Conflict over the settlement of totaled vehicle claims remains one of our most litigated issues of the day. Typical allegations in the litigation include insurers' failure to comply with laws dealing specifically with totaled vehicles, breach of contract, unfair claims practices, fraud, unjust enrichment, failure to provide proof that the various computer formulas used to determine a totaled vehicle's value have been appropriately validated, and misuse of statistical methods.
The principal focus of this commentary is the regulatory standards for settling total losses and a comparison of how the market for settling total losses is distinguished from the automobile retail market. A future commentary will describe some of the statistical problems that insurers face in using third-party vendor computer programs to value total losses.
The Regulatory Standard
The regulatory gold standard for settlement of totaled vehicle claims is the Property and Casualty Unfair Claims Settlement Practices Model Act 902, Section 8 (A), adopted by the standard setting body for insurance, the National Association of Insurance Commissioners (NAIC). Section 8 (A) sets the conditions for settling total losses, namely the following.
A. When the insurance policy provides for the adjustment and settlement of first party automobile total losses on the basis of actual cash value or replacement with another of like kind and quality, one of the following methods shall apply:
The insurer may elect to offer a replacement automobile that is at least comparable in that it will be by the same manufacturer, same or newer year, similar body style, similar options and mileage as the insured vehicle and in as good or better overall condition and available for inspection at a licensed dealer within a reasonable distance of the insured's residence. The insurer shall pay all applicable taxes, license fees and other fees incident to transfer of evidence of ownership of the automobile paid, at no cost other than the deductible provided in the policy. The offer and any rejection thereof must be documented in the claim file.
The insurer may elect a cash settlement based upon the actual cost, less any deductible provided in the policy, to purchase a comparable automobile including all applicable taxes, license fees and other fees incident to transfer of evidence of ownership of a comparable automobile. Such cost may be derived from:
The cost of two or more comparable automobiles in the local market area when comparable automobiles are available or were available within the last ninety (90) days to consumers in the local market area; or
The cost of two (2) or more comparable automobiles in areas proximate to the local market area, including the closest major metropolitan areas within or without the state, that are available or were available within the last ninety (90) days to consumers when comparable automobiles are not available in the local market area pursuant to Subparagraph (a); or
One of two or more quotations obtained from two or more licensed dealers located within the local market area when the cost of comparable automobiles are not available pursuant to (a) or (b) above; or
Any source for determining statistically valid fair market values that meet all of the following criteria:
The source shall give primary consideration to the values of vehicles in the local market area and may consider data on vehicles outside the area;
The sources data base shall produce fair market values for at least eighty-five percent (85%) of all makes and models for the last fifteen (15) years taking into account the values of all major options for such vehicles; and
The source shall produce fair market values based on current data available from the surrounding location where the insured vehicle was principally garaged or a necessary expansion of parameters (such as time and area) to assure statistical validity. [Emphasis added.]
The Act further specifies the following.
(3) When a first party automobile total loss is settled on a basis which deviates from the methods described in Subsections A (1) and A (2) of this section, the deviation must be supported by documentation giving particulars of the automobile condition. Any deductions from the cost, including deduction for salvage, must be measurable, discernible, itemized and specified as to dollar amount and shall be appropriate in amount. The basis of the settlement shall be fully explained to the first party claimant.
Actual cash value (ACV) and fair market value (FMV) are not defined in the statute. ACV has three meanings in the insurance industry, one of which includes FMV. Traditionally, ACV in the insurance context means replacement cost minus depreciation. It can also involve a much broader notion called the broad evidence rule, which requires an adjuster to consider all relevant evidence to determine a vehicle's value, including replacement cost less depreciation and FMV.
FMV, of course, is viewed by some as a third method of setting value. It is defined as "the probable price at which a willing buyer will buy from a willing seller when both are unrelated; neither party is under any compulsion to buy or sell; all relevant facts are known; and the transfer from seller to buyer is all inclusive."1
ACV and FMV are sometimes treated as different ways of saying the same thing; indeed, some states mandate that ACV and FMV are the same, while others are silent on the question. Yet, to some, a simple formula like "ACV equals replacement cost less depreciation" does not seem the same as a back-and-forth negotiation presumed to occur under an FMV transaction.
About the Many Markets for Vehicles
Based on the model law's wording, it is a reasonable inference that "market" means retail automobile dealer market, and the initial focus ought to be in the local market area. In fact, the statute relies heavily on retail auto dealers and automobile industry data for implementation. Such reliance on the automobile industry's sales data implies that data used for determining a vehicle's value should be independent of the insurance industry—otherwise, insurers would control both the data sources in addition to authority for determining the value of a totaled vehicle.
Automobiles change hands in different markets. For example, the wholesale market is for dealers who buy from manufacturers for sale in the retail market.
Retail purchases involve at least five types of transactions: cash, trade-in plus cash, trade-in with credit, full credit, and direct purchase through online sources. Multiple additional options are also available in automobile dealerships, including extended warranties, automobile clubs, and credit life and disability insurance. Adding further to the complexity of retail markets are used vehicle only, new vehicle only, and a mixture of the two in the retail businesses.
Likewise, dealerships where the sticker price is nonnegotiable (think CarMax) will certainly be influenced by different factors in the exchange than one in which bargaining over price and options occurs. The trade-in market in which owners trade in one used car for another used vehicle may find different factors at work than one in which a used vehicle is traded for a new one. Finally, modern technology permits a buy direct option, essentially operated as a "choose what you want," an Amazon-like system of purchase. Tesla, for example, sells its vehicles directly to buyers, and other models are considering bypassing dealers and adopting some form of the Tesla example.
