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Tort, social security, and no-fault schemes: lessons from real-world experiments.

In dealing with the problem of personal injury, societies have to make a choice between regimes of tort liability, the general social security system, and tailor-made no-fault compensation schemes. The arguments bearing on this choice are complex and difficult to justify. However, in one important area most industrialized countries operate a no-fault scheme already, and have done so for almost a century, namely workplace accidents and occupational diseases. In spite of the long tradition of workers' compensation systems, it is unclear whether they are a good or a bad thing. A few decades ago and thus relatively recently, two jurisdictions--the United Kingdom and the Netherlands--have abandoned workers' compensation for a combination of employers' liability with rather generous protection under the general system of social security. Now the time has come to review the experience of these jurisdictions and compare it to the performance of workers' compensation systems that continue to operate in much of the rest of the industrialized world. One recent and important example that highlights the differences between the two approaches involves the way each deals with claims for compensation of diseases caused by asbestos. The asbestos cases also illustrate the current challenges faced by workers' compensation systems: tort suits brought against employers alleging intention or other forms of aggravated fault and launched against third parties under theories of products liability. In the United States, workers' compensation systems have been pushed aside by mass litigation, where manufacturers of equipment and raw materials are named as defendants. This development has no parallel in other jurisdictions and raises important policy issues that are ripe for a fresh discussion.
INTRODUCTION

I. SYSTEMS OF WORKERS' COMPENSATION: BASIC FEATURES
      A. Compensation Regardless of Fault of Employer and Contributory
         Fault of Employee
      B. Insurance and Collectivization of Claims
      C. Scope of Protection
      D. Limited Compensation
      E. Resolution of Disputes Out of Court
      F. Immunity of Employers from Damages Suits

II. EMPLOYERS' LIABILITY: BASIC FEATURES
      A. Liability in Contract and Tort
      B. Four Features of Private Liability Systems
      C. The Trinity of Defenses
      D. Full Compensation
      E. Dispute Resolution through Litigation
      F. No Insurance and Collectivization of Claims

III. ECONOMIC ANALYSIS OF WORKERS' COMPENSATION
      A. Efficient Deterrence
         1. Efficient Deterrence from a Torts Perspective
         2. Efficient Deterrence in Employment Relationships
            a) Coasean Bargaining
            b) Bargaining in the Real World
            c) Empirical Evidence for the Efficiency of Workers'
               Compensation Systems
         3. Efficient Employee Behavior
            a) Irrelevance of Contributory Fault
            b) The Importance of Employee Behavior for Efficient
               Deterrence
            c) Justifying the Disregard for Contributory Negligence
     B. Efficient Risk Bearing
        1. Wage Premiums and Strict Liability Compared
        2. Fault-Based Liability vs. Strict Liability
     C. Efficient Administration of Claims and ex post Moral Hazard
        1. The Advantage of Workers' Compensation Systems
        2. Containing ex post Moral Hazard and Abuse within Workers'
           Compensation Systems
        3. Balancing the Costs and Benefits of Controls against Abuse

IV. REAL-WORLD CHOICES BETWEEN WORKERS'
    COMPENSATION AND EMPLOYERS' LIABILITY
    A. The Motives for the Revival of Employers' Liability
       1. Getting Rid of the "Industrial Preference".
       2. Social Security as Basic Protection, Tort as a Supplement
    B. The Failure of Social Security
    C. Tort as an Indispensible Fall-Back Mechanism
    D. Asbestos-Related Diseases as a Touchstone of Liability Systems
    E. Conclusion

V. CIRCUMVENTIONS OF WORKERS' COMPENSATION SYSTEMS
    A. Dissipating the Savings in Administrative Costs
    B. Suits against Employers
       1. Inroads into the Immunity Principle
       2. The Substantive Issues: Full Income Replacement and
          Damages for Nonpecuniary Losses?
          a) The Seriousness of the Harm
          b) Including Damages for Non-Pecuniary Losses
          c) Restraining Moral Hazard
          d) Economizing Administrative Costs
          e) Conclusion
       3. The Administrative Issue: Upgrading Workers' Compensation
          Benefits vs. Private Suits against Employers
    C. Claims against third parties
       1. U.S. Exceptionalism
       2. Explanations
       3. A Critique of Third-Party Liability for Industrial Injuries
          a) Deterrence
          b) Administrative Costs

VI. CONCLUSION


INTRODUCTION

The choice between tort law and other compensation systems such as social insurance and no-fault compensation schemes has been the subject of academic discussion for decades. While proposals for no-fault compensation schemes, particularly in the area of traffic accidents, were implemented in some jurisdictions, the thrust of this movement has faded away. (1) Currently, there is some discussion on shifting medical malpractice into no-fault compensation schemes. In Scandinavian countries, first-party patient insurance has more-or-less replaced tort, and scholars have advised both European jurisdictions (2) and the United States (3) to follow this model. The discussions of no-fault compensation or insurance schemes as a replacement or a supplement to tort seem to circle around the same issues, regardless of the subject matter involved. Invariably, the driving force behind no-fault plans is to economize administrative costs. (4) The tort system consumes a large fraction of the money that goes around for itself--in the form of court and lawyers' fees instead of allocating the funds to victims for the purpose of compensation. No-fault schemes seek to award the victims a larger share of the overall costs of the system. The main concern advanced against the move away from a tort system is deterrence; the incentives to take care and to adjust activity levels are weakened if the threat of liability is removed. (5) Empirical studies are somewhat diverse but seem to confirm the prediction that incentives to take care suffer with the introduction of no-fault plans. However, where injuries to the victim's health and body are at stake, i.e., damage that is impossible to replace and difficult to "repair," the effect is smaller than anticipated. (6)

This Article does not focus on how exactly the trade-off between efficient administration and efficient deterrence should be made in regard to specific subject-matter areas such as traffic accidents or medical malpractice. Rather, it focuses on the single area where no-fault has in fact been operating for decades in most jurisdictions: workplace accidents and occupational diseases. The no-fault plan that governs in this area is called workers' compensation, which has replaced the liability of the employer that previously existed. The evaluation of these institutions in light of the compensation and deterrence goals raises complex issues about the performance of workers' compensation systems that are already in place, but also about the performance of hypothetical systems of employers' liability that would exist, if it weren't for workers' compensation schemes.

While this Article cannot provide a definite answer to this empirical question, it highlights the experience of two European countries, the United Kingdom and the Netherlands, which decades ago abandoned their systems of workers' compensation in favor of reviving the private cause of action against the employer. Now the time has come to ask how this choice has fared in practice (Part V). In addition, the article confronts challenges to workers' compensation systems that have arisen in the U.S. particularly, namely movements around the immunity rule of workers' compensation, which rely on suits against employers, alleging aggravated fault, and,

secondly, damages claims brought against third parties (Part VI). Before confronting these real-world examples it is important to understand the central features of the competing regimes as well as the policy issues underlying the choice between workers' compensation and employers' liability. In order to set the stage, Parts I and II begin with a brief recollection of the basic principles of workers' compensation systems and of employers' liability. Part IV then offers an economic analysis of the relevant policy issues along the three familiar dimensions of efficient deterrence, efficient risk-bearing, and efficient administration of claims. The topics discussed include the choice between liability rules, the existence and scope of the contributory negligence defense, the option of entrusting the administration claims to public or private insurance agencies, and the choice between a judicial or amicable mechanism of dispute of resolution.

