After market versus OEM parts: The issue is choice

Rough Notes, Dec 1999 by Zinkewicz, Phil

State Farm, the nation's largest auto insurance company, suffered a major setback in October when an Illinois jury ruled that the insurer had breached its contract with policyholders by requiring body shops to use lowerpriced, "after market" parts for crash repairs, rather than parts made by auto manufacturers. The jury ruled that State Farm had to pay $456 million as compensation to policyholders who had filed a total of about 4.7 million claims. Subsequent to that jury ruling, a Marion, Illinois, judge awarded plaintiffs in the case an additional $730 million, finding that State Farm had violated the state's Consumer Fraud Act. Of that $730 million, $600 million was in punitive damages.

The class-action verdict and finding of fraud brought to the forefront once more an issue that has been debated within the insurance industry for years. Do insurers, in auto repair situations, have the right to push for less expensive after market parts to be used in lieu of more expensive OEM (Original Equipment Manufacturer) parts? The answer to that depends very much upon whom you are talking to.

Many insurers, of course, believe the answer is yes. There is, after all, a significant cost saving in using after market parts. In a recent survey by the Alliance of American Insurers (AAI), it was shown that a bumper from a 1996 Ford Explorer cost $370 from Ford and $278 from an independent manufacturer. According to the same survey, a replacement hood for a 1995 Pontiac Grand Am cost $307 from General Motors, as opposed to $254 from an after markets provider. Just those differences alone are significant.

Many insurers believe that the State Farm situation, if upheld upon appeal, could set a precedent that would cost the auto insurance industry overall dearly. David A. Hurst, a State Farm spokesman, said: "We consider the verdict a major setback for our policyholders and the company, and all consumers." Clarence Ditlow, executive director of the Center for Auto Safety and a backer of after market parts,said: "If this decision stands, the auto companies will be sitting fat and happy, getting monopoly prices on crash parts again."

The American Insurance Association was also critical of the State Farm situation. "Not only is this the costliest decision against an insurance company, but it will prove to be the costliest decision against insurance consumers," said David Snyder, assistant general counsel for the AIA. The AIA says that the use of after market parts saves policyholders $800 million a year. Commenting on the court ruling, Snyder said: "The bottom line is that insurance consumers gain nothing and will be hurt in the long run by increased costs. Plaintiffs' attorneys and original equipment manufacturers came out as the winner."

Oddly enough, consumer activists, who usually say "night" when insurance companies say "day," are not all that opposed to after market parts. Some even favor their use if auto insurance costs can be held down as a result. Moreover, regulators in some states have even mandated the use of after market parts if they are available and if they are of "like kind and quality."

But the legal complexities of the State Farm decision aside, one issue that has emerged from the controversy is whether or not auto insurance policyholders are being given the proper choices when purchasing coverages. Here, independent insurance agents have a particular stake because it is axiomatic that an uninformed or poorly informed insured can lead to an E&O lawsuit.

Christoph Ritterson, a vice president of Chubb & Son who is responsible for worldwide marketing of the Chubb Group of Insurance Companies' personal insurance products, believes that, if policyholders are not being given the proper choices, they should be. "On the subject of OEM parts, for example, it's really just a question of what the customer wants," says Ritterson. "We did a survey of our insureds and found that in 80% of cases, they preferred having their autos repaired with OEM parts. So we designed our "Masterpiece Auto Preference Policy" with that in mind. Our policy pays 100% of the cost of original manufacturer parts when repairing the vehicle. That gives the insured the ability to choose the type of replacement parts."

Ritterson also said that many insurance companies rely on their own network of repair shops, which may be located miles away from an insured's home, rather than allowing an insured to choose where the repair work will be done. An insured who insists on using his/her own repair shop may not be fully reimbursed for the labor rates.

"Depreciation of some parts can be one of the unpleasant surprises an insured discovers once the car is at the repair shop," says Ritterson. "Typically, new parts replace used parts. The insurance company may only pay the cash value of the used part, which is always less than the cost of a new part. The amount the insured is paid reflects only the depreciated value of the used parts. The insured has to make up the cost difference between the old parts and the new."