Piecing Together Parts

The splash of the well-publicized Avery vs. State Farm Insurance Co. aftermarket parts lawsuit in the U.S. continues to leave a wake in insurer vehicle damage claims handling practices. Originally filed in an Illinois court in 1997, the class action lawsuit, which alleged that the insurer breached its contract with policyholders by failing to tell them about the use of aftermarket parts in auto repairs, led to an eye-opening US$1.2 billion award against State Farm in 1999. Currently awaiting judgment on appeal to the Illinois Supreme Court, the case has spawned several copycat lawsuits across different states, as well as in Canada. State Farm has indicated that it will appeal the decision all the way to the U.S. Supreme Court.

In Canada, there are currently five class action aftermarket parts lawsuits in Ontario and four in Quebec, which are being treated as consolidated actions. The class action is certified in Quebec, expert reports were due by December 2003 and the trial is expected to begin towards the end of January 2005. Certification motions will be heard after June this year for one of the cases in Ontario, which will act as a test case. The essence of the class actions against various insurers is that the insurance company(s) did not fully indemnify the insured under the auto policy because, in using aftermarket parts, the value of the vehicle was diminished.

RETHINKING AFTERMARKET

But not all class action lawsuits have gone ahead. In February 2003, three separate lawsuits in Ohio, Washington and Florida were overturned or dismissed, giving insurers some hope they may finally be getting control over the long-running parts crisis. All told, more than a dozen state courts in the U.S. have struck down aftermarket parts class-action lawsuits. But even with some legal victories, many are taking a wait and see approach to the use of aftermarket parts.

The short-term result of all this attention is that insurers have revisited how they use aftermarket parts, with some, such as State Farm and Liberty Mutual, deciding not to use them at all. In other cases, insurers have developed strict protocols for when aftermarket parts should be used in vehicle repair. Several U.S. states have passed legislation requiring insurance companies to disclose when aftermarket parts are used in auto repair. In Ontario, recent auto insurance reforms stipulate similar consumer disclosure measures.

In the longer-term, many insurers are awaiting the outcome of the State Farm case to see which way the legal wind will blow on use of aftermarket parts. There is concern about the viability of non-OEM parts and the aftermarket manufacturing industry in general. Many wonder what impact the lawsuits will have on repair costs and, ultimately, insurance premiums.

“Aviva Canada is concerned about the [aftermarket parts] lawsuits from the standpoint that they could affect an important part of the parts procurement market that stimulates competition in a manufacturing-dominated playing field,” says Wendy Hillier, vice president, claims for Aviva Canada. “The lawsuits in Canada continue to struggle in addressing the issue of inferiority [of parts] because that issue is too broad and does not apply to all aftermarket parts currently on the market.”

The issue with aftermarket parts, depending on whom you talk to, is either money or safety, or both. Crash parts, often referred to as “cosmetic” parts, are the sheet metal components of vehicles most frequently damaged in car accidents, such as fenders, hoods and door panels. There are two main sources for the parts – the original auto manufacturers (OEM) and generic or aftermarket crash parts suppliers. A third category has also emerged in the form of auto recyclers, who provide refurbished OEM parts in the repair of vehicles.

In terms of marketshare, estimates show that OEM parts dominate the collision repair process, with anywhere from 75%-80% of parts sold, while aftermarket parts account for 10%-15%. The rest are mainly recycled or rebuilt parts. A study done by the Insurance Bureau of Canada (IBC) in 2000 concluded that, of the $1.12 billion spent by Canadian private insurers on replacement parts for collision repair in 1998, about $157 million (or roughly 13%) involved aftermarket parts.

COST DRIVERS

Up until the late 1970s, car manufacturers enjoyed a virtual monopoly on the production and sale of replacement parts. In the early 1980s, independent manufacturers began selling cosmetic sheet metal auto replacement parts, often at a substantially lower cost. The introduction of aftermarket parts forced the price of OEM parts down by an average of 30%, according to the U.S.-based Insurance Information Institute (III). In fact, the IBC study notes that, without aftermarket competition, OEM prices would be over 94% higher than their aftermarket counterparts. The report also estimated that the elimination of aftermarket competition would result in a potential overall annual loss of $148 million in Canada and a corresponding hike in premiums.

The auto manufacturing industry has waged a massive public relations and legal campaign to discourage the use of aftermarket parts, claiming they are unsafe and inferior. While car maker spokespersons did not respond to requests for an interview, the typical position of manufacturers is iterated in a statement from General Motors about “imitation” or aftermarket parts: “GM does not support or recommend the use of any imitation part. Many independent OEM studies have documented the lesser quality of imitation repair parts…Also, studies have proven that the OEM replacement parts are designed to meet defined quality, safety and appearance specifications that are not replicated on imitation parts.”

The issue of safety is a “red herring more than a real problem,” observes Jack Gillis, president of the Certified Automotive Parts Association (CAPA), an independent organization that inspects generic auto parts and guarantees quality through a certification system. “Aftermarket parts are not used for anything related to the structural integrity of the vehicle, with the possible exception of hoods, which insurers typically CAPA-certify anyways. The OEMs have been bringing this issue up for years, but it is not there.”

There have been at least seven studies of aftermarket crash part safety, according to the U.S. General Accounting Office. Not surprisingly, the results vary according to the sponsor. One study, published by Consumer Reports, concluded that aftermarket crash parts are generally of poorer quality, fit improperly, rust more quickly and may compromise safety. Another study, conducted by Ford, stated that aftermarket crash parts are inferior to Ford genuine parts and are not of “like kind and quality”. Three other studies, sponsored by insurance companies and related associations, concluded that crash parts, whether original or aftermarket, do not influence vehicle safety. “Although these studies are useful, they do not resolve the debate over the safety of aftermarket crash parts…because they reach different conclusions and are limited in number and scope,” the GAO stated in a 2001 report.

