Auto Insurance, The Industry’s Orphan Annie

Last year saw total auto insurance in Canada grow by 16% year-on-year to $13.9 billion based on direct written premiums, according to company data collected by CU for its “Statistical Issue 2003” annual report. With auto premiums accounting for nearly 50% of all premiums written across Canada, it is notable that the increase for auto is almost entirely due to price hikes as most insurers have reduced or “capped” their exposure to this high-loss line over the past year.

The extent of losses being incurred by insurers on auto is highlighted by the $650 million reserving adjustment made in 2002 by the industry specifically for this line. In contrast, other than liability business, all other lines of business produced a favorable reserve development last year, observes Paul Kovacs, chief economist at the Insurance Bureau of Canada (IBC). Last year was an “unprecedented year” in terms of adverse reserve development, he adds. “The issue is auto, auto and auto,” Kovacs says in summarizing the poor financial performance of the insurance industry during 2002. “Auto markets remain weak in all markets with the exception of Quebec…the average annual loss ratio for auto insurers in Ontario increased to 96.4% [for the 2002 financial year], up from 88.9% in 2001. The fourth quarter result for Ontario shows marked deterioration with a loss ratio of 101.7%.”

The cost of auto has taken a greater toll on the Canadian insurance industry than simply a drain on capital resources – last year saw Markham General, which specialized in Ontario auto, placed under liquidation while several major players such as Royal & SunAlliance Insurance Group and CGU Canada/Aviva implemented restructuring initiatives in a bid to quell their auto losses. Most recently, CGU/Aviva axed several senior management members (including president Stuart Kistruck) at Pilot Insurance Co., which following restructuring of the Canadian operations, served as the group’s Ontario personal lines carrier. The Pilot management shakeout occurred after an audit revealed a reserve shortfall totaling about $195 million, which a company statement says primarily relates to personal lines auto. While Pilot’s ability to write business has not been restricted by the reserve shortfall, a CGU/Aviva statement says that the company will be “cautious” in taking on new business until rate a dequacy is achieved.

The removal of Markham, which wrote about $80 million in premiums annually, and underwriting cutbacks by Royal & SunAlliance, have added pressure to the already capacity-hungry auto marketplace, brokers say. They point to the dramatic growth in marketshare of the industry’s high-risk auto pool, the Facility Association (FA), during 2002, which rose as a total countrywide share by 62% year-on-year to 2.9%. A significant percentage of auto business currently going into the FA should be going into the standard market, they note, except that there is simply little interest by insurers in accepting business (see CU’s cover article from April 2003 issue for further details).

Most insurers consulted by CU in researching this article concur that the biggest problem with auto insurance is the fact that it is a regulated product that too often becomes a “political tool” applied by politicians in political campaigns (with many of the provinces facing elections this year, insurers are concerned that auto product reform initiatives currently underway will either be swept aside, watered down to become ineffective, or delayed while industry losses continue to grow. Ontario’s auto reform under Bill-198 has been in various forms of legislative packaging from almost a year ago, and it is unlikely to become effective before the second half of this year).

Specifically, insurers remain concerned over fraudulent abuse in bodily injury (BI) claims in Ontario, and runaway tort costs in the Atlantic Canada region. Also, insurers remain unhappy with the rate filing systems applied by most provinces which hamper timely pricing adjustments on covers and limit price increases, while the “take all comers rule” that requires that all drivers regardless of their risk profile have to have access to insurance has added to industry losses. Short of deregulating auto insurance, companies say they will not increase their exposure to the market until meaningful product reforms have been introduced, and reduced cost benefits begin to filter through to their bottom-lines. In the meantime, brokers and insurers share a concern that the high political profile currently being given to auto insurance price increases – specifically in Atlantic Canada – could see some regions ultimately falling to state-run insurance systems.

AUTO CAPACITY

“Auto is a product that we [as an industry] are all losing money on. It’s also a product that we can’t afford to move out of – I’ve got too much ‘fixed cost’ tied into it,” says Igal Mayer, president of CGU Group Canada Ltd./Aviva. He points out that the nature of the auto product, specifically personal lines, involves a comprehensive infrastructure to maintain, with just a company’s commitment to its distribution force being a major factor. “That’s why I’m reluctantly sticking by it. To get out will mean a major re-engineering.”

In describing the state of the auto insurance marketplace countrywide, Mayer comments, “it’s bloody well bleeding. I’m still losing [money] after rate increases. We need product reform, whether it be healthcare in Ontario and tort reform in Atlantic Canada.” The problem with writing auto, he adds, is that for various reasons across the country, the “cost inflation” has become so runaway that insurers do not know how to price the product.

