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Recently, a state court in Marion, Illinois issued a verdict with sweeping ramifications for automobile insurance policyholders nationwide. Associate Judge John Speroni ruled against State Farm Mutual Insurance Company and awarded a class of 4.7 million policyholders $1.2 billion in damages because State Farm used crash parts not produced by original equipment manufacturers (OEMs) in collision repair. The decision threatens the viability of aftermarket crash parts, which provide a competitive alternative to OEM parts for collision repair. It also demonstrates the need for class action reform.
The class-action lawsuit tips the scales in the ongoing debate between insurance companies and automobile manufacturers in a way that ultimately may yield little more than higher costs for consumers across the country. The fact that the decision has implications well beyond the borders of Illinois on issues that have traditionally been addressed by state insurance commissioners raises questions about the use of class action lawsuits and the need for civil justice reform.
Snider v. State Farm Mutual Auto Insurance Co. The decision handed down by Judge Speroni found that State Farm breached its contracts with policyholders by repairing vehicles with non-OEM parts. The plaintiffs claimed that State Farm breached its insurance contract by relying on non-OEM parts when estimating the costs of collision repair for policyholders. The parts in question are generally referred to as crash parts, which include hoods and cosmetic sheet metal and plastic parts such as fenders, body panels, and grilles. Those not produced by OEMs are commonly known as non-OEM parts, aftermarket parts, competitive auto parts (a term used by the non-OEM parts industry), or imitation parts (a designation used by OEM manufacturers). Close to 80 percent of the parts used in collision repair are OEM parts. Of the remainder, 5 percent of the parts come from salvage, 12.3 percent come from non-certified aftermarket parts, and 3.2 percent come from certified aftermarket parts.1
Under the contract stipulation in the insurance policy, State Farm was to return vehicles damaged in accidents to their “pre-loss condition,” and use parts of “like kind and quality.” The case further alleged that non-OEM parts could not return a vehicle to its pre-collision condition and State Farm’s failure to inform customers of this was a violation of the Illinois Consumer Fraud Act. The plaintiffs also sought to prohibit State Farm from referring to non-OEM parts as “quality” parts, due to the alleged failure of non-OEM parts to return a vehicle to pre-crash condition.
In its defense, State Farm pointed to the lack of consumer harm associated with non-OEM crash parts as well as the company’s disclosure policy that informs consumers of the use of non-OEM parts when providing estimates of repair costs. Moreover, the policies issued in many states include specific provisions stipulating the use of non-OEM parts in collision repair, due to the significant savings they provide for State Farm and its policyholders. For example, State Farm states that in 1997 alone, policyholders saved $243 million due to the use of non-OEM parts. The insurer also states that insurance rates were reduced by about $2.5 billion and $1.5 billion was returned to policyholders in the form of lower premiums over the last two years.2
State Farm also provides every policyholder a satisfaction guarantee on any repair job. For example, plastic and sheet metal parts are guaranteed for as long as the customer owns the car. Should a policyholder be dissatisfied with a repair job, State Farm will repair the car once again at no charge. In Addition, other non-OEM parts will have their own warranties equal to, or better than, OEM parts.3 The insurance company also offered evidence that OEM parts offer no guarantees that they will be better than non-OEM parts. For example, there are no external quality checks on OEM parts (non-OEM parts may be certified by an outside facility, while OEM parts are not.)
Taiwan tin or monopoly money? The debate over the use of non-OEM parts is not new. Nor is it surprising that competition in the crash parts market has lowered prices.4 With roughly 35 million motor vehicle accidents every year, insurers have an incentive to seek out low-cost collision repair parts. When suppliers respond to this demand, consumers gain through more choices and lower prices. Not only are non-OEM parts cheaper, but their existence has also put downward pressure on OEM parts. Yet whether such parts can return a vehicle to pre-loss condition has been a raging debate since the market first opened in the 1980s. Automobile manufacturers producing OEM parts refer to non-OEM parts as imitation parts, while others deride them as “Taiwan tin.” Insurers decry the monopoly enjoyed by OEM manufacturers at the expense of consumers, and point to quality control measures such as the creation of a non-profit organization to certify used car parts as a demonstration of the quality of non-OEM parts.
