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Every Claim Is Not the Same

Insurance companies have led most consumers and shop owners to believe there’s no difference between first- and third-party claims – even though entirely different sets of laws and rules apply. And these differences can affect every aspect of your shop, from job scheduling to parts selection to liability to profitability.

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An Illinois shop owner recently dealt with the following situation: His customer’s late-model van was damaged when it was rear-ended by a negligent driver. The adjuster for the at-fault party’s insurance company wrote an estimate specifying repair of the tailgate assembly using filler material rather than replacement. The adjuster’s estimate was also written using the insurance company’s "discounted" labor rates.

Not surprisingly, the shop owner disagreed with both the method of repair and the discounted labor rates. So, with his customer’s authorization (but without the insurance company’s "approval"), the shop owner went ahead and replaced the entire tailgate at his posted "door rates" using new original equipment manufacturer (OEM) parts. The end result: The customer received the first-rate repair he was entitled to and the insurance company overnighted a check to the shop in the exact amount of the final repair bill.

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Was this a fluke?

Not at all. It was a properly handled third-party claim.

I got my first glimpse into the inner-workings of the collision repair industry approximately five years ago while representing a woman in a "bad faith" case against her automobile insurance company. To make a long story short, I met with a few shop owners to discuss the damage to my client’s vehicle and ended up spending an even greater amount of time discussing the day-to-day problems owners were facing with regard to getting paid on insurance claims. Since then, I’ve spent a considerable amount of time advising shop owners as to their rights and obligations when dealing with consumers and insurance companies on repair-related issues.

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One of the things that’s always shocked me about this $30 billion per year industry is the lack of comprehension of the differences between first-party and third-party insurance claims. Consumers don’t understand the differences. Some shop owners have a glimmer of knowledge about the issues on a basic level, but only a few have an understanding of all of the implications it can have on their businesses. And, even though insurance companies fully understand the differences, many of them use that knowledge to exploit the ignorance of consumers to the detriment of both the consumer and the shop.

The differences between first- and third-party claims are really a matter of consumer-protection law. However, because the rights and responsibilities of a repair facility are, in almost every case, intertwined with the rights of its customers, anyone whose livelihood is tied to the success of a body shop has a vested interest in making sure he properly understands the issues.

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The reason for this is twofold. First, as the repair scenario described above indicates, repairing a third-party claimant’s vehicle can be less of a hassle and more profitable than repairing an insured’s vehicle. (It’s for this reason that some shop owners who understand the differences have chosen to market themselves exclusively to third-party claimants.) Second, because of the dramatic increase in lawsuits focused on the quality and safety of repairs being performed, shop owners must be aware of the liability issues associated with repairing a claimant’s vehicle.

This is why I hope to give you an explanation (a brief and generalized one) about first-party and third-party insurance claims and how the differences can affect the operations and liability of your collision repair facility. This is not intended, nor should it be construed, as legal advice. Indeed, because insurance law is state specific and can be complicated, there’s no substitute for consulting an attorney who’s knowledgeable about the laws of your state for advice related to any particular situation.

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Contract Law Vs. Tort Law
Illinois, like a majority of states, recognizes the difference between first- and third-party claims. (This is opposed to states that have adopted statutory schemes commonly referred to as "no-fault laws.") Basically, this means that a consumer who’s been involved in a collision caused by another driver may have two options for recovering the cost of necessary repairs:

  1. She can make a claim with her own insurance company (a first-party claim). Or …
  2. She can pursue payment through the party who caused the collision and/or that person’s insurance company (a third-party claim).

As stated by a former director of the Illinois Department of Insurance: "There’s a marked legal difference between an insured and a claimant when filing a claim with an insurance company."

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What it boils down to is that, because there’s a written policy of insurance (i.e. a contract) between a consumer and his or her own insurance company, the express terms of that policy will control the rights and obligations of the parties in the event of a covered loss. And, a failure of either party to fulfill its obligations under the policy would constitute a breach of the contract. Thus, the point to remember is that first-party claims are governed by the law of contracts.