I. SYSTEMS OF WORKERS' COMPENSATION: BASIC FEATURES

There is no single workers' compensation system. Instead, there are as many systems as there are jurisdictions running such programs. This is most pronounced in the United States where each state operates its own workers' compensation system. (7) In spite of all the resulting variation, the central features of workers' compensation systems are surprisingly stable across jurisdictions. These features are outlined below.

A. Compensation Regardless of Fault of Employer and Contributory Fault of Employee

The primary goal of a workers' compensation system is to compensate workers who have suffered job-related accidents or diseases. Thus, workers' compensation systems are based on the principle of strict liability, where workers are entitled to compensation regardless of fault on the part of the employer. (8) Even where due care had been taken, so that the injury or disease is the consequence of a contingency that could not have been avoided at reasonable cost, the employee-victim still recovers. The employer or the workers' compensation organization against which claims are to be directed cannot defend itself by establishing that a fellow employee caused the harm. Finally, the claim even survives in cases where the worker inflicted the injury upon himself through behavior that would be classified as contributory negligence in tort. (9)

B. Insurance and Collectivization of Claims

The original German model of workers' compensation deliberately avoided the private insurance market and thus eschewed the option of a combination of strict employers' liability and mandatory insurance. (10) Instead, new administrative institutions were created by combining features of a public insurance company with those of a regulatory agency charged with overseeing firms and ensuring workplace safety. (11) Within this framework, the party who is strictly liable is not the employer himself but the newly created public insurance carrier. However, employers bear the full financial burden of the system and thus remain "strictly liable" for the costs of defending, processing, and satisfying claims for compensation of work-related accidents and diseases.

While most countries in Europe and elsewhere have followed the German model, the United States has taken a different course that relies on the private insurance industry instead of public quasi-insurers. (12) Only six states require the employer to participate in a state-run workers' compensation scheme; (13) the majority merely impose an obligation to insure against the liabilities generated by workers' compensation. (14) What the European systems achieve by transferring liability to public entities, these jurisdictions achieve through a combination of private liability insurance and the involvement of an administrative institution overseeing the program. (15) The personal liability of the employer is not the original one that existed under the common law of torts, but a liability regime created by the workers' compensation statutes themselves and reflecting the general features of such systems.

Regardless of these differences, the central feature of workers' compensation remains that the claim of the worker is independent of the solvency or even the continuing existence of the former employer. (16) In this sense, workers' compensation systems imply a collectivization of claims.

C. Scope of Protection

Workers' compensation systems do not compensate just any harm suffered by employees in the course of work. Their scope of protection remains limited to particular categories of harm, namely personal injury, disease, and death. (17) Damage to property as well as pure financial losses continue to remain outside of the scope of protection. In principle, the same is true for dignitary injuries and other types of harm to nonphysical interests of the person. However, it has become increasingly difficult to draw the line between physical and nonphysical personal rights.

D. Limited Compensation

Tort law generally provides for full compensation. While it may be difficult to establish the elements of a private cause of action in tort, the successful claimant is entitled to comprehensive relief. The party held liable must "make the victim whole again," i.e., restore the victim to the situation she would have been in but for the wrongful behavior. In cases of personal injury, the tortfeasor is liable for the costs of medical care, full replacement of lost wages, and any other pecuniary loss suffered as a result of the injury, such as the costs of devices and appliances that assist disabled persons in their daily lives. On top of that come damages for nonpecuniary loss, i.e., for the pain and suffering sustained due to the injury and the disabilities or disfigurements that remain after the resources of medical treatment have been exhausted. While it may not be possible to render the victim fully neutral between the hypothetical state of the world without the harm and the actual state of the world that includes a money payment, full compensation aims to get as close to this state as possible.

Workers' compensation systems function very differently from the private law of torts and damages. As far as medical care is concerned, workers' compensation carriers normally provide it "in kind," by referring patients to medical service providers operating on their behalf and under their control, or by at least requiring the patient to obtain authorization from the carrier before turning to other physicians and hospitals. (18) Damages for lost earnings are not calculated in each individual case with the aim of making the victim whole, but are based on schedules or grids. (19) To the extent that benefits are not scheduled, they are calculated on the basis of reduced earning capacity or, depending on the jurisdiction, reduced physical capacity, which are both independent of the amount of income actually lost by the victim-applicant. (20)

In many jurisdictions, the common method of benefit-assessment in cases of partial or full, temporary or permanent disablement is to have the handicap resulting from the injury or disease assessed by a medical expert who establishes the percentage-degree of disablement, and then to award a pension which reflects the degree of disablement and the level of wages earned before the harm. (21) Depending on how the system is calibrated, where the degree of disablement is 100% the employee may be entitled to full income substitution, while in cases of partial disability the level of compensation will be set correspondingly, as a fraction of the income earned at the time of injury. (22) Income benefits are commonly subject to an absolute cap, as well as to a relative one expressed in terms of a maximum fraction of pre-injury earnings. In jurisdictions where benefits are not subject to income tax, the typical measure of income replacement for fully disabled workers is two thirds of the pre-injury wages. (23) Typically, compensation is not awarded as a lump sum but in the form of a pension that is paid in addition to wages still being earned. From time to time, the level of the pension will be adjusted to account for inflation and possible increases in the overall level of wages. In this sense, workers' compensation systems grant damages in the abstract, independent of the facts of the case. For example, the U.S. Supreme Court has famously held that a worker who, subsequent to the injury, underwent re-training and managed to earn three times his pre-injury salary was nonetheless entitled to partial disability benefits. (24)

A striking difference between the damages available under tort and the benefits due under workers' compensation is that the latter excludes compensation for nonpecuniary harm, in particular, damages for pain and suffering. Likewise, while some jurisdictions entertain regimes of punitive damages in tort claims, this remedy is not available in workers' compensation, so injured workers never receive monetary benefits beyond those in the form of pensions.

