Liability insurance, joint tortfeasors and limited wealth

This article offers a theory of optimal liability insurance and applies the theory to analyze the impact of various liability rules. When multiple injurers have limited wealth and are subject to joint and several liability, liability insurance decisions are the outcome of a game rather than a single-agent decision problem. With endogenous insurance decisions, expanded liability or a move to joint-and-several liability can have the perverse effect of reducing both compensation to accident victims and incentives for accident avoidance. The model provides as well a demand-side theory of why liability insurance markets are so unstable: the liability insurance game yields multiple equilibria, suggesting a cascading of decisions to drop liability insurance and extreme sensitivity to small shocks.