From Law Reporter: Journal of the Consumer Lawyers of Hawaii, July, 1997

WHY CHOICE NO-FAULT FAILS
- TIM RYLES

A coalition of liberal Democrats and free market Republicans in Congress is spearheading an effort to lower your car insurance rates. The effort is called federal choice no-fault and includes House and Senate bills. The Senate version, S625, is currently at the hearing stage of the legislative process as no-faulters recycle efforts to blame the tort system for market, regulatory, and statutory shortcomings of automobile insurance. Its objective is to give consumers a choice between no-fault insurance and tort system insurance plans when they buy car insurance.

Proponents of S625 hail it as the equivalent of a tax cut. It will save American consumers $246 billion over a five year period, claims House Majority leader Dick Armey, and, he adds, the average driver will save $240 a year under the legislation.

In reviewing sponsor and proponents' arguments for a federal choice no-fault program, I am reminded of the lyrics to a song by country music star George Strait: "I've got some ocean front property in Arizona. From the front porch you can see the sea. I've got some ocean front property in Arizona. If you buy that, I'll throw the Golden Gate in free." Bottom line: Don't believe them. Choice no-fault is a bad deal for consumers and the latest excuse to deform American tort laws.

BACKGROUND IN GEORGIA
I admit that at one time in my career I might have bought the argument and the property. This was especially true during my term as head of Georgia's Consumer Protection Agency and during my tenure as President of the National Association of Consumer Agency Administrators. But then I ran for and won the office of Insurance Commissioner and saw auto insurance from a different perspective. Georgia's experiences with no-fault and the reforms we enacted or adopted between 1991 and 1994 show the fallacy of no-fault claims of savings for consumers and point to regulatory practices which can deliver what no-fault can't deliver: more reasonable prices for auto insurance.

Between 1986 and 1990, Georgia legislators, consumers, regulators, and insurers battled over various ways of fixing Georgia's no-fault law and reversing the escalating costs of auto insurance. The presumption was that we had the right system (no-fault), we just didn't have the right model. No progress came during that period. No-fault was like a giant tar baby; the more we debated it, the more we got stuck in the same old set of finger pointing and scapegoating. Ultimately, I decided to run for Insurance Commissioner on a campaign pledge of lowering auto insurance rates.

My 1990 General Election opponent offered a choice system as his solution to the problem. My examination of choice in Kentucky led me to the conclusion that choice had not lowered auto insurance costs there. And in comparing average costs by state, I noted that if we concentrated solely on the cost factor, one salient conclusion emerged: auto insurance in no-fault states cost more at the time and still costs more than is true under other systems.

Still, why no-fault costs more was unclear to me until I saw the system from the inside as a commissioner and recognized that Georgia's problem was not our inability to get the right model; rather, we had the wrong system. The purpose of this article is to review Georgia's experience and suggest meaningful ways of containing car insurance costs. While there are several weaknesses in S625 itself, my references to this legislation are modest, principally because, as indicated in the following observations, I believe there are several feasible ways to contain car insurance costs.

No-fault, I discovered, is an expensive program to maintain. It is first dollar payment of medical claims; in Georgia, it was the medical component that was least controllable. Compounding the natural market forces of medical inflation was the fact that insurers were blindly writing checks for medical claims with almost no verification of injury or even insistence upon accurate identities of injured parties in many instances. The reason for this lackadaisical approach to claims handling was that the government forced drivers to buy the coverage, thereby guaranteeing insurers a market. Georgia's mandatory no-fault became an income maintenance program for insurers and the agents who sold the coverages; in fact, when asked to explain why costs were seemingly out of control, insurers described their role in passive terms, i.e., "We don't determine the costs of auto insurance; we just pass 'em on. Insurance companies are nothing more than a pass-through operation." In economic terms, there was no incentive to fer ret out inefficiencies in the system. Several medical providers knew this and became very proficient in exploiting the system for pecuniary gain.

No-fault was a game. Without an incentive to control costs under a government mandated program of no-fault coverages, claims management among insurers was a misnomer; claims weren't managed, they were paid. Con artists figured this out and insurance fraud became a cottage industry, consisting of professional runners, medical providers, and genuine ambulance chasing attorneys with some assistance from police and emergency medical service personnel who alerted the runners when accidents occurred.

There's a lesson here: no matter what proponents tell you about insurance fraud, no-fault will do nothing to control it. On the contrary, no-fault is to insurance fraud what octane level is to gasoline: the more no-fault you have, the greater the fraud. It came as little surprise to me that when Georgia repealed no-fault, some medical providers who had participated in gaming Georgia's system moved to Florida, which has a generous no-fault system.

