No-Fault Automobile Insurance
This article was originally published in the Autumn 2001 issue of the Expert Witness.
In a recent paper, Norma Nielson and Anne Kleffner, of the Faculty of Management, University of Calgary, recommended that Alberta adopt a no-fault automobile insurance system.
The purpose of this article is to provide a response to Nielson and Kleffner. The article is divided into five sections, in which we discuss:
- the deterrent effect of tort rules,
- the high cost of no-fault insurance systems,
- arguments concerning the role of lawyers,
- evidence concerning the costs of bodily injury claims, and
- evidence concerning insurance fraud.
The Deterrent Effect
Although Nielson and Kleffner argue that one of the functions of an ideal “…system for compensating accident victims [is to] … provide individuals with incentives to behave in a way that minimizes accidents and the resulting injuries…” they choose to ignore this function in their paper. As the majority of recent empirical studies have shown that accident rates are higher in no-fault regimes than in tort-based regimes, their failure to address this issue seriously biases their conclusions.
For example, recent evidence suggests that fatal accident rates are between 5 and 10 percent higher in no-fault jurisdictions than in tort-based jurisdictions. This means that, at the 1998 highway fatality level of 429, the introduction of no-fault insurance would result in the deaths of between 21 and 42 Albertans per year.
We have identified five studies published in the 1990s that offer rigorous analyses of the effects of no-fault insurance on automobile accident rates. These studies argue that no-fault may reduce the deterrent effect of insurance in two ways.
First, insurers have historically provided a deterrent to accident-causing behaviour by increasing drivers’ insurance premiums when they have been found to be at fault for accidents. Under no-fault insurance systems, however, fault is not measured. As a result, insurance companies find it more difficult to tie premiums to driving behaviour and the deterrent effect is weakened.
Second, in tort systems, the party that has been found to have “caused” an accident is required to bear most of his or her own costs. The threat of having to bear these costs is presumed to act as a deterrent to accident-causing behaviour. In no-fault systems, on the other hand, the parties are compensated fully for all of their costs, regardless of fault. Thus, the threat of having to bear those costs is removed and the deterrent effect of insurance is once again weakened.
A concern of all of the studies identified by us is that, because the incentive to report accidents may vary among insurance regimes, changes in the reported number of accidents may not reflect true changes in the underlying accident rate. Accordingly, three of the studies restricted their analyses to fatal accident rates, as these rates are not subject to reporting error. All three studies found that the incidence of fatal accidents increased following the introduction of no-fault.
In the first of these, Devlin (1991) found that the number of fatal accidents increased by 9.62 percent after the introduction of no-fault in Quebec.
Similarly, Cummins et. al. (1999) found that fatal accident rates were between 5.5 and 9.9 percent higher in US states that had no-fault insurance than in those that permitted full access to the tort system.
And Sloan et. al. (1994) estimated that for every 10 percent of drivers who were denied access to the tort system (by no-fault insurance), the fatal accident rate rose by 7.2 percent. (For example, a move from a system that permitted full access to tort law to one that allowed access to only 80 percent of drivers would increase the fatal accident rate by 14.4 percent.)
A second approach was adopted by Cummins and Weiss (1991). They argued that, as no-fault insurance systems did not alter the legal rules involving property damage claims, there should be no direct effect of no-fault on those claims. However, if no-fault affected driving behaviour through changes to the rules concerning personal injury claims, an indirect effect on property claims would be expected. That is, if no-fault reduced the incentive to take precautions to avoid personal injury, that reduction should increase both personal injury and property damage claims.
Accordingly, Cummins and Weiss compared property claims between tort and no-fault states. Their finding that property claims were 4 percent higher in no-fault states led them to conclude that the introduction of no-fault had reduced the deterrent effect of automobile insurance and increased the number of automobile accidents.
Finally, Devlin (1997) investigated the effect of no-fault insurance on the severity of automobile accidents in the United States. She found that the probability of sustaining a serious accident was significantly higher, and the probability of sustaining a minor accident significantly lower, in no-fault states than in tort states. That is, even if the overall accident rate was the same between two states, the average severity of accidents would be higher in the no-fault state than in the tort state.