By contrast, there’s generally no contract between two drivers who just happen to get into collisions with one another. Accordingly, their rights and obligations can’t be controlled by contract law since there’s no contract between the parties to enforce. Therefore, their rights and obligations are controlled by a particular state’s statutes as well as what’s commonly referred to as the state’s body of "tort law." Thus, for the purposes of this article, the key point is that third-party claims are generally governed by tort law.

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Right about now you might be scratching your head and wondering what the differences between contract law and tort law could possibly have to do with lost profits for your business. The significance is that insurance companies have led most consumers and shop owners to believe that all insurance claims are created equal – even though insurers know that entirely different sets of laws and rules apply to first- and third-party claims. More importantly, the difference is more than theoretical because it can affect every aspect of a shop’s business, from job scheduling to parts selection to liability for the repairs performed.

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A Typical Policy of Insurance
One of the easiest ways to understand the differences between first- and third-party claims is to consider how a typical policy of insurance is written and organized. In Illinois, for example, a typical policy may contain the following language and be divided into the following sections:

Part I: Physical Damage Coverage.

Collision Coverage. To pay for loss caused by collision to the owned automobile but only for the amount of each such loss in excess of the deductible amount stated in the declarations as applicable hereto.

Comprehensive (excluding Collision). To pay for loss caused other than by collision to the owned automobile but only for the amount of each such loss in excess of the deductible amount stated in the declarations as applicable hereto. For the purpose of this coverage, breakage of glass and loss caused by missiles, falling objects, fire, theft or larceny, explosion, earthquake, windstorm, hail, water, flood, malicious mischief or vandalism, riot or civil commotion, or colliding with a bird or animal, shall not be deemed to be loss caused by collision.

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Limits of Liability. The Company’s liability for all losses under this part shall not exceed the smallest of the following:

  1. the actual cash value of stolen or damaged property or part thereof at the time of loss;
  2. the amount necessary to repair the damaged property at the time of loss;
  3. the amount necessary to replace the stolen or damaged property at the time of loss with like kind and quality property less depreciation; or
  4. the applicable value if any, stated in the declarations.

Part II: Liability.

"The company will pay on behalf of the insured all sums which the insured shall become obligated to pay as damages because of:

  1. bodily injury …;
  2. injury to or destruction of property, including loss of use thereof, hereinafter called property damage, arising out of the ownership, maintenance or use of the owned automobile … and the company shall defend any suit alleging such bodily injury or property damage and seeking damages which are payable under the terms of this policy …"

As you can see, Part I of this policy covers the cost of repairing or replacing the insured’s own vehicle (i.e. a first-party claim). It gives the insurance company a number of options for fulfilling its obligations and requires the policyholder to, among other things, pay a deductible. You should also note that it’s the language in the Limits of Liability section of Part I referring to "like kind and quality property" that insurers rely on when adjusting claims based on the cost of aftermarket (A/M) or salvaged (LKQ) parts.

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Part II, on the other hand, covers the liability of the insured for bodily injury and property damage caused to someone else (i.e., a third-party claimant). It states that the insurer will pay "all sums" the insured is legally obligated to pay as damages up to the limits of coverage. In Illinois, for example, liability insurance is mandatory (first-party coverage is not) with a minimum limit of $15,000 for property damage liability. Part II does not (and could not) require the payment of a deductible or limit the company’s liability to the cost of A/M or LKQ parts.

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The reason why one section of an insurance policy can limit a person’s recovery while another section cannot is simple and derives from the fact that a person is bound by the contract he agreed to. However, a person cannot be bound by a contract that he was not a party to. Accordingly, while the rights of the parties in a first-party claim will be governed by the express terms of the insurance contract, in third-party claims, their rights are governed by what "reasonable people" would believe the injured party is entitled to.

Insurers Know the Difference
Even though these legal principles are straightforward, insurance companies still try to convince shop owners and consumers that it’s proper for the insurer to adjust both first- and third-party claims in the same way. For instance, I always find it interesting when an adjuster or claims handler tells a consumer or shop owner that "we were told to treat everyone like a policyholder." While that’s probably true, it doesn’t make it right.