Let me follow up on the game aspects of no-fault. In this system, there are several winners: insurers, agents, medical providers, fraud perpetrators, runners, and the attorneys who specialize in no-fault benefits. (As an aside, one can also say that the government is a winner as well since higher insurance premiums mean increased tax revenue.)

There's one consistent loser: the honest, hard-working-motorist-consumer who picks up the tab for it all. Remember, this is the alleged winner from no-fault systems. This unintended consequence of winner as victim suggests that no-fault is one of those liberal ideas from the Sixties, a kind of Model Cities or Comprehensive Employment and Training Act program for the car insurance industry, that just won't die from repeated dosages of Prescription Fact.

While the court vacated this decision and later ruled en banc on the case, nothing in the second opinion suggests that the court changed its mind about whether insurance may be viewed as a good.(See Electronic Citation 1997 FED App. 0230P, 6th Cir., August 1, 1997).

WAYS OF CUTTING INSURANCE COSTS
Georgia repealed no-fault in 1991. At the same time, we moved from a file and use rating system to a prior approval one and strengthened our anti fraud statute. For four years we allowed no increases in private passenger auto insurance. Period. And I determined that if cost cutting in auto insurance is a major public policy consideration, there are ways to do it; however, pure no-fault, modified no-fault, and choice no-fault are not among the ways I would suggest.

So, what are the alternatives? What will control auto insurance costs? I make the following recommendations with a caveat: I don't think the federal government should play any role in auto insurance regulation. While there is a role for the federal government in insurance regulation (and I have so stated in previous appearances before both House and Senate committees), auto insurance is not part of that role. Indeed, Congress thought the president's health insurance proposals were too much for Washington to swallow, wait till they see what they're in for if the federal government wades into the political thicket of auto insurance regulation. With this in mind, here are my suggestions.

1. Prior approval rating systems are the best means of assuring that rates are not excessive. As a supplement to prior approval authority, I found that advance knowledge on the part of insurers that a thorough actuarial examination of their filings would be done by actuaries working for the commissioner and that no rate increase would go into effect without a public hearing had a chilling though desirable effect on what had otherwise become a perfunctory process. Many insurers do not want their staff testifying under oath about why they need a rate increase, nor do they want to discuss on the record how they allocate expenses, make underwriting decisions, handle claims, compensate their agency sales force and so on. In short, properly implemented, prior approval and the public hearing process limit increases to companies able to defend the increase and signal all companies that they will have to act and speak in public the same way they do in private.

2. A strong anti-fraud program is an important component of rate stabilization. For several years, I had listened to insurer lobbyists cite fraud and abuse as the major villain in high insurance rates. I took them at their word. We passed a strong fraud statute, granted immunity to persons who turned in suspected fraud perpetrators, and I insisted that every insurer establish a Special Investigative Unit to investigate fraud and to coordinate activities with the Department of Insurance fraud staff.

With regard to rating plans, insurers were informed that any insurance representative who wanted to propose higher insurance premiums would be expected to report fully on what the company was doing to combat fraud. No effort, no rate increase was the not so subtle message.

3. Controlling overhead costs is another major consideration. I was startled to find that the overhead costs in some of our larger companies approached or even exceeded 50 percent. (Also, for the Committee's information, in most rate filings, a simple loss ratio of 65 percent is assumed, meaning that 35 cents out of every premium dollar goes for something other than paying claims.)

What is an acceptable overhead cost? My initial target for Georgia insurers was 30 percent with a long range objective of 25 percent. Changes in technology may reduce that to even less in today's market, but in most instances, reduced overhead costs will lead to considerable savings to consumers. AND it is important for regulators to set targets on these matters to encourage auto insurers to operate outside their monopoly mind set -- a mind set that developed over decades of experience with either the government or lenders forcing consumers to buy their products.

4. Related to the overhead costs is the role of agents' commissions in auto insurance. State laws or regulations typically prohibit agent's from competing on commission fees; therefore, if the company pays 15 percent commission, no agent may charge less, no matter how important a lesser charge might be in attracting or maintaining business. An agent's license can be revoked for cutting commission fees. Critics recognize this as our last form of fair trade laws and a legalized form of price fixing which ill serves consumers.