E. Resolution of Disputes Out of Court

The concentration of liability in a single entity, be it a public workers' compensation carrier or a private insurance company that is overseen by an administrative agency, makes it easier to implement special procedures for the purpose of resolving disputes. While institutions and procedures vary across jurisdictions, they all share central features of alternative dispute resolution. (25) Typically, the aggrieved worker files her claim with the competent workers' compensation carrier who, in case of approval, will provide immediate relief in the form of medical care and income replacement. If the claim is rejected and a dispute arises, special dispute resolution boards will investigate the case and, depending on the jurisdiction, either propose a settlement or enter a binding decision. While such decisions may always be challenged in a court of law, such non-judicial processes help to settle the majority of disputes without court intervention and thus lowers the overall administrative costs of workers' compensation systems as compared to the tort system. (26)

F. Immunity of Employers from Damages Suits

The flipside of no-fault liability of workers' compensation carriers for the consequences of work-related injuries and diseases is employer immunity. (27) If, after obtaining workers' compensation benefits, the worker could bring private claims against her employer, the worker would receive double compensation. Conversely, employers would have not only to fund the system of workers' compensation but also to shoulder the costs of individual damages claims brought against them. The costs of this double recovery would eventually have to come out of the pockets of the employees themselves who would have to accept lower wages. For these reasons, workers' compensation systems generally bar individual actions against employers, making the claim against the workers' compensation carrier the sole remedy.

There are several ways for victims to escape the limitations of workers' compensation benefits and to recover full tort damages. One is to rely on the exceptions to the principle of employer immunity that many legal systems allow in cases of aggravated fault. (28) Another path that leads out of the immunity principle, which has been used extensively in the United States, is to sue third parties (other than the employer), which contributed to the injury or disease. The incentive to collect fully compensatory and additional punitive damages explains the surge in suits against manufacturers of industrial installations, equipment, tools, and raw materials, in cases involving workplace accidents and occupational diseases. (29)

II. EMPLOYERS' LIABILITY: BASIC FEATURES

A. Liability in Contract and Tort

The basic elements of workers' compensation systems have been set out above. The alternative is a system of more or less pure employers' liability. In such a world, the employer is personally liable for the damage sustained by his employees, in the same way that he is liable to third parties. It is a matter of argument whether such liability would result in a contractual claim or in a claim in tort. Civil law systems will ground the action primarily or even exclusively in the law of contract, (30) i.e., in the employment contract. In contrast, common law jurisdictions (like England) seem to base it on tort, albeit with strong contractual flavors. (31)

B. Four Features of Private Liability Systems

While the differences between a contract and a tort approach may be important in theory, they remain inconsequential in practice. Under both theories, liability for the consequences of workplace accidents and occupational diseases shares four common features of private claims for damages: (32) First, the responsibility of the employer is based on fault, i.e. on a failure to take the requisite care in the organization of the business and of the work flow, the equipment of the workplace, and the training of workers. Second, where liability has been established, the defense of contributory negligence remains available to the defendant. Third, however, if the victim succeeds, she is entitled to full compensation of pecuniary and nonpecuniary losses. Damages are calculated in every single case and not awarded on the basis of statutory schedules and grids. Fourth, disputes are resolved by the civil courts, without prior involvement of ADR-like dispute resolution boards.

C. The Trinity of Defenses

These four features of employers' liability each pose rich and highly complex sets of sub-issues that are absent from workers' compensation systems. The requirement of establishing fault on the part of the employer requires courts to set the requisite standard of care, which may be a difficult determination to make. Another complex task is to determine the scope of liability in cases where the harm was caused by the negligence of a fellow employee, (33) and when the employee was guilty of contributory negligence. (34) The well-established tort doctrines of vicarious liability and contributory fault provided anchors for the holy--or, rather, "unholy"--trinity of defenses available to the employer under late-nineteenth-century law: the fellow-servant role, assumption of risk, and contributory negligence. (35) The scope of vicarious liability of employers for harm caused by one employee to another had been seriously curtailed by the so-called "doctrine of common employment" or the "fellow-servant rule," which exonerated the employer from liability for workplace accidents caused by another member of the workforce, provided that the fellow employee was not charged with organizing and ensuring the safety of the workplace. Even where the victim succeeded in establishing a prima facie case against the employer, she was still subject to the defenses of assumption of risk and contributory negligence. Thus, the injured employee lost her claim for compensation if the accident in question involved negligence on her own part, but also where it appeared to be a natural consequence of the general risk caused by the plant or operation in question.

Interestingly, the two European jurisdictions that revived employers' liability and abandoned workers' compensation were careful to leave the unholy trinity of defenses dormant in their graves. (36) In the modern law of employers' liability in England and the Netherlands, respondeat superior has trumped the "fellow-servant rule," assumption of risk has been abolished, and contributory fault has been limited to a narrow set of cases involving egregious behavior by the employee.

D. Full Compensation

If the claimant succeeds in establishing the elements of liability, she is entitled to full compensation of losses incurred, including damages for pain and suffering and loss of amenities. Lost earnings will be replaced in full, with the size of the award depending exclusively on the decrease in earnings caused by the accident or disease. This calculation requires difficult projections about the earning prospects of the claimant in the impaired versus the hypothetically unimpaired state of the world. In legal systems that permit punitive damages, the victim of a tort may recover damages in excess of her loss, provided that the defendant is guilty of aggravated fault, i.e., acted recklessly or with an intention to harm others.

E. Dispute Resolution through Litigation

Disputes that cannot be resolved by the parties out of court are dealt with under the normal procedures of the civil justice system. While these may seem adequate or even superior to the services of special tribunals set up to dispose of claims brought in workers' compensation, they consume more resources, and they take much longer to dispose of a case. (37)

F. No Insurance and Collectivization of Claims

Private systems of liability, regardless of whether they are based on contract or tort, are powerless to ensure the actual satisfaction of claims for damages. The victim bears the risk that, at the time of suit or judgment, the tortfeasor or other responsible party may no longer exist or may be insolvent. While the risk of insolvency could be captured by a statutory mandate to take out liability insurance, there is no general duty on firms to do so. Even if such a duty were introduced, it would be powerless to deal with situations where the employee switched from one employer to the next over the course of her worklife so that it is impossible to attribute the loss to one particular employer and his insurance carrier.

III. ECONOMIC ANALYSIS OF WORKERS' COMPENSATION

The choice between workers' compensation and employers' liability involves a whole range of complex policy issues. For the purpose of analyzing these issues, economic analysis offers by far the most elaborate and systematic framework. Surprisingly, however, workers' compensation has remained a rather barren spot within the landscape of economic analysis. While the topic was discussed in the early days of law-and-economics scholarship, (38) modern treatments are generally lacking. Given the preference of economic theory for market solutions and private ordering, it seems that workers' compensation systems, which substitute the individual action against the employer with a claim against a private or public insurance carrier and even dispense with the defense of comparative negligence are unattractive. However, a closer analysis reveals that things are not as simple and that workers' compensation systems may indeed fare much better than anticipated.

A. Efficient Deterrence

1. Efficient Deterrence from a Torts Perspective

Those jurisdictions that have replaced workers' compensation and revivified employers' liability have universally adopted the fault principle. It seems that this choice was made intuitively, without much reasoning about the trade-offs involved. Lawmakers may have thought that fault-based employers' liability was something of a natural supplement to the protection granted by social insurance programs which, of course, do not require the victim to establish wrongdoing on the part of someone.

