As mentioned above, the Michigan Catastrophic Claims
Association was created by the legislature in 1978 to address the problem that
many insurers were unable to afford reinsurance protection for the portion of
unlimited PIP coverage that they were financially unable to retain as their
sole responsibility. Under the MCCA's excess reinsurance, a primary insurer
pays a reinsurer to cover the amount of a claim in excess of a fixed level,
known as a "retention." When the costs of a claim exceed that retention level,
the reinsurer pays that portion of the claim or reimburses the primary insurer.
This prevents a primary insurer from being made insolvent by a single large
Different retentions are appropriate for different insurers,
depending on factors such as size. However, the MCCA legislation mandated
participation by all insurers at a $250,000 level. This was too large for some
insurers, which had to buy additional reinsurance to cover the gap between an
appropriate retention and $250,000. Larger insurers had to pay for reinsurance
at that level whether they needed it or not. In essence, this fixes prices for
reinsurance. Consumers cannot benefit from lower premiums resulting from
reinsurance savings that efficient primary insurers might otherwise obtain.
Legislation passed in 2001 implemented gradual annual
increases in the MCCA retention, up to $480,000 effective July 1, 2010, then
to $500,000 effective July 1, 2013, and thereafter increased biennially by 6
percent or by the same rate of increase as the consumer price index (CPI),
whichever is less. None of these retentions is any more appropriate for any
particular insurer than the original $250,000. The arbitrary nature of these
increases is evidenced by the fact that in 2001 a legislature that was
interested in adjusting the retention to reflect CPI increases would have
raised the original $250,000 retention to approximately $800,000, rather than
the $300,000 it actually mandated for 2002.
The MCCA is required to calculate annually the total
premiums that will be needed to pay all claims that will be incurred in the
ensuing year. This immediately proved difficult (something that private
reinsurers already knew and that explains their reluctance to provide the
reinsurance for an unlimited amount). That total is then assessed to all
insurers according to the number of vehicles each insures. Technically the
assessment is calculated on a "car year" basis — one year of coverage for one
car. The assessment for the first year was $3.00. By the 10th year, the amount had
increased to $22.67 — $15.77 to cover the year's anticipated losses, $6.81 to
apply to prior year deficits, and $0.09 for MCCA expenses. In later years the
assessment has ranged between $5.60 and $143.09. For the year beginning July 1,
2010, the largest assessment on record consists of $116.84 to cover the year's
claims and $26 to reduce a deficit, and $0.25 to cover MCAA administrative
Some critics have contended that the volatility in
assessments results from mismanagement or incompetence, but in fact it is
caused by PIP coverage being unlimited. When an accident occurs, an insurer
must establish a liability, known as a reserve, on its books equal to the total
anticipated payments it will make on the claim. For serious accidents, this can
amount to hundreds of thousands of dollars per year for many years in the
future, often for the lifetime of the injured person. When notified of the loss
the MCCA must establish a reserve for the amount in excess of the retention. If
the MCCA set such reserves for the total amount that would be paid over time, the
annual anticipated losses that help determine its required annual premium would
be dramatically increased, resulting in enormous increases in that premium and
thus in per-vehicle assessments as well.
These claims will be paid out over long period, so the MCCA
does not need to collect all the money at once. Instead, it discounts the
reserves based on anticipated investment income it will receive over the
duration of the claim payments. This discount reduces the amount needed for assessments.
Meanwhile, medical costs are likely to increase over time, so the MCCA includes
these increases in its calculation, thus increasing the amount it might
otherwise need to collect. Anticipated investment income normally exceeds the
anticipated increase in medical costs, so the net effect is to reduce the estimate
of premiums and assessments needed to pay all the claims. This discounting has
a dramatic effect. In 2010 the future payments for 12,404 active claims are expected
to exceed $71 billion, but the discounted reserves are about $12.7 billion.
The difference is billions of dollars that did not need to be collected.
Nonetheless, the rates assumed for investment income and
medical inflation are necessarily estimates. No one can be certain of
investment returns over the next several decades, and no one can be certain of
how much medical costs will increase. No one can even predict the cost of claims
in the next year. Conditions change over time. The MCCA must acquire as much information
in these areas as possible and adjust its assumptions about interest rates,
stock market returns, inflation, and claims trends.
There are additional unintended consequences arising from
the methodology chosen by the legislature to determine the per-vehicle
assessments each year. That assessment is determined on a car-year basis (a
unit of measurement to which a rate is applied to determine a premium).
Regardless of the type of motor vehicles insured by a company, the per-vehicle
charge for a particular year will be the same for all vehicles. No consideration
was given to the possibility that the actual claim cost for some classes of
motor vehicles would vary significantly from the average charge imposed by the
MCCA. One of those classes is historic vehicles, which were legally recognized as
an exception in 2003. Under this exception, the charge for "historic vehicles"
is 20 percent of that for other vehicles. The 20 percent charge was not based
on any data about the actual costs of that class, but was a political
concession to a special interest group whose vehicles obviously have smaller
exposure to catastrophic losses.
At the time of that legislative change, a more significant
class with claim costs well below average — which had actually been measured by
the MCCA — was brought to the attention of legislators. Commercial vehicles,
based on an actuarial analysis of the period from September 1, 1996, through
December 31, 2001, had an average annual MCCA-covered loss of $10.78 per vehicle.
Private passenger cars had an annual average of $62.31. The annual average for motorcycles
was $151.04. But all three were charged the same annual assessment.
An example of the impact of this scheme is the 2002 MCCA
assessment of $71.15 per vehicle. Had that assessment been distributed among
the three classes in proportion to the MCCA claim costs of the previous five
years, commercial vehicles would have paid $12.77, motorcycles $179.04, and
private passenger vehicles $73.85. Commercial vehicles subsidized the other classes
to the tune of $58.38 per vehicle for a total overcharge of approximately $29
million, based on an estimate of 500,000 insured commercial vehicles.
The reason for the much smaller per-vehicle claim costs for
commercial vehicles is that when an employee is injured in a commercial vehicle,
and insurance is available from both the employer's workers' compensation and
automobile policies, the workers' compensation policy pays first. The employer
pays the cost of the injuries through its workers' compensation policy, but
then, because of the MCCA subsidy, has to pay again for the injuries through
its automobile policy premiums. The extra $29 million could have helped create
a lot of jobs in Michigan. The legislature addressed the issue of commercial
overcharges in 2003, but due to the opposition of insurers that wrote predominantly personal lines and that
apparently did not want to see a $2.70 (3.8 percent) increase in the
per-vehicle assessment paid ultimately by their customers, the subsidies
continued. As a result, no action was taken, and the MCAA overcharges — of 450 percent
on Michigan businesses — have continued to the present day.
As noted, the MCCA assessment is now significantly higher
than in 2002 and has been so for all the intervening years except 2003, when it
was $69.00. The negative impact on Michigan business investment has therefore
probably been even greater than in the above example. The MCCA's board should
initiate a study to determine that economic damage. Lawmakers should change the
law to require that commercial vehicles be assessed by the MCCA based upon
their actual claims experience.