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By Richard A. Epstein

On November 22, 2013, the Food and Drug Administration flexed its regulatory muscle by sending a warning letter to a genetic-testing company that goes under the stylish name of 23andme. The object of FDA scorn was a diagnostic kit that the tech company, backed by among others Google and Johnson & Johnson, sold to customers for $99. The kit contained an all-purpose saliva-based test that could give customers information about some 240 genetic traits, which relate to a wide range of genetic traits and disease conditions. The FDA warning letter chastised 23andme in no uncertain terms for being noncooperative and nonresponsive over a five-year period in supplying information that the FDA wanted to evaluate its product as a Type III device under the Medical Devices Act.

Legal Regulation of 23andme There is no doubt that the FDA is on solid legal ground. This case is not like the processes involved in Regenerative Sciences, LLC v. United States, where the FDA asserted that physicians' use of certain stem-cell procedures for joint disease involved the use of a drug that required FDA approval before it could be approved for use. In an earlier essay for the Manhattan Institute, I argued that this classification was in fact both legally incorrect and socially mischievous. In this case, the legal arguments are not available to 23andme because the current definition of "medical devices" covers not only those devices intended for use on the human body, but also those used for the diagnosis of disease. The Type III classification means that this device has to receive premarket approval from the FDA, which in turn requires that it be shown to be safe and effective for its intended use. Getting approval under this standard is arduous business, because any such approval must be for each of the tests separately. 240 tests thus require that number of approvals. The costs are prohibitive, and the delay enormous.

The FDA Warning Letter is significant both for what it says and for what it does not say. On the former, it details all the various steps that the FDA has taken in order to help shepherd 23andme through the FDA's processes, including the types of warning that the products should contain, and the various modifications that could be introduced in order to mitigate the risks of its use. It then notes that 23andme has done little to take advantage of the assistance offered to it. Indeed, worse, it has simply gone about its business selling the kits, without so much as a bow in the direction of the FDA.

The FDA Warning Letter and Its Possible Substitute The FDA then gives a list of the dangers that could follow from this action, which consists essentially of false positives and false negatives with respect to certain of its key components. The gist of this indictment is contained in the following paragraph:

For instance, if the BRCA-related risk assessment for breast or ovarian cancer reports a false positive, it could lead a patient to undergo prophylactic surgery, chemoprevention, intensive screening, or other morbidity-inducing actions, while a false negative could result in a failure to recognize an actual risk that may exist. Assessments for drug responses carry the risks that patients relying on such tests may begin to self-manage their treatments through dose changes or even abandon certain therapies depending on the outcome of the assessment. For example, false genotype results for your warfarin drug response test could have significant unreasonable risk of illness, injury, or death to the patient due to thrombosis or bleeding events that occur from treatment with a drug at a dose that does not provide the appropriately calibrated anticoagulant effect. These risks are typically mitigated by International Normalized Ratio (INR) management under a physician's care. The risk of serious injury or death is known to be high when patients are either non-compliant or not properly dosed; combined with the risk that a direct-to-consumer test result may be used by a patient to self-manage, serious concerns are raised if test results are not adequately understood by patients or if incorrect test results are reported.

The gist of the situation is that more information is a bad result because it could result in overconfident actions by patients who have the temerity to treat themselves without physician assistance, without ever asking whether some of these kits were sold to customers on the recommendation of their physicians. It is of course perfectly proper for any risk analysis to address the downside of certain course of action. But it is wholly incorrect for any risk analysis to ignore the benefits that could be derived from the 23andme kit. It takes little imagination to rewrite this letter to accentuate the positive. The FDA might try using my edited version:

For instance, if the BRCA-related risk assessment for breast or ovarian cancer reports a true positive, it could lead a patient to undergo much needed prophylactic surgery, chemoprevention, intensive screening, or other morbidity-reducing actions, while a true negative could result in the knowledge that no actual risk that may exist. Assessments for drug responses carry the benefit that patients relying on such tests may turn to a physician to control dose changes or even undertake certain therapies depending on the outcome of the assessment. For example, true genotype results for your warfarin drug response test could alleviate significant risks of illness, injury, or death to the patient due to thrombosis or bleeding events that occur by using doses appropriately calibrated anticoagulant effect. These risks are typically mitigated by International Normalized Ratio (INR) management under a physician's care. The risk of serious injury or death is known to be reduced when patients are well treated and properly dosed; combined with the benefit that a direct-to-consumer test result may be used by a patient to seek medical advice for proper treatment and explanation of the underlying disease.

The revised letter is every bit as true, if not more so, than the FDA's, rather different picture. In fact, a balanced appraisal, which the FDA never adopts, requires a blend of the two letters, by letting consumers know that the use of these tests could lead to bad results in some cases and good results in others. But in making this assessment it is critical to keep the dynamic element in mind. The forces of competition and the desire to increase sales will drive those companies who are in the market to improve their overall results. We can expect therefore over time that the correct results will be used. It is also the case that the FDA or anyone else could remind their customers that it is best to seek medical treatment for dangerous conditions because self-medication is a dangerous business--as if that were not known far and wide already.

Dealing With Two Kinds of Error
In light of these competing scenarios, the FDA should therefore have asked the question of the relative proportions of good and bad outcomes from the test. In dealing with this question, there is no reason whatsoever for it to stop with its list of hypothetical bad outcomes, without inquiring about the frequency and severity of bad outcomes. Some information on that question is of course available in this case, given that the kits in question have been marketed for over 5 years to about 475,000 customers, and it would be useful to know just how those patients fared over that time. Perhaps the FDA could devote some of its resources in this direction. That outcome is, however, not likely. In dealing with this issue, the FDA always wants to put the burden of proof on companies to show that their products are safe and effective, and will never look at field results that the companies present that tend to support that result. The proper procedure, however, is always to work in the opposite direction. The FDA should have to show by clear and convincing evidence that 23andme leads to the dangerous results that the FDA claims by surveying customers of the firm.

The reason for this proposed reallocation of the burden of proof is what it is in all these cases. Once the FDA keeps a product off the market, downstream actions by individual consumers and their physicians cannot undo its mistakes. But if the product is let on the market, patients and physicians need not use it if its risks outweigh its benefits. It would be a far more searing indictment of 23andme if customer complaints of false positives led physicians to discourage patients for relying on these treatments. But thus far, the physician complaints have all come at a distance from experts in the field who double down on the FDA warnings. Let them warn away, so long as they do not ban products, which given standard patterns of usage may do far more good than harm. All too often the FDA acts as though consumers are gullible and uninformed. It is time that Congress recognized that much of the danger to patient comes from the FDA. Its vaunted mission is "Protecting and Promoting Your Health." I for one wish it would quit trying to protect mine and that of other people who would like to control their own lives.

Richard A. Epstein is a professor of law at NYU Law School, a Senior Fellow at the Hoover Institution, a Senior Lecturer at the University of Chicago and a visiting scholar with the Manhattan Institute's Center for Legal Policy. His forthcoming book is "The Classical Liberal Constitution," from Harvard University Press.

By Richard A. Epstein

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Right now, the Senate is anxiously considering HR-SA 3590, the Patient Protection and Affordable Care Act—a.k.a. the Reid Bill—which builds on earlier efforts in the Senate and House to reach a new consensus on health-care reform.[1] Many legislative uncertainties remain, but its key characteristics seem fixed in stone, and they highlight the radical nature of this legislation.

Senator Orrin Hatch has long urged that the legislation is unconstitutional for its overreaching on individual choice. This paper focuses on the constitutional question in the ratemaking context, by comparison to analogous regulations in the context of public-utility regulation.
One telling sign of the relevance of this analysis comes from the Congressional Budget Office ("CBO"). In a recent release, it has treated the proposal as if it nationalizes much of the private health insurance industry, most specifically because it may well require that rebates to customers kick in whenever, in its words, "medical loss ratios are less than 90 percent."[2] In plain English, the Reid Bill assumes that health-care administration, which is always costly, can be done cheaply even in the new legal environment, so cheaply in fact that these health-insurance rebates kick in whenever insurers' administrative expenses exceed 10 percent of their premium dollar. As the CBO has concluded, "this further expansion of the federal government's role in the health insurance market would make such insurance an essentially governmental program ..."

In effect, the onerous obligations under the Reid Bill would convert private health insurance companies into virtual public utilities. This action is not only a source of real anxiety but also a decision of constitutional proportions, for it systematically strips the regulated health-insurance issuers of their constitutional entitlement to earn a reasonable rate of return on the massive amounts of capital that they have already invested in building out their businesses.

In order to make out this argument, let me proceed as follows. In part I, I shall give a general overview in order to place in context the system of health-care regulation that shall be operated through the State Exchanges that would be formed under the Reid Bill. In part II, I shall give a detailed analysis of some of the major provisions of the Reid Bill. In part III, I shall give a brief analysis of the economic assumptions that underlie the Reid Bill, and the way in which they are likely to lead to extensive price fixing. In part IV, I shall flesh out the constitutional implications of the above analysis. I shall then close with a brief conclusion, which recommends that the Reid Bill be scrapped.

I. AN INSTITUTIONAL AND CONSTITUTIONAL OVERVIEW The concern that I wish to address at the outset deals with the unprecedented level of systemic coercion that the Reid Bill exerts on the various firms that supply health-insurance coverage in the small-group and individual health-insurance markets. Constitutional concerns with these provisions arise even if one assumes that Congress has the power under the Commerce Clause to pass comprehensive regulation of health care in this form. Independent of any question about the scope of Congressional power, it is critical to consider that the Fifth Amendment affords regulated health-insurance companies protection against the taking of property without compensation and without due process of law.
These overlapping guarantees bind both the federal government and the state governments in all of their activities, whether undertaken jointly or independently.

These constitutional provisions have been subject to extensive interpretation in the Supreme Court in ratemaking cases, which must be taken into account in dealing with the legislation. The Supreme Court's basic constitutional requirement is that any firm in a regulated market be allowed to recover a risk-adjusted competitive rate of return on its accumulated capital investment. See Duquesne Light Co. v. Barasch, 488 U.S. 299 (1988).

The Reid Bill emphatically fails this test by imposing sharp limitations on the ability of health-insurance companies to raise fees or exclude coverage. Moreover, the Reid Bill forces on these regulated firms onerous new obligations that they will not be able to fund from their various revenue sources. The squeeze between the constricted revenue sources allowable under the Reid Bill and the extensive new legal obligations it imposes is likely to result in massive cash crunch that could drive the firms that serve the individual and small-group health-insurance markets into bankruptcy.

Although the Constitution requires that regulations permit regulated firms to recover a risk-adjusted competitive rate of return, the Supreme Court has left it up to federal regulators to decide which approach to rate regulation they wish to take. On page 20, I discuss the two major tests that are used to determine whether rates are confiscatory. In one instance, the risk of imprudent investments is left on the firm, and in the other, it is imposed on the ratepayers. Here, the combined effect of all the provisions in HR-SA 6590 makes it unimportant to choose between these two tests, because the blunt truth is that the Reid Bill flunks both tests.

To make this analysis more concrete, it is important to understand the pervasive transformation that the Reid Bill, if passed, will work on both suppliers and users of all health-insurance services. On the one hand, the Reid Bill depends on a combination of huge general tax increases, which is coupled with special levies on industries such as medical-device and pharmaceutical companies. These tax revenues are then used to fund subsidies for large segments of the population in order to allow them to purchase qualified health-care plans that are sold through a set of State Exchanges that the Reid Bill creates. In order to prevent these subsidies from flowing through to the various health-insurance issuers, the Reid Bill imposes extensive obligations on any health-insurance issuer or health-plan provider that wishes to participate within the system in order to keep them from capturing subsidies meant for others. The effect of the subsidies is to increase the level of health care that will be demanded in the United States. The effect of the regulations is likely to be to impose huge costs on various health-insurance companies as they struggle to meet the influx of demand when they are at the outer limit of their capacity.

There are at this point enormous uncertainties about how this entire scheme will play out. My view is that it will prove ruinous on all three fronts. The general public tax increases will be so sharp that it is unlikely that they will generate additional revenues. The subsidies will be so large that the demand for medical services will be left largely unsatisfied, so two consequences are likely. First, an increased queuing for various health care services is to be expected. Second, there will be increased pressure to exclude large groups of people from the system, on the lines of Massachusetts's recent decision to cut from its system 31,000 legal immigrant aliens (who pay taxes but do not vote).

Furthermore, on the supply side of the market, all health-insurance companies will find themselves in an impossible dilemma. If they decide to offer their health-insurance plans outside the State Exchanges, they will be unable to compete for the subsidized consumers who are only able to spend their tax dollars within the framework of the State Exchanges. Their position will be worse because they shall continue to be subject to all present mandates and regulations that have an impact on their business. Insurers outside the Exchanges also face the likely prospect that they will still be further taxed and regulated to help finance the intolerable burdens that arise under the subsidized insurance supplied within the State Exchange system.

Therefore, it is impossible in my view to look in isolation at the regulations of the health plans and health-insurance issuers that operate under the State Exchange system. This is not a case in which a lonesome competitor complains about a subsidy that some private person gives to its competitor. This is a case in which the party that provides the subsidy to health-insurance consumers for use within the State Exchanges also has the power to regulate and tax the non-Exchange competitors in whatever fashion it sees fit. These impositions are, of course, not only applied at the federal level, for the full consideration of the regulatory burden must also take into account any additional regulations and taxes that the states, with explicit Congressional blessing, are allowed to impose on health-insurance plans and insurance issuers that remain outside the State Exchange system.

This level of systemic coercion frames the debate about the constitutionality of the Reid Bill. Those parties that do not wish to suffer the Bill's regulations in order to gain access to a subsidized consumer base are not free to compete in an unregulated market. Direct federal and state government regulation remains a fixed feature of their life. Government regulators at the state and federal levels have both the power and the motive to hit non-Exchange health insurance issuers with a range of taxes and regulations that could quickly make their economic position intolerable. I reached this conclusion before I read the recent CBO report, which concluded that the level of government regulation with the new proposal to require rebates when the Medical Loss Ratio was under 90 percent left so little flexibility for private carriers that they should no longer be treated as nongovernmental entities. It is worthwhile to quote the CBO's words here:

Certain policies governing MLRs, particularly those requiring health plans whose MLR falls below a minimum level to rebate the difference to enrollees, can be a powerful regulatory tool. Insurers operating at MLRs below such a minimum would have a limited number of possible responses. They could change the way they provide health insurance, perhaps by reducing their profits or cutting back on efforts to restrain benefit costs through care management. They could choose pay the rebates, but if they raised premiums to cover the added costs they would simply have to rebate that increment to premiums later. Alternatively, they could exit the market entirely. Such responses would reduce the types, range of prices, and number of private-sector sellers of health insurance...

The CBO of course is not charged with drawing the constitutional implications from its findings. But its report reaffirms what should be evident from the Reid Bill itself, namely, that health-insurance issuers subject to the rebate provisions are practically forced to operate within the State Exchange system where the guaranteed-issue and renewal provisions coupled with the onerous requirements of the essential-benefit plans put them in this impossible position: They cannot earn a reasonable return on their investment, which is required under the Takings and Due Process Clauses of the Fifth Amendment to the Constitution. Let me now offer a more detailed analysis of how this looming tragedy is likely to play itself out.

II. AN ANALYSIS OF H.R.-S.A. 3590—THE REID BILL The most obvious feature of the Reid Bill is the incredible level of coercion it imposes on the private companies that supply health-insurance coverage, levied in a coordinated one-two attack. On the one hand, the Reid Bill imposes major requirements on how they do business. On the other, it imposes powerful financial limitations on the revenues that such firms can collect for the provision of their services. Yet the Reid Bill contains no mechanism that guarantees that the revenues in question will be sufficient to cover the new obligations that it imposes. Instead, the Reid Bill relies on extensive but standardless delegation to the Secretary of Health and Human Services to fill in the gaps of the legislation. (The Reid Bill does not create, as does section 241 of H.R. 3962, a new Health Choices Administration with its own commissioner.)

The range of matters that are subject to administrative control under the Reid Bill transforms a large sector of the insurance industry. The traditional law of insurance gave the insurer the complete power to determine whether to accept or reject a given risk, or to determine the premiums to be charged to an insured, the policy limits, and the terms and conditions on which the policy was issued. The duties to disclose were extensive but these were correctly imposed on the insured who alone possessed the relevant knowledge about the nature and scope of the risk.

