Michigan Auto Insurance Reform: The Case for Choice and Consumer Power

Transcription

1 June 2010 Michigan Auto Insurance Reform: The Case for Choice and Consumer Power Eli Lehrer * State law requires Michigan residents to buy automobile insurance. As a result of political wrangling and rising medical costs, however, the system under which they buy it has some problems and is at risk of developing more. Several current legislative and executive proposals could exacerbate these problems. This paper describes how the legislature, insurers, and Michigan citizens could make the system better, increase choice, and reduce auto insurance costs. If Michigan policymakers want a better system for auto insurance, they should empower consumers. The paper consists of four parts. Part 1 provides background on automobile insurance in general and describes the ways Michigan residents currently purchase it. Part 2 discusses some flaws and common complaints about the current system. Part 3 presents an agenda for reforming Michigan s auto insurance system to offer consumers more choice, decrease costs for many residents, and boost the state s economy. Part 4 offers a summary and concluding remarks. If Michigan policymakers want a better system for auto insurance, they should empower consumers by allowing insurers to offer a broader range of auto insurance options and improve the regulatory framework in which insurers operate. 1. The Basics of Automobile Insurance All auto insurers sell policies intended to cover damage that a driver causes to the person and property of others and to a driver s own car, and to pay for a variety of other possible expenses. * Eli Lehrer is a senior fellow of The Heartland Institute, where he is national director of the Center on Finance, Insurance, and Real Estate. A more complete bio appears on page The Heartland Institute. Nothing in this report should be construed as supporting or opposing any proposed or pending legislation, or as necessarily reflecting the views of The Heartland Institute.

2 Auto insurance policies take three specific forms. The first bodily injury and personal liability insurance is mandatory in Michigan and all but one other state. 1 The second collision and comprehensive coverage is never required by law but almost always mandated by lenders that make car loans. The third uninsured motorist and other expenses is not mandatory in Michigan or any other state. Michigan s bodily and personal liability insurance policies have two parts: general liability and personal injury protection (PIP). State law requires all motorists to have coverage for $40,000 in injuries and $10,000 in damages to property. A driver found to be more than 50 percent at fault in an accident typically must pay all damages. If a driver does not admit fault, courts and lawyers use the tort law system to determine fault. When Michigan drivers get into accidents, they typically make claims against their own insurance company, even when they were not at fault in the accident. This part of the policy rarely comes into play in Michigan, however, when two or more Michigan-licensed drivers get into an accident. Instead, all drivers carry PIP that is not based on assessment of fault. When Michigan drivers get into accidents, they typically make claims against their own insurance company, even when they were not at fault in the accident. PIP provides coverage for medical costs and, usually, a portion of lost wages in the event a driver or passengers gets injured in an accident. The remaining two types of coverage collision and comprehensive exist mostly to protect property. Collision coverage provides payments for damage to one s own car, regardless of whether the driver himself or another driver was responsible for the damage. Comprehensive coverage provides a replacement car or cash if a car is stolen or damaged by something winds, floods, falling trees, etc. other than another driver on the road. In Michigan, these are also typically dealt with on a no-fault basis. Some types of coverage don t fit neatly into these categories. One common type of coverage, uninsured motorist, offers insurance against an accident with a driver who has no insurance or other assets with which to pay damages. Many insurers also provide other types of coverage. It is common, for example, for insurers to provide coverage for rental cars when one s own car is in the shop, pay for towing, and negotiate motorist discounts on services ranging from car repairs to flower delivery. Limited forms of PIP-like coverage typically called med pay, which provides partial coverage for medical bills are also available in some states but are superfluous under Michigan s PIP system. 1 American Association of Motor Vehicle Administrators. Financial Responsibility Laws, The requirements vary from state to state. California, for example, allows drivers to post a large bond in lieu of securing insurance. Virginia, in practice, does not levy penalties on drivers who fail to secure insurance, so long as those drivers stay out of accidents

3 How Michigan Compares to Other States: Similarities In many important respects, Michigan s automobile insurance systems works the same as those elsewhere in the United States. Michigan consumers are required to purchase automobile insurance, and Michigan insurance companies set their prices subject to a degree of political oversight that s common in the United States. Driving a car imposes certain risks on other individuals, and people who have a car, the thinking goes, should have to show they can take responsibility for those risks. The law governing Michigan auto insurance, the Essential Insurance Act, was originally passed in 1979 and took effect in It is contained mostly in MCL Figure 1 summarizes how Michigan s auto insurance mandates compare with those of border states and the rest of the country. Figure 1 How Michigan Compares on Auto Insurance Mandates Michigan Border States Rest of the Country Is auto insurance required? Yes Yes (1a) Yes, except in New Hampshire (2a) Is personal injury protection required? Is coverage for personal injuries capped in a typical policy? Can injured motorists ordinarily sue those at fault in accidents? Yes No 12 other states require PIP No Yes Yes No Yes Yes The way Michigan has insurance companies set rates is also the norm in the United States, although in some respects the state makes it more difficult for insurers to sell the products they want and consumers to buy them than in other states in the region. Like 31 other states, Michigan requires auto insurers to file their rates with a state insurance department and requires department officials to approve or disapprove those rates within a set period of time. This rate-setting system is called file and use, and it is the most common insurance rate-setting system in the country. Other states use a variety of other systems, including no file, use and file, and flex rating. Some flex rating and use and file systems operate very much like file and use in practice. Figure 2 summarizes the similarities and differences between Michigan s rate-filing system and those elsewhere in the Midwest