“So much relies on regulation,” Mayer muses with regard to the exceedingly high losses coming through auto. “If you look at markets where auto has succeeded, there is a direct correlation with reduced regulation. If we could tailor products, I think it would be amazing how quick capacity would return [to the marketplace].” As such, he believes that in a “best case scenario”, current capacity within the auto line will not diminish further, although it is unlikely insurers’ appetites will improve in the short-term either. “Basically, there is no capital coming in [to the industry], we’re [the industry] still losing capital. The only way to raise capital is through earnings,” he adds.

In this respect, Mayer does not expect the auto product will be profitable this year, and may possibly produce a “break-even” for the 2004 financial year – assuming that the regulatory reforms currently in the works are implemented. “This is an oil-tanker to turn [around],” he notes.

Larry Simmons, president of Royal & SunAlliance Insurance Group, points out “capacity is the main issue [with auto] now, otherwise we wouldn’t be seeing the Facility Association growing at the rate it is”. Basically, he adds, “there’s something amiss with the auto product, the industry’s results have not improved despite price increases. It’s because it’s [auto] a regulated line.”

That said, Simmons concedes that “some diligence” applied by insurers in the past could have staved off some of the adverse conditions that resulted in the current market losses as well as capacity shortage. “This is a capital problem, and it’s a results problem, with Ontario being a big part of it [the problem].” Regulatory reform is critical in order to get auto back into the black on insurers’ earning statements, he adds, which in turn would see a return of market capacity. “I wish we [the industry] didn’t have political regulatory involvement in auto. But, I think the [provincial] governments are beginning to realize that they have to deal with the problem.”

While capital limitation on insurers is not the main driving force behind the withdrawal of capacity in auto insurance, Simmons says that, even if he had access to additional capital, “I wouldn’t commit it to auto”. He adds, “We [Royal & SunAlliance] would like to find a solution to auto in Canada. It’s the biggest line, but at Royal we’re not willing to grow this business generally. I’m watching to se e what is happening with [product] reform, but industry patience is growing thin.”

The political factor is a big part of the problem with the auto line, says Bill Star, president of Kingsway General Insurance Co. “But,” he adds, “insurers are also to blame, we’ve been shooting ourselves in the foot for years. You just have to look at the losses incurred by the industry on business that isn’t regulated. I doubt that insurers would have made money on auto even without rate regulation.”

In addition to rate inadequacy which arose from the “soft market” years, Star believes that the insurance industry “has been way too complacent” in dealing with loss control, notably the impact of fraud and healthcare abuse in the Ontario marketplace. As such, the industry’s efforts to bring the auto product back to profitability should be less focused on rate increases and directed more at combating fraud. Kingsway disclosed a record underwriting profit for the first quarter of the current year, which Star attributes partly to the company’s efforts over the past year to curtail fraudulent claims and abuse of the auto system by vendors such as medical practitioners and paralegals.

Ernst Notz, president of The Citadel General Assurance Co., says he is “passively optimistic” for the future of the auto product in Canada from a profitability standpoint, assuming that regulatory reform is acted on promptly. He too does not believe that capital shortage in the industry is the main cause for the sharp reduction in capacity within the auto market. The real issue is cost, he adds, and auto is not a line that companies can predict where it is headed based on current market conditions. He notes that The Citadel is not a large auto writer, the company has focused its resources on commercial business, “where we [The Citadel] can get the rates that we want”. In this respect, Notz says The Citadel is reluctant to write new auto business. However, he also points out, “we have grown our book of auto in Quebec, and quite willingly because we’re making money there.”

FA DILEMMA

The dramatic increase over the past year in the FA’s share of the Ontario market and in the Atlantic Canada region has alarmed brokers as well as the association’s member insurers. The FA serves as a high-risk pool for auto insurance to insure as a “market of last resort”. The FA’s losses are carried by member companies based on a formula of how much auto insurance they write.

With the FA’s combined ratio having risen by 17% over 2002 to a high of 160% (with Ontario and Atlantic Canada being the main loss culprits), the association is worried over the run-away increase in its underwriting losses (the FA reported a loss of $192.8 million for 2002) which largely stem from the fact that its pricing is restricted by regulators. As a result, the “gap” between the FA’s pricing and the standard auto market has narrowed to the extent that the association is becoming “repopulated” observes FA president Dave Simpson. Notably, the FA’s share of the Ontario market rose to 2.8% for 2002 from the previous year’s 1.8% (with a combined ratio of 188%), while its share of the Atlantic region rose to 4.9% for New Brunswick, 5% for Nova Scotia and 6.6% for Newfoundland/Labrador – with growth in marketshare of the east-coast doubling, or nearly doubling in each province, compared with its 2001 position.