In this traditional environment, regulation of insurance companies was directed to two different issues. The first was a general form of consumer protection, which requires a full disclosure of the terms of policies, which of course does not negate the critical duties to disclose information about material risks imposed on insured parties. The second went to the issue of solvency, in order to counter the real risk that the insurance carrier that had accepted a premium today might not be around to pay off the health care bills that it had promised to pay tomorrow. Competitive forces were generally used to determine premiums. The various efforts to impose mandatory price controls and coverage on insurance contracts in both the individual and small-group markets have typically driven up the cost of business and have resulted, for example, in a reduction of the number of individual employees who are covered by voluntary plans.
What is most striking about the combined effect of the various provisions in the Reid bill is its cavalier disregard for the long-term stability of all segments of the private health-insurance market, which are likely to be caught in a pincer between the heavy mandates for coverage on the one side and their inability to exercise any underwriting control over their book of business on the other. The Reid Bill does not achieve this objective by imposing direct restraints. Instead, its preferred method of social control lies in the power of the Secretary to designate any health plan of a given insurance company as a "qualified health plan" ("QHP"), as defined in section 1301, which allows the health-insurance company to serve customers who are eligible for financial assistance under this bill. The size of these various benefits is sufficiently large that no company that fails to become a QHP issuer is likely to survive in an insurance market in which coverage is offered on the Exchange, as few people will prefer to purchase a full-price plan to a heavily subsidized one. The restrictions imposed on QHPs, however, are so onerous that all health insurance companies are in effect caught in an impossible bind. The only way to reach subsidized customers is to submit to ruinous financial regulation. The system, therefore, operates in effect as a direct set of controls on virtually all companies that wish to remain in the marketplace.

Let me set out some of the key provisions that are likely to have negative impact on firms, which are added to the Public Health Service Act by section 1201 of the Reid Bill. Section 2704 provides: "[a] group health plan and a health insurance issuer offering group or individual health insurance coverage may not impose any preexisting condition exclusion to such plan or coverage." Unlike the earlier House and Senate Finance Committee bills, there appear to be no exceptions to this particular rule. Yet section 2705 makes it clear that the "health status, medical condition, claims experience, receipt of health care, medical history, genetic information, evidence of insurability, disability, or source of injury (including conditions arising out of acts of domestic violence) or any other health status-related factor determined appropriate by the Secretary" cannot be taken into account in setting rules concerning enrollment eligibility.

In addition, section 2702 provides that every health insurance issuer in the individual or group market must accept all applicants. Section 2703 imposes the similar requirements on health-insurance issuers to renew or continue in force all individual and group plans. These sections create the risk that some firms will be inundated with applications that they will be unable to serve. Unfortunately, the mechanisms that the Reid Bill relies on for dealing with the capacity questions are unequal to the challenge of regulation in any fast-moving and complex market.

The technical amendments found in section 1562 of the Reid Bill would make applicable to all issuers in the group and individual health-insurance markets certain provisions in section 2711 of the current Public Health Service Act, 42 U.S.C. § 300gg-11, which are currently applicable only to issuers in the small-group health-insurance market. These provisions are codified at the end of new section 2702.

To begin with, the provision, as amended by the Reid Bill, would require issuers in the group and individual health-insurance market to accept every employer and eligible individual who applies for coverage, unless such an issuer could demonstrate to the applicable state authority that it lacks the financial capacity to underwrite additional coverage. No firm has the capacity to underwrite all the business that comes its way. At some point, its marginal cost of supplying additional coverage becomes prohibitively high. It is relatively easy for any health-insurance issuer to determine that point for itself. It is far more difficult for it to have to incur the time and expense to demonstrate that point to some applicable state authority, which will then be given the power to determine, without bearing financial responsibility of its mistakes, just how much business the health-insurance issuer must underwrite, and which individuals should be eligible for that coverage.

The amended provision also requires the health-insurance issuer to further show that its decisions to deny coverage are not based on the differential costs of supplying that coverage to various individuals and groups under new section 2702 of the Public Health Service Act. And once it makes those determinations, it must remain out of the market for 180 days unless it gets state administrative approval. When market conditions change, or some individuals or groups opt out of coverage, yet another hearing is required to reenter into the market. There is no assurance that these applicable state authorities have either the resources or capacities to determine these multiple questions for huge numbers of health-insurance issuers within the short period necessary to allow them to participate effectively in the health insurance market, including in the Exchange. There does not appear to be any federal funding to help out the states in the discharge of these responsibilities.

The overall level of federal control is heightened by the requirement that all health-insurance issuers in the individual or small-group market provide an essential benefits package that includes a wide range of "ambulatory patient services, emergency services, hospitalization, maternity and newborn care, mental health and substance abuse disorder services, including behavioral health treatment, prescription drugs, rehabilitative and habilitative services and devices, laboratory services, preventive and wellness services and chronic disease management, pediatric services, including oral and vision care." Section 2707. These essential benefits are subject to explicit minimum requirements that the Secretary "shall ensure that such essential health benefits reflect an appropriate balance among" the required services set out in section 1302(b)(1), not discriminate in any way "against individuals because of their age, disability, or expected length of life," and cover the full needs of "diverse segments of the population, including women, children, persons with disabilities and other groups." No health-insurance issuer that participates in this market will be able to skimp on coverage.

In addition, the cost of compliance is heightened by the requirements of section 2711, which covers all group health plans and health-insurance issuers and prohibits the use of "lifetime limits on the dollar value of benefits for any participant or beneficiary" (except for certain exempt plans that are not otherwise regulated under state or federal law) and "unreasonable" annual limits on the value of benefits for any participant or beneficiary. At the same time that these coverages are guaranteed, the Reid Bill limits the amount of cost-sharing that can be required of plan participants and the size of the deductibles ($2,000 for an individual and $4,000 for a family in the small-group market). Such is the command of section 2707(b), making section 1302(c)(2) applicable to health insurance issuers in the individual and small-group markets. Finally, termination of enrollees is often difficult under section 2712, which allows for the rescission of coverage only with respect to any individual enrollee "who has performed an act or practice that constitutes fraud or makes an intentional misrepresentation of material fact as prohibited by the terms of the plan or coverage."

The combined impact of these interconnected provisions is clear: there is no feasible way that an insurance carrier can respond to the increased costs of servicing of its book of business either by declining coverage or by reducing services. With all escape hatches closed, the critical question is whether the health-insurance issuer is in a position to raise rates in order to offset the risks in question. On this question, section 2794 introduces a complex system of de facto price controls that depends on the close cooperation of state and federal officials. The initial process that goes into effect in 2010 requires the Secretary and the states to develop a plan to look for "unreasonable increases" in charges for insurance coverage. At this point, all health-insurance issuers must submit to the state insurance commission authority "a justification for an unreasonable premium increase prior to the implementation of the increase." (It is not stated as to how one justifies increases that are, by definition, unreasonable.) Thereafter, once the information has been submitted and evaluated, it appears that the state insurance commissioner shall make appropriate recommendations "to the State Exchange about whether particular health insurance issuers should be excluded from participation in the Exchange based on a pattern or practice of excessive or unjustified premium increases." In effect, it appears that the State Exchanges can exclude health-insurance issuers from offering their plans through the Exchanges, at which point the subsidies to insurers will be lost.

As of 2014, the Secretary is put in a position to "monitor premium increases of health insurance offered through an Exchange and outside of an Exchange." Section 2794(b)(2)(A). Of equal importance, the combined effect of section 2794(b)(2)(B) and section 1312(f)(2)(B) would seem to permit the states to influence the premiums charged in the large-group market, even when no large-group coverage is offered through the State Exchange. And the states are put in the position under the Reid Bill to deny Exchange access to those small-group and individual plans that they determine have excessive rates. That power to exclude from the Exchange remains a death knell for all plans in health-insurance markets in which coverage is offered through the Exchange, so that the power to exclude again converts itself into a de facto power to set maximum rates.

In addition, after 2014, it is at least possible that the power of the Secretary to "monitor" could be read as a way to introduce price controls through the back door. The natural reading of the section seems not to support that view, but administrative officials often receive deference in their statutory interpretations under Chevron, Inc. v. National Resources Defense Council, 467 U.S. 837 (1984). More specifically, the primary meaning of "monitor" is to "observe" or to "keep an eye on." But a secondary meaning is to supervise, which in this context might be read to give the Secretary those more expansive powers.

The level of regulation over prices is not confined to these provisions. As currently configured, the Reid Bill contains global caps on profits that operate on a heads-I-win-tails-you-lose principle. Thus, section 2718(a) of the Public Health Service Act, as added by the Reid Bill, imposes on "[a] health insurance issuer offering group or individual health insurance coverage" reporting obligations on the amount of premium dollars that are spent on "clinical services," activities to "improve health care," and all other "non-claim costs." Up to the end of 2013 (unless extended), if this information reveals that the non-claim charges exceed 20 percent of total costs in the group market, or 25 percent in the individual market, the Reid Bill provides that, in the first instance, there "shall" be an annual rebate in the amount of the excess over that level, section 2718(b)(1)(A) & (B). Section 2718(b)(1)(A) & (B) also provide that the individual states may order a reduction in the 20 or 25 percent non-claim figures, so that the annual rebate kicks in at a lower percentage.

In making that determination, under section 2718(b)(2), the states "shall seek to ensure adequate participation by health insurance issuers, competition in the health insurance market in the State, and value for consumers so that premiums are used for clinical services and quality improvements." The amount of any state-adjusted rebate under section 2718(b)(1)(B) with respect to coverage in the individual health insurance market can be adjusted only if the Secretary determines that such rebates will "destabilize" the market. It is difficult to understand how these inconsistent commands can be simultaneously achieved. "Adequate participation" suggests that rates must be kept high enough to keep firms in the market, while "value for consumers" pushes strongly in the opposite direction. In the middle, "competition in the industry" is effectively gutted by the extensive system of regulation that prevents firms from gaining extra profits from valuable new innovations in health-care management or delivery systems.

The most insidious feature of this provision, however, lies in its unconstitutional insistence on a global limitation on the profits obtained by any firm that runs this regulatory gauntlet. The first point here is that no firm would be able to show that its non-claim expenses do not exceed the maximum statutory allowances. Given the high level of administrative costs that the Reid Bill imposes, this is, to say the least, a strong possibility. It could easily be that the health-insurance companies will find themselves in the unenviable position of having to issue rebates at a time when they are operating at a loss. In addition, neither bill takes into account the strong likelihood that overall costs will vary from year to year. These statutory provisions are strictly one-way ratchets, such that the gains, if any, in one year will be taxed away even if there were losses in previous years, or even if losses are expected in future years. The lack of any averaging provision, therefore, has the unhappy effect of placing a hard cap on earnings that is unrelated to the overall risk of the venture.

There is yet another feature that requires some brief notice, for it goes to the stability of preexisting plans. One of the ways that the legislation allows for "acceptable" coverage to be obtained is by enrollment in a "grandfathered" health-insurance coverage plan. That sanctuary is far narrower than is commonly supposed. Under section 1251 of the Reid bill, the only new enrollees that allow the plan to keep its protected status relative to the State Exchanges are those that admit new dependents of an employee or new employees. The admission of any other person into the plan, such as retirees, will eliminate the preferred grandfathered status under section 1401 of the Reid bill, which adds section 36B to the Internal Revenue Code; section §36B(1)(b)(3)(c)(iii) determines the eligibility of plan enrollees for various refundable tax credits or other premium assistance.

Section 1251 is, however, silent with respect to other possible features. The definition of "grandfathered Health Insurance Coverage" in section 202 of the House Bill made it crystal clear that this grandfather status would be lost when an existing plan added or removed a benefit, or increased the premium for one group of employees unless the same proportionate increases were imposed for all plan participants. The Reid Bill is silent about the effect of these changes, which ordinary plans necessarily make dozens of time each year. The question, therefore, remains unanswered as to whether most grandfathered plans will be able to maintain their preferred status, or whether they will lose that preferred status and be required to meet all the substantive and procedural requirements necessary for new plans to participate in the State Exchanges. Questions of this magnitude should not be left to administrative discretion, but should be resolved in the Reid Bill itself.

III. FROM COMPETITION TO PRICE CONTROLS: THE ECONOMIC ANALYSIS Whether or not the Secretary is able to claim more extensive powers, it appears that the complex price-control mechanism implicit in the Reid Bill operates on the indefensible economic assumption that price controls are needed to wring inefficiencies out of the operation of health-insurance issuers. Yet economic theory unambiguously leads to the opposite conclusion. To take only the extreme cases, the logic behind pure competition is that it leads to efficient outcomes because the ability of customers to go elsewhere leads firms to reduce the costs required to meet any specified level of service. In general, a competitive market is regarded as socially optimal because there is no movement in price, quality, or quantity that could make one party better off without making another party worse off. Any assumption that price controls, however implemented, offer some hidden road to the efficient allocation of resources has been repeatedly exploded. One need only think of the systematic cut back in services that is the hallmark of rent-controlled apartments to understand this basic economic principle.

The logic of competition is clear. In competitive markets, the firm is always engaged in a delicate balancing act whereby it must ask whether the additional services that it could supply will generate revenues equal to, or greater than, its cost of providing those services. The pressure of competition could never force a firm to offer its products or services for sale at a loss. At the same time, the ability of customers to go elsewhere will drive prices down to the marginal cost for the provision of those products or services. Even the existence of monopoly power does not allow any firm to make any money if it is forced by regulation to provide goods and services below their costs. The existence of monopoly power only speaks to the possibility of a firm raising its prices above marginal costs, for which rate regulation may be an appropriate response, although always difficult to implement. But there are clear caveats here that need to be observed first.

First, to justify rate regulation, there needs be some evidence of the existence of monopoly, which is not likely in health-insurance markets in which multiple parties are already in competition with each other. To be sure, that condition is not uniform, in part because of the state restrictions on entry that are allowed under the 1945 McCarran-Ferguson Act, 15 U.S.C. §§ 1011-1015. But the existence of this entry barrier does not require any form of rate-of-return regulation. It is a simple matter to repeal McCarran-Ferguson to the extent that it authorizes state barriers to out-of-state competition. That one legislative fix should reduce prices and expand access, but not cost the federal government a dime.

Second, the rate regulation imposed by the federal government cannot be allowed to become confiscatory by denying the firm the ability to recover an appropriate return on its capital. There is nothing that a system of price controls can do to lower costs. In fact, price controls generally increase the costs of production to firms by forcing them to meet heavy compliance costs. Under the Reid Bill, the costs of providing service will necessarily increase because of the heavy compliance costs imposed on health-insurance issuers, the uncertainty of their business position, and their inability to select or decline customers or to set premiums in accordance with known risks of various individuals or groups. There is no reason whatsoever to think that any firm operating in this heavily controlled environment could eliminate inefficiencies from its current operation to offset these losses. To give an analogy, one of the major problems of rent-control and rent-stabilization systems is that once landlords are revenue constrained, they cut services to save costs. They were already doing their best before the regulation, which offers no magic bullet. The logic same holds here. Services will be cut or delayed, in either visible or covert fashion, just as the recent CBO report indicates. As far as I know, there has never been a price-control system that can improve quality of output, and there never will be.

Third, it is wholly unclear as to how private firms will be asked to price their services under these new mandates dealing with guaranteed service and preexisting conditions. One possibility, which seems inconsistent with Section 2794, is to allow for competitive pricing without allowing the state to set the prices which are required. But given the requirements under the Reid Bill, that position will not lead to an offer to supply health insurance at a price that is lower than the blended cost incurred for serving all potential customers. Those numbers could easily make the insurance unaffordable for all but the most sick people. As healthier individuals either stay out of, or abandon, the health-insurance market because of high premiums, the blended rate will have to increase. Quite simply, the risks of adverse selection by insureds are enormous: those individuals whose health prognosis improves could leave the system, while those whose condition has worsened will continue to demand coverage at the same rates as before.