The ongoing discussion concerning the quality of non-OEM parts is a healthy sign of competition that can ultimately yield lower prices and better quality. As consumers become more informed about aftermarket crash parts, there is a greater incentive to produce a broader range of quality parts. As the studies about quality fly between the sparring partners, consumers are becoming better informed and producers are making better products. Yet the court’s recent decision may stifle this growing market; State Farm has already announced it is temporarily suspending the use of aftermarket parts, and just recently, Nationwide, the fourth-largest automobile insurer, announced that it also would be dropping the use of non-OEM parts.5
Quality, safety, and consumer harm. The market is a powerful process that allows producers and consumers to coordinate their plans in a way that provides consumers with the product that most accurately satisfies their demand. Competition in the market for crash parts has provided consumers with more choices about collision repair. The market process, with many producers competing for the consumer’s scarce dollars, generates information that will allow consumers to make informed decisions in the marketplace. In the debate over the use of aftermarket parts, both sides of the debate have produced studies about the quality of their respective products, and both sides can respond to these findings in ways that drive producers to make better products for consumers. At the same time, consumers become more informed, allowing them to make better choices, much the same way they decide whether or not to use an OEM or non-OEM brake pad or shock absorber. Already, the market for automobile insurance has responded to the crash parts lawsuits, with some companies offering special premiums for customers who want exclusively OEM repair parts.6
Much of the debate surrounding the use of aftermarket parts focuses on the quality of the parts produced by non-OEM manufacturers. Car manufacturers assert that OEM parts are superior in terms of both safety and quality, and there are those in the collision repair industry who agree.7 Others in the collision repair industry disagree, as do the insurance companies who rely on the parts for collision repair. To ensure the quality of the non-OEM parts they use, the insurance industry established the Certified Automotive Parts Association (CAPA) in 1987 as a non-profit organization that would serve as the Underwriters Lab for aftermarket parts. The insurance industry still provides roughly 40 percent of the funding for the organization.
The role of CAPA is to test and certify non-OEM parts to ensure their quality. Today, there are over 2,000 certified parts available and more than 7 million certified parts have been sold. To certify a part, a manufacturer must allow an independent testing laboratory to assess its factory and manufacturing processes. Once the facility is approved, the manufacturer submits parts to CAPA for certification. Parts are evaluated on the basis of such criteria as the durability of welds and screws, resistance to chipping and erosion, and so forth. If the parts are in compliance with the standards, the parts may carry the CAPA Quality Seal.
However, many car manufacturers assert that because non-OEM parts are “reverse engineered” and made without access to the original manufacturer’s specifications, they cannot be of like kind and quality when compared to OEM parts. Moreover, car manufacturers assert that the use of non-OEM parts may pose a safety threat. As GM’s general manager for collision parts noted:
|The crash testing and other evaluations we do to ensure compliance with the Federal Motor Vehicle Safety Standards as well as analysis done to meet our own internal guidelines confirms the proper design and assembly specifications are properly in place before we put a vehicle on the market. Any deviation in the use of parts not specifically designed and tested to meet the original specifications, such as the use of imitation/aftermarket parts, can compromise the integral balance between the designed safety systems.8|
Proponents of the use of aftermarket parts contend that safety is not an issue, because the parts are cosmetic in nature. Brian O’Neill, president of the Insurance Institute for Highway Safety stated, “The source of the cosmetic parts used to repair cars has little to do with the possibility of injury in these cars after they’ve been repaired. With but one exception (windshields), there are no federal standards for replacement parts because there’s no reason to believe—let alone assume—that such parts significantly influence car crashworthiness.”9
While the use of CAPA parts for collision repair has increased, the level of complaints about such parts has remained low. In 1997, CAPA received only 985 complaints on the 2.5 million parts that it certified. There are some in the industry who remain concerned about the fit and performance of non-OEM parts, but their use is becoming more common. CAPA has responded to such concerns by adopting new standards to develop a better fit, while implementing even tighter quality control standards on certified parts.10
The fact is that non-OEM crash parts are a growing part of the market. One survey found, that in 1998, 73.2 percent of body shops purchased aftermarket parts and used them on 23.8 percent of their repairs.11 Older cars, especially, are served by the aftermarket for crash parts, because pre-loss condition clearly does not mean “new.” In any event, both sides continue to debate the quality of aftermarket parts. To date, the National Highway Traffic Safety Administration, the federal agency that regulates auto safety, has not deemed it necessary to issue regulations on the use of aftermarket parts. The technical nature and complexities of the debate suggest that a twelve-person jury with a limited ability to assess and evaluate any data they are presented may not be the appropriate mechanism for resolving this dispute.