In fact, the choice between liability rules is not that easy. Traditional economic analysis suggests that the difference between fault-based and strict liability does not affect incentives to take care. (39) Under the assumptions that courts set the standard of care at the efficient level, injurers (employers) will be led to take care because doing so avoids liability altogether. Confronted with the choice either to take efficient precautions and bear the costs of these precautions or to take less than efficient precautions and bear the costs of diminished precautions plus the costs of accidents caused by his actions, the rational employer will take efficient precautions. Under a rule of strict liability, the employer bears the costs of any accidents caused in the course of employment without being able to exonerate himself by establishing his diligence. However, he still has an incentive to take care to the extent that the costs of precautions are lower than the costs of accidents avoided by taking such precautions. In other words, under strict liability the potential injurer has an incentive to adhere to the same precautionary standard he would be held to under a negligence regime. Therefore, both principles of attributing liability theoretically work equally well with regard to care levels.

A second concern of liability rules is to generate efficient activity levels. The activity level denotes the amount or quantity of a potentially dangerous activity, given a particular liability rule. The goal is to make sure that potential injurers engage in dangerous activities only up to the point where the gain from another unit of the activity is equal to the loss in terms of additional accident costs, assuming that efficient care has been taken. In the case of a business entity, the price charged for its goods and services should reflect the full costs of production, including the costs of any harm caused in the course of production. (40) If the fault principle is applied, firms would be able to deny responsibility for any damage caused, so long as appropriate care had been taken. Since victims, not employers, would bear the costs of the residual harm that was caused in spite of precautions, the balance sheet of the firm would not reflect the full costs of production. Part of the risks associated with the products and services offered by the firm would be externalized to victims who sustained injuries as a consequence of diligent behavior. In turn, firms would not need to account for these costs in setting prices, thus causing prices for the goods and services supplied to be too low. As demand is inversely correlated with price, demand for such goods and services would be too high. In effect, the economy would produce more goods and services than it should in light of the total costs of production, including the damage caused to third parties. In order to avoid the misallocation of resources implicit in excessive demand, "the cost of the production should bear the blood of the workman." (41) Thus, in returning those costs from the victim to the firm in order to generate efficient activity levels, a regime of strict employer liability seems to be preferable to its fault-based alternative.

2. Efficient Deterrence in Employment Relationships

a) Coasean Bargaining

The line of argument sketched above ignores the fact that workplace accidents and occupational diseases are different from ordinary tort cases, for the reason that victim and injurer are in a contractual relationship with one another. This feature is important, because in a setting where transactions costs, including the costs of information, are zero, the parties will invariably reach the efficient result through bargaining, regardless of the initial placement of liability. The attribution of costs associated with a particular liability rule, if efficient, will be replicated in the bargain of the parties or, if inefficient, will be pushed aside. In essence, this is the reasoning that became known as the Coase theorem. (42)

Applied to the employment contract, the question is how the employer and employee would allocate the risk of workplace accidents and occupational diseases if they made this issue the subject of their bargain. Take first the example of a system where employers are immune from liability. If both employer and employee are perfectly informed about the probability and severity of harm, the wage negotiated by the parties will include a premium that reflects the expected value of the harm. (43) Wage premiums that accurately reflect the level of expected harm are equivalent to damages payments due under a liability system. They increase the costs of production by the expected costs of harm and generate incentives to drive down overall costs by reducing expected harm. The employer may reduce expected harm in the two ways familiar from tort analysis: (1) by taking precautions; or (2) by reducing activity levels, i.e., by hiring fewer workers. Where the wage plus the premium necessary to induce employees to accept a given level of risk is higher than the value generated by the work of this particular employee, the employer will abstain from hiring. This, in fact, is precisely what the efficient employer should do. Thus, under the assumption that the parties to the employment relationship are perfectly informed about the risk of harm involved in the job at issue, the employer faces the right incentives to take care and to adjust the activity level so that optimal deterrence obtains.

The presence of a liability scheme alters the dynamics of the parties' negotiations as the employee discounts the expected costs imposed by workplace accidents and occupational diseases by an amount equal to the expected damages payments due to him in case of injury. If the risk of injury is held constant and all else is equal, the presence of liability will reduce the wage premium paid under the respective employment contract, as the demand for labor depends on the total costs of employment and not only on the cash wages received by the employee. (44) Obviously, the effect that the expected costs of compensating workers reduce aggregate salary (wage plus premium) is independent from the nature of the liability regime in question, whether it is workers' compensation or employers' liability. The reduction in the wage premium will certainly be more pronounced where liability is strict and generous damages are offered, and less pronounced where liability is contingent on a showing of fault and damages are under-compensatory. In addition, the costs involved in the administration of a compensation system will depress wage premiums, too. More efficient systems of liability will, therefore, lead to higher damages levels or to higher wages than less efficient ones. All that can be said from this perspective is that employers and employees would prefer more cost-efficient liability systems to less cost-efficient ones.

In conclusion, the liability rule does not seem to matter at all. Absent liability, the higher the risk of injury caused by a given job, the higher the wage premium will be that the employee is able to negotiate, and vice versa. Firms will always internalize the full costs of accidents and diseases, either in the form of wage premiums to be paid to all members of the workforce ex ante, or in the form of damages payments paid to those actually injured ex post or in any combination of both. (45) From this perspective, a system of no liability generates the same incentives to take care and to adjust activity levels as a system of fault-based or strict liability employers' liability would.

b) Bargaining in the Real World

Note, however, that this conclusion only holds where transaction costs are negligible. In the real world, such low- or zero-cost situations are rare. Major sources of transaction costs are the costs of gathering, processing, and analyzing information that is relevant to the transaction at stake. (46) Where at least one of the parties lacks relevant information, bargaining may not lead to efficient outcomes. The efficient allocation of the costs of harm caused by workplace accidents and occupational diseases by means of contract turns on the ability of the employee to perceive the risk associated with a particular job, to translate it into a number equal to the costs of expected harm, and to calculate a wage premium that reflects the costs of expected harm due to occur within the period of time for which the wage is paid, e.g. a week or a month. While substantial empirical literature shows that wage premiums compensating workers for occupational hazards are in fact paid, (47) the existence of wage premiums as such does not prove that they adequately reflect the risks of harm associated with various jobs. This fact is acknowledged by the empirical literature itself, which concedes that the results obtained from studies "indicate that complete market failure does not necessarily exist," (48) but they "do not prove that risk is allocated efficiently by the labor market." (49) The extent of market failure due to misinformation about risk and other defects in the bargaining process remains unknown.

For the purposes of the present analysis it is unnecessary to explore further the potential of employer-employee bargaining to incentivize the employer to take care and to adjust the activity level efficiently. That question remains open to empirical analysis on the degree to which workers are well-informed and successfully able to bargain for wage premiums. Rather, the crucial question to ask is whether a system combining a rule of employer immunity with wage premiums produces more efficient incentives than does a rule of strict liability.