Fourth, persons who choose to stay out of health-plan coverage when healthy (even by paying some tax) will migrate to the plans quickly once their own health condition deteriorates. They would have complete and accurate knowledge of their own condition that they would not need to disclose to the insurer, which is in effect under a statutory duty to enter into a losing contract. The scope of the potential liabilities is only increased by the huge number of individuals to whom this option is made freely available. Wholly without any other consideration, the key requirements prohibiting the use of pre-existing condition exclusion and requiring guaranteed issue and renewal could easily impair the success of health insurance issuers. Ironically, the programs that have the best coverage are the ones that are most at risk, as there is nothing in either the Senate or House bill that appears to alter the rates to account for the differential level of services offered. Other things being equal, the dominant response under this type of mandate would be to reduce the level of coverage across the board, thereby decreasing the options available to many plan recipients. But even this option is blocked by the statutory requirements for "essential health benefits," with their mandatory minimums. On this score, the degrees of freedom to vary rates that the Reid Bill allows health-insurance issuers in the individual and small-group markets relate to "only" four factors, whether or not the coverage is offered through the Exchange. Section 2701(a)(1), as added by section 1201. In addition, these provisions apply with equal force to all health-insurance issuers in the large-group market if the state allows any insurer to sell large-group health insurance coverage through its Exchange.

What is noteworthy about these rate-setting provisions is that they do not allow the health-care-insurance issuers the ability to accurately price their products. The first factor stipulates that coverage for individuals may differ from that offered to families. The second calls for states to establish one or more rating areas within their respective states, subject to review by the Secretary if its areas are found to be "not adequate," under criteria that are nowhere specified in the bill. The choice of these areas--are cities and suburbs in the same or different areas, for example--could be critical for individual plans because the total premium is likely to be sensitive to the areas that are chosen. A health insurance carrier that has an expensive book of business will not be able to adjust the rates accordingly once the geographical boundaries are determined. That nonindividualized treatment could easily create substantial losses for some firms and competitive advantages for others. Finally, some variation is allowed for age up to a 3-to-1 ratio, and for tobacco use up to a 1.5-to-1 ratio. Both these numbers are smaller than the actuarial difference among these groups, so that this provision also requires cross subsidies among plan participants under the guise of "prohibiting discriminatory premium rates," set out in section 2701(a).

At this point, the only possible response of companies is to raise prices to levels that could easily prove economically and practicably unacceptable. Yet once that is done, the prohibitions against "unreasonable" premium increases of section 2794 kick in to make it highly likely that the offending heath insurance issuer will be thrown off the Exchange. But what other alternative is possible? Piling one mandate on top of the other places powerful pressures to impose price controls on the health insurance issuers. After all, the requirement for guaranteed renewal will not satisfy the purposes of universal coverage with the State Exchanges if it is only offered at a price that is beyond the reach of the individuals whom it is supposed to benefit. In the end, therefore, I think that the implementation of the Reid Bill will lead key government officials to impose direct and comprehensive price controls.

This point requires some elaboration. Every scheme that denies a firm the ability to refuse to deal with potential customers has to have either a nondiscrimination rule or a price-restriction rule or both. Thus, standard public utilities have to take all comers. In some instances, they do so on a first-come, first-served basis, as was the case typically when railroads were so regulated. Or these utilities need to articulate some rule that requires a cut back in services offered to earlier customers to make way for later ones, as was typically the case with public-utility hook-ups for gas and electricity. But those provisions will not work in an environment that imposes specific duties, for customer access could easily be denied by what some government administrator deems to be systematically high prices. The only way to make sure that these regulated plans provide access is through some system of oversight on the rates that can be charged.

At this point, the Reid Bill exacerbates the major difficulties of government regulation. The voluntary market under competition will never price goods and services below their cost to the firm. As these costs go up, the health-insurance markets will shrink, for it is quite likely that this mega-mandate will provide many people with services that they do not want and cannot afford. The only two options then are to take some benefits out from the mandate, or to impose price controls at either the state or federal level. Clearly the latter is more likely to be chosen, but there is nothing in either regulatory scheme to rule out the risk that the prices charged will not cover the full costs of providing the benefits. Once again, the risk of price controls is close at hand, even without any explicit authorization on the point.

The situation is still made worse because the federal standards are best understood as creating floors and not ceilings. Indeed, section 1311(d)(3)(B) of the Reid Bill coordinates federal and state programs by providing that state benefit mandates continue to apply to Health Insurance Exchange participating plans so long the state agrees to reimburse the federal government for any increase in premium credits that is attributable to the premium increase arising from the mandate. These additional demands could prove to be extremely costly to companies that seek to acquire nationwide coverage for their employees in the face of specialized mandates that often vary in their economic impact across state lines.

IV. CONSTITUTIONAL ANALYSIS This detailed analysis of the Reid Bill helps to set up the appropriate constitutional analysis. The applicable standards for constitutional review have usually been developed in connection with rate-making procedures in natural monopolies. Within this context, the social objective is to limit the monopoly returns to public utilities, which do not face the risk of competition from new entrants, because they operate in a market in which the declining marginal cost of the initial entrant prevents a new entrant from gaining a toehold. In such a situation, one permissible legislative response is to impose some form of regulation that brings that established player back to a competitive rate of return. I shall pass by all the difficulties in implementing such a program. It is important to note, however, that it is never a satisfactory response for regulators to drive the rates of return down to zero, for then no one would ever be prepared to provide services.

Since it is necessary to compete for capital across the entire range of activities, the constitutional protection afforded under both the Takings and the Due Process Clauses provides that the rate of return cannot fall below that which the investors in the firm could obtain in a competitive market. That calculation has to take into account the level of risk associated with the business, which in general is low with respect to public utilities that have at least de facto protection against new entry.

The hard question, therefore, is what kinds of systems of rate regulation will pass constitutional muster. Within the traditional ratemaking system, the first issue concerns what goes into the rate base. One view is to allow the firm only to include those investments that remain used and usable in the business, which means that the firm has to take the risk of investments that go to waste. For taking this risk, it receives a higher risk-adjusted rate of return. See Smyth v. Ames, 169 U.S. 466 (1899). The alternative is to permit the use of a broader rate base, and to allow therefore a lower rate of return because the risk of poor investments falls on the ratepayers. See Federal Power Commission v. Hope Natural Gas, 320 U.S. 591 (1944). In other instances, it is possible to avoid the cumbrous ratemaking proceedings by instituting a system of rate caps, which in effect tell a firm in an industry like telecommunications that its rate increases will be capped because the increased efficiencies in doing business mean that the unit costs of supplying services will always be on the decline.

What is striking is how far the ratemaking system for health insurance is from all the above. There is no natural monopoly in health insurance, and there is a powerful way to open up health-insurance markets by knocking down the state barriers to entry that have been in effect since 1945 under the McCarran-Ferguson Act. Once it is clear—and it is generally clear—that the health insurance industry is competitive or could easily be made competitive, the entire rationale for government ratemaking is undermined. The point of ratemaking was to require the firm to accept competitive rates of returns in a market setting where it enjoyed monopoly power. Here, the market is either competitive already, or easily can be made so. In this environment, ratemaking no longer serves any useful function.

Contrary to the implicit assumption behind the Reid Bill, ratemaking cannot induce further efficiencies once competitive forces have driven out all elements of monopoly power. Yet all firms are trapped, for the only way in which they can escape ever more onerous requirements and restrictions is to render themselves ineligible to enroll new groups or individuals—whose health insurance, of course, their tax dollars will continue to fund. In addition, right now the Reid Bill subjects plans outside the Exchanges to certain other legal requirements, which could easily be tightened down the road. The non-Exchange health insurance issuers are, therefore, placed in an untenable position that exposes them to the multiple strategies in the Reid bill that control rates and set the terms of service and that will have three unacceptable consequences: (1) to reduce the rate of return of health insurance companies below competitive levels, (2) to pile expensive administrative mandates on them, and (3) to generate major uncertainties as to how the federal obligations on such companies will pan out.

At this point, there is a near mathematical certainty that the scheme of health-insurance market regulation contemplated by the Reid bill will reduce the risk-adjusted rate of return below the level needed to keep these firms in the individual and small-group health-insurance markets. I am not aware of a single provision in the Reid Bill that looks to ensuring a minimum rate of return. And there are countless provisions in the bill that impose new obligations to cover services while eliminating the revenue sources to deal with them. It is just this combination of regulatory programs that leads the CBO to treat private health insurance issuers as part of a federal program--as though they have been subject to de facto nationalization.

This systemic regulation of both Exchange and non-Exchange carriers shows, moreover, that those health-insurance issuers that participate in the Exchange are shorn of all constitutional rights. The requirement that the states order rebates of money spent on non-claim expenses is not constitutionally permissible unless and until the Reid Bill makes some allowance for earning a reasonable rate of return. That return, moreover, must take into account the extra riskiness that flows from the grant of broad delegated authority to the Secretary.

In addition, the decision to order rebates in good years without adjustments for the losses in bad years makes it impossible for a firm to earn a reasonable rate of return. In utility rate regulation, it is not constitutionally permissible to impose an annual rate cap just at the competitive level, while leaving the carrier obligated to eat the losses in poor years. Section 2718 of the Reid bill goes even further than such unconstitutional provisions in the utility context:[3] it imposes a hard cap, without any accurate accounting for administrative costs or any explicit recognition of the constitutional right to earn a reasonable profit.

To make matters worse, these overall caps apply on top of all the restrictions on the ability to decline coverage or vary rates that are involved in other provisions of the Reid Bill. These provisions necessarily raise the administrative costs of providing insurance. There are no upper bounds on what can be required by various federal and state officials who are charged with oversight of individual and small-group plans in many instances, and all health-care plans in others. At this point, it is only a matter of time before the cost obligations are so enormous that even complete freedom in setting prices would not allow the firm to remain in business. Nor will this problem be cured by the vast pattern of subsidies and taxes that permeate the rest of the bill. Quite to the contrary, the subsidies may put greater pressure on the capacity of health insurance companies to operate, given that these firms have no capacity to choose which plans to provide to which customers.

Given these facts, it is impossible for the rate regulation of firms in the competitive health insurance industry to recover the constitutionally permissible rate of return. So long as competitive rates of return remain the constitutional benchmark, rate regulation necessarily fails. The unregulated rates are already at the competitive level. Any system that reduces revenues, raises costs, and increases uncertainty cannot possibly meet the applicable constitutional standard.

To my mind, the only serious question about the legislation is whether a facial challenge will be allowed to the Reid Bill when it does not contain explicit price-control features. Such facial challenge are often denied in land-use cases, but in rate-regulation cases the result has usually been otherwise. To wait until the program has run its course is to consign a health-insurance company to the substantial risk of bankruptcy just for trying to stay in business. It does not have the option to hold off development until the legal uncertainties are resolved. Since neither the United States nor the individual states will pony up the huge losses sustained by the regulated firms, the challenges have to be allowed before the statute is implemented and not afterwards. How this issue will play out in litigation no one can say for sure. But it would be, in my view, irresponsible for the Senate to pass any health reform legislation that does not address the serious constitutional infirmities found in the Reid Bill.

CONCLUSION: This ill-conceived legislation has many provisions that regulate different aspects of private health-insurance companies. Taken together, the combined force of these provisions raises serious constitutional questions. I think that these provisions are so intertwined with the rest of the legislation that it is difficult to see how the entire statute could survive if one of its components is defective to its core. How courts will deal with these difficult issues is of course not known, but rate-regulation cases normally attract a higher level of scrutiny than, say, land-use decisions.

There is, moreover, no quick fix that will eliminate the Reid Bill's major constitutional defects. It would, of course, be a catastrophe if the Congress sought to put this program into place before its constitutionality were tested. Most ratemaking challenges are done on the strength of the record, and I see no reason why a court would let a health-insurance company be driven into bankruptcy before it could present its case that the mixture of regulations and subsidies makes it impossible to earn a reasonable return on its capital. At the very least, therefore, there are massive problems of delayed implementation that will plague any health-care legislation from the date of its passage. I should add that the many broad delegations to key administrative officials will themselves give rise to major delays and additional challenges on statutory or constitutional grounds.

The health of the American people should not be held hostage to such unwise legislation. The Senate should reject the Reid Bill because of the unsustainability of the statutory scheme regulating health-insurance markets. But there is also little doubt that its central arrangements are unconstitutional, and will face serious legal challenge for years to come. Rather than embarking on a fundamentally flawed course of action, sure to spark litigation, the Senate should start over with other reforms that go in the opposite direction: simplify the system so that market forces can increase both quality and access in ways that no system of government mandates can hope to do. Deregulation is a word that has been forgotten in the current debate. It should be returned to center stage.[4]

Richard A. Epstein is the James Parker Hall Distinguished Service Professor of Law at the University of Chicago, the Peter and Kirstin Bedford Senior Fellow at the Hoover Institution, a visiting professor at the NYU Law School, and a visiting scholar at the Manhattan Institute.

I wish to thank Paula Stannard for her prompt, gracious and expert assistance in guiding my way through the statutory quick sands. Any remaining errors are, of course, entirely my own.

NOTES:

1. H.R. 3962, The Affordable Health Care for American Act, passed the House this past November 7, 2009. A second bill, S. 1796, the America's Health Future Act of 2009, was reported in the Senate from the Senate Finance Committee on October 19, 2009. A third variant, S. 1679, the Affordable Health Choices Act, was reported in the Senate from the Senate Health, Education, Labor and Pensions Committee on September 17, 2009.

2. Congressional Budget Office, "Treatment of Proposals to Regulate Medical Loss Ratios," December 14, 2009. "A Medical loss ratio, or MLR, is the proportion of premium dollars that an insurer spends on health care: it is commonly calculated as the amount of claims incurred plus changes in reserves as a fraction of premiums earned." Id.

3. If we were to assume that the health insurance company gets, at most, a competitive return in good years--an assumption more generous than what the Reid Bill provides--it still gets less than a competitive return in poor years. The situation becomes like a coin flip, in which the regulator wins with "heads" and the regulated health-insurance company loses with "tails." Over the long run, the firm is necessarily deprived of a competitive rate of return except in the wildly improbable scenario that the firm earns exactly the competitive rate of return in all years.

4. See, e.g., Richard A. Epstein & David A. Hyman, Controlling the Costs of Medical Care: A Dose of Deregulation, available at http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1158547.

By James Copland

This piece was originally published by the The Washington Post, 3-15-08.

To preempt or not to preempt: that is the question with which the U.S. Supreme Court is wrestling in 2008. In a series of cases—two recently decided and one scheduled for argument this fall—the court has been looking at whether state lawsuits, filed on behalf of individuals allegedly injured by pharmaceutical drugs and medical devices, interfere with the Food and Drug Administration's federal regulatory scheme. To the extent the answer is "yes," many tort claims against drugs and devices could be preempted, since federal law is supreme over that of that states.

The court's first FDA preemption decision of 2008, last month's Riegel v. Medtronic, was called "the most momentous Supreme Court product liability decision in some time" by law professor Michael Krauss of George Mason University. Charles Riegel and his wife had sued medical manufacturer Medtronic, claiming that a Medtronic-made catheter that ruptured during Mr. Riegel's heart surgery was defectively designed and labeled under New York law.

Medtronic argued that whatever the law of New York, the FDA had approved the device's design and labeling—the very question at issue—under its extensive premarket approval process. And the Medical Device Amendments of 1976 specifically states that once a device has gone through that approval process, states may not "establish or continue in effect ... any requirement ... which is different from, or in addition to, any requirement applicable under [federal law] to the device."

With such explicit preemption language, the Supreme Court found it easy to determine, by a viote of 8 to 1, that the Riegels' state tort claim was barred by federal law. The decision will not apply to all medical devices but rather only those that, like the catheter, are "Class III" devices subject to the FDA's most rigorous testing procedures. Also, individuals can still sue if they can show that the device was manufactured in noncompliance with the design approved by the FDA, or if the FDA determines that the company committed fraud in the application process.

In its second major preemption case, Warner Lambert v. Kent, the Supreme Court last week deadlocked 4 to 4 (Chief Justice John Roberts had recused himself). The court simply let the lower court decision stand without any written decision or even an indication of where each justice stood.

Court watchers interested in preemption are therefore anxiously awaiting a case scheduled for this fall, Wyeth v. Levine, which promises to define the scope of preemption doctrine for FDA-approved products apart from the medical devices covered in Riegel. Levine involves a state "failure-to-warn" claim: Wyeth's FDA-approved label noted the risk of Levine's injury, but the plaintiff argues that the label could have been stronger or more specific and that the FDA's label was merely a "floor."

