Concerns about Loss Payments and Use of Aftermarket Parts

Summary: The loss adjustment practice of applying betterment reinforces the principle of indemnity. Insurance should put an insured back to the same position he was in prior to a loss. And, if an insurance payment would put the insured in a better position, he should not receive the whole payment. Rather, his payment by the insurer should reflect a reduction for betterment.

The history of auto claims adjustment has been that physical damage losses under a personal auto policy are adjusted on an actual cash value (ACV) basis. ACV has traditionally been defined as replacement cost of the car (the whole car) less depreciation. However, under the current version of the personal auto policy (PAP), insurers may now calculate the ACV of individual parts. For example, an insured who punctures his radiator in an accident does not get a new radiator. Rather, he gets the new radiator less his deductible less an amount for betterment because he now has a better radiator.

This process is discussed in this article.

Topics covered: Introduction Limit of liability provision A dictionary definition Examples of losses What's the solution?

Introduction

As mentioned, betterment is a practice that reinforces the principle of indemnity. An insurance payment should put an insured back in the same position as prior to the loss. If it would better him, the insured should receive only a partial payment. For example, if an insured's car suffers hail damage and the car is repainted, he has a car that is worth more. Betterment would properly apply.

Limit of Liability Provision

The Personal Auto Policy, PP 00 01 01 05, will pay the lesser of the following:

1.The actual cash value of the stolen or damaged property; or

2.Amount necessary to repair or replace the property with other property of like kind and quality.

The addition of the wording “with other property of like kind and quality” in the 1994 edition of the form supports the betterment wording and should allow insurers to use aftermarket repair parts. For clarification, aftermarket parts are produced by a company other than the auto manufacturer.

The policy also allows an adjustment for depreciation and physical condition in determining actual cash value but only in the event of a total loss. In the event of a partial loss, the policy states, “If a repair or replacement results in better than like kind or quality, we will not pay for the amount of the betterment.”

The PAP incorporates anti-betterment language into the policy. Some insurers are applying this provision not only to the entire vehicle but also to its parts.

A Dictionary Definition

Because the policy does not define “betterment,” a common dictionary definition applies. Webster's Ninth New Collegiate Dictionary says that betterment is “an improvement that adds to the value of a property or facility.”

The problem is that many auto insurers contend that any new part added to a car after a loss constitutes betterment, such as new computers, new paint, a new radiator, or a new water pump. The opposing view is that even though the radiator may be new, the rest of the car is still older and the value has not really increased; there has been no betterment. A new radiator does not add to the market value of the car.

Examples of Losses

Many agents have provided examples of how this interpretation has been applied. For instance, an insured ran over an object in the road. The oil pan was punctured and the oil drained out rapidly. As a result, the engine had to be rebuilt. The cost to rebuild the engine (with 75,000 miles on it) was $1,612.93. According to the 1989 policy—before the wording “with other property of like kind and quality” was added—the insured would receive a check for $1,412.93, after applying a deductible of $200 (presuming that the car had an ACV of more than the amount of the loss).

However, this particular loss was not adjusted in that manner. The insurance company's position was that the average life span of an auto engine is 100,000 miles, and applied a betterment penalty of 75 percent to the settlement. $1,612.93 less 75 percent is $403.23. To that the insurer then applied the deductible, and the insured received a check for $203.23. Since the total repair price ($1,612.93) included parts and labor, the insurer applied betterment to both parts and labor.

Another claim involved a 1988 auto that suffered flood damage. The computers necessary to run the car (located under the front seat) were damaged by rising flood waters. The repair cost $1,625.49. With a $500 deductible, the expected recovery amount would be $1,125.49. Instead, the insurer took an electrical betterment of 10 percent per year—60 percent total—and paid the insured $543.23.

On the other hand, computers do not gradually get worse. They either work or they do not. The contention of the agent was that when the insured got new computers for old, he did not get a better car. He just got his car back in working order. Again, this adjustment would have been no problem under the 1989 policy. If the ACV of the car were more than $1,625.49, the insured would have been paid $1,125.49.

When the air conditioner in a 1983 Mercedes caught fire, the insurer applied a betterment of 10 percent per year, subject to a maximum of 80 percent. The amount of the claim was $4,605.47. Under the 1989 policy, the insured would have been paid this amount less his $200 deductible and an amount for the part that actually failed and caused the fire. Again, due to the insurer's strict reading of the betterment provision, this insured received only $2,780.77.

In another case, an insured had the same problem with the assigned risk fund in a northeastern state. A man was leaving work one night when he swerved to miss a dog. He hit the curb, doing considerable damage to his car. His car was a 1991 Honda Accord with all the bells and whistles and not quite 60,000 miles on it.

The total repair was $3,387.94. The auto fund took a 59 percent betterment on the loss, and the insured spent $1,318.78 plus his $500 deductible. However, what is really interesting is that the auto fund's policy does not contain the language allowing for an adjustment due to betterment. It allows only for use of parts of “like kind and quality, with deduction for depreciation.” Thus, the auto fund would have been fine to repair the car with aftermarket parts, but was, apparently, out of line in making an adjustment for betterment.

There would have been no problem with this loss under the wording of the 1989 policy. The automobile blue book showed that this car had a trade-in value (ACV) of $10,225. Since the ACV was more than the repair estimate, the insured would have been paid $2,887.94, after applying his deductible.

What's the Solution?

The issue of betterment should be addressed on personal auto forms. One way to do this is to add a definition of betterment. Another way is to clarify how betterment is to be applied. Some companies have already stated that the only type of betterment to be considered will be that which betters the value of the entire car, not just of its individual parts. A third solution is to add examples of losses and potential loss adjustments to the policy.