The received wisdom is that insurance can function well in a world of “risk” – the determinable probability of loss — but that insurance can function only poorly, or not at all, in the face of “uncertainty” – the indeterminate probability of loss. This received wisdom colors a lot of thinking, and judicial decision-making, about any number of policy problems, perhaps most prominently about the proper scope of tort liability. If the threat of liability cannot be reduced to a particular probability, the thinking goes, then it will be difficult or impossible to insure against, and part of the point of tort liability, to encourage spreading the risk of loss, will be undermined.
Tom Baker has pioneered the use of qualitative empirical research to shed light on issues in torts, insurance, and insurance law. In this Article, he employs empirical research to call into question the received wisdom regarding the capacity of insurance to function in the face of uncertainty. In an impressive combination of thick description and theoretical insight, he shows how the phenomenon of the insurance “runoff” has been able to function, with increasing frequency and effectiveness, despite the fact that its fundamental purpose is to insure uncertain probabilities of loss.
An insurance “runoff” occurs when an insurer ceases selling insurance and remains in business only to pay claims under previously-sold policies. Baker explains how, in the past several decades, responsibilities for some of the most severe and uncertain insurance exposures, such asbestos and environmental cleanup liabilities, have been transferred by the companies responsible for them in the first instance to runoff entities whose reason for being is to assume these uncertain exposures, for a price. In effect, the runoff entity insures the original company against highly uncertain liability.
In 1996, Lloyds of London created a runoff entity (“Equitas”) to assume its syndicates’ liabilities under past policies, which had long-tail exposure to asbestos, environmental cleanup, toxic tort, and products liability claims. And Warren Buffet’s Berkshire Hathaway owns a runoff company (NICO) that has engaged in Loss Portfolio Transfer (LPT) deals with insurance companies to function in a runoff fashion to liquidate liabilities under these portfolios. Apparently neither Lloyds nor Buffet has read the economics textbooks telling them that this won’t work.
But it has. Not only for Lloyds and Buffet, but also in life insurance, financial guarantee insurance, pensions and annuities, and long-term care insurance. Based on a series of field interviews and other research, Baker walks the reader through the mechanics of runoffs, explaining how a runoff entity engages in the underwriting, investment projection, and insurance policy claims management necessary to insure the uncertain exposure that it has assumed. This is legal sociology at its best, undercovering the actual economics of the runoff entity from the inside. It is impossible to read Baker’s account without being impressed, and maybe a bit frightened as well, by the way that the possibility of making a profit generated the ingenuity necessary to create the very institution of the runoff.
Baker ends by briefly assessing the public policy costs and benefits of runoffs, and comes out provisionally in their favor, all things considered. He argues that insurance is always dealing with one form of uncertainty or another, and that we should therefore jettison the ideal type of insurance as a risk-spreading entity, and substitute a paradigm of insurance as an uncertainty-management mechanism. Perhaps it would be better just to hold these two inconsistent ideas in our heads at the same time. Be that as it may, Baker has helped to shatter the received wisdom about the former idea, and brought the latter idea into the mainstream.