Thus, the court must decide whether Levine's claim is preempted by the FDA's extensive review and approval of pharmaceutical labeling. The case is more difficult than Riegel in part because the Food, Drug and Cosmetic Act contains no express preemption provision, so the court can reject Levine's failure-to-warn claim only if it determines that the federal regulatory scheme preempts such lawsuits. How the justices will rule in Levine is anyone's guess.

The so-called "presumption against preemption" is rooted in concerns over federalism, but in this context, such concerns are misplaced. The marketing and sale of pharmaceuticals and medical devices clearly is a part of interstate commerce, the core object of the federal regulatory power, and Congress has established an exhaustive regulatory process through the FDA. It's hardly news that state courts could interfere with such a scheme: In the 81st Federalist Paper, Alexander Hamilton observed that "the prevalency of a local spirit" could bias state courts in national commercial cases, a prediction since amply confirmed by academic empirical research.

The Supreme Court should also resist the temptation to follow the lead of Justice Ruth Bader Ginsburg, who in her dissent in Riegel argued that Congress never intended to override state tort law, the Medical Device Amendments' preemption language notwithstanding. Ginsburg may actually be right, but a focus on "legislative history" misses the point, as NYU law professor Catherine Sharkey noted at an American Enterprise Institute forum last month: Congress is intentionally vague in passing such laws, as a necessary precondition for logrolling the votes needed for the statutes' passage. The statute's language and structure should govern, and if Congress truly has an interest in weakening the FDA's regime by permitting state-level tort lawsuits, it can still do so by changing the law—as trial-lawyer-allied Democrats like Sen. Edward M. Kennedy (D-Mass.) and Rep. Henry A. Waxman (D-Calif.) are, alarmingly, threatening.

However the court rules in Levine, the implications for business, the lawsuit industry and the American consumer are huge. Consider that Merck spent upwards of $1 billion defending against Vioxx claims before recently reaching a partial settlement agreement for more than $5 billion, while the estimated tab for Wyeth over its recalled diet drug combination Fen-Phen is $21 billion. Although business's gain in Levine would obviously be the lawyers' loss, it should be the average consumer's gain as well, since eliminating massive tort exposure would encourage companies to develop more life-saving products. The FDA carefully weighs not only the costs and benefits of new drugs, but also overwarning vs. underwarning in its label approval process, since overwarning about drug dangers can obfuscate the most significant risks and deter life-saving pharmaceutical uses.

As Justice Stephen Breyer suggested during oral argument in Kent, it makes little sense that a jury of 12 lay people, looking only at the costs to an injured individual, could override the FDA's considered judgment. Any sensible federalist would agree.

James Copland is the director of the Center for Legal Policy at the Manhattan Institute. He owns shares in pharmaceutical companies.

BY RICHARD A. EPSTEIN

In a recent issue of the New Republic, Arnold Relman, a former Editor—in—Chief of the New England Journal of Medicine, offered a most unflattering review of my recent book, Overdose: How Excessive Government Regulation Stifles Pharmaceutical Innovation (Yale University Press, 2006). The Editors of the New Republic have decided not to publish any reply from me. I am therefore grateful that the Manhattan Institute has stepped forward to publish my reply, with—I should add—an open invitation to Dr. Relman to respond if he so chooses.

In dealing with a longish review, the usual approach of the aggrieved author is to take on only one or two points of the critic, and let the reader draw whatever inferences he or she chooses about those points that were not addressed. The Relman review, however, makes so many instructive errors that a different course seems preferable. Let me first start with a few general observations and then turn to a point by point rebuttal of his argument.

The most obvious difference between us is that we inhabit two different intellectual universes. He dwells from the more liberal and more complacent medical culture of Cambridge, Massachusetts, and I come from the less fashionable and more driven legal precincts of the University of Chicago. Thus two great divides separate Relman from myself.

Start with the professional training. I am a lawyer by training, with an extensive, if informal, background in economics. I have worked extensively and actively in the health field area on a wide range of topics on health care, ethics, law and medicine for the past 30 years, much of it spent in the company of health care professionals with medical training. Relman is a doctor by training who fancies himself an expert in "social medicine," who has as best I can tell no formal training in any of the collateral disciplines that bear on the comprehensive analysis of health care. In his view, mere lawyers are always out of their depth in dealing with the kinds of issues raised by the provision of health care, including of course the development, testing, and marketing of pharmaceutical products. My view is that the technical matters of medical treatment can easily be bracketed in dealing with the larger institutional issues. I do not wish to decide which drugs should be tested in what clinical trials, but, even in the absence of that information, can comment intelligently on the use of these clinical trials in dealing with FDA approvals for new drugs or with their role in litigation. Indeed, in my work as a torts scholar, I am constantly forced to examine detailed medical information that involves such hotly litigated questions as whether Bendectin causes child defects or thimerosal causes autism. In my view, there is nothing whatsoever in Relman's traditional medical background that offers him any comparative advantage in dealing with the full range of property rights, regulatory, marketing, patent, and tort issues that are examined in Overdose, which should be evident to anyone who has worked his or her way through Relman's review.

The second deep cleavage between us has to do with world views. Relman is a generation older than I, being born in 1923, while I was born a generation later in 1943. The difference in age matters, because he takes the New Deal critique of markets as a verity from which all other truths flow. Indeed, for a man so insistent on field expertise, he shows no hesitation to take on Milton Friedman for his heretical views of the role and organization of market institutions. Those sentiments are quite evident in his searing conclusion that insists that markets "do not do a good job of protecting the public interest. If we want a pharmaceutical industry and a health care system that put patients' welfare and society's needs ahead of profits, we will need more regulation, not less."

I of course am very much in the camp of Milton Friedman, which is evidenced by our parallel lives at the University of Chicago and the Hoover Institution. And I was deeply honored to speak at his memorial service held at the Hoover Institution this past January. All that does not mean that I slavishly agree with all that Friedman says-a pose that Friedman himself would have found most distasteful. It does mean, however, that I take strong issue with the simple–minded portrait that Relman paints of my views. The proper question is not whether we put society's interest ahead of profits. That formulation of the question gives no guidance as to what should be done. Clearly if we are to have pharmaceutical companies, then we must allow them to have some profits in order to attract and retain capital. Relman is not subtle enough to distinguish between a risk-adjusted competitive rate or return and monopoly profits, or to recognize that the former advances social welfare and the latter retards it. Indeed, Relman's gripe is not only with Friedman but with every neoclassical economist from Adam Smith to the present

That said, the right question to ask is how we maximize a system of overall social welfare, which cannot be done if the industry is driven out of business. On that structural question I am happy to align myself with both Smith and Friedman on a number of key points: that voluntary transactions are preferable to coerced ones, that subsidies and taxes can easily distort the choices of private actors, that state officials often have private agendas to advance even when in public office, and that the state which concentrates its effort on the control of force and fraud, the provision of public infrastructure and the control of monopoly-which means refusing to create state monopolies-will do better than the big New Deal government that sees in every market a looming imperfection, which only the wise hand of government can correct. The system of government control that Relman proposes is ruinous to the ends of patient welfare and social prosperity that he supports.

His fundamentally unsound world view does create a huge professional and philosophical chasm between us. Worse still, it infects every portion of his New Republic review. Here it is convenient to break down his arguments by into two areas. I will first treat his general critique of the economic issues raised on matters of drug, pricing, patenting and marketing. Thereafter I shall turn to health and safety, with special reference to the FDA, clinical trials and tort liability.

RELMAN'S ECONOMIC CRITIQUE:

Corporate responsibility. Relman begins his attack by quoting Pfizer CEO Jeffrey Kindler, a lawyer by training no less, who says: "We will transform virtually every aspect of how we do business, focusing on actions that create and sustain value for our shareholders." That statement, made by the CEO of a company whose stock has been under constant pressure should be regarded as good news to shareholders, and to anyone else who is concerned with Pfizer's recent lag in performance. But not to Relman, who sees in this benign pronouncement the spread of Friedman's dreaded influence into the sacred precincts of the pharmaceutical industry. Indeed Friedman said, famously, in words that wave a red flag before Relman's eyes: "Few trends could so thoroughly undermine the very foundations of our free society as the acceptance by corporate officials of a social responsibility other than to make as much money for their stockholders as possible." Relman hears in these words not "we shall do our best by our shareholders." Rather, to him the words say: "the public be damned."

Now it turns out that Friedman (who was not a lawyer) did overclaim in this sentence. The proper analysis says that the corporation is (or is formed by) an agreement among its shareholders, so that any gifts that it chooses to make should be in accordance with the conditions of its charter, which in some cases may allow for such giving. Indeed, I know of no case where a corporate gift has been successfully attacked in court. Relman can breathe easily on this point. But that is a mere detail. Friedman's central point is that shareholders can agree on any program that maximizes share value. Once that is done then the shareholders as individuals can make whatever charitable gifts they see fit with the dividends and gains that they make from their investment. Friedman's argument, which Relman does not understand, is that private giving at the shareholder level is preferable because avoids the real conflict of interests that arises when corporations make gifts to some charities but not to other. And needless to say, Relman shows no evidence of the major corporate law qualification to this rule, namely, that "gifts" to charitable or other institutions that work to promote the good will of the corporation are consistent with the operation of a profit-making institution, as countless cases have held.

We can ignore the fine points of the analysis, because Relman is after bigger game. His view is that Kindler is engaged in some massive hypocrisy when Pfizer makes all these high-sounding statements that it is "working for a healthier world," or "putting its patients first." Pharmaceutical firms are not unique in making these remarks; Ronald Reagan remarked as the spokesman for General Electric, "Progress is our most important product." But Relman is thoroughly confused about how corporations work. The management owes duties of loyalty and care to the shareholders; after all shareholders have put their money in with the firm, and it would hardly do to allow the management to misappropriate the funds so that the shareholders go home empty-handed. But the customers of the firm are not investors, and they can walk away and buy somewhere else if they do not like what they get. The key challenge to any firm is to figure out how to secure their repeated loyalty and that can only be done by offering them goods and services that they value at more than they pay, which the corporation can produce at a cost lower than the prices they can command. Therein lies the critical concordance of interest between buyer and seller that Kindler grasps. Kindler knows that unless he can preserve the good will of his customer base, Pfizer will have to close up shop. The firm has to walk a tightrope, and in that regard it is no different from any other company in any other industry. Indeed, one major problem for any firm in a large industry is that its reputation really matters, such that a single infraction can produce losses in future sales that far dwarf any direct fine or tort judgment that could be imposed. These are good features, because we now know that large companies bind themselves to good behavior by their brand and reputation. One of the first things that Kindler has to do is to make sure that his firm does not acquire a reputation that matches that of the tobacco industry (for which, years ago, I consulted). It is very hard to do in the face of uninformed critics who see a large target that finds it difficult, even with the money it spends, to mount an effective public relations campaign. Like many corporations, pharmaceutical companies are only omnipotent in the fevered imagination of their most severe critics. In reality, a single bad headline or court ruling can erase billions in shareholder value and leave CEOs like Kindler trembling.

After his initial foray, Relman then turns to my view that regulation has hurt the industry in ways that do not help the public. Relying on the judgment of unnamed experts on the drug industry, he concludes that the industry's greatest enemy is itself, not regulation. But, put the word "greatest" to one side, and there is no either/or there. I made it quite clear in Overdose that the industry blockbuster model has not worked well, and that some of the fault lies in the management of the major companies-a point that Pfizer's Kindler obviously accepts. But one cause does not operate to the exclusion of all others, and Relman must be blind to think that the endless efforts to undermine patent protection, to increase the length of clinical trials, to impose price controls, to allow for multi-billion dollar consumer refunds and tort actions has no impact on the day-to-day operations of any pharmaceutical firm, and its long-term prospects. Any change in costs can produce negative results, and it is just unsupported allegation to say that the drug companies have a deep obsession with "financial ambitions and marketing considerations," so-his italics-"that is the root of their current problems." His argument might have some tenuous credibility if deemed to explain why some firms succeed and others do not. But if there is an industry-wide risk of stagnation, it is just wrong to assume that the management of every firm falls prey to these biases. The more plausible diagnosis for a systemwide failure is the systemwide effects of expanded regulation and liability.

Competition and Monopoly. Relman will have none of this equivocation. So that is where I come in, as an industry "apologist" who can put his lawyerly skills to defend the indefensible, which in this case is acting as handmaiden for the industry's monopolistic ambitions while preaching the virtues of free competition. He notes my consulting connections, fully disclosed, to the pharmaceutical industry, and then attacks my general view on health care, as developed in Mortal Peril: Our Inalienable Right to Health Care?, which is deeply opposed to universal health care. Oddly enough, Relman thinks that it is some kind of indictment of my position to say that excessive health expenditures through Medicare and Medicaid "has had negative, although unintended, consequences." But rather than explaining why I am wrong to his committed New Republic audience he just makes the comfortable leap: the man who cannot be trusted on health care is the man who cannot trust on pharmaceutical issues either. The nub of his argument: "prescription drugs are different from most other commercial products-so different that they warrant government regulation of their development, their manufacture, and their sale." At no point does he stop to ask where the libertarian position might call for regulation, which would surely include cases where impure drugs are sold as real, or where drugs are misrepresented as to their uses or side effects. By implication he confuses the libertarian position of small government and free competition with the anarchist position of no government at all.

Nor does he see any reason to do so because he takes the view that I will abandon my principles at the drop of the hat by arguing "for stronger government support of the industry's monopoly rights and for government protection against price competition from abroad. He wants handouts from the public without public oversight." Here, Relman has lost his intellectual compass. On the first point, "industry monopoly rights" refer to patents, which grant exclusive rights to sell particular products to individual inventors. By putting the proposition in this inflammatory way he makes it appear that I wish to block new entry by other firms to compete with firms that have already received patents on drugs already in the marketplace. In fact, in Overdose I am at pains to attack large claims that would give any firm a patent over entire areas of treatment, including my extensive defense of the judicial decision University of Rochester v. G. D. Searle & Co. 358 F.3d 916 (Fed. Cir. 2004) (a case on which I briefly worked for Searle), which refused to allow the University of Rochester to obtain a patent over all drugs that relied on any Cox-II method of inhibition. The patent system, rightly used, gives people exclusive control over their own products, which is a monopoly of sorts. But so long as there are multiple substitutes subject to different patents, then no firm in the industry exercises monopoly power. There can be, and with sound policies, should be effective competition among holders of different patents of drugs that are in the same class.

Relman's statement about "government protection from price competition from abroad" also reflects either economic ignorance or conscious deceit. The last thing that I favor is allowing any firm to induce the government to place tariff or tax barriers to entry on products from overseas. But the programs to which he refers are not efforts by pharmaceutical companies to block competition by other firms hawking their own products. Rather it has to do with the issue of parallel importation, where goods from the United States are sold to, say, Canadian firms at prices dictated by the Canadian government for internal Canadian use, with the knowledge that they will be reimported into the United States for sale at lower prices than those available domestically.

For Relman, who knows nothing about the fine print of this initiative, to call this program "free trade" is a bad joke. The defenders of parallel importation make it clear that American firms should be under a statutory duty to sell as much of any good as any buyer wants to buy at a price that is determined by the state monopolist (more precisely, monopsonist) on pain of losing their privileges to sell in the United States. Then once these goods are sold, the research pharmaceutical firms are barred from asserting their patent rights against a rival firm that wants to sell the products that it has commandeered courtesy of the United States Congress. This looks more like involuntary servitude than free trade. But then again perhaps Relman is in favor of those provisions that hold that doctors, as a condition for being able to work in the voluntary market, have to devote as much of their time to government service for the poor as the state asks, for fees that it determines.