4 Figure 2: Rate-Filing Permissiveness Like all other states, Michigan requires insurers to charge rates that are adequate but not excessive or unfairly discriminatory. 2 By all three standards, Michigan s current system seems to do an adequate job. Rate adequacy is a key principle of insurance regulation and a major reason why governments regulate insurance. Insurance is different from most other products in that it is useless if it is sold for too little. If a car manufacturer sells an automobile for less than it costs to produce or an airline sells a plane-full of seats for less than its operating costs, consumers get a good deal even if the company goes bankrupt as a result. Insurance, however, must be sold at a price high enough that the insurer can have reasonable certainty of paying claims it can expect. This is called actuarial adequacy. An insurance company that doesn t remain solvent that is, capable of paying its claims essentially commits fraud every time it sells a policy. Protecting consumers from fraud is a valid function of government. 2 Some states may use slightly different language, but these three principles are universal in American insurance regulation

5 Allowing insurance to be sold for inadequate rates also has bad consequences for the insurance market itself. A dishonest insurance company that sold policies at inadequate rates could drive honest players from the market for a significant length of time. Because many insurers pay claims mostly from current premiums, drawing on reserves and reinsurance only when catastrophes hit, an insurer that charged too little might be able to go years before being detected. In the meantime, its under-pricing would likely drive truly solvent insurers out of the market. Of course, no company that wants to remain in business charges inadequate rates. Nonetheless, it is difficult to dispute the idea that government has a valid role in enforcing rate adequacy. Michigan appears to do this reasonably well. A state that fails to enforce adequacy can have runs of insurers becoming insolvent, but Michigan has not had a significant auto insurer insolvency in the past five years. 3 Excessive rates, which Michigan law prohibits, are defined by two interrelated characteristics: conscionability and profit margin. Like all other contracts, insurance rates must be conscionable; even if a customer is willing to pay it, an insurer is not allowed to charge $1,000 a year for a policy that provides only $500 worth of coverage. Excessiveness is generally held to exist when an insurance company s combined ratio is at.6 or less. (See sidebar.) With a few minor exceptions, rate excessiveness is uncommon in Michigan. Since there s no specific law about what constitutes a reasonable combined ratio and the loss ratios for some types of insurance fluctuate greatly from year to year, even a What Is a Combined Ratio? Combined ratio is the insurance industry s standard measure or profitability. It consists of a claims ratio and an expense ratio. Claims ratio is the ratio of claims as a percentage of the revenue earned from premiums. Expense ratio is operating costs paying agents, administering claims, and advertising as a percentage of the revenue earned from premiums. A combined ratio of.6 means that for every dollar of insurance sold, 60 cents are paid out and 40 cents are profit. very competitive and well-run insurance market will occasionally have excessive loss ratios for short periods of time. While excessiveness of rates may become a problem in a market with few carriers, the reasonably large number of carriers operating in Michigan makes it difficult for a company to charge excessive rates. The one comprehensive study of this issue a 2004 Wayne State University report on premium excessiveness in Michigan found the state s automobile 3 Michigan Property and Casualty Guarantee Association, Latest News,

6 insurance market was generally competitive and provided a fair number of choices. 4 With a few potentially significant exceptions in a small proportion of individuals auto policies, the study found excessive rates were not common in Michigan. 5 Unfair discrimination refers to the use of unfair characteristics in determining insurance rates. Most prominently, insurance departments generally are expected to stop insurance companies from violating the letter or spirit of civil rights laws. These laws, found at the federal, state, and local levels, prohibit discrimination on the basis of gender, race, creed, color, religion, and, in some cases, sexual orientation. Except for gender, these characteristics are generally uncorrelated with driving risk or nearly impossible to verify. An insurance company would experience enormous public relations headaches if it opted to use some of these characteristics in rate-setting, and the enforcers of civil rights laws would have good grounds to stop them from doing so. Men get into more very serious accidents than do women, while women are involved in slightly more accidents overall. Michigan insurance companies are prohibited from using gender in determining auto rates. But in other states, it is common for companies to charge women lower rates than men. Men get into more very serious accidents than do women, while women are involved in slightly more accidents overall. Michigan state Sen. Martha Scott (D-Highland Park) and Consumer Advocate Butch Hollowell have alleged that insurance companies use of additional factors such as geographic location and credit scores constitutes unfair discrimination. But neither attribute refers to a characteristic that anyone suggests deserves specific legal protection, and few people object to their use in making certain public decisions. States that have banned their use have done so largely through statutes specifically intended to do so, not because they constitute unfair discrimination. 6 Michigan s insurance regulators can and do reject rates for a variety of reasons, and they do so under rules and guidelines similar to those in the rest of the states. If the Office of Financial and 4 George Galster, et al., The Competitiveness and Premium Excessiveness of the Home and Auto Insurance industries in the State of Michigan, Center for Urban Studies, Wayne State University, and the Michigan Office of Financial and Insurance Services, September 30, Galster et al. find seven rating territories Flint Inner, Lansing Inner, Monroe, Jackson Inner, Detroit Suburban, Ann Arbor Outer, and Benton Harbor outer have excessive rates for state-mandated coverage (PIP coverage), although not for other coverages as the researchers define them. Since it relates to only a small portion of the total auto policy, this finding may not have significant public policy implications. It may, however, merit additional scrutiny. 6 For example, California s Proposition 103, which establishes the system for setting automobile insurance rates, bans credit scoring outright and limits the use of geography. Illinois law limits the degree of rate differential within each state-defined territory

