Return to the CMA: this time its personal

Anyone who undertakes work in the field of credit hire will be well aware of the distorting effect on the measure of damages that the seminal case of Lagden v O’Connor [2004] 1 AC 1067 has had, through the overturning of The Liesbosch [1933] AC 449 and the carving out of the principle, that an impecunious claimant is entitled to claim the full cost of the credit hire charges from a tortfeasor, rather than being limited to the basic hire rate of a comparable car on the open market.

Because there is no “market” for credit hire cars and the purchaser lays off the cost of the replacement car onto the tortfeasor rather than having to put his hand into his own pocket, credit hire companies are free to set their charges at a level pegged not by competitive factors, but rather by what they think they can recover in court. Thus whereas in many contexts where damages are awarded, there will be factors which control the reasonableness of any award of damages, in this particular context there are none.

Conceptually the question as to how you cure this anomaly is not straightforward. One way is to recognise the market failure for what it is and legislate a series of tariffs, akin to the ABI/GTA agreement, which of course only applies to non litigated claims.

This seemed a real possibility a couple of years ago when the CMA was undertaking its review of the motor insurance market, though they decided not to act, given that the change to the law that would be required was disproportionate to the scale of the problem.

A copy of the final report published by the CMA can be found here, and is interesting reading for anyone working in this field: Private motor insurance market investigation Final Report.

The key findings made can be summarised as follows when discussing the separation of control between the incurrence of costs and the liability to pay them:

26. Separation occurs because, under tort law, a non-fault driver is entitled to compensation for their loss from the at-fault driver through the at-fault driver’s insurer. The cost liability lies with the at-fault insurer whereas the cost control lies with the party managing the claim. This party is usually the non-fault insurer or an intermediary such as a CMC or a CHC rather than the at-fault insurer. The value of the claim that can be submitted by the party managing the claim is determined not by the actual cost incurred but by the level of claim which a court would consider ‘reasonable’.

27. At-fault insurers have an incentive to ‘capture’ a claim so that they can control costs effectively. A captured claim is one where the at-fault insurer agrees with the non-fault driver that it will manage the claim. We estimated that claims were captured in about 25% of cases. For these captured claims, and for the small proportion of claims where both drivers are insured with the same insurer, the at-fault insurer has both cost liability and cost control such that there is no separation. There is separation of cost liability and control in the remainder of claims.

28. Associated with this separation, the party handling the non-fault claim often has the opportunity to earn a rent by recovering from the at-fault insurer the ‘reasonable costs’ of the post-accident services provided as determined under tort law despite this amount typically being significantly above the actual costs incurred. When the claim is managed by a CMC/CHC, this rent is often ‘captured’ by the party which referred the non-fault claim to the service provider (eg the non-fault insurer or broker) through a referral fee. For example:

(a) Claims handling and car hire intermediaries can charge at-fault insurers more than the costs incurred and compete to obtain work via referral fees, providing non-fault insurers, brokers (and others) with an opportunity to earn a revenue stream

(b) Some, but not all, non-fault insurers directly charge at-fault insurers more than the cost of repairs incurred.

(c) When cars are written off, at-fault insurers may not receive the full salvage value of the car.

29. We found that, as a result of these practices and conduct, there was a higher potential for dispute over claims and an excessive level of frictional and transactional costs, representing inefficiencies in the supply chain.

30. In assessing the competitive effects of this market structure and the conduct of parties within it, we considered a benchmark ‘well-functioning market’ to be a market which delivered consumers’ legal entitlements in an efficient way. Relative to this benchmark, we found three effects on consumers:

(a) Higher costs for at-fault insurers could lead to higher PMI premiums.

(b) The revenue stream to non-fault insurers and brokers (from referral fees and profits on directly-managed claims) could lead to lower PMI premiums.

(c) Separation could have some direct benefits to customers.

31. We found that the higher costs incurred by at-fault insurers were likely to be broadly reflected pro rata in higher premiums. We therefore expected that the effect on individual premiums would vary according to a driver’s risk of having an at-fault accident, being greatest for drivers with the greatest risk.

