Contracting Over Malpractice Liability

Jennifer Arlen, NYU Law School


Proponents of contractual liability assert that contracting is superior to malpractice because patients will select the rules that maximize their welfare so long as contracting is voluntary and the parties correctly estimate the costs and benefits of imposing liability. This article analyzes the claim that patients have optimal incentives to contract into liability when they are informed about the consequences of liability. It shows that contractual liability is inefficient, even when patients are informed, because contracting itself is not an optimal mechanism for imposing liability because patients derive less benefit from imposing liability by contract than they could obtain from liability imposed by the state by fiat. Specifically, this article examines the two plausibly-efficient forms of contractual liability: individual negotiable contractual liability and MCO contractual liability. It shows that neither provides patients with sufficient benefits to induce optimal contracting over liability.

Patients engaged in individual negotiated contracting with medical providers at the point of service do not have optimal incentives either to adopt malpractice liability reforms or contract around reforms adopted by the state because malpractice liability is designed to confer collective, multi-period, benefits on patients – in the form of investments in safety that benefit many patients collectively both now and in the future. Patients do not derive the full benefit of the collective, multi-period investments produced by malpractice liability when required to impose it through individual contracts. Accordingly, even when contracting is informed and voluntary, patients can be harmed by the introduction of contractual liability because it provides incentives for them to reject liability even when they would be better off were liability imposed by the state. By contrast, collective non-negotiable contracting between patients and Managed Care Organizations) does not face as serious a collective goods problem. But this form of contracting is inefficient because it is distorted by adverse selection. MCOs will charge patients more for liability than is optimal because patients’ demand for liability provides a signal of their expected demand for expensive medical services since liability confers the greatest expected benefits on patients likely to need hospital care. Accordingly, contractual liability will not induce even informed patients to impose liability whenever they would be better off were it imposed. Thus, we cannot be confident that states could better serve patients by allowing contracting over liability than they could by adopting effective reforms to malpractice liability and leaving it within the control of the tort system.