Trieschmann, Hoyt & Sommer

Risk Management for Auto Owners–Part II

Chapter 14

©2005, Thomson/South-Western

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Chapter Objectives • Describe how the average automobile insurance dollar is used• Identify and describe some of the key factors that drive

automobile insurance costs• Describe actions that individuals, governments, and insurers

could take to reduce auto insurance costs • Explain how no-fault auto insurance operates and how it might

reduce auto insurance premiums • Discuss the trade-offs among benefit levels, the right to sue,

and automobile insurance costs • Review attempts to reduce the problem of drinking and driving • Explain some of the advancements made in auto safety during

the past twenty years• Discuss trade-offs among automobile safety, better mileage,

and the cost of autos

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Where Does the Auto Insurance Premium Go? • People often assume that because automobile

insurance is expensive– Insurers must make massive profits on each policy

sold

• Table 14-1 provides detailed information • For every $100 received in premiums

– $104 was paid out in losses and expenses – However, this does not mean that the insurance

industry lost money – Considering investment gains, insurers made $1 in

after-tax profit for every $100 of premiums collected

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Table 14-1: U.S. Premium Dollar Expenditures, 2002

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Where Does the Auto Insurance Premium Go? • Key reason there has been so much controversy

over the use of aftermarket parts in auto repair– The fact that most auto claims expenses are for

repairing damage to autos • Aftermarket parts are often dramatically less expensive than

original equipment manufacturer (OEM) parts • Insurers are very interested in using aftermarket parts

– As are some insureds

• However, some people argue that aftermarket parts are of lower quality than OEM parts

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Where Does the Auto Insurance Premium Go?• State legislatures and the industry have responded in a

variety of ways to the controversy over aftermarket parts – Most states have passed legislation requiring insurers to notify

insureds when aftermarket parts are being used– Other states have gone further

• In Massachusetts, for example, all vehicles with fewer than 15,000 miles of use must be repaired with OEM parts

– Other states have laws that encourage the use of aftermarket parts when they are available

• The insurance industry’s approach has been equally varied – Some insurers state that they always use OEM parts– Others generally use aftermarket parts unless the insured has

purchased an endorsement that provides for use of only OEM parts

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Auto Death Rates

• Automobile accidents are the leading cause of death for people under the age of 25

• Table 14-2 shows the annual number of deaths from vehicle accidents in recent years – As well as the death rate per 100 million miles driven – The total number of fatalities has stayed relatively

stable• While the death rate per 100 million miles driven has

consistently declined overtime

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Table 14-2: Traffic Deaths, Selected Years

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Auto Death Rates

• The death rate is not equal across the 50 states – See Table 14-3

• In general, southern and western states have the highest rates – New England has the lowest

• Table 14-3 also shows that the low death rates do not always lead to low average premiums – Some of the states with the lowest death rates have some of the

highest average expenditures on auto insurance – Congestion seems to be a much bigger factor than the death

rate • Differing regulatory environments also contribute to the

variation in premiums across states – Table 14-4 provides average auto insurance expenditures for

additional states

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Table 14-3: 2002 Death Rates and 2001 Average Premium Outlay for Selected States

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Table 14-4: 2002 Average Auto Insurance Expenditures for Selected States

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Car Theft

• A significant portion of the cost of automobile insurance is due to the theft of cars – Approximately 1.2 million motor vehicles are stolen

each year in the U.S. • With a combined value of over $8 billion

• American thieves tend to prefer stealing foreign cars – Of the 25 most frequently stolen vehicles in 2002 only

four were domestic

• Urban areas tend to have higher theft rates • The recovery rate on stolen vehicles is low

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Cost Containment

• Risk managers realize that insurance should be considered within the context of all available risk management tools

• Several ways exist to lower losses from automobile accidents – Reduce the frequency and severity of the

accidents – Restrict payments – Redistribute expenses and losses

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Loss Control and Prevention

• If fewer accidents occur, costs should be lower, or at least should not increase as quickly

• Accidents can be reduced by building better highways and safer cars and perhaps by lowering speed limits

• Expanding the interstate highway system is one way to make highways safer– As are breakaway light posts and guard rails and impact barriers

• While insurers can lobby for road improvements, they’re not in a position to require them or pay for them

• Even to the extent to which legislators wish to spend taxpayer money on transportation needs – Frequent debates still occur over the proper balance of spending

between highways and mass transit

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Loss Control and Prevention

• For the past 30 years, the federal government and the insurance industry have been encouraging the automobile industry to build safer cars that will not be severely damaged in minor auto accidents

