J. of Empirical Legal Studies 747.

46These will be part of the replication data set and do files we are preparing for Black et al. (forthcoming). Wecurrently expect to post the data set and do files on SSRN, with within-SSRN links to the data set from BHS and thisarticle and from professional websites.

398 Black et al.

Black, Bernard, David Hyman, Charles Silver, Kathryn Zeiler, & William Sage (forthcoming), To Sue isHuman: A Profile of Medical Malpractice Litigation. Yale Univ. Press.

Carson, Elaine E. (2005) “The New Texas Offer of Settlement Practice—The Newest Steps in the TortReform Dance,” 46 South Texas Law Rev. 733.

Hersch, Joni, Jeffrey O’Connell, & W. Kip Viscusi (2007) “An Empirical Assessment of Early OfferReform for Medical Malpractice,” 36 J. of Legal Studies S231.

—— (2010) “Reply to ‘The Effects of “Early Offers” in Medical Malpractice Cases: Evidence fromTexas’,” 7 J. of Empirical Legal Studies 164.

Hyman, David, Bernard Black, Kathryn Zeiler, Charles Silver, & William Sage (2007) “Do DefendantsPay What Juries Award?: Post-Verdict Haircuts in Texas Medical Malpractice Cases, 1988–2003,”4 J. of Empirical Legal Studies 3.

Knoll, Michael (1996) “A Primer on Prejudgment Interest,” 75 Texas Law Rev. 293.O’Connell, Jeffrey (1982) “Offers That Can’t Be Refused: Foreclosure of Personal Injury Claims by

Defendants’ Prompt Tender of Claimants’ Net Economic Losses,” 77 Northwestern Univ. Law Rev.589.

O’Connell, Jeffrey, & Patricia Born (2008) “The Cost and Other Advantages of an Early Offer Reformfor Personal Injury Claims Against Business, Including for Product Liability,” 2008 ColumbiaBusiness Law Rev. 423.

O’Connell, Jeffrey, & Christopher J. Robinette (2008) A Recipe for Balanced Tort Reform.Studdert, David M., Michelle M. Mello, Atul A. Gawande, Troyen A. Brennan, & Y. Claire Wang (2007)

“Disclosure of Medical Injury to Patients: An Improbable Risk Management Strategy,” 26 HealthAffairs 215.

Studdert, David M., Michelle M. Mello, Atul A. Gawande, Tejal K. Gandhi, Allen Kachalia,Catherine Yoon, Ann Louise Puopolo, & Troyen A. Brennan (2006) “Claims, Errors, andCompensation Payments in Medical Malpractice Litigation,” 354 New England J. of Medicine2024.

Vass, John (2009) “Measure to Cap Nursing Home Damages Fails in House,” April 21 Chattanooga TimesFree Press.

Yoon, Albert, & Tom Baker (2006) “Offer-of-Judgment Rules and Civil Litigation: An Empirical Studyof Automobile Insurance Litigation in the East,” 59 Vanderbilt Law Rev. 155.

Zeiler, Kathryn, Charles Silver, Bernard Black, David Hyman, & William M. Sage (2008) “Physicians’Insurance Limits and Malpractice Payouts: Evidence from Texas Closed Claims, 1990–2003,” 36J. Legal Studies S9.

Appendix

In this appendix, we provide a more formal treatment of how BHS model an early offerprogram, and compare our approach to HOV. Putting aside punitive damages, litigationcosts, and the time value of money, an early offer will reduce expected payout if:

z d d m ypaid e full∗ > ( ){ }∗ +( )max ,, 1 . (1)

Here, d is damages; the “e” subscript indicates economic damages; the “paid” subscriptindicates the amount that would be paid if liability were certain; the “full” subscript indicatesactual allowed damages; m is the minimum offer; y is the fee percentage; and z is the ex antelikelihood that the plaintiff will win at trial.


This formula applies to both tried and settled cases. The left-hand side gives theexpected payout under current law. The right-hand side gives the payout under an earlyoffer program.47

The payout decline from an early offer program is the difference between the twosides of Equation (1), summed over cases in which insurers expect to save by making anearly offer:

payout declineearly offer suitable cases

= ∗[ ] −∑ z d di paidi

i, ,max ee full m y, ,( ){ }∗ +( )[ ]1 . (2)

HOV have a similar formula (their Equation (4)), except that (1) they assume y = 0.10; (2)instead of the formula for current payout on the left-hand side of Equation (1), they use asingle value c; and (3) they include litigation costs in their base equation, while we addressthem separately.