Later on in his essay, Relman again then criticizes the industry for the "extraordinary steps that a Republican-controlled Congress took to ensure that Medicare would not be permitted to influence market prices by directly purchasing prescription drugs for beneficiaries who enroll in Part D under the so-called Medicare Modernization Act of 2003." I did not discuss this issue in the book, but it is worth noting why Relman is in such error on the point, for which the work of the Manhattan Institute's Ben Zycher is so instructive. See his The Human Cost of Federal Price Negotiations: The Medicare Prescription Drug Benefit and Pharmaceutical Innovation, Medical Progress Report, No. 3, November 2006. The first point here is that letting the government into the market on the buy-side does not advance competition, but creates a huge monopsony position capable of forcing down drug prices, which of course the industry does not like. But on this point its position and the public interest correspond. Just as monopolies set prices too high, so monopsonies set them too low. The huge fraction of the market under Medicare will lower rates of return that will reduce the funds available for funding new drugs, which will impair innovation, just as Overdose claims, and Zycher documents. No matter whether one looks at reduction in funds for research ($10 billion per annum), or new medicines delayed (107 to 220, depending on assumptions), the result is the same. In Relman's world regulation is a free good. In the world we live in, it is not.

Nor should we think that the only adverse consequences of government control lie in the future. It is worth noting that even before Relman wrote the Democratic effort to insert the government into the purchasing process started to falter. It is not that the current plan participants were worried all that much about the future. They were worried about the present. The Veteran's Administration is treated as the ideal for Medicare Part D, for its ability to control costs. But how? By limiting choice. Yet many people will prefer to pay more to get more, and the insertion of government into the purchasing process promises to bring in its wake the same restrictions on formulary that are found, say, in England and Japan, which delay the use of new drugs until it is too late for some people. There are, in a word, all sorts of principled reasons to be opposed to any expansion of the government role on the buy-side of the market.

The Cost of New Drugs. Relman then continues his critique of the industry by noting that I am wrong to make too much of the high costs and risky investments needed to bring pharmaceutical products to market. His first point is that the exact cost is a "mystery" because the company data is not public, even though it was given to a team of researchers led by Joseph DiMasi, director of economic analysis at the Tufts Center for the Study of Drug Development, in forming an estimate of the costs of drug development. See Joseph A. DiMasi et al., The Price of Innovation: New Estimates of Drug Development Costs, 22 J. Health Econ. 151-85 (2003) (available here). But this is not an insuperable obstacle. There are certainly crude measures that are publicly available that point to the high, and ever higher, cost of new drug innovation. If research budgets total around $35 billion for the industry, and we produce about that number of new products, then we have something of a rough first approximation of a billion dollars, which can to be corrected to take into account other factors. But don't count on Relman to make the right adjustments. He first notes the standard figure of $800 million, developed by DiMasi's team several years ago doubled today, only to comment: "Yet both these figures include the so-called time-cost of the money spent, a theoretical and much-disputed quantity that contributed about half of the $800 million figure." So now we have it: the "so-called" cost of capital is not a cost of production because, at least to one untutored physician, a dollar spent today is precisely offset by a dollar earned eleven years from now.

There is still the nasty question of how to recoup these costs, which present a difficult problem in any high-fixed, low-marginal cost business. Relman notes that I assert that high prices are needed "to recoup the high cost of their initial R&D, but that implication is denied by at least some of the leaders in the industry," but notes thereafter that Raymond Gilmartin, past Merck CEO, has "publicly stated that it was the 'value' of the drug to the patient that was the prime determination of price, not what it cost to bring the drug to market."

Relman's brief foray into pharmaceutical pricing reflects his total ignorance of the subject. As I explained in Overdose, high-fixed, low-marginal cost products present special challenges in market settings, because there is little tendency of the price of drugs to fall to the marginal cost of their production, which is all that Gilmartin wanted to say. The argument here depends on a variety of second-best considerations. So long as a company could recoup all its costs and normal profits in the first patented pill produced, marginal-cost pricing would be a great boon for all consumers that purchased the second to nth pills. After all, it is only that first pill that costs $800 million. But there's the rub: Who pays for that first pill? Clearly, no one consumer can cover its full marginal cost, so that if the company is to make back its costs plus a reasonable profit, it has to charge users two through ten million some figure above the marginal cost to make back something of what it lost on that first pill. But how much, and to whom?

Here is where the rubber hits the road. There is no unique algorithm which explains how much gets charged to any customer. The "value" issue arises because you cannot charge anyone more for a drug than it is worth to them, or indeed more than they can afford to pay, taking insurance into account. What makes matters more complicated is that every buyer understands the situation and hopes to negotiate a deal that allows it to pay as little above marginal cost as possible. This leads to price discrimination in these markets, where some customers who can move elsewhere pay less than those who do not. Relman notes that prices remain high at retail pharmacies, but misses the point when he treats that segment of the market as representative of the whole, when in fact they are not. Retail pharmacists and independent drugstores have to carry all lines. HMOs and other provider groups do not and can play off one supplier against another, leading to lower prices for them. Hence, one has to look at the whole market, to see how it all works. It is in this world wholly incomplete to make his observation that "the listed wholesale price of a prescription drug almost never goes down, no matter how much its sales increase." Listed prices are not where the action is. What you have to know is the number of side deals and rebates and special programs that constitute the full market, about whose structure Relman does not have a clue. And through it all, we do know this much: we should expect in general prices to rise as costs for production rise, because companies will not produce goods when they do not think that cost recovery is attainable over its useful life. The distribution of these increases is hard to predict because of the complex dynamics of market pricing, but connection between costs and prices, however hard to measure, is to this extent real.

Relman of course touches none of these issues. He notes that cancer therapies can run $50,000 per annum, but does not examine either the cost or benefit side for these drugs, or how deregulation might lower prices. He notes that the industry runs high profits, but scoffs at the notion of risk-related return, even in the face of the industry's mediocre performance in the stock market. To him the "the industry" (and never the firm) just "dictates" prices. And what does he propose? In his New Republic review, nothing. But his sympathies, like those of Marcia Angell, lie with a system of price controls that is sure to be a disaster, given the number of products, the shifts in prices, the number of different distribution paths and the like. Maybe Relman doesn't think that pharmaceutical companies should behave like ordinary firms. But he surely gives us no inkling here of what pricing regimes follow from his own enlightened view of the industry.

Advertising. Relman is equally uninformed when it comes to advertising, which in his inimitable authoritarian style he would like to limit or ban. But there are two sides to this story as well. Start with the consumer side. On many conditions, people are undermedicated because they are unaware of the risks they face or the conditions that available drugs can treat. Getting this information out is critical and can save lives. And once a patient gets to a physician, he may well take a different drug for the condition than the one for which he saw the ads. The key point is to get patients into the system, which only advertisement can do.

Next Relman does not appear to believe that advertisements lower average costs because of his excessive reliance on list price as evidence of market prices. But of course they do, for why else would a firm advertise if it could not recoup those costs and then some? The increases in total costs are offset by the increase in volume so that greater penetration takes place in the market. Of course, we have to worry about fraud, and he is not the first to observe that the line between truthful and false advertisement is filled with grey, which is what makes this so difficult a field to regulate even for a libertarian who has to balance the risk of too much against the risk of too little regulation. Relman is oblivious to the need for trade-offs at the margin-here and everywhere else.

Next there is drug promotion to the profession. Here it is quite remarkable the number of institutions-like Penn, Yale or Stanford—that have taken the position that any drug sponsorship of a program is so tainted that it should not be allowed in university medical centers. This position is wholly misguided. The question here is: what is the alternative? Let us assume for the sake of argument that there is some bias in each drug company-sponsored program. Funny, the doctors should know this as well. But there are also benefits. The sponsorships are competitive, and overstatements by one sponsor are inevitably caught by another. Nor are these presentations the only source of information. Doctors can generate their own information sources to supplement and correct what the companies say. Unfortunately, the dominant attitude today is that drug company sponsorship is not a cost to be traded off against other costs, but an evil, to be banned.

And what is put in its place? Well, there is the rub. Troyen Brennan and colleagues (see Brennan et al., Health Industry Practices That Create Conflicts of Interest, 295 JAMA 429 (January 2006)), came up with the dreamy proposal of asking drug companies to contribute money to educational funds that anti-drug company doctors could spend on their own spiel. Talk about aiding and abetting your opponents. As fiduciaries to shareholders, no company would sponsor education on fields in which it does not do research. Their proposal is a total nonstarter. So where will the medical schools and learned societies come up with the money? Don't ask such nettlesome questions, for good intentions cures all practical ills. Just assume that the lesser amounts information gathered from these sources will be more reliable. But don't count on it. Individual physicians do not have reputations the size of drug companies, and many will not speak for free anyhow, at least many times. So the likely upshot of the ban is less information with greater bias, albeit in a different direction. This is not progress, but a dangerous cutting of ties between industry and universities and learned societies that should be fostered, with due care and attention to conflicts of interest. Fruitful partnerships should not be bludgeoned to death on the strength of some idle idealistic assumptions.

Patents. Relman is equally fearless when he takes on the patent issues. He references the interesting work of Adam Jaffe and Josh Lerner, Innovation and Its Discontents (2004), who think that the standards for patents are too lax, and thinks that it supports the charges that Marcia Angell makes in her book (which I have reviewed unfavorably) that too many patents are given for me-too drugs that do not represent real product advances. But Jaffe and Lerner are talking about a different problem. Me-too drugs are not double-click patents. No one doubts that the spate of me-too drugs on the marketplace meet whatever patent standards Jaffe and Lerner would propose; and they surely meet the recent Supreme Court standards of nonobviousness in KSR International v.. Teleflex (2006), which dealt with the positioning of sensors in gas pedals. How could these me-too drugs not be nonobvious extensions of existing molecules when the FDA requires that they go through separate testing. Two molecules may look similar but their behaviors could be quite different, so the hard matter never concerns patentability, which is a given, but regulatory approval.

On this point, Relman and Angell are the defenders of the single worst idea of regulatory policy to come along in a long time. Recall that Relman thought that I was too soft on monopolies. So their new suggestion is that the FDA ratchet up its standard so that a new drug should be let into the market only if it outperforms the existing drug. The problems with this proposal are legion. Most obviously, separate companies work on parallel tracks so that the FDA approval of the first now freezes out all the others: talk about the monopolist's best friends, Relman and Arnold? And think about the effect on research expenditures. There are fewer winners in this world, but the lucky winners get much more in the new winner-take-all game, so there will be redoubled research efforts to patent early just to preclude others, and for what? To make sure that consumers pay higher prices, which will happen if there is only a single seller in the market, with its own super high initial cost. Or maybe it is to deny options that arise for patients that do better on one therapy than other? Relman and Angell's repeated defense of their position remains a mystery. Ruinous and foolish, from a social point of view, are apt words to describe so misguided a social policy.

Safety and health issues. Even though Relman makes an utter hash of the economic issues, one might think that he would do a bit better in talking about the health and safety issues, which are more up his alley. But again he misfires on all cylinders.

In dealing with this issue, it is useful to break the topic down into three different questions. The first of these deals with purity and contamination. The second deals with drug safety, i.e., whether the product when properly formulated has adverse side effects that outweigh the benefits of its use, and the third topic is effectiveness: even if a particular drug does not kill, will it at least help?

In my view, the most important of these by far is the contamination and purity issue, which was the exclusive target of the original Pure Food Drug and Cosmetic Act. We now have a clear set of reminders as to why that is so, as we think about the contaminated products that have come in from China, which at great public expense have to be confiscated and destroyed. It is only because of the relative success in dealing with this issue that we tend to forget its dominant importance.

The issue has, regrettably, resurfaced with drugs. The reports of world wide drug counterfeiting with disastrous results are too numerous to count. And yet what is Relman's reaction to one portion of the problem? Simple denial. More concretely, one set of objections to the parallel importation scheme from Canada and elsewhere is that there are real health risks that have to be watched. There is no question that the history of protectionism in the United States and elsewhere is replete with cases where disappointed competitors raise deliberate health scares to keep out superior products with lower price tags. But this is not one of them. Relman, however, dismisses the matter with a wave of the hand, calling the entire concern "spurious," without ever bothering to say why. He does not explain why the huge return from selling bogus goods gives no incentive for unscrupulous people to break into a porous system. He does not explain why long supply lines through foreign territory increase the opportunities to distribute counterfeit drugs into the market. He has no explanation as to why private companies spend small fortunes to label and track goods in an effort to thwart counterfeiting. He gives no explanation as to why every FDA official who has looked at this issue, in both Democratic and Republican administrations, will not give their blessing to parallel importation or why Congress, after its usual bluster, always backs down on the issue. Perhaps he will buy these drugs, but not I, at least if I can figure out which ones they are.

The real front on this issue, however, deals with the role of the FDA as a good government agency that is designed to deal with the safety and efficacy of new drugs. Relman starts by charging me with the "incredible assertion" that pharmaceutical goods are "ordinary products." His refutation: we have the full system of regulation that is now in place to deal with them. Clinical trials, prescription requirements and lots more. And so he is right descriptively. Drugs are not treated as an ordinary good, but neither are lots of things, from wheat, which is subject to all sorts of odd subsidies, to rental units in New York City, to gasoline, telephone lines, to land. And lo, for each, when special restrictions are imposed, rational actors' antisocial behavior in response to such imposed incentives occurs. Medical care is not immune to these dangers. No one over sixty-five will admit to the overconsumption of medical care, but when three-fourths the cost of Medicare comes out of public funds contributed by others, the overconsumption should be taken as a given, as a cost to be taken into account along with the real and supposed benefits of the program.

In response it could, and should, be said that health care raises real problems with information, but so do lots of other goods, including complex financial services and retirement plans, computer programs and the like. There are differences in all these goods, but one mistake that Relman makes is to think that only former editors of the New England Journal of Medicine understand just how difficult it is for ordinary people to understand medical services. But again, that problem is not unique to health care, but arises in other markets as well, like real estate and life insurance. And so in some instances people hire brokers, and in others they hire doctors. It is one thing not to know much about drugs, but it is far more dangerous not to know that you do not know anything about drugs. The point here is that knowledge of deficiency is sufficient to get one to hire professional help, which is an ordinary response in some but not all sorts of markets. There are of course lots of ways to compensate for information deficits without giving the FDA the power to regulate which drugs get on the market and, increasingly, what kinds of warnings they provide.

Relman is dismissive of any critique of FDA policy, in large measure because of the touching faith that he places in clinical trials. "Does Epstein really not understand that properly designed and conducted clinical trials are now universally accepted as the most reliable means of determining the effectiveness of a drug?" Or elsewhere that "clinical trials . . . changed the basis for the use of drugs from something akin to hearsay and witchcraft to something much closer to science." Well, yes I do understand his point, but at the same time wish to place it in perspective. The first rejoinder; "reliable" does not mean "quickest". And for people who do not have the luxury to wait years until a well run clinical trial is done, the rational thing to do is to make the best guess of future treatment on the strength of information that is available to them here and now. And for these people the fetish over clinical trials is a death sentence. In the usual case, as rational agents guided by rational physicians, they will typically try those treatments that do meet the heightened standards of clinical trials. But when those options fail, and the choice is high risk or certain death, people are willing to roll the dice because they have a higher expected utility taking the chance than they have by sitting passively by waiting to die.

The point here is not some nasty pharmaceutical propaganda. Indeed the most vocal attackers against clinical trials, without exception, are not pharmaceutical companies (who fear the liability implications of allowing people to use their drugs), but the ordinary patient who knows how to make the simple expected utility calculations that elude Relman and, more importantly, the FDA. No where in his review did Relman mention the efforts of Abigail Alliance-that's Abigail as in Abigail Borroughs, whose family sought vainly to get her access to Eribtux or Iressa, not on the advice of Richard Epstein, but on the advice of her own Johns Hopkins oncologist. See http://abigail-alliance.org/story.htm. There are no pharmaceutical companies on its board of directors- just ordinary people who wonder why the FDA stands in the path of their last best hope because it knows that clinical trials are the most reliable form of information. And then there is the litigation, as Abigail Alliance tried and failed to assert a constitutional right to obtain treatment of any drug that has made it through Phase I clinical trials, so that its toxicity was within measurable levels. See Abigail Alliance v. von Eschenbach, 2007 U.S. App., Lexis 18688. Perhaps that exotic argument should have lost, but if so it was before a judiciary that takes far too sanguine a view of the Congress and the FDA to protect us from serious danger. Whether correct as a matter of constitutional law or not, the impulse for the attacks on the FDA come from the people who want to take the drugs. And Arnold Relman knows so much about medicine that he is prepared to turn them away at the gate. What a way to put people before profits. For shame!

