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No Fault... Or Your Fault?

Jun 30, 2007

By Fluegge, Kyle

When I relocated from Missouri to Michigan as an undergraduate, the enigma of auto insurance had me scratching my head; indeed, the two states differed almost as much as night and day. But surprisingly many residents of Michigan do not even know about their states mandatory no-fault policy or its impact on their premiums, even though these policies have been in existence for more than thirty years. Although Michigan remains a part of a shrinking field of no-fault states (Hawaii, Kansas, Massachusetts, Minnesota, New York, North Dakota, and Utah are the others), its consumers frequently brush aside the real meaning of no-fault or even how it came to be. While most states maintain a liability system in which negligent drivers pay the injured parties, in a no-fault system, all drivers pay their own accident costs, regardless of who is to blame. This system minimizes the ability of the injured party to sue negligent drivers. This characteristic is of course the inherent "benefit" of no-fault: minimizing the court costs associated with lengthy tort action so that customers' auto premiums are kept at a minimum. Historical fact, however, does this reasoning no justice whatsoever.

And indeed why should it? Logical reasoning provides two explanations. First, if there is no "pay-thc-piper" punishment for reckless drivers, who has any real motivation to drive safely? In liability states, drivers are required to carry at least this insurance to protect other drivers. Any additional coverage is at the insured's discretion. However, for those carrying only liability, it is in their interest to drive with caution. One example I can think of is a rear-end accident. When teenagers start driving, most parents tell them that no matter what happens, if you rear-end someone, it is always your fault. That is why you must pay attention. If not, it will hit your pocketbook. Lesson learned.

However, with no-fault, these kinds of accidents can be nightmares for those rear-ended. Without collision coverage, it could be your fault that you end up with no vehicle, not the person who rearended you. On a slightly better note, you could end up with its blue book value for a totaled car, no transportation, and no legal recourse besides a mini-tort claim of $500. This scenario would be the absolute best case. Sound fair? If an insurance company has to pay for its client's totaled car when the client was not in any way negligent, it is no wonder that these insurance companies are reluctant to reduce premiums. These higher premiums, our second reason, of course result in higher revenues for those insurance companies whose consumers actually carry insurance. Indeed, in some no-fault states such as Minnesota, the numbers of illegal, uninsured motorists are increasing as a result of these higher premiums.

Most consumers would be dumbfounded to find out that the largest expense (sometimes as much as 50 percent of the premium) under a no- fault automobile, personal injury protection (PIP), pays for medical coverage that many customers already have through their employers. In essence, it is a double payment for the same coverage. While this coverage provides a benefit for those without medical insurance, is the purpose of auto insurance to provide such coverage? Many disagree with this PIP coverage, especially because in Michigan (and other no-fault states, although to a lesser degree), the lack of a cap on the personal injury protection claims produces problems with fraud, thus further increasing an already expensive premium.

Some states have seen these reasons as justification to repeal their mandatory no-fault laws, among them Nevada (1980), Washington D.C. (1986), New Jersey (1989), Pennsylvania (1990 - reenacted as choice no-fault), Georgia (1991), Connecticut (1994), Colorado (2003), and Florida (2007). In all cases except New Jersey (which remains choice no-fault) and Florida, these repeals have lowered premiums drastically. In Denver, Colorado, residents have seen their premiums decrease by as much as 40 percent. Additionally, speeding- related fatalities from crashes have decreased by about 20 percent from the last full year of no-fault, 2002, to the first full year of liability (2004). This figure was roughly the same for other categories, including alcohol and single-vehicle crashes.

So what exactly is choice no-fault, and is it any better? For New Jersey and Pennsylvania, a customer is able to choose between no- fault and a traditional tort policy. However, the default in New Jersey remains no-fault, whereas the default in Pennsylvania is the tort system. In an assessment of the 200 1 premiums for collision coverage, Pennsylvania's premium was about 6 percent lower than the national average of $27 1 . However, New Jersey's collision premium was almost 44 percent higher than the national average. A similar breakdown is seen under the tort system, in which PIP coverage is eliminated. Although costs for bodily injury and property damage would increase premiums, the overall savings from the elimination of PIP could be substantial. Thus, in New Jersey, it could be your fault that you have no-fault.

What about customers in those mandatory no-fault states? You might be surprised to know that in several of those states, policymakers already have brought this issue before the legislature. A repeal of no-fault could be in your state's future. The purpose of my research in Michigan is to assess consumer-reaction surveys to this state's auto insurance policy, how much is really known and understood about no-fault (after all, you pay for it), and whether it is really preferred among those affected by it the most. If not, is the traditional tort system the ideal? Or is it best to maintain customer choice between the two?

Kyle Fluegge is a PhD student in economics at Ohio State University with research interests in consumption and labor economics, including-research related to human capital and child outcomes.

Copyright National Forum: Phi Kappa Phi Journal Summer 2007

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