First‐Party Versus Third‐Party Compensation for Automobile Accidents: Evidence From Canada

• Published date: 01 March 2010
• Author: Anne Kleffner,Mary Kelly,Maureen Tomlinson
• DOI: http://doi.org/10.1111/j.1540-6296.2009.01177.x
• Date: 01 March 2010

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Risk Management and Insurance Review, 2010, Vol.13, No. 1, 21-44

DOI: 10.1111/j.1540-6296.2009.01177.x

FIRST-PARTY VERSUS THIRD-PARTY COMPENSATION

FOR AUTOMOBILE ACCIDENTS:EVIDENCE FROM CANADA

Mary Kelly

Anne Kleffner

Maureen Tomlinson

ABSTRACT

Insurance regimes for compensating losses arising from automobile accidents

vary by jurisdiction, ranging from a pure tort system to a pure no-fault system,

with both systems having well-documented benefits and costs. The majority

of published research focuses on the benefits and costs associated with the

compensation for bodily injury. This article extends the existing literature by

examining the differences between first-party and third-party recovery for both

physical damage and bodily injury losses in Canada. Our comparison of auto

insurance costs per insured vehicle suggests that government-run, pureno-fault

provinces have lower average costs than provinces with private tort and modi-

fied no-fault. Lower costs arise from the elimination of tort costs associated with

noneconomic damages, lower claims settlement costs due to first-party compen-

sation, and scales of economy arising from monopoly power.The second goal of

the article is to examine the impact of first- versus third-party compensation on

the settlement of property damage claims. We analyze the claim files of a large

insurer that operates within both a traditional tort (third-party) environment

and a first-party recovery environment for property damage. We find that in a

first-party recovery regime claims are settled sooner,settlement costs are lower,

and not-at-fault drivers are compensated at a higher rate than in the traditional

tort environment.

Mary Kelly is an Associate Professor in the School of Business & Economics, Wilfrid

Laurier University, Waterloo, Ontario, Canada N2L 3C5; phone: (519) 884-0710, ext. 2551;

e-mail: mkelly@wlu.ca. Anne Kleffner is an Associate Professor in the Haskayne School of Busi-

ness, University of Calgary, Calgary, Alberta, Canada T2N 1N4; phone: (403) 220-8596; e-mail:

Kleffner@ucalgary.ca.Maureen Tomlinson is Manager, Business Services for The Economical In-

surance Group in Kitchener,111 Westmount Road South, Ontario, Canada; phone: (519) 570-8500,

ext. 42502; e-mail: maureen.tomlinson@teig.com. The authors would like to thank the insurance

company executives who provided insight and feedback for this project. We are also grateful

to David Chan for research assistance on the project, Gilles Bernier for helpful comments and

assistance in obtaining data, and the Insurance Bureau of Canada and Manitoba Public Insurance

for providing data. This article was subject to double-blind peer review.

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22 RISK MANAGEMENT AND INSURANCE REVIEW

INTRODUCTION

Insurance regimes for compensating persons injured in automobile accidents vary across

jurisdictions. On one end of the spectrum are pure tort regimes whereby persons are

compensated for their injuries only if another party is at fault, with payment coming

from the at-fault driver’s liability insurance. The third-party insurer pays for the loss,

and there is no first-party compensation. In contrast, there are pure no-fault regimes

whereby injured parties are fully compensated for their injuries by their own insurer,

even if they are at fault, and have a complete prohibition against any right to sue an

at-fault party. In this regime, the first-party insurer provides compensation.

Dissatisfaction with existing tort regimes led to the development of no-fault insurance

(Lascher, 1999). Proponents of no-fault claimed that it would overcome many of the

inefficiencies and inequities of the existing tort regimes: achieving faster settlement of

claims, lower claim settlement costs, and more accurate compensation for economic

losses (O’Connell, 1989; Keeton and O’Connell, 1965; among others). No-fault regimes

attempt to compensate those injured in accidents without regard to fault, while the aim

of a tort regime is to judge fault accurately and to hold the at-fault party financially

responsible. In short, whereas no-fault regimes place a greater emphasis on compensa-

tion, tort regimes place a greater focus on accountability for negligence. Currently, in

North America, most states and provinces have something in between: auto insurance

provides for some level of first-party benefits for injuries and there may or may not be

some restriction on the right to sue.

Many researchers have described the advantages and disadvantages of both tort and no-

fault regimes and attempted to measure the differences between the two. The majority

of the work has focused on insurance costs and compensation for bodily injury since

no-fault regimes in the United States relate to bodily injury only.1It is an empirical

question whether or not no-fault can help control auto insurance costs. Fundamentally,

costs depend on the level of first-party benefits and the threshold that determines which

parties have the right to sue.

This research adds to the literature by examining two key issues. First, we look at the

relationship between the insurance regime (tort vs. no-fault), market structure (private

vs. government run), and insurance costs for mandatory insurance coverages across

Canada. Wecompare auto insurance costs per insured vehicle in three distinct systems—

government-run pure no-fault, private modified no-fault, and private tort—and find

that government-run pure no-fault has the lowest average cost while private modified

no-fault has the highest cost.

Second, we examine the effect of first- versus third-party recovery for not-at-fault phys-

ical damage losses across two Canadian jurisdictions.2With respect to efficiencies in

first-party versus third-party recovery regimes, our research differs from previous re-

search in that we examine the claim files of a large insurer that operates within both a

traditional tort (third-party recovery) environment and a first-party recovery environ-

ment for not-at-fault property damage. Our focus on physical damage, as opposed to

1The exception is Michigan, which operates under a first-party recovery for property damage

claims.

2At-fault property damage losses to one’s automobile are a first-party coverage in all provinces

in Canada.