The beat does not stop there. Relman does not mention at all the pressing issue of off-label uses, because again it does not fit in with the tidy story that makes clinical trials the indispensable gold standard of American medicine. But there is in the United States a peculiar bifurcation of authority over the practice of medicine. The FDA may be able to keep a drug off the market, but it cannot regulate the practice of medicine. So once the drug is out there, then physicians can use it not only for its stated implications but also for off-label uses. And they do. Sandra Johnson (See Polluting Medical Judgment? False Assumptions in the Pursuit of False Claims Relating to Off-Label Prescribing, Marketing and Research, Minn. J. L. Science & Technology (forthcoming)) has put together figures that suggest that for many oncogenic drugs, the off-label uses dominate the permitted uses by large margins.

Consider the drug thalidomide, devastating when taken in early pregnancy, but is now sold as the renamed Thalomid. In the earlier version of this article, I had written that Thalomid "is licensed for use in treating leprosy. But its booming sales are a function of its success in cancer treatment." The fuller and more accurate story has turns out to be more instructive than my earlier cryptic reference. Thalomid was originally licensed by the FDA for use in treatment of leprosy in July, 1998. In May, 2006 it received approval from the FDA for the treatment of multiple myeloma, after accelerated clinical trials which were, as is wholly proper, directed to determining the adverse side effects of the drug when put to its intended use in combination dexamethasone (Dex), where the both gains and the adverse side effects were higher with the combined treatment than with Dex alone. The FDA approval (see www.fda.gov/cder/Offices/OODP/whatsnew/thalidomide.htm) took place on an accelerated basis, based in part on a randomized clinical trial of 207 patients recently diagnosed with multiple myeloma. The approval requires additional clinical trials to demonstrate the clinical benefit of the drug. Since the distribution of Thalomid is tightly controlled, the off-label use of the drug today is likely to be smaller than with other drugs.

Here are some troublesome questions about this history. First, what was the frequency of Thalomid use for multiple myeloma in the 1998 to 2006 period? Second, how many deaths could have been averted if the drug could have been used on an interim basis for all cases of multiple myeloma for which it is indicated? Third, how was the information accumulated that made it attractive to run the clinical trial on this drug, as opposed to the many others where it has not taken place? Fourth, to what extent does the accelerated treatment meet the standards that Relman would require before letting dangerous drugs on the market? And fifth, does it tell us anything about the current get-tough policy on various cancer treatments that are used typically in last-ditch circumstances? Interestingly, there is a voluntary organization, the National Comprehensive Cancer Network (www.nccn.org) , composed of 21 leading cancer research institutes. The key question is whether this network is better able through conversation and suasion to deal with these new therapies than the FDA? And if it is, is its work hampered by the grey market status of off-label uses? Taken as a whole, there is nothing in this somewhat unusual success story That strengthens Relman's case for a strong FDA control over the use of drugs for the treatment of deadly cancers.

Thalomid is of course only one of many potent cancer drugs, and its own history seems to account for the exceptionally tight controls that are placed on its distribution. But the general picture seems to be that many anticancer drugs do not have clinical trials to back them up, but none of Dr. Relman's peers will sit by to watch patients die if they think that the drugs could shorten the odds. It would be nice to collect data on the effectiveness of these uses, but the FDA will not allow drug companies to promote off-label uses, or to warn about their side effects, so that one obvious avenue of information collection is blocked. But even if it did, time still is of the essence, and there is little if any systematic evidence that suggests that physicians who take a drug licensed for breast cancer do their patients a disservice if they try using it on otherwise incurable colo-rectal cancer. There is a bit of theory that suggests the tumors may respond the same, an anecdote here or there which says that it might have worked, and the utter absence of anything better. Would Relman want to shut down this entire mode of doing business because there are lots of doctors out there who don't know the meaning of a "gold standard"?

Perhaps not. Perhaps we should have clinical trials for those additional uses. A nice idea, but with strings attached. Those trials take time. The company that has the patent on the drug will not spend millions to get it approved for a new indication just before it turns generic. Patients will not wait for a clinical trial that will take years to deal with an illness that leaves them with an expected life of six months. Who is kidding whom with respect to gold standards?

And last, much science, including medical science, does not take place with gold standards anyhow. Surgery is a business that is done in decentralized fashion without the blessed oversight of the FDA. The progress in its many fields is palpable. Hip surgery forty years ago left foot-long scars and required extended hospitalizations and exhaustive physical therapy. But it was better than a wheelchair. Now there is minimally invasive surgery that can have a patient in at dawn and out on crutches at dusk. Yet, last I looked, no FDA-clone that guided this progress. It was the same decentralized system of knowledge acquisition that has worked so well everywhere else, and which could work again with drugs if we dropped the fixation with clinical trials.

Does this mean that I think that these trials are useless? Of course not. But there are clinical trials and clinical trials. Relman only glorifies the practice, and he makes the odd assertion that things have gotten better because of the more rapid deployment of drugs since the passage of PDUFA (for Prescription Drug User Fee Act) in 1993, which did use drug company user fees to speed the process along. Relman says optimistically that "for many drugs" the FDA requires "only one or two good clinical trials." But PDUFA is only part of the story, and the shortened periods of patent lives make it clear that the path to drugs has become longer, even with PDUFA in place.

A most instructive study, dating from November 2003, makes the point. See Jim Gilbert et al., Rebuilding Big Pharma's Business Model, 21 Business Med. Rpt. (available here). From 1995 to 2000, the authors estimate total costs of bringing a new drug to market at around $1.18 billion dollars, of which about $550 million were spent in the discovery phase, and about the same amount in clinical trials. Move on to 2000-2002, and the total figure by their estimates runs to $1.78 billion. The discovery phase costs moved up slightly but the huge expansion in costs comes in clinical trials, distributed over all phases, which now run about $1 billion, give or take. The expedited procedures of which Relman speaks lie only in his imagination.

The recent trends are no better. Richard Miller, for example, in a recent Wall Street Journal op-ed "Cancer Regression," (August 1, 2001), lamented how the FDA has backtracked on its fast track programs for cancer drugs. Perhaps Dr. Relman thinks that the rejection of five new cancer treatments by the FDA is a sign of speedy progress. But the deluge of angry letters to the FDA when it refused to follow the positive recommendations on the promising new vaccine for advanced prostate cancer, Provenge, for example, was mounted by patients who saw in it the only refuge from advanced prostate cancer. Yet at no point does Relman address any of the mountain of evidence against him. Nor does he turn his scientific eye to each new FDA protocol that requires additional trials on smaller populations, starting from the premise that expedited FDA approval is solely a source of agency embarrassment. There is a lot that can and should be done to rationalize clinical trials, even if the FDA were kept in place. And there is a lot that accurate review of post-marketing data can do on extended populations to pick up safety risks that matter.

Indeed, one important use of good clinical trials is to throw out of court the various law suits in tort litigation, but you would not know this from Relman's screed, because he does not mention a single word about tort litigation, even though he well understands the risk that medical malpractice litigation poses to medical progress. It would have been nice for him to say that the lawsuits against Bendectin did no earthly good, even if they made it next to impossible for any firm to market ever again an antinausea drug for treatment in early pregnancy. And the same perverse saga is taking place right now with thimerosal, with its asserted but dubious connection to autism. On these cases the FDA has done the retrospective studies that have confirmed the safety of the drug or preservative. Legally, the FDA has taken the position that its licensing procedures should block any attack on FDA-approved drugs. The legal arguments are tough on both sides, but in the midst of his attack on my position, why doesn't Relman at least defend the FDA against the use of junk science by (some) plaintiffs' lawyers? Perhaps he believes that the agency is in the pocket of the drug companies, when the greater pressures come from an irate Congress and vehement critics like himself who constantly harp that the FDA offers too little "protection," and not too much.

Well, then, what about the use of warnings as a substitute for bans? Such an approach is an improvement because the FDA cannot have a monopoly over warnings, which anyone can issue, and which are found in great abundance in the Physician's Desk Reference and other services. But don't think that warnings are harmless either. There has been a long question of whether Prozac causes or prevents teen suicide. Over the objection of most psychiatrists who prescribe the drug, the FDA put a black box warning on it, which accomplishes three things. First it frightens-an official warning, you know-patients and physicians off the drug. Second it makes it easier to win a malpractice suit against a prescribing physician for any subsequent adverse outcome. And third it increases the number of suicides because of the lower rates of drug use in the at-risk teen age population. Just what the doctor ordered.

CONCLUSION. There is a common theme to all the points contained in Relman's ill-tempered broadside. Relman's belief about the operation of pharmaceutical markets was the attitude that my grandmother took to flea markets. If the other guy wants to sell at a given price, don't buy, because he is there to rip you off. Today, Relman's view is that if the company makes a profit, then we have to be suspicious about its motive and its performance. He utterly fails to grasp that most markets in ordinary goods-pharmaceuticals included-survive because they generate win/win transactions, just as Smith and Friedman said. His third party interventionism acts as a tax or a ban on the transactions, and thus creates smaller wins or real losses. Then again, anyone who thinks that Milton Friedman was talking through his hat when he spoke about the efficiency of markets will take a jaundiced view of private profits and public health, thinking that the will mix no better than oil and water. I can't comment on his medical skills, but as a professor of social medicine, even at Harvard, it would help if Dr. Relman took, for the first time, Economics 101.
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Richard Epstein is the James Parker Hall Distinguished Service Professor of Law at The University of Chicago and the Peter and Kirsten Bedford Senior Fellow at The Hoover Institution.

By Ramesh Ponnuru

Ramesh Ponnuru and the National Review have graciously allowed us to reprint his article "Social Injustice," which discusses the inroads trial lawyers are making with the political right, through socially conservative populists among their midst. We've also been allowed to attach an exchange in the letters-to-the-editor section of the magazine, in response to the column (download PDF).


The website for the Center for a Just Society, a new social-conservative group in Washington, has a lot of the items you would expect to see: denunciations of embryonic-stem-cell research; calls for an end to the filibustering of Bush's judicial nominees. The quality of the writing at ajustsociety.org is a cut above what you would find from most social-conservative organizations, and the range of issues is slightly wider. The Center attempts to bring "Judeo-Christian perspectives" to bear on topics that social conservatives have traditionally ignored. Thus it makes a moral case for Social Security reform. What most sets the Center's website apart from the sites of other conservative organizations, however, is what it has to say about tort reform. Or, rather, "tort 'reform.'"

In one of the statements on its website, the Center writes: "[T]here is a widespread effort underway to take away our right to a trial by jury. Those pushing this wrong-headed agenda claim that it will reduce the costs of healthcare and eliminate 'frivolous lawsuits.' . . . [T]ruth be told, the agenda behind the agenda [emphasis in original] has less to do with lowering the cost of healthcare and eliminating frivolous suits and more to do with immunizing wrongdoers from the consequences of their behavior."

This perspective reflects the views of the Center's chairman, Ken Connor. He is best known as a social-conservative leader. He was president of the Family Research Council, and he represented Florida governor Jeb Bush in the Terri Schiavo case. (The Center was in the thick of the Schiavo fight as soon as it set up shop, back in March.) But he has also had a long career as a trial lawyer suing nursing homes for what he calls "elder abuse."

The Center is in its infancy. It does not even have an office yet. Its advocacy of tort reform has not received much attention. The most impact it has had came when Focus on the Family, James Dobson's much larger and more influential conservative organization, publicized its description of the Republicans' medical-liability reform bill as an attack on the sanctity of life. But the Center may represent an emerging trend. There are some signs that social conservatives and the trial bar may be making common cause—which means that on litigation reform, the social and economic Right may be headed for a split. Whether that split occurs will depend on whether the social Right can see through the misleading slogans of the trial bar.

ALLIANCES IN FLUX

In the weeks between Justice Sandra Day O'Connor's announcement that she will retire from the Supreme Court and President Bush's nomination of John Roberts to replace her, there were reports of tensions between Bush's social-conservative and business supporters. Social conservatives didn't want a new justice in O'Connor's mold. They were fond of originalist jurists such as federal appeals-court judge Michael Luttig. Business lobbies worried, however, that Luttig was less likely than O'Connor to impose limits on punitive damages in lawsuits against corporations.

Harry Reid, the leader of the Senate Democrats, seemed to pick up on this tension. He said that several Republican senators would make fine replacements for O'Connor: Mike Crapo of Idaho, Mike DeWine of Ohio, Lindsey Graham of South Carolina, and Mel Martinez of Florida. His list omitted two Republican senators who had more frequently been mentioned as possible nominees to the Court: Jon Kyl of Arizona and John Cornyn of Texas. When asked about the omission of Cornyn, Reid said that he had already listed his picks. All six of the senators have socially conservative voting records. Walter Olson, the author of several of the most important books making the case for tort reform, spotted the distinction among them: Kyl and Cornyn have taken the lead on tort reform, while the other four have often voted with the plaintiffs' bar against most of their Republican colleagues. Crapo, Graham, and Martinez are, indeed, former trial lawyers.

In the end, however, Bush ignored Reid's advice. By choosing Roberts, he was able to mollify both business and social conservatives. Neither constituency knows that he will vote with it, but each has some reason to think that he might. The conservative coalition did not split.

At least, it hasn't yet. But that list of senators who used to be trial lawyers suggests one of the reasons that tensions will persist: There are socially conservative trial lawyers. The profession abounds with politically talented, rich, and influential people. While conservatives have not tended to regard the courts as instruments of social change—as much of the tort bar reflexively does—there are bound to be some outliers. With the Republicans in charge of Washington and threatening the livelihoods of trial lawyers, it stands to reason that the latter would, as the lobbyists say, "reach out" to the Republican party. Connor recently spoke at a convention of the Association of Trial Lawyers of America urging the group to do just that. He says he was received "extraordinarily well."

Connor argues that while some Republicans—the "bluebloods" at the "apex" of the party—have an economic interest in fighting trial lawyers, the "blue collars" at the "base" of the party are against trial lawyers only because the trial lawyers have allied themselves with the Democrats. If the trial lawyers end that alliance, he thinks, common ground could be found.

THE MORALITY OF LAWSUITS

Connor's organization argues that the tort system is valuable because it holds corporate wrongdoers accountable. It thus affirms the value of responsibility and, when injuries or fatalities result from corporate misconduct, the sanctity of human life. In certain respects, this claim is obviously true. But tort reformers are not composed exclusively of corporate wrongdoers, their flacks, and their dupes. As Olson puts it, "Much of the popular success of the litigation-reform side has come precisely from people's feelings that the outcomes of litigation don't track our moral sentiments very closely, and seem to track them less well over time."

Take nursing-home litigation. Until 2001, Connor's native Florida had a "resident's rights" law that allowed plaintiffs to recover damages from nursing homes without proving negligence. Nursing homes were often sued over bedsores—even though they are hard to avoid for invalid patients. Ted Frank, who runs the American Enterprise Institute's Liability Project, points out that "Christopher Reeve, who had the finest medical care money can buy, died from a bedsore infection." And the nursing homes faced a Catch-22: They were not allowed to restrain patients who suffered from dementia, but were liable if those patients hurt themselves in a fall. Frank concedes that some lawsuits involved "really substandard care," but says that too many attempted to "hold companies responsible for things they had nothing to do with."

The law forced many nursing-home companies into bankruptcy, causing a shortage. By 1998, one out of every four Medicaid dollars spent on nursing homes in the state was going to pay liability costs. Connor's partner, Jim Wilkes, the lead attorney on most of Connor's nursing-home cases, spent more than a million dollars trying to block limits on liability. The Florida chapter of AARP actually supported the 2001 reform, perhaps swayed by the thought that elderly Floridians needed nursing homes more than the trial lawyers needed the money.

Or take asbestos litigation, which has done more to reward wrongdoing than to punish it. Asbestos claims have soared in recent years even as the incidence of asbestos-related diseases has declined. Lester Brickman, a professor at the Cardozo School of Law, credibly alleges that the explanation is that 80 to 90 percent of recent claims are fraudulent. Lawyers have coached witnesses to make false testimony and get false diagnoses, and then sued companies that played the most minor of roles in the asbestos industry. Not all trial lawyers are, of course, guilty of these tactics. Many trial lawyers, especially those who represent clients whom asbestos actually made ill, are appalled by the false claims. But it is hard to avoid the conclusion that the system has strayed rather far from holding wrongdoers accountable.

