This section explains how consumer reform of the insurance industry differs from the insurance industry's version of reform. Reform of the insurance industry's rates and practices, and so-called "tort reform"…

This section explains how consumer reform of the insurance industry differs from the insurance industry's version of reform. Reform of the insurance industry's rates and practices, and so-called "tort reform" (such as caps on damage awards or "no fault auto insurance") are not mutually exclusive. However, they do very different things and have very different results.

Consumer Protection Reforms

The consumer approach to reform — exemplified by California's Proposition 103 — views the insurance companies' own methods and conduct as the principal cause of excessive insurance premiums and abusive practices.

– This approach recognizes that although insurance companies are in the business of compensating for loss, they are fundamentally engaged in a profit-making enterprise, dependent upon investment income. The higher the premiums, the more insurance companies can invest, and the less they pay out, the more they make. Obviously, national economic factors — such as interest rates — have a tremendous effect upon insurers' investments.

– Insurance companies not only have nothing to gain, but rather have a great deal to lose if accidents or claims decrease. Put another way, insurers typically operate on a "cost-plus" basis: accident costs are passed through to consumers along with a considerable mark-up for overhead and profit.(1) Thus, the more accidents and claims or the higher the medical and car repair costs, the greater the justification for higher rates, which, in turn, yields more revenue for investment and ultimately higher profits. In this regard, the present insurance system perversely rewards insurance companies for the very events insurance is designed to protect against.(2)

– Moreover, the insurance industry reform approach recognizes the subjective nature of the underwriting process, as revealed by the inherent inability of insurance underwriters to correctly estimate the degree of risk posed by any one policyholder. Lastly, it acknowledges that an imperfect insurance marketplace often frustrates social policy goals–such as ensuring that all motorists have the opportunity to purchase compulsory insurance at a fair price.

– Finally, the consumer reform approach views the insurance function as being so directly related to the economy and society that insurers carry a quasi-public responsibility, which, in turn, requires public oversight and regulation.(3)

"Tort Reform"

"Tort reform" proposals backed by insurance companies and their allies in other industries, is premised on the assertion that the overuse or abuse of the civil justice system is responsible for premium increases. By banning some or all auto accident litigation–particularly by proscribing payment for non-economic damages–supporters claim that "no-fault" will reduce compensation as well as the "transactional costs" of the legal system, thereby enabling insurers to reduce their premiums.

In 1988, the two approaches to auto insurance reform were presented to California voters. Californians chose the reform approach — imposing rate rollbacks and stringent regulation of insurers — and rejected "tort reform." And, in 1996, California voters again rejected "tort reform," voting down special interest ballot initiatives. The 1988 insurance wars and tort reform are covered in other parts of this site.
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Footnotes:

(1) In 1995, for example, insurance companies paid out a national average of 65¢ for every $1 in auto insurance liability premiums they received. See A.M. BEST, BEST'S AGGREGATES AND AVERAGES, PROPERTY-CASUALTY EDITION, UNITED STATES 101 (1996). This figure does not include investment income of 9¢ on every premium $1. See id. at 176.

(2) A California insurance industry executive described the situation succinctly: "Who's unhappy? Not the doctors. Not the lawyers. And insurance companies can pass [the costs] along. If the public wants to tolerate this abuse, we'll deliver it." Mark Thompson, Highway Robbery, 11 CAL. LAW. 28, 29 (1991).

(3) In most states, courts have held that insurance companies stand in a unique fiduciary relationship with their customers. See WILLIAM M. SHERNOFF ET AL., INSURANCE BAD FAITH LITIGATION §§ 1.01–.05 (1996). Occasionally, the insurance industry itself acknowledges the imperfections of the private marketplace, as when it urges government to subsidize or supplant private insurers in the sale of certain forms of property-casualty insurance, e.g., creation of the California Earthquake Authority, a state agency established to relieve insurance companies of the risk associated with earthquake insurance coverage. CAL. INS. CODE §§ 10089.50–.54 (West Supp. 1998).