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In my view, the corporate culture inside many insurance companies is analogous to the one that reportedly existed at Enron Corporation. Namely, the people up the chain of command have a vested financial interest in keeping their front-line adjusters and claims handlers ignorant of some of the basic legal principles related to their jobs.

They must think that disclosing what a third-party claimant is really entitled to in terms of OEM parts, choice of repairer, loss-of-use damages and diminished value would cut too far into the insurer’s profits. Therefore, they probably feel it’s safer to keep their own people in the dark rather than risk having to answer questions from them, such as "Why are you making me take advantage of this person who did nothing wrong and only had the misfortune of getting hit by someone insured with our company?"

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Ironically, one of the most succinct explanations of the differences between first- and third-party insurance claims can be found in a brief filed recently by the National Association of Independent Insurers (NAII) in a first-party diminished-value case in Louisiana. In a nutshell, the NAII was asking the appellate court to recognize and give effect to the differences between contract and tort theories of recovery and to find that first-party DV wasn’t covered under the terms of the insurance policy at issue. In doing so, the NAII conceded that only state legislatures and judges, not insurance companies, can limit a third-party claimant’s recovery of his or her damages. The brief states:

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"A [wrongdoer] has an obligation to restore the property, as nearly as possible, to the state it was immediately preceding the damage. This obligation allows recovery for diminished value if there is proof of such lost value despite a quality repair job. The [wrongdoer] must make whole the person or property injured. There is no contract between the [wrongdoer] and the injured party. There are no limits on liability in [tort] except those which are judicially or legislatively imposed." *See endnote.

The question, therefore, isn’t whether a distinction between the two types of claims exists. Rather, it’s whether consumers, shop owners, state regulators and people inside the insurance companies who understand how the average consumer is being taken advantage of will allow the sham to continue.

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What the Differences Mean in Real Life
Now that you have an idea of the theoretical differences between first- and third-party claims, we can turn to the practical differences. Perhaps the best way to do this is to look at repairs to two vehicles following a typical car accident in a state like Illinois. Let’s consider the following hypothetical situation:

Your shop is located next to an intersection controlled by a stop sign. On a Monday morning, I’m stopped at the stop sign in my green, 1997 Chevrolet Tahoe, waiting for the traffic to clear. All of a sudden, a red, 2001 Ford Explorer rear-ends my Tahoe, causing significant damage to both vehicles. Fortunately, nobody is injured.

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Both vehicles are subsequently pulled into your shop for repairs. The owner of the Explorer reports the accident to his insurance company, ABC Insurance Company, and the insurer tells him that one of its adjusters will inspect his vehicle on Friday morning. The claims handler also indicates that the insurer has a list of "preferred shops" that will, among other things, warranty the repairs performed. The claims handler then contacts me and says the same thing.

Although this fact scenario is about as straightforward as it gets, it still gives rise to scores of legal issues that the scope of this article will not allow me to discuss. Nevertheless, the following is how I, as an attorney and the consumer, would handle a few of the issues that might arise.

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Notice: Must the owner of each vehicle notify the wrongdoer’s insurance company prior to repairs?

  • Red Explorer (driven by person who hit me): Yes. An insured generally must notify his insurer as soon as possible after a loss and give the insurance company the opportunity to inspect the vehicle prior to repairs. Whether or not the insurer avails itself of the opportunity to inspect the damaged property is within the discretion of the insurance company.
  • Green Tahoe (my vehicle, which got hit): No. There’s no requirement in Illinois that the owner of a damaged vehicle give notice to a wrongdoer’s insurance company prior to repairs. This is true even if the situation presents a close question as to whether or not the cost of repairs may exceed the fair market value of the vehicle.

As a practical matter, however, allowing the wrongdoer’s insurer to inspect the vehicle prior to or during repairs may help expedite a settlement. Nevertheless, it’s not a legal requirement. Therefore, if I knew that your shop could start the repairs on Wednesday, I’d tell ABC that the repairs would begin on Wednesday and that they could either send somebody out immediately to view the vehicle prior to repairs or wait until Friday and see it after the repairs have started. (Talk about speeding up cycle time!)