These studies show convincingly that no-fault insurance reduces the incentive for drivers to take precautions. The result is that, under no-fault insurance, there is an increase in the number of fatalities, in the overall number of automobile accidents, and in the average severity of accidents. Although these effects were ignored by Nielson and Kleffner, it is clear that they must be taken into account when changes to the insurance system are being considered.
The High Cost of No-Fault Insurance
Empirical analyses of no-fault insurance jurisdictions indicate that there are virtually no cost savings to be obtained by switching from tort law to no-fault insurance. Indeed, experience in no-fault states and jurisdictions around the world indicate that the system is not effective in reducing the overall cost of accident compensation.
Our review of the research indicates that there has been no realization of lower insurance premiums as a direct result of the adoption of no-fault insurance.
- According to the National Association of Insurance Commissioners data (1988–1998), liability premiums in the US no-fault states are amongst the highest in the country. New Jersey (a no-fault state) has the highest average liability premiums and exceeds the national average premium by 71%.
- In their analysis and evaluation of no-fault Laws, the Foundation for Taxpayers and Consumer Rights (1997) point out:
- Though many states have experimented with various forms of no-fault plans, few have been shown to obtain reduced insurance premiums.
- No-fault states have the highest average automobile insurance premiums.
- Between 1989 and 1995 premiums in mandatory no-fault states rose nearly 25 percent more than in no-fault states.
- Premiums fell immediately in states that repealed no-fault insurance.
- The Insurance Bureau of Canada (1991) reports that during the first year following the implementation of the no-fault scheme in Ontario, insurance industry profits increased by $750,000,000 with no appreciable decrease in premiums.
- Nielson and Kleffner (2001) report that no-fault has not reduced auto insurance costs, but rather, costs are higher due to the very generous benefits paid out (e.g. in Quebec and Manitoba there is no time or amount limit on medical payment benefits). This further raises the question of how a no-fault system implemented in Alberta can realize significant cost savings.
- The few jurisdictions that cited savings due to no-fault attribute the reduction in costs to the elimination of non-economic loss award for persons whose injuries do not exceed a prescribed threshold (Carroll and Kakalik, 1991). Regardless of the threshold level, non-economic loss is real. Eliminating or restricting individuals’ compensation for losses concerning pain and suffering and mental anguish means denying them the funds necessary for physiotherapy, psychological treatment etc. which are critical to reparation for non-economic loss. This is at odds with the very intent of no-fault insurance, which is to compensate an individual adequately for losses arising from the accident regardless of fault.
- Nielson and Kleffner claim that no-fault plans match compensation more closely with economic loss by increasing the fraction of economic loss that is compensated and by reducing the amount of compensation paid people in excess of their economic loss. In other words, they recommend reducing victim compensation in order to save money.
Nielson and Kleffner suggest that attorney involvement in claims is a key contributor to the escalation of bodily injury costs. Their conclusions are based on a study conducted by the Insurance Research Council that examined medical utilization in cases that did and did not involve attorney representation. That study concluded that represented claimants were more likely than non-represented to seek treatment from medical practitioners and that the former had a higher average number of visits to practitioners than did the latter.
Nevertheless, the authors suggested that claimants represented by lawyers were no better off than those who were not represented. In particular, despite the fact that average gross compensation to the represented claimants was higher than that to claimants not represented; the former netted less for their injuries than did the latter. The difference is explained by the fact that represented claimants incurred higher costs – including legal fees and court costs – than did non-represented claimants.
The All-Industry Research Advisory Council (1988) shows households that hired attorneys had longer settlement times for injury claims than those who did not. Households that reported large economic loss were more likely to have hired an attorney. Further, although 80 percent of households that did not hire lawyers were satisfied with the overall amount that they received from all benefit sources, only 58 percent of claimants who did hire attorneys were satisfied.
These studies do not support Nielson and Kleffner’s claim that lawyers provide no valuable function in the claims settlement process.