"Fixed commission rates have contributed to a regressive rate structure in automobile insurance and produced unfairly discriminatory rates," concluded a Report of the U.S. Department of Justice to the Task Group on Antitrust Immunities in January of 1977.If, as proponents of no-fault assert, residents of our nation's cities pay more for car insurance than non-city drivers, one reason is that the commissions on city residents are substantially more costly.

The urgency of addressing this issue is reinforced by the fact that in commercial auto insurance transactions, commissions are negotiable. So, corporate shoppers for car insurance can get a break on car insurance; individuals can't. Simply permitting competition at the commission level will do more to contain premium costs than even the most avid no-fault advocate can envision from no-fault's presumed benefits.

Short of open competition among agents, perhaps a cap on commission levels for that portion of the premium mandated by law would assist in rate reduction. Also, consistent with what some companies are now doing, lowering the commission level on renewals can have a positive effect on costs. After all, renewals are either clerical and/or computerized operations in most companies, meaning that agents play essentially no role in the renewal process. Clearly, this justifies reductions in commissions.

5. Rewarding insurers that do a good job of managing investment income is another way of encouraging insurers to contain costs. After all, if an insurer is getting a good return on investment, there is less need for higher rates. Regulators may assist in this effort by setting goals for good returns on investment. One way of rewarding companies for complying with this type of program is to give them a break on the premium tax.

6. Expedited claims settlement procedures is another cost saving device. The claim that gets paid quickly is a claim requiring no loss reserve account; no loss reserve account means you don't have to pay someone to manage loss reserves.

7. Close scrutiny of insurer underwriting guidelines may also yield considerable cost savings. Underwriting guidelines are the factors used by insurers to determine IF they want to write your business and if so in what kind of company and at what price. From a regulatory and litigator perspective, both the secrecy surrounding underwriting guidelines and their application make them the soft underbelly of the car insurance industry.

One commonly used underwriting guideline is a driver's score on a credit report. Underwriters usually believe that a good score means a favorable risk who can be placed in a standard company while a bad score means the risk is bad. So, a bad score means no insurance will be issued or, if issued, it will involve issuance from a nonstandard (high risk drivers only) company, i.e., "We'll insure you, but it'll cost a lot more."

My concern about credit report usage is simple: What does my ability to keep Equifax happy have to do with my dexterity behind the steering wheel of my car? After several days of public hearings and several months of urging insurers to substantiate a relationship between credit report scores and the likelihood that someone will file an auto insurance claim when I was a commissioner, I am still waiting for the data. Yet, many drivers are paying more or less, depending upon the driver, not because of accident record, driving record, or other criteria that bear some statistical relationship to claims experience, but because of the score they receive on some credit report maintained by a faceless credit reporting bureaucracy hundreds or thousands of miles away.

This is grossly unfair to consumers. It represents a greater threat to the pocketbooks of a substantial portion of the driving public than any of the issues raised by tort versus anti-tort debates. If Congress is serious about addressing car insurance costs, perhaps it should be examining the use of credit reports as underwriting criteria.

8. Other underwriting guidelines used by insurers which may affect both availability and cost of insurance include marital status (divorced means higher costs), length of time at present address (if it's not very long, you pay more), zip code (some cost more than others), and occupation (lawyers are especially suspect).

Examine these underwriting guidelines and eliminate or condition their use (as I did with some of them in Georgia) and you will cut insurance costs and prevent the car insurance industry from acting like our national nanny on life style preference.

9. With regard to zip code factors, I want to elaborate. Congress has already heard suggestions from Peter Kinzler that "The tort system is not only a problem for the poor, it is a problem for our cities. People know that if they move across the city boundary to a neighboring suburb, they can dramatically reduce their auto premiums. The last thing our cities need is another incentive for people to abandon them."

It is true that a simple move down the street may affect what you pay for car insurance. But what no-fault or choice no-fault will do to alter this is beyond my comprehension. Territory - where you live - is an insurance rating factor; it has nothing to do with the type of insurance system in a state. Insurers call it territorial rating. It is used in tort, modified no-fault, no-fault and any other system in existence. And to the best of my knowledge, the courts are not crowded with tort claims regarding claimants' zip codes or central city vs. suburban residence. And passage of federal choice no-fault will have absolutely no effect on this practice unless you make it unlawful to use territory as a rating factor.

10. Outside the bodily injury area, different means of handling property damage may also offer cost reductions. For example, the equivalent of a parts/body repair Preferred Provider Organization (PPO) can save money. And while it is perhaps an unsettling idea for the luxury automobile market, nothing dictates that auto insurers have to insure a $100,000.00 luxury car. How much could premiums be reduced if collision coverage were limited to $35,000.00 or some other dollar limit for all vehicles?