• Airbags represent a significant example of automobile safety improvements – The auto industry did not rush to embrace airbags

• Since they increase the cost of automobiles

• Many safety features in autos have been mandated by the federal government – Not promoted by the auto industry

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Loss Control and Prevention

• Many authorities believe that lowering the speed limits reduces the number of accidents and has a favorable effect of reducing fatalities – When the speed limit was lowered to 55 mph on the interstate

• The number of auto-related deaths declined and less damage and fewer injuries occurred when accidents did happen

– The insurance industry has been a big supporter of lower speed limits

• However, drivers seem to prefer higher speed limits

• Vehicle size is an important factor in accident severity – The death rate in the smallest cars on the road is significantly

higher than that in the largest cars – Beginning in 1970 a significant trend emerged toward

purchasing small cars with excellent gas mileage – However, in the last decade the trend has been toward larger

trucks and SUVs

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Restriction of Payments

• Restricting payments can help hold down the cost of auto insurance

• One way insurers can restrict payments is by fighting fraudulent claims – However, insurers must not be so aggressive in their

investigations that they deny legitimate claims • Another way to restrict payments is to encourage the use

of larger deductibles by giving attractive rate credits for them – In many cases, persons do not choose the $1,000 deductible

option because the rate credits do not make it appealing to do so – Consumers may have the financial resources to assume the

larger deductible but believe the $1,000 deductible is a poor buy – Through the use of more attractive pricing of higher deductibles

• Insurers would reduce overhead and claims adjustment expenses by reducing the number of small physical damage claims

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Redistribution of Losses and Expenses • Most auto liability insurance claims are adjusted

according to driver negligence • One party is deemed to be at fault and the guilty

party pays for the loss – This process is based on tort law and is adversarial in

nature

• Those who desire reform, such as insurance companies and some consumer groups – Describe the system as wasteful because lawyers’

fees and other adjustment expenses consume too much of the premium dollar

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Redistribution of Losses and Expenses• The proponents of reform say that

– Small claims are frequently overpaid in order to get injured parties to settle quickly

– Severely injured persons often do not receive enough payment and do not receive it for a lengthy period of time

– The contingency fee system encourages too much litigation

• People can sue with almost no upfront costs and perhaps obtain a settlement

– They have nothing to lose by suing

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Redistribution of Losses and Expenses• Plaintiff lawyers and other consumer groups

argue that the present system is satisfactory – They feel it gives the ordinary person his day in court

and allows access to the legal system for everyone – They believe the costs are worth the benefits

• Note that plaintiffs’ lawyers have a great deal to lose if the present system is changed to no-fault – As they receive much of their compensation from

lawsuits

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No-Fault

• Under a pure no-fault system insureds would purchase auto insurance that would work similarly to property insurance

• No person would be held liable for an accident – The tort system would be eliminated

• Each person’s auto insurance would pay for damage to his or her car and for injuries to the insured and his or her family while riding in automobiles

• No litigation would be necessary about fault – Because the insurance policy would pay without

regard to fault

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No-Fault

• The level of benefits would be determined by the consumer when the insurance policy was purchased

• The injured parties would be sure to receive payment for real economic losses and medical expenses – However, no opportunity would exist to sue and collect for

noneconomic losses, such as pain and suffering • Because no liability losses would occur, there would be

less need for the involvement of lawyers • Fewer insurance adjusters would be needed because

fault would not have to be determined • The money saved through less fault determination could

be used to provide consumers more benefits than at present – Thus, a redistribution of benefits would occur from lawyers and

adjusters to insureds

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No-Fault

• What is the potential sum of money to be gained from the no-fault process?

• The Insurance Information Institute has estimated that in 2002 $19 of every $33 paid for bodily injury liability payments goes toward legal fees and noneconomic losses – Not all of this money would be saved if universal no-fault

insurance were adopted • But it does indicate the maximum

• Because of this great potential to either save money and reduce rates or to significantly increase benefits – Some insurers and consumer groups are strong supporters of

no-fault

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Modified No-Fault

• No pure no-fault plans are in operation in the U.S. because – Many Americans do not want to give up their right to

bring a tort action – Strong lobbying efforts by trial lawyers

• However, various modified no-fault plans have been enacted or proposed by several states – The right to sue is restricted, not eliminated – Some states use a dollar threshold system

• Once damages from an injury are greater than some dollar amount, the insured may bring a tort action