- The studies ignore the fact that cases requiring legal representation are usually more complex than those that do not require representation. Individuals who choose not to hire lawyers usually do so because they have relatively simple cases. Nielson and Kleffner have the causal relationship reversed. It is not that lawyers “cause” cases to take longer to settle; it is that plaintiffs seek legal representation when they recognise that they have complex cases.
- Households are not forced to use lawyers. The fact that many choose to do so indicates that they believe that lawyers provide a valuable service. Hiring a lawyer to assist in the pursuit of a damage claim is analogous to hiring a realtor to help in the sale of a property. Individuals have the option of selling their property privately. The fact that many people choose to hire realtors provides strong evidence that people perceive value in doing so - otherwise they would not do it. Similarly, purported “evidence” that claimants obtain little or no value from the hiring of lawyers must be set against the undeniable evidence that most claimants do hire lawyers.
- Satisfaction and payout of benefits cannot be compared on a consistent basis. Such comparisons assume that the severity and complexity of injuries is the same. It also assumes that all people hire lawyers for the same reasons.
Nielson and Kleffner conclude that since attorney involvement in settling claims “results” in lower net settlement amounts and longer time to settlement, it would appear that reducing attorney involvement would be one way to increase satisfaction of claimants.
But there is no empirical evidence to show that reducing attorney involvement would increase satisfaction of claimants. On the contrary any restriction on such involvement would be expected to lead to more dissatisfaction as the claimant no longer has a choice or a place to turn for representation should he or she not agree with the claim offered by the insurer.
Increasing Proportion of Accidents Producing Injury Claims
According to Nielson and Kleffner, in Alberta the number of bodily injury claims has been rising much faster than property damage claims. During 1986–1999: the number of vehicles insured increased 24 percent, the number of bodily injury claims increased 157 percent, property damage claims frequency decreased from 4.94 to 3.04, and the number of property damage claims decreased 22 percent from 59,353 to 45,996. Claims cost for bodily injury losses (cost per insured vehicle) increased 200 percent while the consumer price index increased only 43 percent.
Nielson and Kleffner attribute the dramatic rise in bodily injury costs to a purported change in the claiming behaviour of motorists and passengers. They suggest that many of these claims are in fact not legitimate. However, the statistics that they report do not allow them to draw this conclusion.
- The argument assumes implicitly that all drivers are identical and suffer exactly equivalent injuries in any accident. It ignores the fact that increased costs to treat injuries could be attributed to an increase in severity of injuries due to more crowded road conditions, increased number of passengers per vehicle, and/or the requirement to compensate for rising income losses.
- That bodily injury claims costs increased more rapidly than the consumer price index does not provide any evidence of fraud or increased litigiousness. First, over the period investigated by Nielson and Kleffner (1986-1999) per capita medical costs rose by more than 75 percent in Canada (almost double the rate of inflation over that period). Second, wages and salaries also increased more rapidly than inflation, thereby increasing claims costs for lost earnings. Third, and most importantly, the Supreme Court rulings in the “trilogy” cases in 1978 led to a dramatic change in the way that damages were assessed in Canada. These changes allowed plaintiffs to obtain damages that much more closely reflected the losses they had incurred than had been possible previously. The result was that, over the 1980s, bodily injury damages rose while the lower courts absorbed and applied the Supreme Court’s new rules.
- Bodily injuries can arise independently of property damage. While there might be fewer fender benders, the increase in bodily injury claims and costs may be attributed to an increased severity of automobile accidents and increased number of passengers per vehicle.
- Furthermore, with improvements in the quality of automobile bodies, there may have been an increase in the number of accidents that do not cause significant property damage yet result in serious personal injuries (particularly to the neck and back).
Changes in Claims Behavior
Nielson and Kleffner cite two studies that purport to show that no-fault insurance reduces the propensity to exaggerate claims for personal injuries – studies by Cassidy et. al. (2000) and by Carroll et. al. (1995). Both of these studies are so seriously flawed as to be of no value.
Nielson and Kleffner identify the Cassidy study as the most important Canadian research examining the link between claiming behavior and treatment patterns. In this study, funded entirely by Saskatchewan Government Insurance, Cassidy et al examined 7462 whiplash injury claims filed in Saskatchewan in the six months before, and the twelve months after, that province converted from a tort liability to a no-fault system.
