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Why Do We Have No-Fault Auto Insurance, Anyway?

Sept. 25, 2014
Auto Insurance, Insurance
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Most people don’t like the idea of paying for someone else’s mistakes, but for some drivers, it’s a way of life. A dozen U.S. states have no-fault auto insurance, a system in which each driver’s insurance pays for his own damages in an accident.

States introduced no-fault to keep costs in check but have had mixed results. Still, the system has many passionate supporters, even as some states consider dismantling it. What’s all the fuss about? NerdWallet contacted a few experts to find out.

What is no-fault insurance?

No-fault is “a system of auto insurance where insured motorists who are injured by the negligence of someone else accept some limitations on their right to sue that negligent party for bodily injury damages,” according to Burke Christensen, director of the Risk Management and Insurance program at Eastern Kentucky University.

How do injured drivers recover damages? “Everyone buys first-party coverage. No matter what happens to anyone, you just go to your insurance company,” said Michael McCloskey, an assistant professor at Temple University’s Fox School of Business. This gets claimants their money faster and ideally without costly litigation.

No-fault doesn’t eliminate all auto-related lawsuits. No-fault drivers may still sue, but their damages must meet specific criteria to have a legitimate claim.

“The idea behind no-fault was, let’s put a limit on what people can sue for, and then we’ll eliminate small claims, and people will save money,” said Kathy O’Donnell, former president of the Massachusetts Bar Association.

What kinds of no-fault insurance exist?

The basics of no-fault insurance are the same from state to state, but some implement it differently.

For example, drivers in no-fault states must have a serious injury to bring a suit, but states’ criteria differ.

“The seriousness of the injury is determined by the cost of the medical expenses in some states.  If the cost exceeds a certain amount (usually between $1,000 and $4,000), then the injured party retains the right to sue.  In other states, seriousness is determined by the type of injury,” Christensen said. The first type is also called a “monetary threshold;” the second type is called a “verbal threshold.”

Some states also offer, but don’t mandate, no-fault. “In New Jersey and Pennsylvania they give you the choice,” said McCloskey. “If you do choose it, you get a significant discount on the liability portion of your auto insurance policy.”

Is no-fault the best system for auto insurance?

Most experts agree that not all states need no-fault. “States that have it typically have large cities and are more litigious,” McCloskey said. “Some states just don’t need to pass restrictions on it.”

In states that do have a high rate of lawsuits, McCloskey says no-fault can reduce frivolous litigation and – as a result – insurance premiums.

“Everybody, if you give them an MRI of their back, is probably going to have something wrong with them,” he said. “Find a chiropractor, doctor or a lawyer who’ll play ball, and now you have a lawsuit.”

No-fault doesn’t automatically equal insurance savings. States that have the program see premiums all over the map, with some among the most and least expensive, and others in between. And whether no-fault reduces lawsuits is also controversial.

“The stated goal of saving money has not worked in any state. You’ll have at least two no-fault claims, and if the threshold is met, a bodily injury claim, instead of one claim in a traditional tort system,” O’Donnell said. “It really has created an administrative nightmare in terms of claims, and the costs are passed on to consumers. Therefore, premiums increase.”

In O’Donnell’s opinion, this is partly because no state has found an effective threshold. Massachusetts’ is $2,000, a low bar, given today’s medical treatment costs.

O’Donnell also points out that thresholds themselves can be problematic. “If you set a threshold, people will meet it,” she said.

Though costs are important, drivers in no-fault states may have other reasons for liking or disliking the law. “A person injured in an accident is assured of some coverage for his or her injuries even if the party causing the accident cannot be located,” Christensen said.

On the other hand, “because each insured motorist pays to cover his or her own injuries, dangerous drivers don’t pay for the risk they present,” he added.

What challenges does no-fault face?

No-fault gained popularity in the 1970s, when it was adopted by 16 states. Others allowed drivers to buy first-party coverage without restricting their ability to sue. In the years since, sixstates have repealed it – some only temporarily – and its position is by no means certain in states that still have it. Florida, Minnesota and Michigan have all recently considered – or are considering – serious changes to the system.

For O’Donnell, economics aren’t the only reason to repeal the practice. “Philosophically, it’s not right. You have to hold the person accountable,” she said.

Others, like McCloskey, defend no-fault. “If you’re an unscrupulous person who would want to exploit a lawsuit, then there’s a big drawback,” he said. “But I wouldn’t sue someone unless I’d suffered something serious.”

Damaged car photo via Shutterstock.