7/22/2011

State Farm Insurance Company

One of Peggy Frey’s most valued possessions is her 1998 black Ford Mustang 5.0 convertible. When the front of the car was damaged by an errant pickup truck, the Tampa homemaker expected State Farm Mutual Automobile Insurance Company to restore it with genuine Ford parts. Instead, the auto insurer approved generic replacements (non-OEM parts), which hardly fit together. Now, when Ms. Frey slams the hood, the Mustang headlights comically pop out.

In Ms. Frey’s opinion, the repair job was so shoddy that she believes the value of her Mustang has dropped by at least $2,000. That may not sound like much money, but as many as 4.7 million other policyholders have the same complaint as Ms. Frey. Their claims led to a lawsuit in which six plaintiffs claimed State Farm misrepresented the quality of generic replacement car parts.

How State Farm Started

State Farm was founded in 1922 by George J. Mecherle (pronounced Ma-herl), a retired farmer who had taken a job selling insurance after his failing health prevented him from farming any longer. He was successful as a sales representative, but he did not feel the rates or the business practices of the company suited the needs of the farmers. Mercherle believed that farmers should pay less for insurance because they drove less and had fewer losses than folks living in cities.

When he suggested a better way to sell insurance, his employer laughed and said, “If you think you’ve got such a good idea, why don’t you start your own company?” Using this idea, he started State Farm, a mutual automobile insurance company owned by its policyholders.

By 1928, the decision was made to decentralize. Employees from the Bloomington, Illinois office established the company’s first branch office in Berkley, California. This office provided support for agents and brought service closer to the customer. The Berkley office was the beginning of a tradition that, by the end of the 20th century, resulted in 27 regional offices and more than 1,000 claim service centers. State Farm has grown to include 76,500 employees and more than 16,000 agents servicing 66.2 million policies in the United States and Canada.

In just over 75 years, State Farm has grown from a small auto insurer into one of the world’s largest financial institutions. Despite its growth, the company’s original philosophy of insurance coverage at a fair price coupled with fair claim settlement has remained.

Today, State Farm insures one of every five cars in the United States and is the largest insurer in the country with $24.4 billion in assets. The company is a mutual, which means that it is owned by the policyholders. State Farm does not answer to shareholders. Any dividends are paid out to policyholders. State Farm’s reputation and earnings all benefit the policyholders. Because of this structure, drop in share price or angry shareholders are not at issue. The possible effects of the lawsuit are policy cancellations and increased premiums for the policyholders.

The Use of Non-OEM Parts

Non-OEM (Original Equipment Manufacturer) parts are external body parts such as door panels, hoods, fenders and the like, modeled on parts from the automakers and manufactured and sold at lower cost. State Farm has worked to improve quality in the non-OEM industry by contributing to the formation of the Certified Automotive Parts Association (CAPA). CAPA is designed to scrutinize and certify, where its standards are met, non-OEM parts for use in the repair industry. CAPA’s goal is to provide quality auto parts and eliminate the monopoly of the auto manufacturers: “For years, the car companies have had a monopoly on the millions of parts used by used by consumers to repair car accidents each year… The consumer is being taken advantage of by car companies who are free to charge whatever they want for a product that continues to drive up the cost of crash repair.”

State Farm only used non-OEM parts which are not integral to the mechanics of the vehicle and which have been certified by CAPA. Many body shop owners say that non-OEM parts fit poorly, look shabby, and do not provide the same safety margins as parts manufactured by Ford, General Motors, or other auto manufacturers. State Farm regularly uses non-OEM parts in repairs of cars that have been involved in collisions.

State Farm learned years ago that many body shops were using non-OEM parts without State Farm’s or State Farm policyholder’s knowledge. Moreover, some of the shops charged State Farm and its policyholders OEM prices for such repairs. State Farm, along with other insurers, determined that having a viable non-OEM part industry could benefit consumers by lowering the price of auto repairs.

At least forty other companies have policies requiring use of non-OEM parts, including Allstate, Geico, Nationwide, USAA, Progressive, Metropolitan, and Farmers Group of Insurance Companies. These companies are also involved in lawsuits, but the State Farm case is the only suit that has gone to trial.

In fact, many states recommend and at least one requires auto insurers to use non-OEM parts when possible. Insurers maintain that the policy favoring non-OEM parts benefits the customers by keeping premiums low. State Farm shows that it saved its customers $54.7 million in 1987 and $233.6 million in 1997.

