Using Incentives to Fight Fraud and Reduce the Cost of Auto Insurance

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Introduction

Until a few years ago, the automobile insurance companies serving the city of Lawrence, Massachusetts were suffering under a deluge of claims for auto theft, reported accidents, and personal injury claims, and passing on their costs to the city’s drivers, good and bad. However, after State Senator Susan Tucker investigated the problem, finding that much of the excess cost was due to fraudulent insurance claims, and helped draw the community together to fight insurance fraud with all the political, legal, and professional means at its disposal, the rates of auto theft, reported accidents, and personal injury have dropped greatly. However, while drivers across the state have gained lower rates, substantial rate relief has yet to come to Lawrence drivers directly, both imperiling the coalition and the progress it has made, and failing to encourage other urban areas to follow its example.

A statewide policy that earmarked some of the money saved by the insurance companies by reducing fraudulent claims in urban areas to urban drivers with good driving records would give Lawrence the support it needs to continue and complete its efforts and encourage other urban areas to follow its example.

The Problem

Expensive urban auto insurance not only costs drivers money, but it has social and political ramifications. First, it is a major reason why some families who have worked their way into the middle class decide to move out of the city. The money a family can save annually on auto insurance by moving out of the city is often the equivalent of a mortgage payment or two in another community. High urban insurance rates, then, undermine the investments the government has made to make our cities stronger. Second, it is a major obstacle to the efforts of Insurance Commissioner Julianne Bowler and Consumer Affairs Secretary Beth Lindstrom to introduce more competition into the state’s auto insurance system. Much of the resistance to reform has come from legislators in urban districts who are concerned that their constituents will be paying even more for insurance than they are now.

Because Lawrence is one of these urban areas, how it has reduced its cost to insurance companies, if not to its drivers yet, is of interest to other urban areas, and the state as a whole.

The Lawrence Story

In 2000, State Senator Sue Tucker, alarmed at what her constituents in Lawrence were paying for auto insurance, met with local police, the district attorney, insurance fraud investigators, the local bar association, the statewide chiropractors group, and state agencies like the Registry of Motor Vehicles and the Attorney General’s office. Three relevant facts emerged from these discussions:

1. Lawrence’s insurance rates were so high because its number of insurance claims was so high, and, therefore, reducing the cost of insurance depended on reducing its number of claims.
2. A small number of attorneys, medical clinics, and chiropractors, many from outside the city, had set up shop within the downtown area and conspired with some local drivers to file a growing stream of false accident and injury claims for over a decade unchecked. If they could be stopped, the claims and the cost of insurance would drop.
3. Everyone was blaming everyone else for the problem. Law enforcement blamed the insurance companies for passing the costs of the fraudulent claims onto consumers. Prosecutors blamed the local police for not investigating the accident scenes thoroughly. Attorneys blamed the state laws that ranked auto fraud as a simple misdemeanor and lacked specific prohibitions against paying people to stage accidents. Therefore, a successful resolution of the problem would require a broad policy that would bring all the parties together.

In the words of the Eagle-Tribune Editor-in-Chief William Ketter:

Fake accidents. Phony injuries. Fishy claims. Quick payoffs. Repeat and pretend. That’s the merry-go-round of automobile insurance fraud that nobody was stopping in the City of Lawrence and the state’s other poor urban communities. The consequence: millions of dollars every year in unnecessary bodily injury costs that translate into among the highest auto insurance rates in the country for drivers throughout Massachusetts.[1]

In January 2002, Senator Tucker used $10,000 of her own money to mail every household in the city a leaflet inviting them to join her for a citywide forum explaining why the rates in Lawrence were so high and what needed to be done to bring those rates down. However, she found that the insurance rate-setting process and the connection between high rates and the problem of fraud were difficult to communicate to her constituents.

In fact, it was not until a 65-year-old grandmother was killed while participating in a staged accident on the night of September 4, 2003 that auto insurance fraud became headline news and the public was startled into making the connection between rampant fraud and exploding insurance rates.

