Liability Insurance as Protection Against Legal Error

Document Type



If the legal system operates perfectly in applying the negligence rule, potential injurers always meet the standard of care and are never liable. But substantial evidence suggests that courts make mistakes in applying the negligence rule. We analyze the behavior of the potential injurer, the potential victim and the insurer in the presence of legal errors. We show that, as intuition suggests, the risk of legal errors is sufficient to create a demand for liability insurance. In equilibrium, potential victims sue with positive probability and potential injurers buy insurance,but purchase less than full coverage.