PRESERVING RIGHTS

Auto insurers want to preserve the right to use aftermarket parts for non-structural vehicle components to keep costs down and promote price competition for all parts. Like many insurers in Canada, Aviva Canada has a standard protocol on using aftermarket parts, which is defined by age of vehicle, mileage and part type. “Aviva Canada has standardized the protocol and distributed it to our internal appraisers, external appraisers and our shop network,” comments Hillier, in noting that Aviva only uses aftermarket parts for cosmetic repairs and not safety-related crash items. “Our protocol seeks to ensure a quality repair with the best quality part, while managing repair costs.”

Hillier says the issue is how to balance the best possible repair job with costs. “Consumers expect their insurers to…return their vehicle to the same level of safety as prior to the accident, by utilizing safe repair principles,” she explains. “The consumer does not always link the cost of insurance premiums to the cost of repairs.”

For the $2.8 billion collision repair industry in Canada, the main issue is being able to fix cars without having to declare vehicles a total write-off, according to Larry Jefferies, executive vice president of Carstar Canada. A vehicle is declared a write-off if the cost of parts for repair exceeds its total value. “We want to repair damaged cars,” says Jefferies. “Nothing turns our stomach more than having to declare a write-off.”

Aftermarket and recycled parts can help collision repair shops avoid this situation, as they provide an alternative to costly OEM parts. But, the focus has to be on consistency, quality and availability of these parts, Jefferies stresses. Currently, six aftermarket parts manufacturers, or “warehouse distributors,” control about 95% of the Canadian aftermarket parts market. Jefferies says the customers they sell the parts to fall into two different groups – the collision repair industry and the “do-it-yourself” consumers, who are not as concerned about safety and standards.

Jefferies says the collision repair industry has struggled with the issue of aftermarket parts for the last three years through the “Canadian Collision Industry Forum”, a working group of repair shops, insurance representatives and parts manufacturers. “We brought all the stakeholders together, from the small body shop in Newfoundland to the large repair facilities in Toronto and other urban areas,” he adds. Jefferies, who is chair of the parts and material committee of the CCIF, notes, ” I think we have done as much as we can on aftermarket parts to encourage the availability of quality parts on the market.”

RECYCLE APPROACH

The attention for repair shops is now turning to recycled parts, which account for a growing percentage of the parts used in fixing damaged vehicles, according to Jefferies. Whether called used OEM parts, salvage parts of LKQ (like kind and quality), this is clearly a booming business. Auto recyclers recover material and parts from more than four million vehicles in the U.S. and Canada each year.

There is general consensus that aftermarket parts have improved significantly since the early 1980s. There are also more standards and certification systems for these parts, with the most well-known being CAPA. This certification scheme, which was launched in 1987, is the only one that actively tests and verifies the quality of aftermarket parts. Once a part is approved, it is given the CAPA decal of certification. “Insurers need the ability to differentiate which parts are of a certified quality and which ones aren’t to ensure quality repairs,” says Gillis. “It is in the best interests of insurance companies to support CAPA-certified parts and insist on their usage.”

The main weakness with CAPA certification has been market penetration, a point Gillis acknowledges has plagued the aftermarket parts and insurance industries in the U.S. Of the roughly 61 million parts that are used each year across the U.S. in collision repair, only an estimated 1.6 million are certified. Gillis says a market penetration of only 3%-5% is an indication of errors made by U.S. insurers. “The big mistake by U.S. insurers was not to differentiate between quality and non-quality parts,” he adds.

A study released by CAPA in March of this year shows why this choice is important. A comprehensive vehicle test fit study of more than 1,000 parts showed that 44% of them did not meet CAPA standards for fit, finish and appearance. Many of these parts may still be in the marketplace as non-certified.

CANADA APPROACH

In Canada, the use of CAPA-certified parts is an even smaller percentage than in the U.S., but Gillis actually sees greater opportunities here. “I think there is an extraordinary opportunity for Canadian insurers to step up to the plate and do the right thing for policyholders and for the market in general,” he says.

Costa Kaskavaltzis, manager of automotive and engineering services for IBC, says while other parts quality systems exist, CAPA is the “only technically traceable standard” for aftermarket parts. “I think the issue of supporting CAPA certification has to move beyond high-level endorsement to the daily operational needs of claims departments,” he notes. “The reality is that the clock is ticking for insurers on vehicle damage claims, the client wants his or her vehicle back and the longer you have to wait for a certified part, the harder this becomes.”

Kaskavaltzis points to “frustration among the front-line people in the claims department about the availability of CAPA-certified parts.” And, Jefferies says repair shops also want a wider availability of certified aftermarket parts, although much of this depends on the model of the car, how profitable the parts are, and how quickly they can be sold. “If you look at cars like the ‘Ford Focus’ or ‘Taurus’, these are fairly standard models with relatively long cycle times. The warehouse distributors can manufacture those parts with the knowledge they will sell. If auto makers regularly change the models or reduce the cycle times, the parts are harder to manufacture and move.”

As Canadian insurers define their protocols for use of aftermarket parts and decide how they will support certification of parts, they are also keeping a close eye on the outcome of the class action lawsuits in the U.S. and at home. The size of the State Farm award has unnerved many insurers, who have curbed or eliminated their use of aftermarket parts as precautionary measures.

Many insurance associations say the resulting lack of competition will only cause OEM parts prices to once again rise, potentially returning the big automakers to their pre-1970 period of unrestricted parts monopoly. This will only put more pressure on an auto insurance system that is already under siege. In the turf war between automakers and insurers, the complicated choice seems to be between the safety and costs of vehicle parts. And, erring on the side of caution, many regulators and insurers appear to be going with safety – whether real or illusory.