As a matter of policy, the first option of strict liability is preferable. (50) The employer is better positioned than the employee to gather information about occupational hazards and to control them by taking precautions and adjusting activity levels. While it is certainly true that employees might be better informed with regard to the risk posed by fellow employees whose behavior they may closely observe on a day-to-day basis, (51) the employer enjoys informational advantages in all other areas. The employer controls the use of machinery and other equipment, of raw materials and energy, as well as the time, duration, and environmental conditions of dangerous activities. Given their superior information about risks posed by the factors and circumstances of production, employers can rationally weigh the costs and benefits of one course of action against another. To draw on the example of asbestos, it is (or was) the employer who decided to use this material and who controlled the circumstances of its use--e.g., the duration of exposure, the prompt removal of dust through ventilation, the provision of protective clothes and breathing aids, and the supply of showers. Each of these factors influenced the likelihood that dealing with asbestos on the job would result in the contraction of a serious disease such as asbestosis and mesothelioma.

In contrast, workers will tend to have less knowledge about the occupational hazards to which they are exposed, since they have no systematic overview of the accidents and diseases caused by certain activities. Rather, their informational resources are usually restricted to anecdotal evidence gathered on the particular job. While this may be valuable, it may not be representative of the larger picture. And even where workers have the relevant information about the risks of injury and disease to which they are exposed, they lack the means for adequate and proportionate responses. During their employment contract, workers' bargaining leverage is only based on the threat of "quitting." While empirical studies have shown that the decision to quit or stay is in fact influenced by concerns of workplace safety, (52) it has never been suggested that these decisions generate optimal incentives to take care on the part of employers. Indeed, such a claim could not be made, since most workers will lack relevant information and because the decision to quit or stay is often influenced by a range of factors other than workplace risk, such as the supply of labor, as expressed in the unemployment rate, and the mobility of the worker, which in turn is influenced by the housing market as well as the personal situation of the worker and her family at their current location.

The analysis so far suggests that employers will be in a better position to gather information about and control occupational risks than workers. However, a bilateral comparison that focuses only on the two parties involved in the employment relationship is misplaced. In reality, workers may be supported by trade unions, while employers will act under the guidance of liability insurers. The empirical literature on labor markets suggests that unionized workers receive higher wages and higher workers' compensation benefits, but it remains ambivalent whether the presence of unions increases workplace safety. (53) Studies on safety standards in the mining industry seem to support the conclusion that unions have a positive effect on workplace safety in that their presence drives down accident rates. (54)

At the other end of the spectrum, the employer does not operate in isolation either. There is, of course, a layer of regulatory safety standards set by administrative agencies or other regulators, but these may be disregarded in the present context, as regulatory standards affect the behavior of employers and employees alike. While regulation of workplace safety is important, none of the jurisdictions surveyed relies exclusively on regulation. Rather, they operate dual systems of safety regulation and financial incentives generated by liability rules like those underlying workers' compensation schemes as well as employers' liability regimes. Beyond employees and regulators, liability insurers also supervise and control the employers they insure. Unlike first-party health and disability insurers, which are powerless to control occupational hazards, liability insurers have the means and--thanks to competition in the insurance market--the incentive to risk-rate employers adequately. (55) Commercial liability insurers estimate the risk associated with the potential insured before underwriting, and they adjust premiums ex post through experience rating and retrospective rating for premiums to more finely reflect the insured's actual risk. The same strategies of assessing and rating individual risk are employed by well-run workers' compensation carriers. (56) To the extent that insurance or workers' compensation carriers succeed in setting premiums that adequately reflect risk, the incentives to take care and adjust activity levels generated by a rule of strict liability remain intact. With regard to emerging risks, which are yet unknown, the presence of liability insurers may even improve incentives over the ones that would exist otherwise. By insuring large numbers of firms, industrial liability insurers not only pool the risks associated with the operation of these firms, but they also pool information with regard to the risks involved. Such pooling of information is particularly valuable with regard to new risks which have not yet been appreciated by the scientific and business communities.

In summary, employers and their liability insurers are in a better position to search and gather information on occupational hazards and to act upon such information than workers, even if the latter are organized in, and assisted by, trade unions. This is not to say that workers and unions are never able to learn about occupational hazards and act accordingly, or that employers and their insurers know everything and take appropriate safety measures. Rather, the foregoing analysis merely suggests that employers and liability insurers (and, for that matter, workers' compensation carriers) are in a relatively better position to act in the interest of safety. Even under optimistic assumptions, it is difficult to imagine how the wage premium implicit in an employment contract could fluctuate over time so as to fairly accurately track and reflect changes in workplace safety that occur over the course of the employment relationship. In effect, wages would have to fluctuate much like premiums under liability insurance contracts in order to achieve the same incentives to control risk on the part of the employer. It is reasonable to assume that such dynamic matching of wages and job risks is not achieved in practice.

c) Empirical Evidence for the Efficiency of Workers' Compensation Systems

The conclusion that workers' compensation systems do a better job than the opposite rule of no liability finds support in empirical studies comparing the accident rates under workers' compensation with those achieved under the systems of employers' liability, which workers' compensation replaced. (57) With the introduction of workers' compensation schemes, the number of claims for minor injuries tended to rise, while the death-rate and the number of serious injuries declined significantly. (58) The obvious explanation is that workers' compensation, by introducing strict liability and awarding benefits independent of actual loss, increased moral hazard, leading to more frequent claims for minor injuries. (59) Deaths and serious injuries are much less likely to fall prey to moral hazard and are therefore a much more reliable indicator of the performance of workers' compensation systems. And it is precisely in this area of serious injuries that these schemes shine, evidencing their beneficial effects on workplace safety.

3. Efficient Employee Behavior

a) Irrelevance of Contributory Fault

Current systems of tort liability routinely provide for the defenses of contributory or comparative negligence within regimes of strict liability. Strikingly, workers' compensation systems diverge from this practice and follow the opposite rule of disallowing the defense of contributory fault, save for narrow exceptions. The latter is understood here to encompass both the doctrine of contributory negligence in a technical sense (which bars the claim against the injurer upon the establishment of victim negligence), and the doctrine of comparative negligence (which reduces the damages claim in proportion to the degree and weight of the victim's contribution). (60) In contrast, workers' compensation carriers are liable for the financial consequences of the harm suffered by the victim regardless of fault on the part of the employer, and regardless of negligence of the employee-victim. The claim only fails if the victim inflicted the injury upon herself intentionally. (61) While some jurisdictions provide for a reduction of the damages claims where the victim also acted recklessly or inexcusably, generally courts seem very reluctant to apply this rule to reject or reduce damages claims of employees. (62)

b) The Importance of Employee Behavior for Efficient Deterrence

From the perspective of deterrence, the defense of contributory negligence is essential for regimes of strict liability to yield efficient outcomes. (63) General economic theory maintains that a regime of strict liability lacking the defense of contributory fault leads to undesirable outcomes, i.e., too many accidents, within settings of bilateral causation. The case of occupational hazards clearly involves a situation where both the potential injurer and the potential victim may affect the probability and severity of accidents through their respective behavior. While the employer chooses the equipment and raw materials, as well as the organization of the workplace and of the production process, the day-to-day operations inside the plant engage the employee. Without the diligent cooperation of workers, safe working conditions are impossible to achieve. Although the employee typically operates within the sphere of the employer, constant supervision and control are impossible. Therefore, the law needs to incentivize both parties, employer and employee, to take precautions in order to achieve the goal of optimal workplace safety. Against this background, it is all the more striking that workers' compensation systems hold employers strictly liable without holding employees accountable for contributory fault. It may seem that employees in their role as potential victims lack any incentive to take care, and will therefore fail to take efficient precautions to avoid the injury in the first place.