The Lawsuit

Six plaintiffs filed suit against State Farm, accusing the company of breaching its contracts with its policy holders when the company specified the use of non-OEM parts in the repair of vehicles damaged in crashes. The suit was given class action status, and about six million current and former State Farm policyholders joined the suit. The six million policyholders were from 48 states and had been insured between July 1987 and February 1998. All of them had auto insurance claims in which non-OEM parts were installed or specified in estimates for their vehicles during the repair process. Not all of the plaintiffs, however, had actually had a non-OEM part installed on their automobiles. Specifically, the lawsuit charged that:

· State Farm breached its insurance contract by specifying non-OEM parts on estimates for repairs to policyholders’ vehicles.

· State Farm knew that non-OEM parts would never return a vehicle to its pre-crash condition and the company’s failure to advise policyholders of this knowledge constituted a violation of the Illinois Consumer Fraud Act.

· Non-OEM parts are incapable of returning a vehicle to its pre-loss condition, so State Farm should cease referring to the parts as “quality” parts. Although none of the plaintiffs claimed a physical harm, their attorneys argued that the use of non-OEM parts raises a safety issue because they are not crash-tested and because modern vehicles are designed to react in certain ways in collisions. Their claim was that because competitive crash parts are designed through “reverse engineering” (a process that involves measuring and then copying the original parts), they will not perform in the same manner as OEM pars, and that, they say, is a safety problem.

Plaintiffs relied on a number of documents from State Farm and CAPA to argue that State Farm had known for years that non-OEM parts are inferior to OEM parts. The most damaging among these documents were several internal memos found which cite a highly placed State Farm executive stating that non-OEM parts are inferior to OEM parts. State Farms defends itself saying that portions of the memos were taken out of context. The full body of the document reveals that the authors were pointing out problems found with certain non-OEM parts, which needed to be addressed. Company spokesman Edward Domansky says that the memo demonstrated State Farm’s concern for its policyholders and dedication to quality.

According to State Farm, use of non-OEM parts by a professional repair shop will return a vehicle to its pre-loss condition. In insurance policies reviewed and approved by state insurance officers, State Farm’s policyholders are fully informed of the proposed use of non-OEM parts when they are specified. During the trial, State Farm presented copies of auto repair estimates that fully disclosed the proposed use of non-OEM parts, a copy of a State Farm brochure that spelled out possible use of non-OEM parts, and the State Farm guarantee that stands behind them. State Farm also showed that no state law bans the use of non-OEM parts and in fact, some encourage or even require their use. In a survey of 1,400 claims with estimates specifying non-OEM parts, only 0.59 percent of State Farm policyholders complained about repairs made using those parts.

Like a Good Neighbor

State Farm’s mission statement says, “We are people who make it our business to be like a good neighbor; who built a premier company by selling and keeping promises…” From the time of filing in February, 1998 the media across the country reported regularly on new developments in the case. With the trial date not set until February 1999, State Farm had to figure out how to retain its good neighbor image.

Questions

  1. How can they retain the “good neighbor” image amidst the legal battles?
  2. What are the critical issues (target about three issues) surrounding the alleged use of non-OEM parts and how should State Farm respond to those allegations?
  3. What communication strategy would you employ for responding to the public’s awareness of the lawsuit and the issues surrounding it?

References

The Associated Press. (1999, October 9). Damage award in State Farm case grows to nearly $1.2 billion. The St. Louis Post-Dispatch.

The Associated Press. (1999, September 30). State Farm auto parts goes to jury. St. Louis Post-Dispatch.

Certified Auto Parts Association website: http://www.capacertified.org

Conrad, D. (1999, October 10). Insurance company in battle to retain good image. Associated Press Newswires.

Felsenthal, E. (1998, October 6). Supreme Court declines to review class-action suit against insurer. The Wall Street Journal..

France, M. & Osterland, A. (1999, November 8). State Farm: What’s happening to the good neighbor? Judges and juries have found the insurer guilty of serious misconduct,” Business Week.

Gallagher, J. (1999, October 8). State Farm stops the use of aftermarket parts action comes as a result of suit; judgment is being appealed. St. Louis Post-Dispatch.

Lohse, D. (1999, October 5). Policyholders at State Farm win parts case. The Wall Street Journal.

Pearson, M. (1999, October 4). $456 mil. verdict vs. State Farm. Chicago Sun-Times.

Pearson, M. (1999, August 24). At least seven other insurers being sued over imitation repair parts. Associated Press Newswires.

Pearson, M. (1999, August 17). Documents prove State Farm knew parts were inferior, consultant says. Associated Press Newswires.

Pearson, M. (1999, August 9). Trial set in State Farm inferior repair parts case. Associated Press Newswires.

State Farm corporate website: http://www.statefarm.com

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