The Insurance Fraud Bureau, the Lawrence Police Department, and the Essex County District Attorney quickly organized an aggressive team of investigators and prosecutors to pursue those engaged in filing suspicious insurance claims. Shortly thereafter, the Eagle Tribune, led by reporter Mark Vogler, published a powerful, in-depth series exposing the nature and severity of the fraud problem. Among the main findings were:

• Although law enforcement and insurance industry officials knew since at least 1990 that fraud was rampant in Lawrence, they had failed to mount a serious effort to combat it;
• Between 1993 and 2002, the number of chiropractic and physical therapy clinics in Lawrence had increased 550 percent, while the number of bodily injury claims rose 150 percent;
• Four of the twelve top-billing chiropractic clinics in Massachusetts were located in Lawrence;
• Some insurance companies were aggressively pursuing fraud while others with a greater market share in the city were doing noticeably less.

Once the community was engaged, it provided the political will to motivate other agents. The state legislative delegation, led by Senator Sue Tucker, worked to pass new legislation that made auto insurance fraud a felony and outlawed the act of “running”—the lucrative practice of lawyers and medical providers paying for cases. In partnership with the local police and the district attorney, the insurance industry funded a task force to investigate and prosecute suspicious claims. The chiropractic and legal communities aggressively worked at weeding out the rogues in their professions who were perpetrating these claims. These combined efforts resulted in more than 150 arrests, ultimately saving the insurance industry $30 million in claims, one of the factors behind the recent 8.7 percent statewide auto insurance rate cut.

Five years later, the situation has dramatically improved. Lawrence has reduced its rate of personal injury claims per 100 accidents from 141 in 2003 to 60 in 2005. There has been a 58 percent reduction in auto thefts and a 29 percent reduction in reported accidents. However, although Lawrence drivers were paying extra because of the rampant insurance abuse, their city’s reduction of that abuse has only lowered their insurance to the degree it has lowered the cost to all drivers across the state: They, and especially those drivers with the best driving records, are still paying too much.

This lack of positive reinforcement not only threatens to undermine Lawrence’s coalition against insurance fraud, but also hinders the duplication of the community involvement behind Lawrence’s success in other urban areas across the state. Under the current system, it takes four years for a community like Lawrence to experience fully the financial benefits of its achievement, making it hard to keep the public momentum and commitment to see through such a program. In addition, a significant time lag exists between the data used to set rates in Massachusetts and the data used to define territories, the key to defining the cost of an individual’s auto insurance bill. The current territorial assignment and ratemaking process lack the flexibility that would encourage communities to begin and continue initiatives to reduce false claims.

The Proposed Solution

A statewide policy that returned some of the money saved by the insurance companies through a reduction of fraudulent claims in urban areas to urban drivers with good driving records would both encourage Lawrence to continue its efforts and spawn versions of its initiatives in other urban areas. It would encourage drivers with good records to become advocates within their communities for an aggressive crackdown on dubious claims. Without this citizen-based advocacy, there will not be the political will to see through the long-term reduction of insurance fraud.

The proposed incentive plan works as follows: excellent drivers that live in communities with personal injury claims more than twice the statewide average[2] will be rewarded if their community reduces its rate of claims by at least 25 percent. One-quarter of the total savings generated by this claim reduction would be credited to these drivers on their annual auto insurance bill—half in the first year after the 25 percent reduction and half in the following year. An “excellent” driver is defined as an operator who has been incident-free for the most recent six years.

In addition to earning a rating of “excellent,” eligible drivers must have registered their car in the city for the entire year the claim reduction occurred and must also keep their car registered in the community during the entire two-year period the credit is to be applied. Not only is this fair, but it also reduces the amount of credits insurers will have to issue because inevitably some of these excellent drivers will move away from the city during these three years.

No additional state bureaucracy would be needed to administer the proposal: it would be handled at the driver’s insurance company. Spreading the credit over two years buffers the costs to the insurance companies, and returning only a quarter of the savings acknowledges that non-urban, non-excellent drivers also have a claim to some rate relief.