7 Insurance Services finds a rate excessive, inadequate, or unfairly discriminatory, it can outright reject the rate. More often, the office draws out the process of rate approval considerably, making it difficult for an insurer to charge a rate the office does not want it to charge. Although Consumer Advocate Hollowell and at least one study have implied otherwise, there s nothing in Michigan s statutes that allow[s] insurers to raise rates at will. 7 There s also no evidence that Michigan has systemically gutted consumer protection, as Hollowell told the author it has done. A variety of court decisions have changed the Judged by the stated goals of preventing rates that are inadequate, excessive, or unfairly discriminatory, Michigan s current insurance system seems to work pretty well. rules of the game slightly, but none has changed the underlying basis of the system. Michigan has the same powers to reject rates and monitor insurance companies as most other states. Two states that border Michigan Wisconsin and Illinois take a decidedly less-intrusive approach to insurance regulation than Michigan. Judged by the stated goals of preventing rates that are inadequate, excessive, or unfairly discriminatory, Michigan s current insurance system seems to work pretty well. In most important respects, Michigan s system of insurance regulation is typical. If Michigan needs more consumer protection than other states, it is not because the system results in rates that overcharge consumers for what they get. How Michigan Compares to Other States: Differences Although Michigan regulates auto insurance in much the same way as most other states, its system is unusual in three respects: # Like drivers in only nine other states, Michigan residents typically don t have to sue other drivers to recover damages when they get into accidents. When Michigan drivers get into accidents even when they are not at fault they almost always make claims against their own insurance companies, rather than the insurance companies of the at-fault driver. # While a few other states have limited no-fault systems, Michigan is the only state that places no cap on the benefits, 8 and only Michigan extends the no fault to everything including physical damage. Michigan drivers can sue another driver only if an accident causes death, 7 See, for example, Jay Angoff, An Analysis of the Profitability and Performance of the Michigan Auto Insurance Market, Roger Brown and Associates, May 30, 2007, ii. 8 People in the insurance industry often refer to the system as one of unlimited benefits, and insofar as no cap exists on the potential benefits, that is correct. But of course benefits are limited to the actual costs of dealing with an injury

8 serious impairment of body function, or permanent serious disfigurement. 9 These suits are rare, as insurers pay most bills. Even when an accident does cause such extensive injuries, few people bother to sue, because most individuals who cause accidents don t have enormous personal resources from which they could pay damages for serious injuries. # Also uniquely, Michigan maintains an automobile insurance catastrophe fund, the Michigan Catastrophe Claims Association (MCCA). Most accidents are paid by individuals own insurers, but those that aren t fall into the MCCA. Currently, the MCCA covers all claims greater than $460,000 the amount will rise in set increments until 2011 and collects a fee (in ) of $ per vehicle to pay these claims. 10 For a typical Michigan resident, the fee represents a little more than 10 percent of the total premium. 11 The amount the MCCA will pay for an accident claim is limited only by the actual amount of injuries an individual sustains and the cost of caring for those injuries; there is no payout cap The amount the MCCA will pay for an accident claim is limited only by the actual amount of injuries an individual sustains and the cost of caring for those injuries; there is no payout cap. All other states that require this kind of coverage have a cap on the payout allowed. The highest cap is New York s, at $50, This sum is paid out entirely by insurance companies; there s no equivalent of the MCCA there or in any other state s automobile insurance system. Car accident victims sustaining the most severe injuries, typically brain injuries, can receive life-long care under the MCCA. Although this care is most commonly provided by trained nurses, case law unique to Michigan has interpreted the law to allow payments to be made to family members for life-long attendant care. 13 Payments for attendant care are not capped, and they represent a large share of overall MCCA expenses. Other states typically provide only limited attendant care coverage before payout caps are reached. Auto insurance industry officials generally contend the MCCA s system of attendant care is a major cost-driver and a source of fraud; trial lawyers and those benefiting from the system disagree. A future Heartland Institute paper will examine the system in more depth. 9 MCL (1). 10 MCCA. Purpose, 11 See Insurance information Institute, Average Expenditures for Auto Insurance By State, 2006, 12 ibid. 13 Van Marter v. American Fidelity Fire Ins Co, 114 Mich App 171, (1982)

