Uncertainty, Insurance, and the Learned Hand Formula

Note: Final definitive version is available at Oxford Journals.http://www.oxfordjournals.orgLaw and economics scholars have written extensively about how insurance markets affect the tort system. They have noted the beneficial cost-spreading function of insurance, as well as the detrimental incentive-distorting affects of insurance, stemming from problems of adverse selection and moral hazard. Surprisingly, however, scholars have over-looked one of the most important salutary functions that insurance serves for the tort system: it provides much of the information courts need to apply the Marginal Learned Hand Formula. This paper explains precisely how insurance markets collect and disseminate information about the expected values of all three variables in the Hand Formula: the probability of accidents, the level of harm, and the burden of precaution. In the absence of the information insurance markets provide, parties in many cases would have no way of cost-effectively determining, ex ante, the proper level of care. Consequently, the Learned Hand Formula could not effectively operate. Although insurance markets cannot provide complete or perfect information for making ex ante calculations of the expected value of accidents and avoidance measures, in many (if not most) cases, insurance provides the best information available. Indeed, as a normative matter, judicial determinations of liability in accident cases might be improved by setting the burden of precaution using insurance market values as a baseline.