Class action lawsuits are not a replacement for state regulation. One of the most disconcerting issues in the State Farm lawsuit is the scope of the class certified by the judge and the principles upon which the certification is based. The suit, initially filed on July 28, 1997, was certified as a class action covering roughly five million policyholders in 48 states.12 The class was certified on December 5, 1997, prior to State Farm’s involvement in the case. Upon being summoned with the class action lawsuit, State Farm immediately sought to decertify the class because other courts had previously addressed the issue and refused to certify a nationwide class action.
More specifically, under Illinois law, there are certain requirements that must be met before a class can be certified. Because State Farm is based in Bloomington, the judge may have viewed Illinois as the appropriate state to adjudicate a class action lawsuit against the insurance company. But there are a number of conditions beyond locale that must be met prior to certifying a class. Pursuant to the Illinois Code of Civil Procedure, Sections 2-801 through 2-806, the following elements must be present before a class action may move forward:
1. Numerosity: The class must have so many members that joinder is impracticable;
2. Common questions of law or fact that predominate over questions affecting any individual;
3. The representative party will fairly and adequately protect the interests of the class; and,
4. The class action is an appropriate (not necessarily superior) method for the fair and efficient adjudication of controversy.
Despite the fact that the class represented policyholders in different states subject to different insurance regulations that were governed by different insurance commissions, the court found that the contractual obligation for collision repair was uniform throughout the country. A broad and simplistic contractual obligation allowed the class to be certified. When state laws or regulations are ignored, the entire nation can, indeed, be viewed as a class under Judge Speroni’s interpretation of Illinois state law. The members are numerous, the questions of law have been defined as common, the broad contractual obligation is applicable to any member, and it is therefore appropriate and efficient to address the issue through a class action.
In effect, the decision to move forward with class certification minimized or dismissed the importance of state level insurance regulation. Substantive law from Illinois would prevail over policyholders in all states. Downplaying the distinction between states by referring to a broad contractual obligation to repair ignores important state-level insurance policies. As the National Conference of Insurance Legislators noted in its amicus brief filed in a challenge to the class certification:
|Thirty-six states have taken seven different approaches to insurer specification of non-OEM parts. One state, Massachusetts, requires use of non-OEM parts. Another state, Hawaii, strongly encourages such use by requiring policyholders to pay the price differential if they insist on receiving OEM parts. Twenty-five states permit use of non-OEM parts upon disclosure to the policyholder. Three states permit use without disclosure. Two states permit use with the policyholder’s consent. Three states require consent during a limited time period. One state requires consent for certain types of non-OEM parts. There are even subcategories of different treatment within these seven categories.13|
The court’s certification of the class in the State Farm case is not unique. State courts throughout the nation have been moving forward with class action lawsuits that extend well beyond their borders and involve substantive issues of law that can vary widely from state to state. As John Martin, Jr., Vice President and General Counsel at Ford Motor Company noted, “[State courts] are applying their own state’s laws to all claims asserted in a purported class action, even though the class is comprised primarily of out-of-state residents and even though the laws of those class members’ respective home states may be radically different.”14
The potential abuse of class action lawsuits has spurred a movement for federal legislation to move such class actions to federal jurisdiction. Given the strictures laid out by the U.S. Supreme Court, federal courts have historically relied on a stricter standard for class action lawsuits. The U.S. House of Representatives has already passed such legislation. Ultimately, however, the issue must be resolved through judicial prudence, in any jurisdiction. Judges must critically evaluate all class actions and enforce the requirements of class certification with an eye toward ensuring that a class is, in fact, properly defined with a common purpose. Certifying questionable classes and approving large settlements in damage class actions threatens the court’s credibility. A recent study by the RAND Institute for Civil Justice emphasizes the importance of the judge’s role:
|Judges hold the key to improving the balance of good and ill consequences of damage class actions. If judges approve settlements that are not in class members’ best interest and then reward class counsel for obtaining such settlements, they sow the seeds of frivolous litigation—settlements that waste society’s resources—and ultimately disrespect for the legal system.15|
Choosing the right tool. Both litigation and regulation address the same problem: minimizing risk while protecting consumers from undue harm. The regulatory system offers protection ex ante by establishing rules governing behavior. Litigation on the other hand, provides compensation ex post, making consumers whole after the fact. Research suggests that regulation and litigation can have different outcomes, and dual enforcement by both can leave producers attempting to satisfy competing and sometimes conflicting ends in a way that thwarts innovation while reducing consumer choice.