9 The Essential Insurance Act also imposes some unusual mandates. Among other things, Michigan operates under a modified take all comers system that more or less requires insurers to offer policies to all but the very worst drivers. The very worst drivers end up in the Michigan Auto Insurance Placement Facility, a state-mandated, industry-run residual market that charges very high rates. 14 Michigan s uncapped benefits and no-fault nature make its insurance system different from those elsewhere in the United States. Those differences lie at the root of some of the problems the system faces. 2. Flaws and Complaints about Auto Insurance in Michigan Michigan auto insurance is relatively expensive, but by some standards it is a good value for state residents. (Despite some high-profile claims to the contrary, Michigan s insurance is not the most expensive in the nation, but it does cost some consumers more than auto insurance in surrounding states.) The Essential Insurance Act also makes it difficult for insurers to know what factors they are allowed to use in deciding to insure risks (underwriting) and determining rates for the risks they decide to underwrite. This section of the paper reviews these flaws and complaints about the system and describes how the state might confront them. Expensive, but a Good Value Consumer Advocate Hollowell says Michigan s auto insurance rates are the Figure 3 Average Auto Insurance Expenditures Top 20 States Rank State Expenditure 1 District of Columbia $1,164 2 New Jersey $1,152 3 Louisiana $1,094 4 New York $1,083 5 Florida $1,069 6 Massachusetts $1,042 7 Rhode Island $1,038 8 Delaware $1,024 9 Nevada $1, Connecticut $ Alaska $ Maryland $ Michigan $ Arizona $ Hawaii $ California $ Washington $ Pennsylvania $ West Virginia $ Texas $820 Source: Insurance Services Office via AIA Fasttrack 14 Michigan Auto Insurance Placement Facility, Background,

10 highest in the United States, 15 citing NAIC [National Association of Insurance Commissioners] and Runzheimer International in making his claim. But data from NAIC, obtained via the Insurance Information Institute, do not support his claim. 16 As Figure 3 above shows, consumers in the District of Columbia and 11 states pay more for auto insurance than those in Michigan. Hollowell also claims, Michiganians pay the highest rates when economic factors such as Average Annual Median Household Income, Cost of Living, and Unemployment Rates, are factored in. In response to a Freedom of Information Act request requesting explanation of this statement, he provided a study that does not mention any of these factors. As Figure 4 shows, Michigan motorists do pay more for auto insurance than those in surrounding states, a difference that cannot be explained by driving habits, traffic density, or wealth. Figure 4 Average Auto Insurance Expenditures Border States Rank State Expenditure 1 Michigan $925 Michigan residents use seatbelts more than residents elsewhere in the United States. 2 Illinois $704 Traffic density which has been shown to correlate with the chances of getting into an 3 Ohio $654 accident is generally lower in Michigan 4 Indiana $631 than elsewhere. Metro Detroit, for example, ranks behind somewhat smaller cities such as 5 Wisconsin $590 Orlando, Las Vegas, and Sacramento in Source: Insurance Services Office via AIA Fasttrack overall traffic density. 17 The number of traffic accidents in the state, which starts from an already lower-than-average baseline, has fallen in recent years at roughly the same rate as elsewhere in the United States. 18 Insurance industry statistics show Michigan residents are about one-third less likely to get into serious accidents than are residents of other states. 19 Michigan 15 Melvin Hollowell et al Annual Report, Office of the Automobile and Home Insurance Consumer Advocate, 7. Annual_Reporta_265837_7.pdf. 16 See National Association of Insurance Commissioners via Insurance Information Institute, Average Expenditures for Auto Insurance by State, , 17 Bureau of Transportation Statistics, via Wendell Cox/Public Purpose, U.S. Urbanized Areas, Traffic Density, 18 See e.g. Office of the Auto and Home Insurance Consumer Advocate, 19 Insurance Services Office, via AIA Fastrack, Personal Injury Protection Liability, Because of Michigan s no-fault system, which severely limits bodily injury liability claims, data on such claims are not comparable

11 residents also earn less income than people in most other states (the state is tied for 35th in percapita income) and, presumably, drive less-costly cars than the median U.S. resident as a result. Except perhaps in certain areas where there is very limited competition, little evidence exists that Michigan residents are overcharged for auto insurance. Instead, residents of the state pay more for auto insurance because current government regulations force them to pay for policies that cover uncapped catastrophic medical benefits. The fee needed to maintain the MCCA alone accounts for more than 55 percent of the difference in rates between Michigan and Illinois. (The comparison with Illinois is particularly fitting because both states are in the Midwest, have roughly the same population, and have a single city that s several times the size of any other in the state.) Benefit payouts also cost more in Michigan. Even though Michigan residents make fewer PIP claims than residents of other states, the average cost of a PIP claim in Michigan is higher than anywhere else. (See Figure 5.) Figure 5 Personal Injury Protection Costs