c) Justifying the Disregard for Contributory Negligence

There are several explanations that mitigate the tension between economic principles and the set-up of workers' compensation. First, incentives to avoid loss may be less important where injury or other harm to one's own body is concerned. (64) Most workers have an intrinsic incentive to avoid losing an arm, a leg or an eye, even if they are promised sizable financial compensation. This is not to deny that full employer liability without regard to contributory fault does weaken the incentives on the part of workers to take care. Evidence from no-fault schemes in the area of traffic accidents suggests that there is a detrimental effect on potential victims' incentives to take care. (65) The point is only that this effect may be smaller than it would be with other kinds of harm such as property damage or financial losses.

Second, it is misleading to think of the payments available under workers' compensation as the "fair price" paid in exchange for inflicting the harm in question. The bargain implicit in workers' compensation schemes involves a broad liability rule and a rather parsimonious quantum rule. The worker who suffered harm never recovers in full; she receives compensation of her financial losses only. In addition, the award of damages is not assessed on a case-by-case basis but drawn from a schedule of disabilities and associated benefits, regardless of the actual amount of lost earnings incurred by the individual victim. For this reason, the liability rule implicit in workers' compensation has been described as one of "shared strict liability"; (66) a better characterization would be "partial strict liability." Far from providing full compensation to the victim, workers' compensation schemes provide limited compensation in the form of prefixed benefits and thus leave a significant part of the incentives to protect oneself from bodily harm and disease intact. (67)

In spite of these optimistic findings, there is room for improvement. As explained below, there is no systematic link between the level of compensation and the associated degree of undercompensation, on one hand, and the preservation of the worker's incentives to take care, on the other. (68) If anything, current workers' compensation systems generate a backwards incentive structure. As the system is set up today, victims of minor injuries stand to receive damages in excess of the harm caused, while those who suffer serious harm are being undercompensated. However, the prospect of receiving compensation will more severely impact the victim's incentives to take care in cases of minor injuries than in cases involving major ones. In addition, minor injuries are particularly vulnerable to ex post moral hazard in the form of false claims and fake injuries. Therefore, limited liability in the form of undercompensation is required most in cases of minor injuries, not major ones, but it is precisely here that the system fails. A decrease in benefits for minor injuries would mitigate these problems, and therefore benefit the overall viability of the system. (69)

With regard to serious injuries, it is essential to focus on the basic justification for the system's disregard for contributory fault. It rests on the recognition that, since mistakes and lapses of attention are inevitable in day-to-day life, allowing the contributory negligence defense, or its comparative negligence companion, would lead to decreased damages claims in routine cases. (70) This concern is particularly acute in the area of occupational risks: since workers spend a large part of their lives at work, it is a statistical certainty that even the most diligent worker will make mistakes and have momentary lapses of concentration once in a while. Furthermore, the worker is typically not in a position to take durable precautions that minimize the risk of lapses and mistakes as it is the employer who controls the organization, equipment, and staffing of the workplace. (71) If these considerations form the basis for excluding the contributory negligence defense, then it would make sense to limit this exclusion to cases of simple negligence, i.e., a lapse or mistake that, in itself, could and should have been avoided but that belongs to a class of lapses and mistakes that will inevitably occur over the course of a work-life. Conversely, the defense of comparative negligence should be available, and damages claims of victims be reduced, where the behavior cannot be excused as an unavoidable lapse of concentration but rather involves conscious disregard of safety rules and the standards of reasonable behavior. The crucial question is whether the worker made a conscious decision to engage in unreasonable behavior or whether the accident was caused by an unconscious lapse of concentration. The Georgia Supreme Court succinctly described the necessary elements in holding that "willful misconduct includes all conscious or intentional violations of definite law or rules of conduct, as distinguished from inadvertent, unconscious, or involuntary violations." (72)

While it seems that no jurisdiction running a workers' compensation system openly embraces the distinction between unavoidable lapses of concentration and conscious disregard for safety, they differ as to their resistance to such an approach. Where the claim of the worker may only be denied upon proof of intentional infliction of harm, it remains difficult to interpret this exception in ways compatible with the proposition made here. Workers' compensation systems which allow for the rejection of claims where it is established that the worker acted in conscious disregard of safety rules and safety instructions, are much more amenable to a functional reinterpretation of that concept in light of the distinction between statistically unavoidable lapses of attention and conscious disregard of safety requirements. The same is true for systems like the French one, which expand the exception to cases of inexcusable negligence and allow for a mere reduction of the workers' claims. To the present day, however, the French courts are unwilling to apply the clause vigorously, (73) as would preserve the incentives of workers to take care and to avoid harm.

B. Efficient Risk Bearing

1. Wage Premiums and Strict Liability Compared

Regimes of no liability and strict liability differ from one another not only with regard to efficient deterrence, but also in how they assign the residual risk of harm, i.e., the risk that remains even after efficient precautions have been taken. Strict liability functions like an insurance plan offered by an employer to its workers. Whenever the worker suffers losses as a consequence of workplace accidents or occupational diseases, the employer is liable to compensate her. The risk of accidents and disease, at least as to their financial consequences, is borne by the employer.

Under a rule of no liability the employee bears the risk of workplace accidents and occupational diseases. Whenever such a risk materializes and results in a serious injury or disease, the worker receives no redress from her employer, because she has already been compensated for her loss in the form of wage premiums collected through the months and years preceding the accident or illness.

The decision between the two regimes of no liability and strict liability seems to be straightforward. It is reasonable to assume that workers will generally be risk averse with regard to the potentially dire consequences of accidents and diseases. (74) Therefore, they would prefer to be insured against the risk of such harm. This is precisely what a system of strict liability provides for; it requires employers to insure their employees against personal injury. It does not matter that employers may be risk averse too, as they in turn can shift the risk of liability to a liability insurer in exchange for a premium.