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Rental Car: Is the owner of each vehicle entitled to recover the cost of a similar rental vehicle for the time necessary to repair the damaged property?

  • Red Explorer: Maybe. It depends on whether the policyholder purchased rental coverage and what the terms of that coverage are. If the policyholder purchased 30 days of rental coverage and the repairs reasonably take 40 days, the extra days wouldn’t be covered. It’s also likely that the benefits might cover only the cost of an economy car.
  • Green Tahoe: Yes. Under Illinois law, I’d be entitled to recover the cost of a full-size sport utility for the time reasonably required to repair or replace my damaged vehicle. If the repairs take 40 days, so be it. These are called "loss-of-use damages," and the only other limit on my recovery would be that, pursuant to an Illinois Department of Insurance Regulation, ABC might be able to limit its payment to a specified daily rate provided, of course, that it could tell me where I could rent a vehicle similar to mine for that rate.

A/M/LKQ vs. OEM Parts: Should the insurance company be able to limit its payment to the cost of A/M or LKQ parts?

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  • Red Explorer: Maybe. It depends on the language of the policy, the law of the state, and the type and quality of the parts specified. This is an obvious answer but, because the issue has received so much attention elsewhere, it wouldn’t make sense to go into it further here.
  • Green Tahoe: No. I’m not aware of any Illinois law stating that the owner of a name-brand product (e.g., a Chevrolet automobile, a Rolex watch, a Sony television, etc.) isn’t entitled to recover the cost of having such a product repaired with new, name-brand parts when it’s damaged as the result of somebody else’s negligence. Certainly I wouldn’t be bound by the "like kind and quality" provision found in the first-party property coverage section of the ABC policy, nor would I care that the use of A/M and LKQ parts may help reduce the amount of premiums ABC’s policyholders will pay over time. Remember, even the NAII stated that a wrongdoer generally has an obligation to "restore the property, as nearly as possible, to the state it was immediately preceding the damage." Thus, if it had OEM parts on it before the accident, it should have OEM parts on it afterward.

An additional consideration is that, even though some states do have laws regulating the use of A/M and LKQ parts, they don’t always say what people think they say. For instance, Illinois has a Department of Insurance Regulation that clearly states that it’s intended to regulate the use of replacement crash parts on insured’s vehicles. However, it’s routinely interpreted by insurance companies and others as giving insurance companies the right to specify non-OEM parts in third-party claims. If you think about it, for that to be true, it would mean that the legislature had to make a conscious decision to allow insurance companies to profit at the expense of individual consumers. While no one is naive about the political power of insurance companies, such a law might not be constitutional. Therefore, you should always carefully scrutinize the laws of your state on this particular issue.

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One final thought that might pique your interest on this topic: If State Farm defrauded its policyholders through its use of A/M parts and must repay them more than $1 billion if the verdict stands up on appeal, what did it do to third-party claimants whose vehicles were repaired during the same time frame using the same parts? It’s ironic but, because they weren’t policyholders and didn’t have a contract with State Farm, they couldn’t be included in the suit. Therefore, you could certainly argue that those consumers got taken advantage of twice – the first time by State Farm specifying the inferior parts and the second time by a legal system that makes it extremely difficult for third-party claimants to sue the other driver’s insurance company for claims-handling abuses.

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Diminished Value: Is the insurance company liable for any diminution of the vehicle’s value as a result of the collision?

  • Red Explorer: Maybe. Again, this is a state-specific issue that depends on the language of the policy and the law of the particular state. And with the recent settlements in Georgia between State Farm and Allstate and their respective policyholders, it’s a topic that’s sure to get a great deal of coverage in the upcoming months.
  • Green Tahoe: Yes. DV is just like any other element of damages that a person is entitled to recover when their property is damaged through someone else’s negligence (e.g., cost of repairs, loss of use, etc.). Consequently, it’s "covered," provided the claimant can substantiate the amount of value the vehicle lost. Be forewarned. A defense that’s been raised on more than one occasion by an insurance company trying to get out of paying for DV is a contention that the repairs performed to the third-party claimant’s vehicle were less than satisfactory.