The Center for a Just Society is certainly right to say that not everything that travels under the name of tort reform deserves support. It argues, correctly, that federal tort reform can trample on state prerogatives. If a state has lawsuit laws that lead doctors to leave it, it ought to be the responsibility of the state's voters and politicians to change those laws. On the other hand, frivolous product-liability lawsuits can't be avoided by skipping the border. No state can shield a drugmaker or medical-device manufacturer located in its jurisdiction from abusive lawsuits filed in other states. In such cases, it's up to the federal government to protect interstate commerce by restraining the states. The Republicans' medical-liability bill should be amended so that it touches only interstate commerce. But the trial lawyers, and the Center, oppose the whole thing.

LIFE AND LITIGATION

The Center opposes the bill on the theory that it is "pro-abortion" because it provides immunity to the makers of RU-486 (the "abortion cocktail"), and prescribing doctors, from lawsuits by the families of women who die as a result of the drug. But this immunity is partial. What the bill says is that if a product or treatment complies with federal regulations, the people who made the product or supervised the treatment can't be sued for punitive damages if something goes wrong. They can be sued for compensatory damages, including damages for causing pain and suffering. But if they're compliant with FDA regulations, for example, the courts shouldn't punish them. The makers of RU-486 already enjoy some legal immunities thanks to Bill Clinton. But even if they didn't, the Center's argument would be faulty. Just as conservatives would not favor raising corporate-tax rates in order to drive companies involved in abortion out of business, they should not oppose efforts to improve the legal environment for corporations because they might help companies involved in abortion.

John Edwards illustrates the bankruptcy of the "pro-life" case for pro-plaintiff medical-malpractice laws. Suing obstetricians for causing cerebral palsy by failing to do C-sections was one of his most profitable lines of litigation. He has boasted about how he swayed jurors by assuming the voice of an unborn child pleading for help. But the evidence strongly suggests that cerebral palsy is usually genetic in origin, and almost never the result of a botched delivery. (One piece of evidence: C-sections have grown more common over the last few decades, while the incidence of cerebral palsy has stayed the same.) Lawsuits, and the resulting malpractice-insurance premiums, have driven obstetricians away from some areas.

In a forthcoming paper for the Journal of Legal Studies, law professor Jonathan Klick and economist Thomas Stratmann provide reasons to believe that such lawsuits result in infant deaths. Specifically, they find that caps on punitive damages in medical-malpractice lawsuits bring infant-mortality rates down. More doctors practice in states that adopt them. The health benefits flow primarily to black infants in rural areas. Klick thinks that federal legislation might have a positive effect on infant mortality, too (although he is careful to note that he does not endorse the legislation). The study undermines the claim that medical-malpractice reform is anti-life.

When John Kerry picked Edwards as his running mate and Republicans attacked the latter for being a trial lawyer, Connor rushed to his defense. But if Connor is concerned about the bad name trial lawyers have in some circles, perhaps he should have blamed lawyers such as Edwards rather than their critics. Connor says, "Trial lawyers should be viewed as stewards of the civil justice system." They will not be viewed that way, however, if a sizable number of them are not acting as such.

The right to a jury trial, meanwhile, isn't nearly as threatened as the Center—and the tort bar—would have you believe. There are, it is true, some proposals floating around to handle medical-malpractice cases through the kind of administrative compensation schemes that long ago took over workers' compensation. But legislated caps on damages aren't an affront to the jury system, any more than are statutes blocking juries in criminal trials from imposing life sentences for shoplifting (to borrow a comparison from Olson). The historical value of the jury was as a brake on the power of the courts. Their role has not been to enable the courts to take actions that the legislature refuses to authorize.

The issues involved in tort reform are complicated, and people can disagree about them in good faith. The Center for a Just Society might well lead social conservatives to make a contribution to this debate (among others). Connor says that the Center will come out for making the losing party pay for civil litigation—a potentially far-reaching reform. If the Center does that, it will be hard for anyone to argue that it is merely a front for the trial lawyers.

But social conservatives ought to keep in mind that the current system features, and even encourages, all kinds of squalid behavior. Lawsuits are filed as fishing expeditions. Firms that have not done anything wrong are targeted because of their deep pockets. Simple fraud is more than occasionally perpetrated through the courts. All of these are forms of bearing false witness. And "Judeo-Christian perspectives" on that have not been positive.

By Richard Epstein

CHICAGO—The most memorable observation in Errol Morris's film, "The Thin Blue Line," runs like this: "It takes a good Texas prosecutor to convict the guilty . . . and a great Texas prosecutor to convict the innocent." Today, this wry remark applies to plaintiffs lawyers, now that Mark Lanier, down in Angleton, Texas, has drawn blood from Merck for its former blockbuster drug, Vioxx.

Forget the jury's whopping quarter-billion-dollar verdict in Ernst v. Merck, because it's cut 90% by the caps that Texas law places on punitive damages. Still, where do $25 million in actual damages come from? Robert Ernst died in his sleep, without pain and without medical bills. His lost income as a Wal-Mart employee was small. But the $24 million price tag for anguish and loss of companionship to his widow Carol is off the charts. And for what?

Not the death of her husband, whose arteries were 70% clogged and who died, so Dr. Maria Araneta's death certificate states, of arrhythmia, or irregular heart beat. No mention of any heart attack. But in his dramatic eleventh-hour maneuver, Mr. Lanier whisked Dr. Araneta back from the Arabian peninsula to testify conveniently that she really thought that an undetected blood clot had caused the death, but had been dislodged in the last-ditch efforts at resuscitation.

Pretend that this new account is true, and it still doesn't show that Vioxx caused the blood clot. Long before Vioxx, people died of heart failure from all sorts of causes, including physical exertion and dehydration. That second causal link to Vioxx was not made even if the first one to a blood clot is generously presumed. Carol Ernst's lawsuit should be DOA right here, but a clever set of jury instructions allowed the jury to say that Vioxx may have been a contributory cause of death.

By what odds? Merck's clinical trials showed an elevated risk of heart attacks but only in persons that took Vioxx in heavy doses for intestinal polyps for 18 months or more. Ernst took Vioxx only for eight months. In post-trial interviews, the jury members revealed their anger that the company didn't show "respect" for its customers by telling the truth about Vioxx's risks. And they clearly were moved by Mr. Lanier's expert bashing of Merck's medical employee, Dr. Nancy Santanello, who struggled to explain how Merck tried to show the efficacy of the drug in response to criticisms of it.

All this goes to show that physicians under the gun make lousy witnesses, which we already knew. To understand the Angleton verdict, one would think that Vioxx were the moral equivalent of mustard gas. But in truth, we should be grateful to any firm that speeds its product to market when its anticipated use promises many more benefits than adverse side-effects. Merck should not apologize for pushing hard to win quick market acceptance; before Vioxx was withdrawn, countless people with chronic pain were able to get on with their lives. Now these folks are left far worse off because of a double whammy: a Food and Drug Administration that yanks too many drugs off the market because it has no idea how to evaluate risk, and individual jurors who think it is their solemn duty to "send a message" to the drug companies on whose products we so desperately depend.

So, in return, I would like to send my message to Mr. Lanier and those indignant jurors. It's not from an irate tort professor, but from a scared citizen who is steamed that those "good people" have imperiled his own health and that of his family and friends. None of you have ever done a single blessed thing to help relieve anybody's pain and suffering. Just do the math to grasp the harm that you've done.

Right now there are over 4,000 law suits against Merck for Vioxx. If each clocks in at $25 million, then your verdict is that the social harm from Vioxx exceeds $100 billion, before thousands more join in the treasure hunt. Pfizer's Celebrex and Bextra could easily be next. Understand that no future drug will be free of adverse side effects, nor reach market, without the tough calls that Merck had to make with Vioxx. Your implicit verdict is to shut down the entire quest for new medical therapies. Your verdict says you think that the American public is really better off with just hot-water bottles and leftover aspirin tablets.

Ah, you will say, but we're only after Vioxx, and not those good drugs. Sorry, the investment community won't take you at your word. It realizes that any new drug which treats common chronic conditions can generate the same ruinous financial losses as Vioxx, because the flimsy evidence on causation and malice you cobbled together in the Ernst case can be ginned up in any other. Clever lawyers like Mr. Lanier will be able to ambush enough large corporations in small, dusty towns where they will stand the same chance of survival that Custer had at Little Big Horn. Investors can multiply: They won't bet hundreds of millions of dollars in new therapies on the off-chance of being proved wrong. They know they'll go broke if they win 90% of the time.

Your appalling carnage cries out for prompt action. Much as I disapprove of how the FDA does business, we must enact this hard-edged no-nonsense legal rule: no drug that makes it through the FDA gauntlet can be attacked for bad warnings or deficient design. In plain English, Mr. Lanier, you're out of court before you make your opening statement. You've already proved beyond a reasonable doubt that the fancy diagrams that university economists use to explain why the negligence system maximizes social welfare is an academic delusion that clever lawyers use to prop up a broken tort system.

So where does that leave Merck? Perhaps in Chapter 11, where this madness may be brought to a halt.

Mr. Epstein, the James Parker Hall Distinguished Service Professor of Law at the University of Chicago and the Peter and Kirsten Bedford Senior Fellow at the Hoover Institution, has consulted extensively for the pharmaceutical industry. His book on the industry will be published next year by Yale University Press.

Reprinted from The Wall Street Journal � 2005 Dow Jones & Company. All rights reserved.

By James R. Copland

Back in January, I responded to a Bob Herbert New York Times column that attacked President Bush's medical malpractice liability reform plan. Herbert had relied heavily on the "Center for Justice and Democracy" (CJD), a Naderite shill for the trial bar that counts on its board of advisors such luminaries as Michael Moore and Erin Brockovich. (For more on the CJD, see Ted's dissection of their "Zany Immunity Laws Awards" at Overlawyered and my challenge to their misleading statements about the Tillinghast study here.)

Yesterday, the "paper of record" was at it again -- this time on the news page -- trumpeting the results of a new CJD study (PDF) purporting to show "that doctors have been price-gouged for several years as insurance industry profits have ballooned to unprecedented levels." Can this be right? As Ted has argued here, such claims make little economic sense: new entrants would take advantage of the abnormal profit opportunity and enter the medical malpractice market. Instead, though, what we've seen in recent years is medical malpractice insurers losing money and exiting the market. Something doesn't add up.

A look deeper into the numbers shows that, as usual, CJD is "creatively" using statistics to mislead its readers:

(1) The study mismatches cash flows by linking current premiums payments to current claim payments. The Times notes that the study claims that "the increase in premiums collected by the leading 15 medical malpractice insurance companies was 21 times the increase in the claims they paid" from 2000-2004. And indeed, the bulk of the report focuses on the relationship between current premiums and claims. But such year-to-year comparisons make no sense, since the average claim takes about 4.5 years to resolve; indeed, about 12 percent of claims take at least 8 years to resolve. It is thus hardly surprising that premium growth might outstrip current claim growth, substantially, over a short period of time. (The CJD report does give some attention to the relationship between incurred losses and premiums, the only sensible comparison from an accounting perspective. Indeed, the CJD admits that "insurers and regulators typically use the incurred loss ratio as a measure of profitability." Nevertheless, the study argues that "many malpractice insurers have in the past posted incurred loss estimates that ultimately proved to be overstated." While that is the case, such variations are not only inevitable given the inexact science of predicting liability exposure, but loss reserves must be reconciled in the accounting statements each year -- a point that might not be self-evident to those with no background in accounting. Also, it's worth noting that in its discussion of incurred loss ratios, CJD mysteriously (or not so mysteriously, see point 3 below) shows only 2003-2004 dollar total comparisons, otherwise sticking to company-by-company ratios.)

2. The study is seriously skewed by "survivorship bias" effects. The CJD study inevitably generates a disconnect between premiums paid and claims paid (or losses incurred) because it fails to acknowledge and account for the exit from the market of major medical malpractice insurers, which guarantees a skewed result that shows premiums growing much more quickly than they actually are and claims/losses not growing as quickly as they actually are. How so? Well, in 2001, the then-largest medical malpractice insurer, the St. Paul Companies, exited the market. In 2001 alone, St. Paul had collected about $530 million in premiums (and generated an underwriting loss of $940 million--out of over $3 billion in underwriting losses that year for the industry, see here (PDF), p. 13, exh. 3). In 2002, the physician-owned Pennsylvania insurer PHICO went bankrupt; by the end of last year, PHICO still had over $1 billion in claim liabilities. Then, in 2003, The Farmers Insurance Group exited the malpractice market; Farmers had written $231 million in premiums as recently as 2002. The exit of these and other major insurers from the medical malpractice market not only contradicts the basic theme of the CJD study--that insurance companies are scoring unprecedented profits by "gouging" their customers--but the sheer volume of these companies' premiums and claims completely distorts the numbers presented by CJD, whose study includes only the 15 largest surviving companies. Let's see how:

Table 2 on page 7 of the CJD report shows premiums growing from 2001 to 2004 79 percent, an annual growth rate of 21 percent. But wait--CJD only shows the $3 billion in 2001 premiums collected by these 15 companies, and does not account for the $500 million+ collected by St. Paul, not to mention those collected by PHICO and Farmers, among others. Add back in ~$1 billion, and all of a sudden the annual growth rate in premiums from 2001-04 is 10 percent--well above inflation, but completely in line with health care inflation. Moreover, it's important to remember that St. Paul and Farmers are still paying claims, and PHICO has $1 billion in claim liabilities outstanding, so the growth in claims paid presented by CJD, at 2 percent per annum from 2001-04, grossly distorts the real picture.

It is hardly surprising that companies like Lexington (a subsidiary of AIG) and MedPro (a subsidiary of GE Insurance) have had such rapid growth in premiums written in recent years after the exodus of such major players as St. Paul, PHICO, and Farmers; nor is it surprising that claims paid (which, remember, take about 4.5 years to resolve on average) have not yet caught up with that rapid premium growth.

3. The study hand-picks its time frame to generate its results. CJD's study picks as its beginning year 2000. At first glance, such a selection might seem arbitrary and innocuous, but in 2000, the industry generated a record $1.8 billion in underwriting losses, followed up by a $3 billion loss in 2001 (see here (PDF), p. 13, exh. 3). These losses followed naturally from an unanticipated and unprecedented rise in the expected value of med-mal claims: the median jury verdict in med-mal cases rose from $500,000 in 1997 to $712,000 in 1999 to $1 million in 2000, where it has since remained. Thus, CJD's use of ratios (e.g., page 14, Table 3) is inherently skewed. Is 2004's 51% incurred loss ratio out of line with what the med-mal insurance industry saw in the 1990s or before? We don't know, because CJD only begins with the beginnings of the current crisis in 2000.

That CJD's choice of years is not merely arbitrary is also evidenced by its "surplus analysis" (see pages 17-19). Without explanation, Table 5 on page 18 shows insurers' surpluses only for years 2002-04. Why would CJD omit years 2000 and 2001, which it had included in its earlier analysis? Well, because the med-mal insurers lost a ton of money in those years and had to draw down their surpluses, which for the industry topped out at $4 billion in 1999 and then were drawn down some $600 billion by 2002 (see here, slide 11). The increase in surpluses since that time is, therefore, merely a return to normalcy for the industry (plus, probably, a little extra cushion given the recent crisis and heightened concerns about potential future claims). (I also note that CJD's insistence that any surplus over the level deemed "adequate" by NAIC is "excess" and thus somehow unneeded is poppycock, akin to arguing that any bank which holds reserves above the minimum level prescribed by the Federal Reserve is somehow acting improperly. There's nothing wrong with management being risk averse, particularly in light of recent industry insolvencies; remember too that 9 of the 12 monoline insurance companies in CJD's analysis are mutual companies, thus owned by their (doctor) policyholders, not outside shareholders.)

