Legal Errors and Liability Insurance

If the courts never make mistakes, so that there is no uncertainty about the negligence rule, potential injurers always meets the due care standard and are never liable. But casual empiricism and economic research provide evidence that the courts make mistakes in applying the negligence rule. We ask whether, as intuition suggests, the possibility of legal errors is a reason people buy liability insurance. We analyze the behavior of the potential injurer, the potential victim and the insurer. We show that, in equilibrium, potential victims sue with positive probability and potential injurers buy insurance, but purchase less than full coverage