You also should have any DRP contracts reviewed by an attorney to make sure they don’t shift the liability for DV onto the shop – especially third-party DV. For instance, at least one insurance company’s new DRP contract states not only that the shop guarantees to restore the vehicle to its pre-loss "value," but also that the shop agrees to pay any DV claims.

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Hard Lessons to Learn
That brings us to the next topic, which involves the liability a shop faces when repairing a third-party claimant’s vehicle. I can make my points most clear by sharing with you some real-life lessons that shop owners have learned when they failed to recognize the differences between first- and third-party claims. Needless to say, I hope you can learn from their experiences without having to repeat their mistakes.

  • True Story #1: With regard to waiting for the at-fault party’s insurance company to "authorize" repairs or to do a "reinspect" for a supplement, one shop owner and his customer found out just how quickly an insurance company can play both sides of the fence.

Essentially, the job involved a relatively hard hit, and the negligent party’s insurer insisted on being contacted each time additional damage was found. The owner of the vehicle was reluctant to just authorize the shop to proceed with repairs, so he instructed the shop to follow the insurance company’s guidelines. The shop complied and stopped repairs on several occasions, while waiting for the adjuster to come back out and "approve" the additional work. In the end, the job took about twice as long as it should have.

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After the customer got his car back, he made a claim for loss-of-use damages for the approximately 60 days the vehicle was actually in the shop. The insurer offered to pay 30 days based on the time the repairs probably should have taken. The consumer rejected the offer and filed a lawsuit against the driver who caused the accident. At trial, the attorney hired by the insurance company argued that because the consumer was a third-party claimant, he was under no obligation to wait for the insurance company to authorize or approve any of the repairs and that the consumer should have just authorized the shop to perform the repairs as quickly as possible. The attorney then argued that the insurer’s liability for loss-of-use damages was limited to the 30-day period. The judge agreed and awarded the consumer 30 days worth of rental charges. I got involved when the consumer started talking about going after the shop for the other 30 days rental charges.

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  • True Story #2: The second situation involved the use of A/M parts in the repair of a third-party claimant’s vehicle. At the time of the collision, both the consumer and the shop owner requested that the at-fault party’s insurance company pay for the cost of OEM parts, including a bumper cover. The request was denied and, because the consumer couldn’t afford the difference in parts prices, she told the shop to use the non-OEM bumper cover.

Approximately six months later, the paint on the cover started to fail, so the consumer took the vehicle back to the shop. A call was then made to the insurance company representative who originally handled the claim and denied the request for OEM parts. After listening to the problem, the insurance company representative stated something to the effect that, because the consumer was a third-party claimant and had every right to insist on OEM parts at the time of the original repairs but didn’t, the insurer wouldn’t accept any responsibility for the problems with the part. The shop owner, therefore, was effectively forced to re-repair the vehicle at his own expense.

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  • True Story #3: The third and final situation involved a claim where the wife of an attorney was rear-ended on an expressway. The attorney, who was well-versed in the differences between first- and third-party claims, took the vehicle to a dealership body shop and told the estimator not to worry about the cost of repairs but to just make sure that all the repairs were done properly. Despite these clear instructions, the shop proceeded to repair the vehicle according to the insurance company’s estimate, which resulted in several obvious and hidden defects.

When questioned by the attorney as to why the shop didn’t follow his instructions on how to fix his automobile, the only explanation the shop had was that that’s not the way the industry works. Well, after a consumer-fraud investigation by a governmental agency confirmed the facts, the shop had the distinct pleasure of re-repairing the vehicle at its own cost and paying the attorney additional money to settle the claim and avoid litigation.

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Them’s Fightin’ Words
Finally, in what’s perhaps the ultimate insult to Illinois consumers (although the practice is in no way limited to Illinois), an Indiana insurance company circulated an "invitation" for Illinois shops to join its DRP program. The invitation outlined the requirements of the program and included a section on "parts usage" that reads as follows:

"The shop will agree to the following guidelines for parts usage.

A. Insured vehicles as follows:

  1. Sheet metal – OEM on latest two model years; LKQ on all other models or OEM if LKQ not available.
  2. Mechanical parts – OEM on suspension or moveable parts; QRP on all other mechanical parts.