The conclusion that strict liability is preferable on grounds of risk allocation is still premature, however. First, it ignores the fact that the worker need not insure the risk of harm with her employer; instead, she might buy coverage for the costs of health care and for income replacement on the insurance market. At the time when workers' compensation schemes were introduced in the late-nineteenth and early-twentieth centuries, most workers were unable to buy first-party insurance to protect themselves against accidents and diseases for which the employer could not be held liable. (75) At that time, the introduction of workers' compensation clearly contributed to efficient risk bearing. Today, this situation has changed, as health insurance and disability insurance are well-established lines of the insurance industry and readily available for (almost) everyone who demands them. Within the wage premium model, workers will negotiate a higher wage for accepting increased risks of injury or disease and then turn around and use this premium to cover the risk of such contingencies by taking out first-party health and disability insurance. Thus, from the perspective of the risk-averse worker, the choice is not really between insurance or no insurance, but between insurance on account of the employer and bundled together with the contract for employment or market insurance bought on the market and paid for with the help of wage premiums due under the employment contract. (76)

A second reason why strict liability need not be superior to no liability in terms of risk allocation is that employers might be risk-averse. To the extent that this is true, a rule of no liability is superior because it lets harms lie where they fall and thus preserves risk spreading, while strict liability leads to a pooling of risks in the lap of the respective employer. But again, this conclusion ignores the availability of insurance, this time in the form of liability insurance. Risk-averse employers may easily cover the risk of loss in the insurance market, while risk-neutral employers will choose to self-insure. In this regard, workers' compensation does not make a difference since it works much like liability insurance. In fact, most U.S. jurisdictions operate workers' compensation systems within a market setting: the insurance industry covers the liabilities of employers under workers' compensation schemes. (77)

As a consequence, the real options are strict employer liability plus liability insurance or workers' compensation, on the one hand, and employer immunity plus wage premiums negotiated by workers, on the other. More precisely, the search for the optimal liability system for workplace accidents and occupational diseases reduces to a binary choice between two systems: One contains the elements of (1) strict liability, (2) liability insurance, and (3) no wage premiums. In the alternative system, (1) the employer faces no liability, but (2) pays wage premiums reflecting the risk of harm, which (3) the employee then applies to the premiums due under health and disability insurance policies bought on the market. In today's economy, which includes well-developed insurance markets for both first-party health and disability insurance and third-party liability insurance, the policy of efficient risk allocation seems to yield inconclusive results. As both parties can insure the risk in question, a comparison of the risk attitudes of the parties concerned does not lead to a definitive answer.

This does not mean the choice between strict liability and no liability should disregard efficient risk spreading altogether; rather, the analysis must focus on choosing, or at least facilitating the use of, the most efficient insurance mechanism. In this regard, and with a view to occupational hazards, a rule of strict liability is preferable because it better combines the objectives of efficient deterrence and efficient insurance. As explained above, the denial of employers' liability would distort the employers' incentives to take care and thus undermine workplace safety. (78) Workers and their first-party insurers cannot effectively control and reduce the ex ante risks of workplace injury. By contrast, under strict liability, employers and their liability insurers would do a better job of providing workplace safety than workers and their health and disability insurers could. For the same reasons, liability insurance for employers would be more efficient and available at lower prices than first-party insurance for workers.

2. Fault-Based Liability vs. Strict Liability

The goal of efficient risk beating also informs the choice between strict liability and liability for fault. With regard to efficient deterrence, it has been argued that strict liability is more desirable for its capacity to facilitate allocative efficiency in the market: Strict liability makes the employer internalize the full costs of production, which leads to truthful prices. (79) Consumer demand responds to these prices, causing employers to produce only the efficient amount of a given good or service. From the perspective of efficient allocation of risk within a world of highly developed insurance markets, liability regimes that depend on fault suffer from their failure to clearly assign the risk of harm. While the principles of no liability and strict liability arrive at clear and wholesale--if opposing--attributions of risk, regimes of fault-based liability are more ambiguous. If the employer takes the precautions necessary to comply with the standard of care, the employee bears the remaining risk of harm, while, if the employer fails to take the necessary precaution, the employer bears the all risk himself. In allowing for different outcomes that assign the risk in opposing ways, fault-based liability systems typically create a demand for insurance on both ends of the relationship. The employer will cover the risk imposed on him through liability insurance, and the employee will shift the remaining risk to health and disability insurers. The administrative costs of a bilateral--and, therefore, duplicative--system of insurance will be higher than the costs of an alternative system which creates a need only for one party to seek out insurance.

The argument above may seem to be overblown, since third-party liability insurance and first-party accident insurance exist together and overlap in large areas anyway. Even though there is some variance in degree among jurisdictions, most people are in fact insured against the contingencies of injury and disease through health and disability insurers. At the same time, most firms have covered the risk of being held liable through third-party liability insurance. The lines of first-party and third-party insurance exist alongside each other everywhere, so the perceived need to choose between one method of risk-pooling or the other is unrealistic. By making occupational hazards the sole domain of liability insurance or, equivalently, workers' compensation, there may not seem to be much to gain in terms of administrative cost savings. But this conclusion ignores the fact that each area of overlap between liability and first-party insurance creates the need for estimating and allocating the cost burden associated with the harm in question to one side or the other. At the intersection of fault-based employers' liability and comprehensive health and disability insurance, the costs of health insurance will depend in part on the scope of employers' liability, which in turn will be a function of the way in which courts operate a fault-based liability system. The simpler way to coordinate the two systems would be to allocate the full costs of workplace accidents and occupational hazards to the employer and to allow health and disability insurers to ignore these costs altogether.

In conclusion, the objective of efficient risk allocation does strongly favor one liability regime over another in settings characterized by the omnipresence of first-party and third-party insurance schemes for both potential injurers and victims alike. Even so, the total administrative costs of insurance will tend to be lower in an environment including strict liability of employers for harm caused by occupational hazards than in an alternative world of fault-based employers' liability.

C. Efficient Administration of Claims and ex post Moral Hazard

1. The Advantage of Workers' Compensation Systems

Assuming that a system of strict employers' liability may be justifiable and even desirable, the next question concerns the mode of enforcement. In theory, there are many answers to this question, but in reality there are only two practical solutions. One solution is the civil justice system that is already in place in every jurisdiction and charged with resolving disputes over damages claims generally. The alternative is to devise a separate set of institutions specifically charged with compensating victims of occupational hazards and processing their claims, avoiding the involvement of the courts of general jurisdiction. The two alternatives reflect the choice between systems of employers' liability and systems of workers' compensation. The civil justice system is the natural choice in search for an institution to resolve disputes that involve civil claims for damages. Conversely, workers' compensation systems require some institutional grounding anyway, and these institutions are commonly charged not only with administering the insurance mechanism, but also with receiving petitions for compensation, with processing these petitions, and with hearing disputes where they arise. In such systems, recourse to courts of law is preserved as a means of last resort, and only after the remedies available within the administrative system have been exhausted.