It is important, therefore, to determine the most efficacious approach to resolve a problem. Regulation may be more effective if the same information applies to a number of individual situations. Rather than have individual litigants collect duplicative data in costly adjudicative procedures, agencies can develop the necessary information in one rulemaking process. Similarly, if an agency’s administrative costs are lower than court costs, a regulatory program may be preferred.
Because agencies and the courts provide similar roles, their authority can overlap; this has generated significant problems in a number of instances. The costs associated with the overlap can be prohibitive. In many cases, businesses may actually pay twice: first, they pay the cost of conforming to regulations; and, second, they pay the cost of litigation. This is particularly true in instances such as the State Farm decision, where the court grants punitive and compensatory damages.16 In fact, one study concluded: “Without coordination of these risk reduction systems, society will rarely invest optimally to achieve the goals of creating efficient incentives and providing appropriate compensation to injured parties.”17
It is generally accepted that regulatory agencies are typically more effective at risk management than is tort law, especially when dealing with complex issues. Agencies such as state insurance commissions are in the appropriate position to gather data and develop clear standards (although the public choice literature demonstrates that even agency decisions are often less than perfect due to rent seeking and information asymmetries).18 However, the legal system is much more costly and is perhaps more suited to a secondary role of dealing with those cases involving highly specific information.19 From an institutional choice perspective, therefore, the issue of aftermarket parts may be more aptly addressed in a regulatory framework. Yet even here, policy must be guided by a goal of fostering a dynamic market, where consumers have the ability to exercise choice.
In the State Farm case, the court’s actions have sent confusing signals to producers, as well as to regulators in other states. The class was certified based on a general concept of a uniform contractual obligation. However, that obligation is by no means uniform; it was carefully established through specific legislation and regulation in the various states.
Conclusion. By seeking out lower cost alternatives to OEM parts, State Farm acted like any firm in a competitive market. Low cost suppliers that can provide quality parts will save insurers money on collision repair and save policyholders money through lower premiums. The market began with increased competition and lower prices. When concerns were raised about quality, the market responded with a seal of approval provided by a non-profit organization. This, in turn, has generated a discussion of experts as the OEMs and non-OEMs critique each other’s work. This generates more information for consumers, who have a choice between policies that only use OEM parts and policies that do not specify the use of OEM parts. It also generates more information to improve the quality of aftermarket parts.