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B. Claimant vehicles as follows:

1. Sheet metal – QRP CAPA-certified or LKQ sheet metal to repair said vehicles.

2. Mechanical parts – QRP on all mechanical parts."

The one thing you can be absolutely sure of is that, even though this insurance company’s "parts usage" policy completely contradicts the most basic principles of insurance law, it’s not a misprint. Rather, it’s a blatant and legally sophisticated way of taking advantage of consumers and shop owners.

If you think about this provision in light of what I’ve discussed in this article, you can easily figure out what this insurance company is trying to get away with. Basically, it means that if an Indiana driver causes an accident with an Illinois driver, the insurer will pay for all OEM sheet metal and all OEM suspension parts for the Indiana resident’s vehicle. However, the innocent Illinois driver is supposed to get stuck with A/M sheet metal and, worse yet, non-OEM suspension parts. The most obvious question is: If non-OEM parts aren’t good enough to use on the Indiana resident’s vehicle, why should the Illinois consumer have to accept them?

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There are three main reasons insurers try to get away with this type of conduct: money, money and more money.

First and foremost, the insurer wants to save money on the cost to repair the claimant’s vehicle, and using knock-off parts is one way of doing that.

Second, the insurer understands that, because of the differences in contract and tort law, its own insureds can sue it for specifying inferior parts on their vehicles in ways third-party claimants cannot. Again, the State Farm case was a prime example of that legal loophole.

Third, it’s obvious that the insurer has doubts about the quality and safety of cut-rate parts and doesn’t want to be liable if one of those parts fails and causes another collision. For instance, if non-OEM suspension parts are used in the repair of an insured’s vehicle and one of those parts subsequently fails and causes another collision, the insurer would be liable for the loss. However, if the parts are put on a claimant’s vehicle and one of them fails, the insurer would, in all likelihood, escape liability. Instead, the shop would probably bear the brunt of the claim. Therefore, from the insurer’s perspective, the more a shop owner is willing to let an insurer ride roughshod over the rights of its customers who are claimants, the better.

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Doing Nothing Costs You Money
As the owner or manager of a collision repair facility, you’re faced with issues relating to automobile insurance on a daily basis. It’s therefore essential to your customers and your business that you have a thorough understanding of insurance contracts and the different types of coverage they provide. Recognizing and being able to properly handle repairs to a third-party claimant’s vehicle is perhaps the most important concept to be learned by a collision repairer in states that have different laws pertaining to different types of insurance claims. If done right, it can mean higher profits, increased customer satisfaction and fewer complications. If done wrong, you can expose your shop to unnecessary liability.

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It bears emphasis that the issues discussed here are just the tip of the iceberg with regard to the various ways insurance law can affect your customers and your business. And, although this industry may never speak with one voice on all issues, there’s little question that the practice of many insurance companies to systematically underpay third-party claims and leave the shop holding the bag for the liability is ridiculous.

There’s always the possibility that some state regulators will step up and start protecting their constituents against these wrongful and oppressive practices. In the meantime, because collision repairers and their vendors have a vested interest in seeing change brought about in this area sooner rather than later, they’d be well-served to start educating themselves and each other on some basic legal principles that directly affect their livelihoods. Hiring an attorney to thoroughly research and advise you as to the laws of your state might cost some money in the short term, but it can definitely pay dividends in the long run. There’s no doubt in my mind that the "sit-back-and-wait-for-someone-else-to-do-something-about-it" attitude that’s so prevalent amongst shop owners probably costs the industry tens of millions of dollars … each year.

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Writer Patrick J. McGuire is a Chicago attorney who represents consumers and corporations in disputes with insurance companies. He writes and speaks frequently on issues that affect the collision-repair industry.


*EMELDA JOHNSON v. ILLINOIS NATIONAL INSURANCE COMPANY, State of Louisiana, Court of Appeal, First Circuit, Docket No. 00-CA-1775. Quoted from the Brief of the National Association of Independent Insurers, Amicus Curiae in support of defendant-appellee Illinois National Insurance Company.

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