11. With respect to bodily injury protection (BI) and costs, since BI is a form of medical insurance that just happens to be a part of the personal auto policy, perhaps attention should be devoted to establishing a special insurance program run by health insurers to make bodily injury protection available as a separate offering, independent of the car insurance policy. As S.S.Huebner, Kenneth Black Jr. and Bernard L. Webb point out, "...[T]here is a great deal of controversy over the question of primacy. This is the decision as to whether to keep automobile insurance as the provider of medical benefits or to let health insurance coverages become primary under certain conditions. Blue Cross has taken a leadership role in advocating the change." (See Property and Liability Insurance, 4th Ed., Prentice Hall, 1996, p. 515.)

Further, states might be encouraged to experiment with residual market mechanisms to find a less costly means of providing state minimum BI coverages to all drivers. Persons wishing to purchase additional coverage could do so by paying for it or by purchasing coverage from the regular market. Such an experiment could be conducted either at the state level or even on a national level through the National Association of Insurance Commissioners or through some equivalent of a Guaranty Association.

12. Most state laws prohibit artificial grouping to secure insurance coverage. What this usually means is that consumers are unable to band together and form groups through which they may, in turn, purchase car insurance and receive volume discounts as is the custom in health insurance. Consequently, statutes making it easier to buy auto insurance through group purchasing arrangements is another means of addressing cost considerations and of injecting competition into the market. (In many instances, these laws are already honored more in the breach than in the observance because of the widespread use of affinity grouping.)

13. Allowing banks to sell auto insurance may also represent a more efficient marketing system; furthermore, streamlined means of making on-line purchases of auto insurance through the Internet also represents a great opportunity for companies to reduce acquisition costs.

14. Eliminating mandatory insurance laws is another means of addressing several problems in the auto insurance system. This point underscores the hypocrisy of choice no-fault proponents. Their lobbyists plead with the Congress to override state regulation and "give people a choice between tort systems and no-fault. Let the free market decide!", they say, adding: "How can trial lawyers be against consumers having a choice?''

Time out. What free market? S625 eliminates the free market altogether in favor of two government mandated insurance programs: no-fault and tort. A true free market would give motorists a real choice: either buy car insurance or don't buy car insurance.

By forcing persons who do not want to pay for insurance to buy it anyway, mandatory insurance encourages both cynicism and an incentive for disgruntled insureds to defraud the system; moreover, since liability coverage is to protect someone else's assets, poor people, who have few assets to protect, end up subsidizing the wealthy. (There's that $100,000.00 luxury car again.) Want to reduce insurance costs? Repeal laws forcing people to buy it. (On this point, see especially the report authored by McKinsey & Company, Auto Insurance Reform In America: A Market-Based Approach, December, 1990, pp.75-76.)

CONCLUDING OBSERVATIONS
In considering the issue of auto insurance reform, it is critical that the information relied upon by the Congress bear a direct relevance to the topic at hand and draw fundamental distinctions among the variety of types of insurance available today.

Some proponents of no-fault suggest that "most insurance in the United States is no-fault insurance". They even go on to say, "Homeowners coverage is a form of no-fault insurance and so is health insurance." (See Kinzler, p.6). This source also includes Medicare as a form of no-fault. Medicare is a government social insurance program; it is an inappropriate analogy. Homeowners, health, and automobile coverages are all commonly recognizable types of insurance. Kind of like Bloodhounds, Chihuahuas, and Pomeranians are all dogs. But they're very distinct from one another.

Regarding homeowners insurance, my house is not likely to collide with my neighbor's house; it has never run a stop sign; it has never hit a pedestrian at a cross walk. Health insurance is written on people, not buildings, ocean going vessels, or motorized vehicles; health insurance underwriting principles are different, rating factors are different, reserving practices are different, marketing practices are different, pricing is regulated differently, and there is no third party liability. And in both homeowners and health insurance, claims must fall within the terms of the policy and proof of loss is required. It is inappropriate to characterize these coverages as examples of no-fault.

I also add that state laws regulate auto insurance rates in very similar ways, irrespective of whether the state is tort or no-fault. Rating laws usually stipulate that rates cannot be "excessive, inadequate, or unfairly discriminatory." While the presumption of S625 is that rates are excessive, at least somewhere, I can find no present evidence that any regulator has made a generalized finding that car insurance rates are excessive. Without such a determination, the proposed legislation rests upon shaky premises.

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