The choice between the judicial system and administrative boards as mechanisms for dispute resolution is closely linked to the difference between tort damages available upon the proof of fault and the more abstract assessment of damages regardless of fault in workers' compensation systems. Establishing an employer's negligence and assessing damages in cases of personal injury are complex tasks that call for a procedural mechanism that matches up to it. Judicial proceedings in courts of law are the natural choice. In contrast, the liability of workers' compensation carriers is strict and independent of contributory negligence, rendering it unnecessary to set standards of care with regard to the behavior of employers and employees. The assessment of damages in workers' compensation does not require extensive fact-finding for the purpose of establishing, upon the balance of probabilities, the loss in earnings caused by the injury or disease in question. Rather, it suffices to establish the total or partial disability of the claimant in terms of an impairment of earning capacity and to then apply the rate of disability to the wages earned before the accident in question. (80) The task of assessing compensation is further alleviated by schedules or scales that translate certain categories of harm into percentage figures reflecting the degree of disability. The determinations necessary to assess damages within such a system are primarily of a medical nature and may thus be made by doctors, who in turn work together with the dispute resolution boards of workers' compensation institutions.

It is received wisdom that private liability systems, for all their benefits, are very costly to operate. In fact, this is the assumption on which the call for no-fault plans and their promise of low administrative costs has always been based. (81) Workers' compensation is no exception; as Peter Lencsis writes: "the delay and expense associated with lawsuits, attorneys, and courts are among the evils that workers compensation is intended to remedy." (82) The idea is that the sizable savings in administrative costs will make the system more efficient because those in need of compensation will receive a larger share of the payments made by injurers and their insurers. The proposition that the operation of no-fault systems involves relatively low administrative costs seems to hold up in practice. However, the numbers vary widely from jurisdiction to jurisdiction. In the UK, the administrative costs of the industrial disablement benefit scheme are said to be no more than 2 percent of benefit expenditures; (83) the figure for general social security schemes is 5 percent; while average administrative costs of the tort system for personal injury claims routinely exceed damages, sometimes by a factor of 1.8. (84) In Germany, the administrative costs of the workers' compensation system are around 10.5 percent of total expenditures. (85) The latter includes not only the pure costs of processing claims and resolving disputes, which together amount to no more than 1 percent of expenditures, but also the overall operating costs of the respective agencies charged with occupational safety regulation and oversight. In the United States, the share of administrative costs of workers' compensation institutions is between 15 percent and 20 percent of total costs of claims, (86) while the respective number for the tort system is said to be between 50 percent and 55 percent of the total costs of claims. (87)

2. Containing ex post Moral Hazard and Abuse within Workers' Compensation Systems

In spite of the variance within these numbers, they confirm the view that workers' compensation systems are much cheaper to operate than the combination of tort and liability insurance. This alone does not prove that the former outperform the latter, as it might be the case that the tort system generates more accurate results than workers' compensation systems. In particular, the tort system might be better able to contain ex post moral hazard and risks of abuse. Ex ante moral hazard occurs when an agent who is protected against the adverse consequences of harm, and whose behavior cannot be monitored by the principal, takes fewer precautions against harm than she otherwise would. (88) One paradigmatic case is that victims who are protected against losses by a rule of strict liability reduce their own efforts to avoid the injury for which they will readily receive full compensation. The standard response of the legal system is in the form of the defenses of contributory or comparative negligence that allow courts to reject or reduce claims where the victim's behavior contributed to the harm complained of and thereby shift part of the losses to the victim. As has been explained above, this form of moral hazard may not be very significant within the context of occupational hazards where the workers' health and bodily integrity is at stake and where the amount of compensation falls short of actual losses. 89 In this context, ex post moral hazard, which occurs after the injury, at the stage of claiming damages or benefits, remains a concern and tends to be much more significant. (90) Where the liability of social insurance schemes is in question, ex post moral hazard occurs when applicants fake or exaggerate the severity of their injuries and diseases in order to be classified as (partly) disabled and thus obtain benefits that they otherwise would not have been eligible to receive.

Indeed, abuse and fraud seem to be a major risk associated with no-fault insurance schemes of any kind. Abuse is the main explanation why the Dutch system of public disability insurance proved unsustainable, (91) why the American public disability insurance is said to be on the verge of bankruptcy, (92) and why the even broader scheme of accident insurance established in New Zealand had to be reformed with the aim of restricting access and scaling down benefits time and again. (93) With a view to compensation systems that focus on occupational risks, the Californian system of workers' compensation stands out as an example for waste, fraud, and abuse. (94) One major factor driving this abuse seems to be the involvement of middlemen such as cappers, lawyers, and doctors who collaborated in workers' compensation mills and, in California, profited from a local rule holding employers liable for the costs of medical examinations even if the claim turned out to be invalid. (95) The second major cause for skyrocketing costs of workers' compensation was the recognition, by the competent courts, of compensable injuries and diseases, the existence of which are difficult or even impossible to verify. (96) Pertinent examples include physical impairments such as back pain, whiplash and soft-tissue back injuries, but also purely psychiatric or mental harm that exists in the mind of the victim only. This is not to say that mental harm is fictional and should never be compensated. However, courts must remain sensitive to the problem that claims involving harm that is difficult to verify are particularly vulnerable to abuse.

As these examples illustrate, the fact that workers' compensation systems restore financial losses only and fail to make the victim whole is insufficient to fully discipline claimants and their advisers. Less-than-full compensation may be good enough to check ex ante moral hazard but it is rather ineffective against the dangers of ex post moral hazard: exaggerating or fabricating injuries. On the other hand, lawmakers and administrators must avoid throwing out the baby with the bathwater in making the claims procedures in workers' compensation too much like civil litigation. In the eyes of some observers, this is the trap the old English version of workers' compensation may have fallen into: "In no time at all, Workmens' Compensation descended from its lofty ideals of being a no-fault social service into a squalid legal battlefield between trade unions and insurance companies, with lying, cheating and chicanery on all sides and astronomical expenditure on administrative, legal and medical costs." (97)

3. Balancing the Costs and Benefits of Controls against Abuse

While the two concerns of controlling ex post moral hazard and of containing administrative costs incurred in the process of claims resolution are clearly in conflict, the conflict does seem manageable in the real world. Existing workers' compensation systems seem to do a reasonable job at containing ex post moral hazard without letting the costs of claims resolution spiral out of control. It seems that the clear, traceable, and palpable attribution of costs to employers on which the funding mechanisms of workers' compensation systems are built leads to tighter controls and more efficient claims resolution procedures than programs funded out of general tax revenues and administered by an agency which is not answerable to any distinct group with an interest in cost control. Where workers' compensation schemes have spiraled out of control, as was the case in California in the 1990s, there were discrete and identifiable reasons for these outcomes, namely lax rules which allowed for broad recognition of nonverifiable diseases and the over-generous compensation of the costs of medical examination.

These problems may be addressed and resolved in a satisfactory manner. The risk of abuse can be reigned in by imposing (1) high recognition thresholds for difficult-to-verify injuries and diseases, and (2) a disciplined screening process that ensures that only genuine claims attract awards. Given that the focus of workers' compensation has always been on physical injury and diseases caused by occupational hazards, these goals are clearly within reach.
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Title Annotation:Introduction through III. Economic Analysis of Workers' Compensation, p. 1-34
Author:Wagner, Gerhard
Publication:Duke Journal of Comparative & International Law
Date:Sep 22, 2012
Words:11650
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