– Other states specify a verbal threshold • A verbal definition is used to determine the threshold

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Add-On States

• Injured parties can collect from their own insurers

• However, no restrictions are placed on the ability to sue

• The first-party benefits are purely an add-on with nothing being taken away in exchange

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Choice No-Fault

• Three states have enacted choice no-fault systems

• People can choose to pay lower premiums to purchase no-fault coverage that restricts the right to sue – Or they can pay higher premiums to retain

their ability to sue

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Evaluation of No-Fault

• It is difficult to definitively state what the full implications of no-fault are

• In a study by the Rand Corporation various alternative no-fault plans were examined – The study made it clear that the specifics of the no-

fault plan had a tremendous impact on cost implications

– In general, total costs • Decline as the tort threshold increases • Increase as the PIP benefit level increases • Are reduced by a PIP deductible • Are reduced if health insurance payments are offset

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Evaluation of No-Fault

• Table 14-5 shows potential savings for alternative no-fault approaches – A combination of

• A stronger verbal threshold• $15,000 PIP benefits• And a $500 deductible in PIP cases

– Leads to a reduction of insurer costs as high as 25 percent

• Subsequent studies by Rand studied the choice no-fault approach – Concluded that such a system could reduce total auto

insurance costs by about 30 percent

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Table 14-5: Potential Savings for Alternative No-Fault Approaches

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Alcohol and Driving

• Driving automobiles while under the influence of alcoholic beverages is one of the most serious problems confronting society with respect to automobile-related deaths – About 40% of automobile-related deaths in the U.S.

involve persons who have alcohol in their blood when the accident occurs

– Numerous people are injured but not killed in alcohol-related accidents as well

• Over the past twenty years, driving while intoxicated deaths have declined significantly – However, recently they have actually increased

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Alcohol and Driving

• The reduction in alcohol-related deaths is due to – Continuing efforts to reduce the incidence of drinking and driving – Studies which determine what factors are most important in

discouraging such behavior • For instance, in the early 1970s many people thought that severe

penalties would cause a sharp drop in drunk driving – However, recent studies have shown that swift action is more important

than severe action

• Mothers Against Drunk Driving has been very effective in bringing attention to the DWI problem – A strong force in getting the legal drinking age raised to 21 years

• A curfew for teenagers may be another potential partial solution to the problem of underage drinking and driving

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New Laws

• States are continuing to pass stricter laws– Sometimes with the prodding of the federal government

• A federal law causes states that do not reduce the blood alcohol content (BAC) that defines drunk driving to 0.08 to lose some federal highway construction funds

• How much does one have to drink to obtain a BAC of 0.08?– Estimate: If a 170-pound man drinks five cans of beer or wine in

two hours • Most states have enacted laws imposing 90-day driver’s

license suspensions of first-time drunk driving offenders • About 30 states have laws allowing for confiscation of

vehicles for drunk driving – But they usually only apply to repeat offenders or underage

drinkers

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Advances in Driver and Auto Safety • During the past 30 years, significant progress

has been made in making driving safer • The number of total accidents per mile driven

has been declining due to – Better emergency room care

• Many years ago there were few, if any, board certified emergency care physicians

• However, today many emergency rooms are staffed with doctors who’ve been trained for this type of care

– Automobile safety features

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Advances in Driver and Auto Safety

• Early emphasis on car safety was directed toward the exterior of the car – However, recent research has shown that the interior

of the car can be dangerous • Today the interior of autos is padded

– Dashboards are softer today than they used to be » Providing better head protection

• The windshield has been modified so that it does not act as an ax when one’s head hits it in an accident

• Children are now required to be restrained • Other safety features include center-mounted

brake lights, anti-lock brakes and traction control

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Advances in Driver and Auto Safety

• However, a continuing problem is the human factor

• Cars can only be made so crashworthy, and highways can be made only so safe

• Individuals have to take responsibility and change their behavior – Not everyone chooses to wear a seat belt

• Seat belt use tends to be higher in states with primary seat belt enforcement laws

– High-speed driving is a similar problem

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Airbags, Auto Property Damage, and Teenage Drivers • Many reasons exist for the high cost of auto

property damage • Ironically one of the reasons has to do with airbags

– When a car hits an object, the airbags deploy – After the accident the airbags must be replaced

• Although the damage to the car may be minor, the airbags are a total loss

• It can cost in excess of $2,500 to replace the airbags • Airbags are considered property damage

• However, airbags have saved many lives– Especially among drivers who have a lower usage rate

of seat belts