Similarly, CJD's "note about medical malpractice stock performance" (pages 19-20) shows similarly manipulative date selection. It tracks the 3 publicly held monoline med-mal insurers' stock performance from May 17, 2002 through May 17, 2005, as compared to the Dow Jones (see Table 7, page 20). But why 2002? Because, of course, in May 2002 med-mal stocks would understandably be depressed, since the industry had had enormous losses ($4.8 billion) in the two preceding years. Remember that St. Paul had exited the market in December 2001 and PHICO was declared insolvent in February 2002. Let's go back further--to 1999, before the 2000-01 med-mal insurance crisis--and check things out:

Of the 3 monoline public companies CJD examines, only FPIC has had publicly traded stock since 1999. On May 17, 1999, FPIC's stock closed at $45.19, which means that it subsequently declined 34 percent by May 17, 2005. On May 17, 1999, the DJIA closed at 10,853, which means that it subsequently declined 5 percent by May 17, 2005.

When you don't use CJD's hand-picked dates, the situation for med-mal insurers doesn't look so pretty does it? Have med-mal stocks grown a lot since 2002? Of course, but only because regulators have permitted premium increases to cover the increases in expected liability, which were generated by the rapid rise in verdicts in the late 90s through 2000. Again, the change is only natural, and has not yet even returned to the status quo ante.

4. The study ignores all costs insurance companies incur apart from payments to claiments to create the illusion of profitability. Finally, it deserves mentioning that CJD seems to assume that insurance companies' only costs are incurred losses, i.e., payments made to claimants. But insurance companies also have allocated loss adjustment expenses (e.g., their own defense costs, including attorneys' fees and expert witnesses) and underwriting expenses (the administrative cost of writing policies). It's not as if an insurance company with an incurred loss ratio of 50 or 60 percent is making huge profit margins (though we can be sure that when the industry has an incurred loss ratio of 100 percent--as CJD shows that it did in 2001, see Table 3, page 14--it's losing a lot of money). Unfortunately, the costs of insuring tort liability are very high; there's just tons of administrative expense in the system.

In failing to take account for the market exit of some of the industry's largest players, mismatching premiums and losses, hand-picking dates to skew results, and painting a deceptive picture of the insurance industry's profitability, CJD's research is at best shoddy and at worst intentionally misleading. It's somewhat tiresome to rebut these studies, but as long as mainstream media sources pick them up rather uncritically, I think it's a useful exercise. For more information on medical malpractice and the misuse of statistics by the trial bar and its supporters, see my rebuttal to a similar Public Citizen report released a couple of months back.

By Ted Frank

I attended yesterday's AEI forum debating the Texas study of Professors Black, Silver, Hyman, and Sage. Based on their study, the authors made a broad statement in a NY Times op-ed: "The medical malpractice system has many problems, but a crisis in claims, payouts and jury verdicts is not among them. Thus, the federal 'solution' that Mr. Bush proposes is both overbroad and directed at the wrong problem." At AEI, however, Professors Black and Hyman made the following two concessions (which I paraphrase from my notes):

  • Over the long run, malpractice insurance prices reflect claim outcomes.
  • Caps on non-economic damages should reduce insurance rates.

Don't expect ATLA to acknowledge these straightforward economic principles in its above-the-fold front-page link to its press release on the study. But once everyone agrees on this central common ground, then, to paraphrase Rabbi Hillel, that's the whole tamale and the rest is just commentary.

After all, it doesn't appear to be the case that the doctors complaining about a "crisis" are concerned only about the first derivative of claims costs. The claim is also the subjective one that insurance costs are "too high" relative to the benefits of the current system of malpractice liability. One can agree or disagree with that value proposition but, once one acknowledges that insurance premiums are a function of claim costs, and further acknowledges that non-economic damage caps would reduce premiums, the authors' op-ed becomes a non sequitur. Perhaps claims costs aren't rising in such a way to cause insurance costs to rise. But proving that premise does not demonstrate that there isn't a "crisis", and doesn't demonstrate flaws in the administration proposal. Ironically, it's the op-ed that is "overbroad and directed at the wrong problem."

And it's far from clear that the premise--that there is no problem of rising risk to insurers from a change in the malpractice environment--is true. As Professor Klick noted at the conference, insurance premiums reflect not just the expected incurred cost, but a risk premium to compensate for the variance of that expectation. And the Texas study did not look at variance. Let's take a look at the Texas Department of Insurance data set used by the Texas study. What does the closed cost data look like in 2000, the year that insurance costs started to rise in earnest?

Extseq #32300902 was a $65,000,000 verdict issued by a jury on December 13, 1999. �The case appears to have been subject to a hi-lo settlement, so it wouldn't have much impact on the closed claims paid data that the Texas study relies upon -- but the fact of such a large verdict has to have had some impact on insurers' pricing. �In addition, there was a verdict of over $33 million that closed in 2000 after settling for about $11 million. �

Let's compare this to the world in 1990, the pre-2000 year in the TDI data set with the highest mean verdict. That year, the most aggressive outlier Texas jury awarded $17 million, a bit less than $23 million in 2000 dollars.

In 1990, there were about seven closed claims with verdicts above $1 million. In 2000, there were about sixteen closed claims with verdicts above $1.32 million (about $1 million in 1990 dollars).

The tail is about twice as tall at the $1 million mark in 2000 than in 1990. There are two outlier verdicts in the 2000 TDI closed claims data that average nearly twice as much as the single largest verdict in the 1990 TDI closed claims data, even after inflation. Yet the Texas study makes the blanket statement that juries weren't any more aggressive over time. Just from the TDI data, this seems to be false.

But wait, there's more. On November 3, 2000, a Dallas jury awarded $268 million to the family of a 15-year-old cerebral palsy patient who died of a medication overdose. This verdict, twelve times the size of the largest 1990 verdict in real dollars, is not in the TDI closed claims data at all, and was thus excluded from the study. The authors acknowledge the incompleteness of their data set, which omits certain self-insured entities that need not report to TDI. I don't think this critique is ambiguous, but let me make clear that I'm not accusing the authors of doing anything unethical by failing to include this data point. But they do err in overestimating the power of the conclusions that can be drawn from the data they do have. Their regressions don't account for increased variance or for the fact that the top three verdicts in twelve months averaged a record $100 million, nearly an order of magnitude higher than those of a decade ago, but the actuaries calculating insurance rates in Texas certainly did. This evidence is certainly evidence is anecdotal, but these anecdotes are large enough pebbles to distort the entire market; in the world of insurance, it's the outliers that create the need for reserves.

By Ted Frank

Dear Professors Black, Silver, Hyman, and Sage,

I was surprised at the counterintuitive preliminary results in your study covered in Reuters for which Professor Hyman was quoted. I read your paper. It seemed that 1990 figures were unusually high, so I downloaded and took a quick look at the 1990 data from the TDI website. Your paper mentions the 1988 and 1989 data collection problems, and it appears to my eye that these problems were resolved by filing closed claim forms in 1990 for a number of settlements that were actually made in 1989. See, e.g., the $14.7 million of settlements and defense costs in TDI #7800282, #7800283, #7900170, and #7900318. The payments were made in 1989, but the claims "closed" in May and June 1990. TDI #9700276 settled in August 1989, but wasn't closed until October 1990, adding $7.9 million in settlement and defense costs to the latter year. If I took the time to construct a spreadsheet macro, rather than just scrolling through, I'm sure I could find additional and similar errors. In contrast, I used 1998 as a control, and a spot-check of the "closed claim" dates for larger settlements seemed to take less time to report, and much more likely to be in the same year.

Did your paper sort data by the Q1G "closed claim" field, or by the Q1E "Date of settlement" field? Because it would appear that there is a strong possibility that the 1990 "closed claim" data, sorted by Q1G, is not directly comparable to that of later years, where data collection was more consistent. From the tables and graphs in your paper, it would appear that a 1991-2002 dataset would result in substantially different conclusions than a 1990-2002 dataset.
In addition, it seems to me that, given the variance involved in medical malpractice verdicts, there are problems of small sample size even in a state as large as Texas. An outlier of two $14 million settlements (as happened in 1990 TDI #7700251 and #8500332) can throw off the entire study. Was there a reason that a three-year moving average wasn't considered?

Finally, how much do malpractice rates increase when subjected to the same deflationary factors that your paper applied to malpractice expenses? I didn't see a chart on that subject, though the former was repeatedly described as a "spike." It seems unfair to compare the real rates of malpractice insurance expenses to the nominal malpractice insurance rates.

Best,

Ted Frank

By Walter Olson

On Tuesday, readers will recall, the New York Times business section ran an article entitled "Behind Those Medical Malpractice Rates" under the byline of Joseph B. Treaster and Joel Brinkley. Yesterday I criticized at length the article's assertion that "legal costs do not seem to be at the root of the recent increase in malpractice insurance premiums". Toward its end, the article goes to make some even more tendentious and misleading comments on the relationship between damage caps and insurance rates. Those will serve as our topic today.

Now, it happens that the impact of damages caps on malpractice insurance rates has been extensively studied by researchers whose opinions on other aspects of the subject diverge vigorously, and the consensus is to confirm the common-sense notion that when set relatively low and not riddled with exceptions, caps do keep insurance rates markedly lower than they would be otherwise. (This isn't to say that the researchers necessarily support caps as a policy matter -- many don't -- just that they find that the impact on insurance rates is in the expected direction and of significant magnitude.) See, for example, Zuckerman, Bovbjerg & Sloan, 1990 (caps on physician liability "significantly lower premiums"), Congressional Office of Technology Assessment, 1993 (at pp. 64-65, summarizing five studies suggesting link between caps on damages and reduction in insurance premiums); Kessler & McClellan, 1997 (finding "substantially and statistically significant lower trend growth in [doctors'] real malpractice insurance premiums" within three years of reforms); HHS, March 2003 (sec. 6, "States with Realistic Limits on Non-Economic Damages Are Faring Better"); Congress's Joint Economic Committee, 2003 (many references); General Accounting Office, Aug. 2003 (see p. 30, "Premium Growth Was Lower in States with Noneconomic Damage Caps Than in States with Limited Reforms"); American Academy of Actuaries testimony, 2003; Congressional Budget Office, 2004 (summarizing, at footnote 11 and accompanying text, yet another such finding). For more summaries of research, see the AMA's Dec. 2004 position paper (pp. 23 et seq.), and Daniel Kessler's comments at pp. 6-8 of his working paper here.

How does the Times handle the task of fairly conveying all this empirical work to its readers? It just ignores the whole pile -- even the 1990 study co-authored by Duke economist Frank Sloan, interviewed himself in the article, which found a "significant" such effect.

By Ted Frank

Opponents of medical malpractice reform make a variety of assertions about the subject in an effort to persuade. But if all of these assertions are true, then trial lawyers are wasting their time lobbying and issuing press releases. They have the power to solve the medical malpractice insurance crisis by themselves�and can make more money doing it.

Joseph B. Treaster�s and Joel Brinkley�s February 22 New York Times article �Behind Those Medical Malpractice Rates� lays out a frequent counter-argument to medical malpractice reform. The medical malpractice insurance crisis, the argument goes, is the fault of the insurance industry. After all, �payments for malpractice claims� haven�t increased as fast as premiums have. (Never mind that those claims statistics omit the amounts that malpractice insurers also have to pay for lawyers and experts to defend against both winning and losing claims�and never mind that the total of all those expenses amounted to $1.375 for every $1.00 of malpractice premiums collected in 2003.) The Times goes on to cite studies that purport to show that caps on non-economic damages in medical malpractice have no effect on insurance rates.

Joanne Doroshow, who is a spokesperson for both Americans for Insurance Reform and its parent Center for Justice and Democracy, two organizations that regularly take the side of trial lawyers, says in one press release that �today�s liability insurance crisis for doctors is not caused by jury verdicts or the legal system. It is driven by the insurance industry�s economic cycle that takes advantage of a weakened economy to price-gouge doctors and make huge profits.� AIR�s web page blames �Poor business practices, shady accounting, money lost in the stock market, not enough profits� and opposes medical malpractice reform in lieu of its proposed eponymous remedy.

Moreover, the New York Times argued in a January 9 editorial ($) that duplicated claims made by Ralph Nader�s Public Citizen, that if the system can be reformed to �weed out the small number of negligent doctors responsible for generating most of the malpractice awards,� the problem will solve itself.

Do trial lawyers believe their own propaganda? I have a modest proposal to find out.

The Association of Trial Lawyers of America, or some other such well-funded trial lawyers� group, should start its own medical malpractice insurance firm. Take some of the billions of dollars won in the tobacco cases, and invest it in offering medical malpractice to the doctors of America. The Sulzbergers, whose family fortunes are suffering with their investment in the New York Times, may wish to chip in as well. If one were to believe the opponents of lawsuit reform, it�s surprising that trial lawyers would want to put their savings anywhere else.

Tort reformers claim that practicing doctors are sued for malpractice indiscriminately. But if it's really true, as Ralph Nader�s Public Citizen claims, that only 5-10% of the doctors are responsible for most or �the bulk� of malpractice, this new insurance firm (let's call it Doroshow Insurance) can undersell other insurers by experience-rating, the practice of using historical data to determine the risk of future claims. Doroshow Insurance will simply offer its lower insurance rates to the other 90-95% of doctors and refuse to ensure the �small number� singled out by the Times. Because this 90-95% will exclude �the bulk� of malpractice claims, Doroshow Insurance and its investors will make even more profits than the �excessive profits� made by the current insurers.

Tort reformers suggest that one way to reduce insurance costs is to cap non-economic damages, where, without caps, only the lawyers� and jury�s imaginations provide a ceiling for pain and suffering awards. But if, as ATLA, AIR, and the New York Times claim, malpractice liability caps do not lower rates, Doroshow Insurance can costlessly promise that it will waive caps for all Doroshow-insured doctors who are sued. If patients care about caps, then this will be a huge marketing advantage for doctors who sign up with Doroshow Insurance. Even if a patient is in a state where lobbying by ATLA and its allies has failed to stop the implementation of caps, those patients can simply choose to have their medical procedures performed by a Doroshow-insured doctor, and avoid caps altogether without changing their jurisdiction. Meanwhile, the non-Doroshow-insured doctors (presumably the ones supposedly causing most of the malpractice) will be driven out of business between facing higher insurance rates and fewer patient visits.

Under this modest proposal of ATLA-sponsored insurance,

  • doctors get cheaper insurance rates;

  • patients both get better health-care and don't have to worry about malpractice caps;

  • lawyers make more money than they ever made before, because they get both the profits from suing doctors and the �huge profits� from running the malpractice insurance industry;

  • and legislators can forget about the malpractice debate and focus on their core mission of investigating Super Bowl halftime shows for indecency.

What a list of winners! Who could possibly be upset by that? Trial lawyers would get the additional benefit that lawsuit-reform advocates would be exposed as charlatans when all that was really needed to solve the malpractice crisis was a trial-lawyer-run insurance industry. The only other losers would be the insurance companies that we're being told are so mismanaged and the small percentage of bad-egg doctors responsible for �the bulk� of malpractice awards.

Indeed, this plan is so profitable, so ingenious, so win-win, that the only reason Trial Lawyers, Inc. could possibly have for rejecting it is if they didn't believe in their own arguments against malpractice reform.

But that couldn't possibly be the case, could it?

Ted Frank is a regular weblog contributor to PointOfLaw.com and an attorney at O'Melveny & Myers in Washington, D.C.

By Walter Olson

Yesterday's New York Times article on medical malpractice insurance wasn't a complete botch. The chart plotting rises in rates and in payouts since 1975 makes an excellent starting point for understanding the controversy, even if it tells only part of the story; the discussion of insurance company investments was generally on target; and much of the remainder of the article practices fairly standard "on the one hand, on the other hand" journalism.

But those aren't the parts of the article likely to make a sensation. Foes of malpractice-suit reform are sure to seize on the following pair of assertions as providing a Times imprimatur to what they've been saying all along: "legal costs do not seem to be at the root of the recent increase in malpractice insurance premiums" and "The recent jump in premiums shows little correlation to the rise in claims." In point of fact, these assertions are flatly in conflict with the evidence presented in the rest of the article, so much so that it's baffling that editors could have chosen to include them. To make matters worse, the article is highly tendentious in its treatment of the issue of how damage caps affect insurance races, and once again the slant is helpful to the anti-reform side.

 

 


Isaac Gorodetski
Project Manager,
Center for Legal Policy at the
Manhattan Institute
igorodetski@manhattan-institute.org

Katherine Lazarski
Press Officer,
Manhattan Institute
klazarski@manhattan-institute.org

Published by the Manhattan Institute

The Manhattan Insitute's Center for Legal Policy.