I label transactions taking place in these markets the automobile regular market.
Vehicle sales also occur among private individuals, wherein transactions are consummated under various circumstances. For example, an auto advertised for sale to strangers may have a higher asking price than one in which an automobile is sold to a relative or friend. An owner who sells a vehicle to erase a debt will operate under a different type of pressure than a seller who brings more leverage to the table.
The salvage market, sometimes referred to as the recycled market, constitutes a specialty market triggered largely by totaled vehicles. Approximately 12 million vehicles are recycled each year in the United States, many of which are sold through auctions at wholesale prices.
The insurer-insured transaction in settling a totaled vehicle claim may also be viewed as a separate but very special kind of market, one in which there are only two parties—an insurance company and an insured. No one else competes in that market, which I call the insured totaled vehicle market.
Given the terms of the model act, an insurer's inclusion of anything other than retail transactions occurring in the automobile regular market is inconsistent with the NAIC standard for valuing totaled vehicles. More specifically, the standard is based on retail transactions occurring in the market controlled by licensed automobile dealers. Further, any database, whether electronic or otherwise, that mixes retail sales data with a nonretail source contaminates the database; therefore, any estimate of a totaled car's value involving nonretail vehicles lacks validity under the NAIC model.
As an administrative law judge opined in construing Rhode Island's regulations on valuing totaled vehicles, "The statutory language is clear and ambiguous, but if intent was to be considered, the intent of the statute is to ensure that total loss values are to be determined by a nationally known and accessible standard publication used by the automotive industry in order to avoid disparities in values."2
A caveat is in order, though. Reliance on dealership transactions does not lead to the conclusion that the dealer and insured totaled vehicle markets are "comparable" mirrors of each other. Indeed, third-party vendors may conduct either simulation or use other methods to represent what goes on between automobile regular market buyers and sellers in determining what ought to be offered to settle a totaled vehicle claim; however, the insured totaled vehicle market shows distinct differences from the retail automobile market, and in addressing disputes in the valuation of totaled vehicles, standards of fairness may be compromised if the adjusting process disregards the differences.
Markets Are Distinct Platforms
In the automobile regular market, both buyer and seller engage in a voluntary mutual exchange. Either party may walk away from the negotiating table with no further obligation to the other; conversely, the insured totaled vehicle market creates a relationship that neither party desires. The insurer is asked to spend money on a claim. The insured claimant may need transportation and medical care for the vehicle owner, injured passengers, or both. Further, if a collision is involved, liability to third parties may be of concern. If violations of law are involved, the insured may face serious legal consequences. It is also important that government creates a market for automobile insurance by mandating minimum coverages as a condition for driving on public thoroughfares. This requirement adds to the absence of choice in the insurer-insured relationship.
The relationship between an insured and the claims adjuster is a matter of contract under which a policyholder's premium purchases a property interest for the insured. In return for the premium, the insurance company makes a promise to pay under certain conditions; consequently, a claim is a demand for collection on that property interest.
Additionally, in the automobile regular market, rules of caveat emptor are prevalent. However, the rules are different for the insured-insurer relationship, which is based on a contract widely regarded in the insurance world as one of utmost good faith. Mutuality is created by the insurance policy. So, whether the insurance adjuster and insured were acquainted before the claim, they had a preexisting relationship created by that contract. In the automobile regular market, the parties have no mutuality concerns.
Further, in the automobile regular market there are multiple sellers, and a consumer is exchanging money for a vehicle. If acceptable arrangements can't be made with a particular dealership, the consumer may seek other sellers. In contrast, in the insured totaled vehicle market, there are two parties, the insured and the insurer, and a claim is nontransferable to another insurer. One cannot shop around for a better deal. The consumer is seeking a fair amount of money from the insurer, so the buyer-seller relationship is reversed. In fact, the totaled car already has been paid for when the insurance policy was issued, and the parties are just deciding how much the insured will be able to collect.
Also, the insurer may spread its payment risks among thousands of insureds and through reinsurance arrangements, but if the insurer's determination of vehicle value is insufficient to pay the entire balance of a loan, whether correct or not, the insured must pay out of pocket.
In the automobile regular market, multiple products may be in play during a sale. To repeat, these include a trade-in, extended warranties, dealer financing, auto clubs, and maintenance contracts. None of these factors are part of the insured totaled vehicle market, where it is all about the money. Add to this the fact that insureds are novices at resolving insurance claims while the insurer may handle hundreds each day, thereby adding to the imbalance of insured totaled vehicle market forces.
The NAIC Model Act and the state variations thereon assign the retail automobile industry a prominent position in determining the value of totaled vehicles. Retail sales data form the basis of valuations and, therefore, data summary data published by dealers' associations are preferred data sources. One consequence of this fact is that the insurance industry's ability to develop its own separate database may confront challenges if the database is based on settlements made by the insurer.
One might also infer that attempts by either insurers or vendors to simulate real market conditions to show that any particular algorithm captures real market behavior is a spurious representation given the differences between the automobile regular market and the insured totaled vehicle markets.
Other obstacles to settling totaled vehicle claims using statistical models without compromising the insurance contract and principles of utmost good faith are the subjects of future commentaries.
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