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The effect of liability insurance on the cost of accidents is not clear. Insurers can help reduce costs by suggesting and insisting upon loss control measures, but in the problem under study the beneficial effect of this monitoring is probably not great.(n323) On the other hand, as noted, insurance carries administrative costs.(n324) In addition, economists speak of the "moral hazard" attaching to the already insured; "[a]n injurer who has liability insurance ... will have a reduced incentive to deter accidents."(n325) Insurance overhead plus moral hazard costs less monitoring benefits is an amount properly assigned to "accident" costs.

Calculating the risk shifting component of PLI is also problematic. If the risks of firm negligence and client insolvency are difficult for auditors to calculate, they are even more difficult for the auditors' insurers. Faced with extraordinary uncertainty because of their limited experience with the new relaxed privity rules and the leveraged balance sheets of many of today's corporations, underwriters will generally be cautious; they will try to err on the high side, especially in the wake of large-stakes lawsuits.(n326) An alternative strategy is for some insurers to drop the professional liability line altogether, perhaps making coverage more expensive because there will be fewer providers. As insurance coverage becomes more costly, passing through its cost in audit fees becomes more difficult.

A perverse counter-approach by some auditors will be to adopt a risk preferring strategy by gambling that their clients will keep their heads above water; that their firms will not be sued; but if sued, will prevail without incurring excessive litigation expense. These firms will "go bare"(n327) or greatly underinsure. Because such firms are unlikely to be able to meet massive third party judgments, they will have succeeded in shifting most of the risk of client insolvency back onto the third parties. Traditionally, such a strategy has been associated with small firms with small clients, but recent financial pressure from litigation experience reported for a number of larger CPA firms, indicates that underinsuring in the present legal (and business) environment has become an inadvertent de facto strategy (n328)

Friction Costs of Litigation

Whenever tort litigation is used as a risk distribution mechanism, the friction costs are high. In personal injury cases, approximately two thirds of liability insurance premiums are siphoned off for litigation costs, primarily attorney fees and administrative expenses.(n329) There is little reason to believe that negligent misrepresentation cases are less expensive.

The higher the stakes to the parties, the more they are likely to invest in the contest itself. Auditors faced with costs attributable to their insolvent clients will spend more on defense to avoid liability altogether than they would if faced with only their equitably apportioned share of the harm. Similarly, plaintiffs and their attorneys who see the possibility of a full and massive judgment will also be prepared to invest more in the litigation process than they would if a smaller recovery were promised. This is especially so because both parties in these disputes perceive that they are struggling in the domain of losses, in which risk seeking has been found to be significantly greater than in the domain of gains, in which risk aversion has been found to be the rule.(n330) When both parties face losses the psychology of risk finds settlement and compromise harder to achieve.(n331) Therefore, when there are insolvent defendants the rule of


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