They claimed to have found that plaintiffs recovered from their injuries much more quickly under the no-fault system than under tort. The purported evidence for this finding was that insurance files for whiplash claims were “closed” much more quickly under no-fault than under tort. The implication drawn by Cassidy et. al. was that plaintiffs were more likely to exaggerate the extent of their injuries in a tort system, where parties are allowed to obtain compensation for “pain and suffering,” than in a no-fault system where such a claim is usually denied.
There are several flaws with this study:
- It is clear that the primary reason the whiplash files closed more quickly under no-fault than under tort was that claimants were provided with a forum in which they could appeal the insurance company’s rulings in the latter but were denied that opportunity in the former. Under Saskatchewan’s no-fault automobile insurance system, decisions about the claimant’s treatment and compensation are made administratively, by the insurer. Under the previous tort system, the plaintiff had the opportunity to appeal the insurer’s decision to the courts, and often did. It was the removal of the freedom to appeal that resulted in claims being closed more quickly, not a sudden decrease in drivers’ willingness to defraud the insurer.
- The study did not give conclusive evidence regarding whether people were physically better or worse off as a result of no-fault. All the research was able to show was that claims closed faster under no-fault than under the tort system.
- The tort claims investigated by the authors were restricted to the period six months prior to the implementation of no-fault. But in the US it has been found that claims filings increase substantially in the six months to a year before no-fault is introduced as claimants expect to be dealt with more fairly in a tort system than under no-fault. As a result, claims experience in the six months prior to the introduction of no-fault cannot be assumed to be representative of all claims under tort.
The second paper cited by Nielson and Kleffner in support of their claim that drivers have been making “excessive” claims against their insurers is Carroll, Abrahamse, and Viana (1995). We have carefully reviewed this paper and conclude that it provides no support for Nielson and Kleffner’s claim.
First, many of the results in the Carroll paper are conditional on the assumption that general (non-pecuniary) damages are highly correlated with damages for economic loss. It is their assertion, for example, that if the loss of income resulting from a broken leg in one accident is twice as large as the loss resulting from the same injury in a second accident, the general damages (damages for “pain and suffering”) in the first will be approximately twice as large as in the second. The result, Carroll et. al. argue, is that individuals have a double incentive to exaggerate the extent of their economic losses.
Nielson and Kleffner imply that this incentive to exaggerate economic losses exists in Canada. It does not, for three reasons.
- The Supreme Court of Canada has set an absolute limit on the size of general damages, of approximately $260,000. The lower courts have interpreted this limit to imply that general damages on “lesser” injuries (for example, a broken leg) must be proportional to those on the most serious injuries, like quadriplegia (that is, on those eligible for the maximum damages). Thus, general damages for a broken leg cannot exceed a relatively low amount, no matter how large the attendant economic damages might become.
- General damages in Canada are determined by the physical nature of the injury, not by the level of economic damages that are consequent on the injury.
- In cases of serious injury (the cases that Nielson and Kleffner argue constitute the bulk of dollar claims in Canada), claims for economic damages are subject to intense scrutiny by phalanxes of lawyers, economists, medical practitioners, vocational consultants, and numerous other expert witnesses in a process that is carefully monitored by both the courts and the insurance industry. The opportunities for exaggeration are severely constrained by both the professionalism of the participants and the adversarial nature of the process.
Second, Carroll et. al. argue that there will be fewer incentives to exaggerate economic damages in states with no-fault insurance if plaintiffs must meet a “verbal” threshold (i.e. must show that their injury is present on a list of eligible injuries) before they can sue under tort than if the plaintiffs must meet a “dollar” threshold (i.e. must show that economic damages exceed a pre-specified level). They conduct two tests of this hypothesis.
First, they calculate the ratio of “soft” injuries (those, such as soft tissue injuries, that are relatively easy to disguise) to “hard” injuries (those, such as broken bones, that are objectively verifiable) in each of the U. S. states. When they find that the two “verbal” threshold states – Michigan and New York – have among the lowest ratios, they “conclude” that their hypothesis has been confirmed. Plaintiffs in the “non-verbal” threshold states are exaggerating their “soft” claims.