32. We also found that the revenue stream to non-fault insurers and brokers from referral fees was likely to reduce the premiums charged by insurers (though there was more uncertainty about the extent of the pass-through than in relation to the higher costs leading to increased premiums). We found that the size of this offsetting revenue stream was smaller than the increased costs both because of the transactional and frictional costs incurred in the manage-ment of non-fault claims, and because of some referral fees being paid to parties which did not provide PMI. Therefore, we found that the net effect on PMI was to increase premiums.

33. We found that the effects were greatest in the provision of replacement cars which were often provided by CHCs. We found that the effects were smaller in repairs and write-offs, where different non-fault insurers often had different practices, and frictional and transactional costs were lower.

34. We found that the practices and conduct we identified had some direct bene-fits to customers but these were small relative to the net effect of higher costs. We also recognised that the existence of credit hire was likely to act as a constraint on at-fault insurers providing non-fault claimants with less than their legal entitlement.

35. Overall, we concluded that the following two features had, in combination, an AEC:

(a) separation, ie the insurer liable for the non-fault driver’s claim (the insurer to the at-fault driver) is often not the party controlling the costs; and

(b) various practices and conduct of the parties managing non-fault claims, which (i) are focused on earning a rent from the control of claims rather than simply competing on the merits; and (ii) give rise to inefficiencies in the supply chain involving excessive frictional and transactional costs.

36. We concluded that these features distorted competition in the PMI market. Our central estimate of the net adverse effect on customers was about £110 million per year (with a range from £101 million to £214 million). Of this, about £84 million (with a range from £67 million to £178 million) related to replacement cars.

37. We considered a number of potential remedies including: recommending a change in tort law, which would have the effect of removing separation for replacement cars; measures to make it easier for at-fault insurers to capture claims; price caps on replacement cars, repairs and write-offs; measures to increase mitigation by non-fault claimants in regard to replacement cars; a ban on referral fees; and improved information to consumers on their rights following an accident.

38. We gave serious consideration to a package of remedies which we thought could reduce transactional and frictional costs for replacement cars while protecting non-fault claimants’ ability to obtain their tort law entitlements. This package included a cap on the amount charged for replacement cars (with two rates, the lower rate applying if the at-fault insurer accepted liability quickly), a revised mitigation statement relating to need and improved information to consumers on their rights following an accident. We consulted on this package in our provisional decision on remedies; however, we found that, in relation to the price cap, we did not have powers to implement the remedy as we had envisaged. We then consulted again on an alternative way by which a price cap remedy could be implemented, but found that it could be easily circumvented and there was considerable risk it would give rise to some distortions. We also considered recommending to government to imple-ment the original price cap remedy through a change in the law. Overall, in light of the responses we received, we decided that a price-cap remedy was not likely to be an effective and proportionate remedy to the AEC and/or detriment and, without this key measure, the supporting measures we con-sidered were also not proportionate.

39. We did not find that any of the other remedies we had initially considered would be both effective and proportionate in addressing the AEC and/or detriment. Some of these remedies would have required a change in the law but we found that such measures represented too fundamental a change in rights given the size and nature of the detriment we had found.

40. We recognised that market participants had already developed some measures to address the transactional and frictional costs which arise due to separation, eg a general industry agreement to which both insurers and CHCs can subscribe, and bilateral agreements either between two insurers or between an insurer and a CMC/CHC. In our view, further development of these voluntary measures would be likely to reduce the detrimental effects of the AEC and be beneficial to customers.

41. We also noted that there appeared to be market-wide support for additional information to be given to consumers concerning their rights following an accident, which we wished to encourage.

42. Lastly, we wanted to highlight that although it was apparent why a basic hire rate, based on the retail hire rates for the type of vehicle hired in the location of the claimant, had become the established benchmark in case law for non-fault replacement cars, we questioned whether this was still the most appropriate benchmark given that, following the establishment and expansion of the credit hire industry, very few non-fault claimants now sourced their temporary replacement vehicles in the retail hire market. In our view, the basic hire rate was, accordingly, artificial and, based on the level of referral fees paid to insurers, brokers and others, it also appeared to us too high.

It may be that a tariff system is back on the agenda: the recent whiplash consultation was no such thing: its scope covered not only all types of personal injury cases of modest value, but also tucked away in the detail of the consultation document was a promise to revisit credit hire. A copy of it can be found here: Reforming the soft tissue injury (‘whiplash’) Claims Process.

The government has already published part 1 of its response. Part 2, which I anticipate some time this month, may have some very interesting things to say about credit hire.

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