What would this incentive mean for a city like Lawrence? To gain some idea, we will use the latest available data, from 2004. It shows there were 25,493 private passenger registrations in the city, of which 42.9 percent (11,130) earned the rating of Step 9, the best driver rating.[3] Because the total amount of savings in Lawrence was $30 million, one quarter of that sum or $7.5 million would be returned to the city’s highest-rated drivers. Dividing this $7.5 million by the estimated 11,130 highest-rated drivers equals $674 per driver. Because the credit will be returned on the driver’s insurance bill over two years, these drivers will receive a $337 credit each year. The other $22.5 million in savings would be spread across the statewide pool, benefiting all Massachusetts drivers.

Benefits

Such an incentive plan should create these benefits:

1. After the two years during which the credit is paid, the state will have lower claim rates and genuine savings on auto insurance for all drivers. (Drivers across the state have already enjoyed an 8.7 percent reduction in their 2006 rates and recent news suggests that statewide drivers are in line for another significant reduction in their 2007 rates.)
2. Urban drivers with excellent driving records will have been made advocates for fighting auto insurance frauds within their communities.
3. Insurance companies will have fewer claims to pay out and will have strengthened consumer loyalty with highly-profitable “excellent” drivers in urban communities.
4. A meaningful reduction in high auto insurance bills for urban drivers would encourage families that have worked their way into the middle class to continue to stay and prosper in our cities.
5. Since lower claim rates in urban areas may minimize a potential spike in rates for urban drivers under a competitive system, there should be less resistance from urban legislators to a more competitive auto insurance system.

Potential Opposition

1. Some insurance companies will resist returning any portion of what they gain from a reduction in payouts for fraudulent claims, arguing that these reductions may be short-lived or outweighed by increases in expenses in other categories. In contrast, other insurance companies will be amenable to this proposal since they recognize that they are only being asked to return 25 percent of their savings to the best drivers in the targeted urban areas. These insurance companies also understand that the most profitable drivers to insure in the entire state are these same excellent, claim-free, urban drivers because they pay high rates but do not file claims.
2. Suburban drivers, who are often cynically told that they are already subsidizing urban drivers, may object to the special reductions earmarked for urban drivers when urban communities reduce the number of false claims. However, the break received by urban drivers must be substantial enough to engage them in the effort to fight false claims or the reductions achieved in the last two years will be lost. If urban drivers do not receive meaningful relief, they will not become politically involved, and unless they become politically involved, there will be no effort and no reduction in fraudulent claims, and the rates will remain the same for everyone. In other words, suburban drivers will only get a reduction if they allow urban drivers to receive a greater reduction.

Relevancy to Massachusetts

Everyone acknowledges that the State of Massachusetts suffers from high insurance rates and high rates of fraudulent claims, and up until recently, it has been able to do little about either. Partly because of the aggressive policies discussed, both rates have dropped, and the preliminary 2006 data presented at the Division of Insurance’s rate-setting hearing in August indicate another fall in accident-related claims, which should show up next year as another cut in insurance rates. While at some point insurance rates will bottom out after most of the fraud has been rooted out, we know we are not there yet since several major urban areas are still at an early stage of their fraud crackdown. That is why properly incentivizing our urban areas to intensify and sustain the pressure of these crackdowns will continue to pay large dividends for all Massachusetts drivers.

However, addressing the fraud issue alone will not be enough to reduce the statewide claims rate to the level it could be. Senator Tucker has recently introduced legislation S.656, An Act to Reduce Auto Insurance Costs and Premiums in the Commonwealth, which will examine a number of ways to improve safety on our roads and thereby further reduce insurance premiums: providing discounts for driver education and safety programs, identifying and redesigning the most dangerous intersections, and improving the enforcement of traffic violations.

Conclusion

Lawrence’s story clearly illustrates that it is possible to dramatically reduce fraudulent claims by creating teams of law enforcement, insurance companies, and citizens to send a loud, clear, and sustained message that fraud will not be tolerated.  Less fraud has meant large savings for drivers across the state.

The debate over the Massachusetts auto insurance system is only likely to get hotter in the months ahead. A statewide policy that uses financial incentives to encourage urban drivers to reduce claims will not only lower rates for all drivers in Massachusetts, it will also help address the fundamental political tension between urban and suburban drivers when reforms are proposed.