No-Fault Auto Insurance

How No Fault Auto Insurance Differs From Standard Auto Insurance

With standard insurance policies, fault is determined or proportioned after an accident involving a vehicle or vehicles occur, and when there are two or more insured parties involved, the insurance companies representing each party will provide compensation according to the degree of fault of their clients.

If, for instance, one driver collides with the vehicle of another and is determined to be completely at fault, the driver’s insurance company is liable to pay compensation to the other party. Whoever is at fault in other words will see their company pay. This is all pretty well understood among drivers and they will naturally seek to avoid mishaps and especially ones that they are at fault.

No-Fault Auto InsuranceIf the parties are found to be proportionately at fault, as sometimes happens, where it becomes decided based upon the circumstances that one driver is 60% at fault and the other 40% for instance, each of their insurers will contribute to the losses of each party according to the proportion of blame assessed.

When many people think of no-fault insurance, they believe that this insurance scheme, which is used in various jurisdictions in several countries, does not use the concept of fault at all. This is not the case at all and no-fault insurance is poorly named in fact, and the confusion that results is believed to have a negative effect upon the standard of care of many drivers.

No-fault insurance, perhaps oddly, uses the same determinations of fault as standard auto insurance does, and these findings of fault do have an impact upon the cost of premiums of the drivers involved in accidents.

The difference between the two is which insurance company pays, where your insurance company will always pay you regardless of who is to blame, as opposed to having the insurer pay according to the fault of their insured.

With standard coverage, if someone hits you and it’s their fault, their insurance company will pay to fix your car and also compensate you and other parties in the vehicle for injuries suffered of a significant enough magnitude to qualify.

If you have no-fault coverage, your own insurance company will pay for your damages and the other party’s insurance company, as long as they have insurance, will take care of them.

The Simplicity of No-Fault Auto Insurance

There are certainly some benefits of no-fault auto insurance over the standard scheme of coverage, with the most obvious one being speedier settlements and payments.

Instead of insurance companies being placed in an adversarial situation, with many disputes requiring lawsuits and legal settlements, no-fault schemes look to simplify things with a process that precludes these disagreements. If an insured makes a valid insurance claim, the insurer now simply pays it rather than having the insured collect it from a third-party insurer.

Since your insurance company has a stake in this, in the adversarial system, they will often go to bat for you so to speak, otherwise you’d be left to deal with the third-party insurance company on your own. These battles are usually costly and without the need for them, in theory anyway, this should bring down rates, if all other things were equal that is.

No-fault insurance is given life by statute, in other words by order of governments, as there is no way that insurance companies would ever opt for such a scheme if they had a choice. The big problem from their perspective is that this all is not conducive to managing risk, and insurance companies exist solely to manage risk for a profit.

If insurance companies wish to do business in a region that mandates a certain form of no-fault insurance, they do need to comply with the rules, in spite of their not fitting their business model very well.

Some jurisdictions with no-fault insurance have a government agency offer the insurance, and in this case, there’s no opportunity for private insurers, but most do allow them to compete.

No-Fault Auto Insurance and Tort Management

The real reason why no-fault insurance has emerged though is to manage the rising cost of insurance claims, and they all set some sort of limitation on them. This is where the simplicity of no-fault insurance really shines, as the government not only has a say in these limitations but this takes these matters out of the legal system and allows them to be administered much better than pitting insurance companies against each other and involving lawyers and courts.

There are trade-offs on both sides here. The assigning of compensation to one’s own insurance company is something that insurers like, due to the simplicity and speediness of the process, but insurance companies hate. However, insurance companies do love limitations on liability, as it reduces their costs.

Those who make claims and have their compensation reduced by no-fault insurance are of course less happy with it, but this is a very small segment of the population, and people generally do not pay much attention to the fact that they may be unable to get very large settlements if they are severely injured or killed as a result of an auto accident.

These claims are called torts, which is a personal claim against someone else for an injury they caused, and many argue that the tort system has gotten way out of line with reasonableness, especially in the very litigious United States.