Indeed, State Farm’s practices received praise from across the ideological spectrum, including liberal consumer advocacy groups such as the Center for Auto Safety and the Consumer Federation of America. Yet the Illinois court stepped into this evolving market and brought everything to a screeching halt. State Farm’s announcement that it is suspending the use of non-OEM parts has been followed by a similar announcement from another leading insurer, and trial lawyers are busy filing copycat cases in the wake of the court’s decision. State Farm, CNA, Allstate, SAFECO, Liberty Mutual, USAA, and GEICO have all been named in an Illinois class action, and Hartford and Travelers are being sued in Connecticut.20 In one suit, CAPA, the non-profit organization that certifies parts, also is accused of being a puppet of the insurance industry that is funded by the industry and deceives policyholders about the quality of non-OEM parts.21
The courts should not stifle the development of a new market aimed at expanding competition and reducing consumer prices. State legislatures and insurance regulators have been watching the market unfold and have established specific state laws and regulations to address concerns that have arisen. To be sure, the issue has also pitted insurance companies and car companies in political battles in state houses across the nation. But the debate has been conducted under full public scrutiny with regulatory experts rather than being settled by twelve people sequestered for a short period of time to evaluate this complex issue. To be second-guessed by the courts with a ham-fisted decision only constrains market forces at a time when they are developing to serve consumers more efficiently. Some seek a legal or political resolution to the problem. But a market-based solution that allows consumers to make informed decisions is the best outcome.
1 “Competitive Auto Replacement Parts: Fact vs. Ficton” National Association of Independent Insurers.
2 “State Farm says consumers lose after judge’s class-action ruling,” Inside State Farm Media at http://www1.statefarm.com /media/release/sniderp1.htm (Oct. 8, 1999). 3 Angi Semler “State Farm Parts Policy on Trial, ”Automotive Body Repair News at http://www.abrn.com/news/ 0298new2.htm (February 1998).
4 An annual study produced by the Alliance of American Insurers finds that when non-OEM parts are available, prices of both OEM and non-OEM decline.
5 David Reich-Hale, “Nationwide Insurance to Stop Using Non-OEM Auto Parts,” National Underwriter, vol. 103, no. 47 (November 22, 1999), p.1.
6 David Reich-Hale, “Auto Insurers, Facing Flood of Lawsuits, Forced to Defend Use of Non-OEM Parts,” National Underwriter, December 6, 1999, vol. 103, no. 49, p. 3.
7 Ben McNamara, “Assessing the Quality of Aftermarket Collision Repair Parts,” AutoInc. Magazine, vol. XLVI, January 1998.
10 John Yoswick, “Non-OEM Parts Do Better in Second Demo,” ABRN (January 1999) at http://www.abrn.com/ news/0199new6.htm.
11 Julie Finn, “Aftermarket Crash Parts” Automotive Service Association at http://www.asashop.org/autoinc/jan99/ collision.htm (January 1999)
12 Arkansas and Tennessee were the only states excluded from the class, as were certain State Farm policyholders in Illinois and Florida.
13 Cited in Zack Stamp, “Threat to State Regulation from Trial Bar” FORC Quarterly Journal of Insurance Law and Regulation, (vol. XI, Edition 1, Spring 1999) at http://www.forc.org/journal/spring99/3.htm.
14 Statement of John W. Martin, Jr., Vice President-General Counsel, Ford Motor Company, before the Courts and Intellectual Property Subcommittee of the House Committee on the Judiciary, March 5, 1998).
15 Deborah Hensler, Bonnie Dombey-Moore, Beth Giddens, Jennifer Gross, Erik K. Moller, and Nicholas M. Pace, Class Action Dilemmas: Pursuing Public Goals for Private Gain, Executive Summary, RAND Institute for Civil Justice (1999), p. 31.
16 See Susan Rose-Ackerman, Regulation and the Law of Torts, 81 American Econ. Rev. 2, 54 (1991).
17 Viscusi, (supra) p. 65.
18 Conceptually, agencies can develop optimal safety standards. However, political forces and rent-seeking activity may generate sub-optimal results. See Buchanan, Tollison, and Tullock (eds.), Towards a Theory of the Rent Seeking Society, Texas A & M Press, (1978).
19 Viscusi (supra).
20 David Reich-Hale, “Nationwide Insurance to Stop Using Non-OEM Auto Parts,” National Underwriter, vol. 103, no. 47 (November 22, 1999), p.1, and Amanda Levin, “Hartford, Travelers Sued Over Auto Parts,” National Underwriter, vol. 103, no. 47 (November 22, 1999), p. 30.
21 “Hartford, Travelers Sued Over Auto Parts,” National Underwriter, (November 22, 1999), p. 30.