The Auto Thorn…

First there was the fall of Markham General, representing a market loss of about $80 million in annual capacity. As underwriting losses from auto insurance, specifically personal lines arising from mostly minor bodily injury (BI) claims in the Ontario market, began to mount over 2002, the true cost of years of price cutting became evident to the industry.

While Markham, which wrote nearly entirely Ontario auto business, was in the process of being liquidated last year, several leading insurers were engaged in restructuring cost-control programs which appeared to focus on reducing their exposure to the auto line countrywide – with Ontario and the Atlantic Canada region being at the top of the list. The result was an almost instant “drought” in auto insurance capacity in the private insurance provinces, which had brokers up in arms being caught between consumer anger over steep price increases whilst at the same time not being able to place covers in the standard market.

The 2003 financial landscape for auto has not improved. Most recently, CGU Group Canada/Aviva announced a major senior management shakeup at its Ontario personal lines carrier, Pilot Insurance Co. (see MarketWatch of this issue for further details). The management ousting came about due to an audit inspection of Pilot’s books which revealed a reserve shortfall of about $195 million – nearly a 50% increase on the company’s stated reserves.

A CGU/Aviva statement says that the reserve deficiency applies almost entirely to personal lines auto. The investigation into Pilot also indicates a “premium deficiency” on current covers (reserving of $26 million for this is included in the $195 million shortfall). As a result, Pilot is filing for an average rate increase of 15% with the Financial Services Commission of Ontario (FSCO). The CGU/Aviva statement notes that, in light of the pricing inadequacy identified at Pilot, the company will be taking a “cautious approach to any growth of the book in the near term”, which suggests that the Ontario auto market could be facing yet another cutback in capacity by a major player.

Is this the worst of it? Hardly, is the response of some industry commentators who believe that the extent of company management shakeups and consolidation that occurred in the U.S. last year is finally catching up in Canada. At the very least, underwriting capacity in the auto line will not grow this year, insurer CEOs say, as losses continue to eat away at their capital resources. At best, auto insurance may produce a “break-even” for 2004 assuming that the various provincial product reform initiatives currently underway are acted on (see cover article of this issue for company commentary).

The destructive impact of auto losses on insurers’ income and balance-sheets is highlighted by the industry’s 2002 financial returns. According to Insurance Bureau of Canada (IBC) data, insurers incurred an adverse reserve development on auto of about $650 million for the 2002 financial year – more than double the reserving adjustments made the year prior. Without the adverse reserve development, insurers’ income returns for last year would have delivered a much better result than the sickly 1.6% return on equity shown. And, of particular concern, is the fact that the Ontario auto loss ratio actually rose in the final quarter of 2002, suggesting that industry performance in this line may well have worsened in the first quarter of this year.

Why are insurers sticking it out in auto? Basically, because there is so much “fixed cost” associated with the product which is inherent in the operations of companies, says Igal Mayer, president of CGU Canada/Aviva. A typical example is distribution networks, which companies are loath to disrupt after years of relationship building. As a result, Mayer says CGU/Aviva continues to “reluctantly” stick with the auto product with a cautious eye on the development of product reform – specifically Ontario reform under Bill-198 which has been lingering without regulations since its passage at the end of last year. In the words of Larry Simmons, president of Royal & SunAlliance Insurance Group, “patience is beginning to grow thin” with the pace of reform.

The biggest problem with auto is that it is a regulated product subject to considerable political interference, insurers say. Notably, the sharp increases in auto insurance prices in New Brunswick over the past year has set the stage for a political battle between rivaling parties as the province moves to an election. The Liberal Party has promised to cut insurance rates immediately by 25% should they be elected into government. In response, the IBC has suggested that such a move would likely see insurers withdraw entirely from the province.

No one in the insurance industry is looking on legislative product reform with “rose tinted glasses”, knowing full well that auto will always carry a “regulatory burden”. However, the extent of the bleeding caused by the auto line has left insurers with little room to maneuver – the only alternative to effective product reform being to exit the auto business. This is something the bureaucrats and politicians would do well to remember.