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How does no-fault insurance work?

 

Marcus Pickett

No-fault auto insurance is a system where an insurance company pays the claims for its own covered drivers, regardless of fault. Currently the law in 12 states, no-fault auto insurance was designed as a way to combat the costs and delays associated with lengthy claims adjustments and tort action (lawsuits).

How does no-fault insurance work exactly? And, if you're moving to a no-fault state from a so-called "tort state," what kind of coverage do you need to buy?

No-fault states vs. tort states

In tort states, fault is determined after an accident -- and the at-fault driver's insurance company is the one that pays up. Tort states require drivers to buy certain amounts of liability insurance to cover the damages they cause to other drivers, their cars and others' property.

In no-fault states, each party in the accident is covered by his or her own insurance policy when it comes to medical costs and lost wages, regardless of who's at fault. As a result, the policies that drivers in no-fault states are required to buy are a bit different. Drivers in no-fault states are generally required to get auto insurance that includes:

  • Property damage protection: This covers any damage you do to others' property, according to the Michigan Office of Financial and Insurance Regulation.
  • Personal injury protection (PIP): This covers your medical costs in the event of an accident. In addition to medical bills, it covers wages you would have earned during the time you were unable to work. If you are killed, the payouts go to your family.

There are a few variations on the no-fault model. Three "choice no-fault" states (Kentucky, New Jersey and Pennsylvania) still allow their drivers to choose whether they want to be insured under the traditional tort or no-fault system, according to the Insurance Information Institute. "Add-on" states (Arkansas, Delaware and Maryland, along with Washington, D.C.) give drivers the option of buying PIP that pays claims regardless of who's at fault. But this extra insurance coverage does not prohibit an injured driver from suing the other driver.

The no-fault auto insurance system is an attempt to cut down on the cost of lawsuits by limiting the ability to sue for damages, according to the Insurance Information Institute. No-fault laws in some states do allow one party to sue the other, but only in narrow circumstances, such as serious or particularly expensive injuries. In theory, if insurance companies aren't paying millions in court costs, the savings get passed on to customers.

Unintended consequences
 
Despite the fact that the no-fault system is meant to reduce costs by limiting lawsuits, most no-fault states have higher-than-average premiums. Population density and accident rates are still the biggest factors for setting auto insurance premiums in any given, state, according to the Insurance Information Institute. Yet there are certain features of no-fault auto insurance that could be inflating premiums:

  • Medical coverage: Requiring drivers to purchase PIP means that insurers are required to foot their medical bills. Michigan is unique in that it allows unlimited care under its PIP coverage, according to the Insurance Information Institute. As a result, claims in the state are generally more expensive than those in no-fault states, according to the RAND Institute of Civil Justice.
  • Auto insurance fraud: The no-fault system may unintentionally be encouraging auto insurance fraud. Staged accidents, in which scammers partner with unscrupulous health care providers to make false injury claims, have become a huge problem. In Florida, questionable claims linked to this type of auto insurance fraud jumped 119 percent from 2008 to 2010, according to the National Insurance Crime Bureau. States with no-fault insurance systems are more vulnerable to this type of fraud. Shorter, state-mandated periods for injury payments give insurance companies limited time to investigate accidents and figure out whether fraud has taken place.

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