No-fault insurance was conceived solely to address this problem, and the fact that insurers bear financial responsibility for their own insured is actually an add-on to this, to make these reduced liability schemes simpler to administer.

It is true that the size of claims does affect the cost of auto insurance pretty significantly, with settlements running into the millions of dollars in some cases. While one may object to any limits if they are on the wrong side of one of these incidents, in areas where the size of tort settlements is perceived to be way out of hand, this can be seen as a good solution to this problem.

Various jurisdictions that have no-fault insurance have their own set of rules regarding the types of claims that can be made for personal injury as well as limits on the amount of compensation rewarded, and this actually makes sense given that a certain region will often have its own particular challenges.

This is all chosen by legislators and their staff and if one lives in an area that mandates no-fault coverage, it is wise to become familiar with whatever limitations and other rules that may be at work should one need to make a personal injury claim.

When it comes to vehicle damage, this is all pretty straightforward, as whichever company provides the insurance on a vehicle will pay for all of the cost of repairing or replacing it.

Why No-Fault Insurance Costs More

With the savings from expediting claims and the reduced amounts that insurance companies pay out in claims, we would think that no-fault auto insurance should be cheaper. Oddly enough the opposite is true generally.

Given that the intention here has to be to reduce the cost of premiums, the fact that no-fault insurance fails to achieve this and actually makes auto insurance cost more is ironic.

To understand how this could happen, we need to look at how insurance companies price risk, which is their primary function. Under a standard insurance scheme, they can price the risk of a given driver according to a number of factors that are known, and while this is far from an exact science, insurance companies are pretty good at this.

With no-fault insurance though, insurance companies can no longer manage the risk of their insured in the same way, and have to rely on chance factors to drive the amount they pay out in claims.

Insurance companies hate such uncertainty, and what this serves to do is to take good drivers and raise their insurance rates to the mean, and on top of that, extra being added to compensate for all the extra uncertainty that is involved.

While insurance companies do not tend to raise the rates of a driver involved in an accident that is not his or her fault, what they do instead is raise everyone’s rates in a no-fault scheme to compensate for the inferior risk management involved, and then adjust them upward should one of their drivers be seen as riskier.

This all actually makes sense because the good driver under a standard auto insurance scheme is considerably less risky than one in a no-fault scheme. In a real sense, no-fault auto insurance punishes good drivers and even mediocre drivers, any driver in fact that would represent more of a risk of a company needing to pay out claims on.

On top of this, insurance companies do need to raise premiums overall to make up for all of this, because they are going to always want to err on the side of caution. When we say that no-fault insurance costs more, we usually mean it costs good drivers more, but the overall cost is more as well.

This is because not being able to manage risks in the same way causes companies to put rates up, even though some other aspects of administering auto insurance may be more efficient. Risk management is paramount though and it’s not really surprising that we see this fate if we understand well enough how insurance is priced and how a lack of accurate pricing affects it.

An insurance company may not like a no-fault insurance scheme, but if they are compensated well enough, which means a normal level of profit plus an added amount to compensate for the inferiorities present in risk management, they have no problem doing business in such a landscape.

There’s also the perception that no-fault auto insurance lowers the normal standard of care on the road, and if this is the case, it’s probably more due to drivers not properly understanding how no-fault auto insurance works, thinking that fault won’t matter or matter as much.

One of the factors in minimizing auto insurance claims is the concept of fault, where if you are at fault in an accident you will pay dearly in future premium costs. If this perception is reduced, in spite of how valid the perception is, this will no doubt affect safety and the number and amounts of claims.

Jurisdictions that have no-fault insurance do not allow for people to opt in or out as they are mandated by law. You would have to move to a different region to be able to get standard auto insurance.

If you do need to go with no-fault, just don’t expect a better deal, especially if you are a good driver as this causes the amount of risk that you present to an auto insurance company go up considerably, something you will of course need to pay for.

John Miller

Editor, MarketReview.com

John’s sensible advice on all matters related to personal finance will have you examining your own life and tweaking it to achieve your financial goals better.

Contact John: [email protected]

Topics of interest: News & updates from the Securities and Exchange Commission, Stock Markets, Bonds, Loans & more.