12 Figure 6 % of Motorists Who Are Uninsured Michigan and Border States State Michigan 17 Ohio 16 Illinois 15 Wisconsin 15 Indiana 14 Source: Insurance Research Council % Uninsured In much of the state, auto insurance rates, while higher than those in surrounding states, are affordable for most motorists. In the City of Detroit, however, the cost of uncapped benefits has driven rates to levels beyond the reach of many residents. An auto insurance policy in Detroit costs, on average, a jaw-dropping $5,072 a year more than a third of the city s average per-capita income of approximately $15, As a result, many Detroit residents go without insurance, driving the statewide rate up to 17 percent, the highest in the region. 21 (See Figure 6.) Although some industry sources have told the author the very high Detroit rates are the result of a system that allows only discounts off a base rate, the one other state that uses such a system, North Carolina, has some of the lowest rates in the country in one of its major urban centers. 22 Fraud also plagues Michigan s automobile insurance system. Although there s no particular evidence that fraud is more common in Michigan than elsewhere by definition, much fraud goes undetected it appears likely that fraud costs Michigan more than it does other states. Because there s no cap on benefit payouts under Michigan auto insurance law, a person intent on fraud can do much more damage to the system than someone can elsewhere. In states where most auto insurance policies never pay out more than a $50,000 limit, no fraud on a single auto insurance policy can cheat customers or insurance company owners out of more than that. In Michigan, by contrast, a single fraud perpetrated carefully enough could cost millions. Even if fraud is no more common in Michigan than elsewhere, there s strong reason to believe it is more costly. 3. Reforming Automobile Insurance in Michigan Although Michigan s automobile insurance system works to a large extent, pockets of weak competition, a higher-than-average uninsured-motorist rate, higher premium rates than in surrounding states, and stratospheric rates in Detroit have brought widespread consensus on the desirability of change. Nobody has said ever told me they are against all change, noted House 20 Runzheimer International, via Insurance Information Institute, The Five Most Expensive and Least Expensive Cities for Auto Insurance, table_sort_746253=3., Philadelphia, Pennsylvania, is a distant second, at $3, Insurance Research Council, Estimated Percentage of Uninsured Motorists by State, 2007, 22 Runzheimer International,

13 Insurance Committee Chair Barb Byrum (D- Onondaga). It is just a matter of how we change it. 23 Previous efforts initiated by the state s consumer advocate and the auto insurance industry have suggested vastly different courses of action. The consumer advocate s office has suggested a series of punitive regulations that, the advocate himself told the author, are intended specifically to reduce auto insurance industry profits. 24 He proposes a burdensome prior approval process for determining insurance rates that would make it nearly impossible for companies to introduce new products and would likely reduce the number doing business in the state. Bills that would begin this process have passed the state House of Representatives but appear stalled in the Senate. For its part, the auto insurance industry has suggested a reform agenda primarily intended The state should aim to create a system to increase corporate flexibility. 25 It also has that gives them maximum choice and proposed subjecting all insurance claims to a control over the auto insurance mandatory fee schedule that would limit policies they purchase. consumers ability to pick their own medical providers and impose a government-controlled rate cap on auto-insurance-related medical costs. 26 Instead of favoring either the insurance industry or an ambitious politician, the legislature should aim to maximize choice and competition for Michigan consumers. In this section we consider reform proposals that would increase choice and improve regulation. Consumer Choice Consumers should play the dominant role in Michigan s auto insurance system. The state should aim to create a system that gives them maximum choice and control over the auto insurance policies they purchase. It should strive to create a system that allows motorists happy with their current coverage to keep it, while opening up new options for those who want them. 23 Interview with author, September 16, Office of the Consumer Advocate. Affordable Insurance For All: A Plan to Protect Michigan Consumers, February 4, 2009, Insurance_Advocate_Annual_Reporta_265837_7.pdf. 25 Insurance Institute of Michigan, Driving Michigan: An Agenda to Reform Michigan s No-Fault System, ibid.,

