Behavioral Factors and Lotteries under No-Fault with a Monetary Threshold: A Study of Massachusetts Automobile Claims

Abstract

Kahane, Yehuda and Haim Levy, 1975, Regulation in the Insurance Industry: Determination of Premiums in Automobile Insurance, Journal of Risk and Insurance, 42:117-132. Keeton, Robert E. and Jeffrey O'Connell, 1965, Basic Protection for the Traffic Victim (Boston: Little, Brown). Mahoney, Patrick F., Bruce Hill, and Emily Norman, 1991, No-Fault Verbal Thresholds: How Is One Pierced?, Journal of Insurance Regulation, 9: 482-496. O'Connell, Jeffrey and Robert H. Joost, 1986, Giving Motorists a Choice Introduction Rapidly increasing bodily injury (BI) claim costs constitute the primary automobile insurance problem of the 1990s. A study by the Insurance Research Council (1990) documents a disturbing national trend: bodily injury claim frequencies are rising despite stable or falling accident rates. Cummins and Weiss (1991) find increasing bodily injury claim frequencies in national data reported for 1983 through 1987. They determine that rapidly increasing medical costs are the single most important factor in determining the BI pure premium (the loss cost per insured car) but that the type of compensation system (tort or no-fault) also plays a significant role.(1) Cummins and Tennyson (1992) point out that, between 1984 and 1989, bodily injury losses grew at an annual rate of nearly 9 percent in no-fault states and 11 percent in tort states, despite annual declines of about 2 percent in property damage liability claims. Claims in both tort and no-fault states exhibited the same rising bodily injury claim per personal damage liability claim ratio identified by the Insurance Research Council. This latter phenomenon is often described as a change in claiming behavior but may be more properly identified as one effect of the operation of a personal injury lottery (Cummins and Tennyson, 1994). A lottery will be said to exist when claimants, perhaps assisted by a lottery manager, make behavioral choices to incur the monetary and psychic costs of filing fraudulent or exaggerated claims with the expectation of general (noneconomic) damages as the lottery payoff. We include the disutility of the fear of being detected for the filing of a totally (planned) or partially (opportunistic) fraudulent claim as a psychic cost for the claimant and/or the lottery manager in appropriate cases. The situation in Massachusetts private passenger automobile insurance in the 1990s shows an exacerbation of the national trends of the 1980s. Rate increases for bodily injury coverages for 1990 through 1994 averaged about 18 percent per year (Automobile Insurers Bureau, 1993).(2) Bodily injury liability (BIL) claim frequencies for 1989 through 1992, the latest data available, show an average increase of slightly more than 9 percent per year. At the same time, property damage liability frequencies fell an average of about 3 percent per year causing the bodily injury liability claims per 100 accidents--more precisely, 100 times the ratio of bodily injury frequency to property damage liability frequency--to rise from 23.1 in 1989 to 33.6 in 1992. This 45 percent increase in the claims per accident rate is consistent with the increasing operation of personal injury lotteries. This article provides operational meaning for an auto personal injury insurance lottery and evidence of its operation in Massachusetts. We rely on the detailed analysis of a random sample of bodily injury claims arising from 1989 accidents to identify claims for simple soft-tissue strains and sprains as the likely conduit for the lotteries. After describing the Massachusetts no-fault automobile insurance system, we provide descriptive models of the traditional and lottery claiming operations. Testable hypotheses are proposed for each claim operation type. Then, it is shown that the no-fault personal injury protection (PIP) coverage is not really fault-neutral, especially for soft-tissue injury claims. A close examination of the determinants of claimed medical charges, and their relationship to the $2,000 tort threshold, provide the initial evidence of the presence of insurance lotteries. …