Why it’s nearly impossible to figure out how profitable Ontario auto is

Your Ontario auto clients have probably read media reports claiming they have been “over-paying” for years, but at the same time your markets are probably telling you they either lose money or barely break even on the product. So how is a broker supposed to make heads or tails of the conflicting numbers?

It’s not easy because a key profitability metric, return on equity (ROE), is always going to be subject to debate.

It’s one thing for any company to calculate its own equity, company-wide expenses (like the CEO’s salary or the cost to keep the lights on), taxes, and investment income. But it’s another thing entirely to break those numbers down by product line within a region.

“Every company will have their own set of rules for making these decisions. What’s more, there is not going to be a single set of comprehensive rules that would apply to all companies,” said Fred Lazar, a York University economics professor and author of a recent trial lawyers-commissioned report on price regulation.

ROE is a key variable used by the provincial regulator to determine an insurer’s profitability in Ontario auto, Lazar points out.

In 2018, the Ontario auto insurance industry had an industry-wide ROE of 3.3%, down from 5.4% in 2017 and 6.6% in 2016, reports the General Insurance Statistical Agency. A 3.3% ROE is akin to making $3,300 a year in profits from a business in which you invested $100,000.

Lazar believes the industry’s average ROE in Ontario auto was in reality 15.9% in 2016, 8.3% in 2017 and 6.5% in 2018. This is based on Lazar’s assumption that the expense ratio is 20%. When he assumes an expense ratio of 25%, Lazar reports that the industry’s 2018 ROE in Ontario auto is 5.3% – although that excludes carriers with negative ROE. Based on these assumptions, he ultimately concludes that Ontario clients “overpaid” by between $556 million and $1.4 billion on auto insurance in 2018.

His conclusions, although they make for sensational headlines in consumer media, are met with a considerable degree of skepticism by the industry.

GISA numbers, for example, show the industry had an underwriting loss of $68.7 million on Ontario auto in 2018. (The ROE as reported by GISA is positive because investment income offsets underwriting losses, meaning the overall income is in the black).

“Because one needs to make assumptions on tax rates, and one needs to make assumptions on equity allocation, and because one needs to make assumptions on expenses, using loss ratios would give a clearer measure of the profitability of the line of business,” said Mary Kelly, chair of insurance at the Wilfrid Laurier University school of business and economics. Kelly is not specifically criticizing Lazar’s report but was asked by Canadian Underwriter whether the profitability figures used for Ontario auto rate regulation are based in large part on guesses and assumptions.

Kelly characterized the industry-wide loss ratio in 2018, at 76%, as not sustainable.

Lazar’s report, released Feb. 13, was an update to previous reports. His first was in 2015 and the second was in 2018. All three were commissioned by the Ontario Trial Lawyers Association.

To figure out a specific company’s return on equity, you have to take the net income in Ontario auto and divide that by total shareholders’ equity in Ontario auto. But net income depends on expenses, and it’s usually not crystal clear how much exactly it costs the insurer to run its auto line in Ontario.

So how exactly do you take an insurer’s equity and fixed costs across all its lines of business and allocate a fraction of that to Ontario auto?

“At the end of the day, it’s ‘Let’s make some reasonable assumptions,’” Lazar told Canadian Underwriter. “We can agree or disagree over the assumptions, but that’s basically the only way you can do it.”

So how can a business selling multiple products in multiple regions break down its total equity by products and by region? In other words, how does a carrier writing home, auto, and commercial products Canada-wide allocate a portion of its equity to auto in Ontario?

“It’s very artificial to say that they can do that at all,” said Kelly, adding that even the individual insurers do not have a “hard number” on this. “If I am allocating my head office costs to a line of business, how do I realistically do that? How much of my CEO’s time is spent on Ontario auto versus Alberta auto? How do I allocate my hydro bill to Ontario auto?”

The true bottom line may be that you shouldn’t expect the war of words – between academics commissioned by plaintiffs’ litigation lawyers and property and casualty industry experts – to end any time soon.