14 To do this, the state should make auto insurance optional, at least for drivers who have health insurance; encourage product flexibility by streamlining regulations; and allow insurers to offer fee schedule policies that could get auto-insurance-related medical costs under control. 1. Make the purchase of auto liability insurance optional in Michigan, at least for those who have health coverage. In the other 48 states that require auto insurance, a strong rationale exists for continuing the mandate. That rationale does not apply in Michigan, however, and therefore the state should make auto insurance optional, at least for any driver who has secured health insurance coverage. Driving a car poses a risk of harm to other drivers, and motorists who get into accidents should have a way to pay at least some of the costs incurred by those other drivers. In most states, that mechanism is automobile insurance. But in Michigan, injured motorists collect from their own insurers. Thus, Michigan auto insurance protects only motorists themselves (at least when they get into in-state accidents), not other drivers on the road. Just as no state requires motorists to secure collision coverage for their own car since damage to one s own car does no harm to others Michigan shouldn t require individuals to carry auto insurance intended to cover only their own medical costs. So long as it maintains a no-fault system, Michigan should ease up on its mandate that drivers purchase auto insurance. The current system seems unfair to both well-off and poorer Michigan residents. Poorer residents who qualify for Medicaid, Medicare, or SCHIP have a public program that provides medical and sometimes long-term-care coverage if they are injured. Yet current Michigan law requires many people who qualify for public assistance to pay for auto insurance, which can be very expensive. Well-off Michigan residents often have either long-term-care coverage or the financial resources to take care of themselves in the event of a serious injury, yet state law gives them no choice but to buy auto insurance. In places where auto insurance is very expensive Detroit in particular the money that individuals currently spend on auto insurance would almost certainly better be spent on health insurance, food, or housing. If the legislature, insurance commissioner, and governor are concerned about the ability of individuals to meet their own accident-related medical costs, they should focus attention on the health care system instead of the auto insurance system. In a no-fault system where insurance protects only the person driving the car, no obvious broader social harm is caused by a person who lacks auto insurance, particularly if that person has health coverage. Thus, so long as it maintains a no-fault system, Michigan should ease up on its mandate that drivers purchase auto insurance

15 To pilot the idea on a smaller scale, the state might consider allowing anybody with health insurance to drop auto insurance. Particularly as 2010 s federal health reforms will require all Americans to obtain health insurance (although true 100 percent coverage is unlikely), the experiment seems particularly worth pursuing in Michigan. 2. Encourage broad product flexibility in Michigan; include a patch for the Kreiner decision as part of a plan for greater flexibility. Michigan should do as much as possible to give motorists choice. However, insurance industry proposals promoting PIP Choice which would allow motorists to select less coverage in return for a presumably lower premium leave a lot to be desired. 27 If Michigan switches to an auto insurance system that allows more choice, it should think much more expansively than simply allowing motorists to choose between unlimited no-fault medical coverage and coverage capped at $50,000. Rather than providing just two options, Michigan should work to encourage the introduction of innovative new products that offer motorists a range of prices and average limits between these two extremes. The critics of proposals for PIP choice make a good point in this regard. Consumer Advocate Hollowell says a $50,000 option is no choice at all because insurers likely would encourage motorists to choose policies with lower limits. Providing just one alternative to unlimited coverage would probably cut premiums only slightly for people who selected the lower minimum, while raising premiums for those who wanted uncapped coverage. Although a few companies offer uncapped (or $1 million cap) insurance policies in other states with no-fault insurance systems, such policies are rare. Instead of offering such a limited alternative, Michigan legislators and insurance regulators should take advantage of the state s unique system of insurance by encouraging product innovation. For example, Michigan residents who have health insurance and drive older, less-valuable cars that are not worth repairing Michigan legislators and insurance regulators should take advantage of the state s unique system of insurance by encouraging product innovation. may quite rationally believe they re better off without any auto insurance for trips within the state. When driving outside of the state, however, those motorists could face severe problems if they chose to go without insurance: An accident could result in enormous claims against them and leave them with no resources. Although some umbrella insurance policies might provide coverage of this sort, out-of-state-only policies aren t common. If Michigan offers optional auto insurance, it should encourage such innovations. 27 See, for example, Insurance Institute of Michigan, Driving Michigan: An Agenda to Reform Michigan s No-Fault System,

16 A system of broader choice also should include a patch for the Kreiner decision (Kreiner v. Fischer, 2004), which strictly limits the definition of pain and suffering that allows tort cases to proceed in Michigan even when people with significant resources do enormous damage. The decision may save money for auto insurers, but in some cases it may prove deeply unfair to people who have been seriously injured. The legislature should craft a limited patch for the decision to allow tort claims in a few cases short of death or serious paralysis. This might best be done by developing a specific catalog of very serious nonfatal injuries such as loss of a limb or severe facial disfigurement and allowing pain and suffering tort claims for these particular injuries even when economic damages are limited. Attempting such a patch has very significant risks, including that of opening a no-fault system up to the very torts it was designed to avert. But courts entertained such claims with no serious adverse results in the 26 years that Michigan had no-fault before the decision. A limited patch of this sort seems only fair and would serve to maximize choice while empowering consumers. 3. Phase in fee schedule -based unlimited medical policies, on an optional basis, to give consumers insight into the costs and benefits of placing additional managed care restrictions on auto-insurance-related health claims. Consumer choice not the desires of regulators or the insurance industry should determine the presence or absence of a fee schedule in Michigan s auto insurance system. Auto insurance companies favor subjecting auto-insurance-medical-related claims to a government-mandated fee schedule. Nearly all modern health plans work on a managed care basis where all doctors that take part in the health plan or all doctors in network agree to an established fee schedule. Forty-two states have workers compensation systems that work in the same manner. The Insurance Institute of Michigan says subjecting auto insurance to a fee schedule would bring a 10 to 30 percent reduction in premiums. 28 That may be correct, but in the medical system as a whole, managed care practices held down prices only temporarily. 29 Nonetheless, even temporary savings may to some individuals prove highly attractive. Therefore, instead of subjecting everyone to a government-imposed fee schedule simultaneously, the legislature should allow managed care auto insurance as a choice for consumers. Under such a choice system, insurers would be permitted to offer policies that limited reimbursements to a fee schedule based on the state s workers comp system or some other system, but they also would have to continue offering policies without the fee schedule. Consumers could compare the 28 Insurance Institute of Michigan, See Bureau of Labor Statistics. Medical Inflation Slowed Last Year, /may/wk3/art04.htm, and Measuring Change for Medical Care in the CPI, cpifact4.htm. As BLS finds, managed care served to contain cost increases between roughly 1994 and 1998, and costs then began increasing at an accelerating pace (with some downturns.)