For tried cases, we observe dpaid and de, full, but not the ex ante probability z that theplaintiff will win. Thus, a key challenge that BHS address is estimating z. Fortunately, ourresults are not very sensitive to plausible variations in this estimate.

In settled cases, if cases settle for their expected value, the settlement amount sshould equal z * dpaid. We observe s, but not its components or de,full. A second key empiricalchallenge is estimating de,full. BHS do so by estimating:

d sd

d

d

d ze full

e paid

paid

e full

e paid,

, ,

,

= ∗⎛⎝⎜

⎞⎠⎟

∗⎛⎝⎜

⎞⎠⎟

∗( )1. (3)

Or, more compactly, if qe = ratio of paid economic damages to full damages, assumingliability:

d sq z

e fulle

, = ∗( )∗⎛⎝⎜

⎞⎠⎟

∗( )econ payout ratio1 1

. (3′)

The first element on the right-hand side of Equation (3) or (3′) is known. The others mustbe estimated. Given a settlement amount s, full payment of economic damages increases inproportion to the econ payout ratio, and in inverse proportion to the fraction qe ofeconomic damages that would be paid (assuming they are owed), and plaintiff’s chances ofsuccess z.

Given de,full, one can estimate payout decline using Equation (2). BHS do so bydividing cases into ranges of paid economic damages ($0, $1–$50,000, $50,001–$100,000,$100,001–$200,000, etc.), and then summing in Equation (2) over cases in the rangeswhere making early offers for all cases in that range would reduce payout. This is appro-priate if insurers can predict the econ payout ratio on average for a group of cases, but haveweak ability to predict this ratio for any individual case. HOV estimate payout reduction byassuming perfect insurer foresight as to noneconomic damages in each case and summingover all cases in which the early offer would reduce payout. To the extent that insurers can

47BHS provide a similar formula using somewhat different notation.

400 Black et al.

(cannot) predict which cases will involve a high econ payout ratio, the BHS “group average”(HOV) approach will underestimate (overestimate) the payout decline.

But our principal concerns with the HOV approach lie elsewhere. HOV estimate fulleconomic damages as s * econ payout ratio, and omit the last two terms on the right-handside of Equation (3) or (3′). This works if one relies on insurer allocations and interpretsthem as we do above in our insurer-allocation method. It is incorrect if one imputes theecon payout ratio from another source, as BHS do in our extrapolation method and HOVdo for cases where they impute this ratio from Florida data.

HOV estimate payout decline using three different baselines—insurer initial reserves,insurer final reserves, and actual payout—from which they subtract early offer payout in anequation similar to Equation (2). They complain that we ignore their use of reserves as abaseline. This response misunderstands our criticism. HOV underestimate the second termon the right-hand side of Equation (2) and therefore overestimate payout decline. Replac-ing actual payout with reserves in the first term does not affect this problem.

With regard to which baseline one ought to use, reserves, if optimally set, are anestimate of the insurer’s expected payout. For cases that later lead to payout, one wouldexpect initial reserves to be below the eventual payout, on average and HOV so find. Thefinal reserve, if optimally set, is more likely to be a reasonable estimate of the expectedpayout. An unbiased final reserve can be understood as simply an estimate, with error, ofexpected payout. For settled cases:

final reserve s zi i i i( ) = + = ∗( ) +ε εi i paidd , . (4)

Here ei is an error term.48

If reserve estimates are unbiased, the errors should have mean zero and the choice ofbaseline should make little difference. If payouts and reserves are different—as HOVfind—this means that the reserve estimates are biased. Thus, it is not clear why one woulduse reserves to measure outcomes under current law. At best, they are a noisy estimate ofactual payouts. In practice, they appear to be biased as well.

48For tried cases, the relationship between the final reserve and the posttrial payout will depend on whether thereserve is set before or after the trial outcome is known. If set before trial, the reserve will include the insurer’sestimate zi of the probability of a plaintiff win at trial. An unbiased estimate would be (final reserve)i = z * di, paid + ei.If the reserve is set after trial but before payment, zi will drop out. TDI provides no instructions on when insurersshould set final reserves, and insurer choices vary from case to case. In some tried cases, the final reserve appears tobe set before trial; in others, it equals the payout exactly and appears to be set after liability is determined.


Documents

O'Connell Early Settlement Offers: Toward Realistic Numbers and Two-Sided Offers