This conclusion cannot be supported by the data. It is clear that the reason the ratio of soft to hard injury claims is low in New York and Michigan is that the verbal thresholds in those states exclude most soft injuries from the approved list. Plaintiffs suffering from non-approved injuries are denied the opportunity to make tort claims. Thus, the ratio of soft to hard injury claims is low in the verbal threshold states primarily because plaintiffs have been excluded by administrative fiat, not because claimants refrained from exaggerating the extent of their injuries in the latter.
Furthermore, the second test that is offered by Carroll et. al. is inconclusive. They argue that, because general damages (for “pain and suffering”) are correlated with pecuniary damages (for medical expenses and lost earnings), individuals have an incentive to exaggerate the level of their pecuniary damages. They predict, therefore, that the average level of damages will be higher in tort states than in no-fault states – particularly those no-fault states that require claimants to meet a verbal threshold before general damages can be awarded.
The evidence they provide, however, shows clearly that there is only a tenuous correlation between damages for soft injury claims and the nature of the legal system. Indeed, if the figure on page 18 of their report shows any correlation it is that average damages are higher in verbal threshold states than in tort states.
To conclude, the Carroll study, like the Cassidy study, provides no reliable evidence that injured parties are more likely to exaggerate their claims in a tort system than they are in a no-fault system.
All-Industry Research Advisory Council. (1988) Attorney Involvement in Auto Injury Claims, December, 1988. Oak Brook, IL.
Carroll, Stephen, Allan Abrahamse, and Mary Vaiana. (1995). The Costs of Excess Medical Claims for Automobile Personal Injuries. Santa Monica, CA: RAND, Institute for Civil Justice.
Carroll, Stephen J. and James S. Kakalik. (1991). “No-Fault Automobile Insurance: A Policy Perspective.” Santa Monica, CA: RAND, Institute for Civil Justice.
Cassidy, J. David, Linda Carroll, Pierre Cote, Mark Lemstra, Anita Berglund, and Ake Nygren. (2000). “Effect of Eliminating Compensation for Pain and Suffering on the Outcome of Insurance Claims for Whiplash Injuries,” New England Journal of Medicine, 342 (16), 1179-1186.
Cummins, J. David, and Mary Weiss. (1991). “Incentive Effects of No-Fault Automobile Insurance: Evidence from Insurance Claim Data,” in G. Dionne, (ed.) Contributions to Insurance Economics. Norwell, MA: Kluwer Academic Publishers, 445-470.
Cummins, J. David, Mary Weiss, and Richard Phillips. (1999). The Incentive Effects of No Fault Automobile Insurance. Wharton School, University of Pennsylvania. Working Paper 99-38.
Devlin, Rose Anne. (1991). “Liability Versus No-Fault Automobile Insurance Regimes: An Analysis of the Experience in Quebec,” in G. Dionne, (ed.) Contributions to Insurance Economics. Norwell, MA: Kluwer Academic Publishers, 499-520.
Devlin, Rose Anne. (1997). No-Fault Automobile Insurance and Accident Severity: Lessons Still to be Learned, Department of Economics, University of Ottawa. Working Paper 9707.
Foundation for Taxpayers and Consumer Rights. (1997). A Failed Experiment: Analysis and Evaluation of No-Fault Laws.
Insurance Bureau of Canada. (1991). Quarterly Industry Analysis Survey, Fourth Quarter.
National Association of Insurance Commissioners, Research Division. (1988-98). State Average Expenditures and Premiums for Personal Automobile Insurance.
Nielson, Norma and Anne E. Kleffner. (2001). “Recommended Reforms to Alberta’s Auto Insurance System”. Unpublished paper, April 23.
Sloan, Frank, Bridget Reilly, and Christoph Schenzler. (1994). “Tort Liability versus Other Approaches for Deterring Careless Driving,” International Review of Law and Economics 14, 53-71.