17 policies and choose whichever is most attractive. It is quite likely that different consumers will prefer different types of policies, in which case both types of policies could exist side by side. In the end, consumer choice not the desires of regulators or the insurance industry should determine the presence or absence of a fee schedule in Michigan s auto insurance system. 4. Allow the creation of a dollar-a-day policy that provides a minimum benefits package at a low rate. To make less-expensive automobile insurance available, Michigan should allow auto insurers to sell dollar-a-day plans intended to provide auto coverage for drivers of modest means who cannot afford or don t want existing PIP coverage. Creating such a policy likely would involve some tradeoffs. For example, since it would be intended for people of modest means driving older cars, a dollar-a-day policy might dispense with collision coverage and instead provide a modest sum to assist in the purchase of another car following serious damage to a vehicle. Any dollar-a-day policy should be a choice; companies that offer them should be required to offer other policies as well. A dollar-a-day plan would be designed backwards from a goal of charging a typical driver anywhere in the state no more than $365 a year for coverage. In high-risk areas, such as Detroit, such a policy would cost more. In lower-risk areas, such as Berrien County, such a policy might cost less... were it not for the current, uncapped benefit The state should not stop with efforts to promote choice, but also should consider proposals to improve the overall quality of insurance regulation in the state. system. Unless changes are made to that system, even a dollar-a-day policy would almost certainly have to cost more than $365 a year. The Michigan Catastrophic Claims Association s fee of roughly $ would leave too little to provide even a very basic policy. Better Regulation A system that allowed for better and broader consumer choice would do the most to improve automobile insurance consumer options in Michigan. But the state should not stop with efforts to promote choice. The legislature also should consider proposals to improve the overall quality of insurance regulation in the state. A better, more uniform, more transparent regulatory system would have two major positive consequences: It would result in lower, fairer, rates and, by making the market more attractive, would draw more competitors (and, perhaps, insurance industry jobs) to Michigan

18 1. Use the credit scoring case currently before the Michigan Supreme Court as an opportunity to clarify and limit the state insurance commissioner s power to restrict underwriting and rating criteria; reserve that power for the legislature. A case currently before the Michigan Supreme Court (Insurance Institute of Michigan et al. v. Commissioner, Financial and Insurance Services) will determine the commissioner s authority to restrict underwriting criteria. 30 Although commonly referred to as a credit scoring case, the case has implications far beyond that. Essentially, Michigan s insurance commissioner with prodding from the governor made a unilateral decision to bar insurers from using credit scoring in underwriting and rating. (Insurance companies nonetheless continue to use it throughout the state while awaiting a court decision on the ruling.) The facts of the case suggest any decision the court reaches will have broad consequences for the commissioner s overall power to allow or deny criteria for underwriting and rating risks in auto insurance. In particular, if the court decides the commissioner has the power under current law to unilaterally restrict what insurers can and can t use to underwrite risk, the legislature should reclaim that power and reserve for itself the authority to make such decisions. If insurers are banned from using a factor that is relevant, the ban can best be justified because political sensibilities won t allow the factor to be used. Any decision to ban a factor widely used in determining insurance rates is intrinsically a political decision. Insurance actuaries have found several factors, from driving record to credit risk, affect the likely risk of a given driver causing a claim. They can use these factors to charge good drivers less and bad drivers more. Although some insurers may give discounts based on things that don t necessarily correlate with actual risk belonging to a specific organization, having stayed with the same company for a certain number of years anything that finds broad acceptance among insurance companies is likely to be a broadly relevant factor that makes business sense for the insurer. An insurer that used a factor that was truly irrelevant and had a significant effect on its rates would likely go out of business quickly. In the aggregate, insurance companies will pick factors that are good from a business point of view. If insurers are banned from using a factor that is relevant, the ban can best be justified because political sensibilities won t allow the factor to be used. One such case might be if an insurer found that a genetic test correlated strongly with insurance risk; many people would likely react with hostility toward the idea of giving DNA samples to their insurance agents as part of the underwriting process. Whether to ban the use of genetic testing in setting insurance rates is a valid topic of political debate. The legislature, as the people s elected representatives, has a far better handle on this type of question than does the insurance commissioner. 30 Docket

19 Thus, if courts conclude current Michigan law gives the commissioner broad power to decide which factors insurers can and can t use, the legislature should take action to reserve that power for itself. If the government is to ban rate-setting factors, the legislature and governor should make that decision. 2. Regardless of the outcome of current and pending court decisions, Michigan should clarify its existing laws to allow the use of credit scores as a rating and/or underwriting factor within reasonable limits. As House Insurance Committee Chair Barb Byrum suggests, the state should strongly consider the NCOIL model law on credit scoring or something similar to it. The court case discussed above will have direct and immediate effects on the use of credit scoring in insurance rates. Because credit scoring is a valuable, valid tool, Michigan insurers should be able to use it. A wealth of research has shown that credit scoring correlates closely with insurers costs and, when used, results in lower, more efficient rates for consumers. Nonetheless, because credit correlates with differences in driving behavior but obviously doesn t cause those differences, many people find the use of credit scores questionable. The issue is a legitimate topic for debate. Several possibilities exist for changing the way credit scoring is used. Many in the insurance industry would like to see unlimited use of credit scoring, while some self-styled consumer advocates want the practice banned altogether. There s a middle ground: Adopt the standard that most other Allowing the use of credit scoring information in setting insurance rates in Michigan will tend to lower rates for citizens of the state. states (including neighbors Illinois, Indiana, Ohio, and Wisconsin) have adopted and follow the model law on credit scoring produced by the National Conference of Insurance Legislators (NCOIL). 31 House Insurance Committee Chair Byrum says the NCOIL model law is an option we should take a careful look at. The NCOIL model allows for the use of credit scoring but places common-sense restrictions on it. Recent amendments to the model, which Michigan s legislature also should consider, allow special exceptions in a variety of hardship cases. The state s uniquely difficult economic situation may mean it should look even more closely at these provisions and consider revising them further to take the state s special circumstances into account. On balance, allowing the use of credit scoring information in setting insurance rates in Michigan will tend to lower rates for citizens of the state. 31 See National Association of Mutual Insurance Companies, State Laws Governing Insurance Scoring Provisions, Not all the states have adopted the actual text of the law, but all except Ohio have adopted its major provisions. Ohio s rules for filing credit-score-related information differ slightly from those in the model law. Current Michigan law already follows most of the provisions of the NCOIL model law, with the important exception that it leaves the question of use of credit-scoring-information up to the state regulatory apparatus

20 3. Carefully consider changes to bad-faith laws; reject much of the legislation on this matter that has passed the House of Representatives. A group of bills passed by the state s House of Representatives in 2009 would increase the grounds on which consumers, lawyers, and other parties could sue insurers for bad faith. 32 Bad faith has a place in the law, but the proposed measures take things too far. For example, the current $1,000 fine for deceptive trade practices is probably too low, and the legislature is right to revisit it (HB 4846), although the proposed $50,000 fine may be too high. On balance, the bad faith package should undergo serious review before it becomes law. If enacted which seems unlikely the laws would drive many insurers out of Michigan and undermine the no-fault insurance system. In Michigan, bad faith laws could prove very expensive for consumers by making nearly every auto accident potential grounds for a lawsuit. Michigan s current auto insurance system provides lavish benefits at low costs by keeping many matters out of court. By creating, through a package of bills, a very broad right for just about anyone to sue an insurer following a claim denial or even an investigation, the bad faith bills would involve the courts much more deeply in Michigan s system. In a system where most serious auto claims went to court anyway, such laws although likely to anger auto insurers and increase regulatory burdens probably would not have material consequences on rates or affect the typical consumer. But in Michigan, such bad faith laws could prove very expensive for consumers by making nearly every auto accident potential grounds for a lawsuit. Another bill, HB 5147, which threatens to imprison company executives found guilty of acting in bad faith, seems likely to cause even more problems. Michigan s auto insurers already pay out more than insurers anywhere else in the country. Although outright fraud is, quite properly, a criminal offense, simply acting in what is declared to be bad faith is best dealt with through fines and, in particularly egregious cases, suspension of a company s permission to operate in the market. Creating criminal penalties for bad faith could undermine the entire idea of bad faith itself. Proving bad faith typically requires only a preponderance of the evidence indicating that one party failed to deal with another in good faith. There s no body of law in Michigan or elsewhere establishing how one would go about proving bad faith to the beyond a reasonable doubt standard required for criminal sanctions. In fact, the very idea of good faith and bad faith in contracts typically involves a fair number of judgment calls on the part of a court or jury. Thus an appeals court faced with a law that criminalizes bad faith would have two options. First, the court could decide on a low standard of evidence for criminal bad faith, thus giving auto insurers the impression (rightly or wrongly) that 32 House Bills 4844, 4846, 5144, 5150, 5146, 5145, and