“The growth of the FA [marketshare] is scary. The more you add auto [in writing auto business to your books], the more you’re punished with [loss] percentages through the FA,” observes Notz. And, speaking at the FA’s recently held AGM, the association’s former chair, and president of State Farm Insurance Co., Bob Cooke, notes that the “take all comers” rule is being questioned south of the border. The governor of New Jersey has indicated that the rule will be lifted, he adds, “I would offer the hope that our political and regulatory leaders throughout Canada would embrace similar wisdom”

ONTARIO BLEEDING

Direct written premiums in Ontario auto rose year-on-year by 17% to $7.5 billion for 2002, according to CU’s Statistical Issue 2003. The auto product currently accounts for just over 25% of total premiums in Canada, observes Mayer. With so much riding for the industry on the future outcome of Ontario auto, he says that “we’re currently at a stalemate. We [the industry] have fraud control [through Bill-198], but we don’t have DAC [Designated Assessment Centre] reforms, where the costs of assessments are prohibitive. The problem with DACs is lack of capacity, there are only 135 of them across Ontario, and turnaround is extremely lagged. Unless we get DAC reform, I’m concerned that Bill-198 will not mean anything.”

With the industry underwriting cost running at over 96 cents per premium dollar in Ontario auto, and medical treatment cost inflation rising by 16% annually, insurers cannot sustain the bleeding being caused by this line, Mayer notes. “We have to bring it [claims cost inflation] to below 10%, we have to cut the knees out from under it.”

Simmons believes that the product reform put forward in Bill-198 is a beginning to address the runaway cost issues associated with Ontario auto. However, he says the reforms as they currently stand are insufficient to encourage insurers wholeheartedly back to the marketplace. “I don’t think this [Bill-198] is sufficient in addressing the issues we [the industry] face in using our capital and pricing it. To attract capital, any product has to gain confidence from investors, which means less restrictive practices on pricing.”

“Ontario auto only represents about 8% of our [Kingsway] total business,” comments Star, “but it caused a huge loss”. As a result, Kingsway began a proactive campaign last year to address claim abuse and fraud within the medical and paralegal communities, which he believes has produced meaningful results. Notably, Kingsway was able to reduce its combined ratio on Ontario auto to 106% for 2002 from the previous year’s 130% ratio. “The problem is that many insurers think that Bill-198 is going to be their salvation, which it won’t,” he told attendees at the recently held Insight Info “Auto-Insurance Reform in Ontario” conference. “Bill-198 won’t stop fraud.”

Star says that auto rates in Ontario could be reduced by 20% if the fraud cost could be removed from claims. One of the biggest problems with personal auto is “solicitation” by paralegals in drawing insureds into making injury claims. “We don’t see fraudulent claims coming from truckers and bikers.” After “black listing” a number of clinic treatment facilities and paralegals identified with inflated claims and “staged accidents”, Star says the number of suspect claims submitted to Kingsway declined markedly – without any legal ramification. “But, we [Kingsway] as one company can’t do it [fight fraud] on our own, the industry has to take it up.”

Robert Gutwein, vice president of Accident Support Services International Ltd., points out that 70% of auto accidents are low impact, which is where most fraudulent claims arise from. He believes that insurers have an opportunity through installing adjusting staff at collision reporting centers (CRCs) to “get into early claims intervention”. He adds, “CGU/Aviva is doing a great job of this.” However, Gutwein notes that the fraud deterrents contained in Bill-198 will not put a stop to claim solicitation by paralegals.

Star does not expect to see insurers increasing their writing of Ontario auto until next year, “because companies want to see results. I don’t think that many [companies] will act all that rapidly next year either.” As such, he believes that the capacity shortage in Ontario auto will continue. “The European owned companies aren’t going to write more business. The Royal & SunAlliance situation has released a lot of business, and now we have the Pilot situation.”

NON-ONTARIO AUTO

Outside of Ontario, the industry’s “hotbed” of auto losses lies in the Atlantic Canada region where political attention has elevated insurance pricing to become an election platform issue – at least in New Brunswick, which insurers had hopes that the province would take the lead in product legislative reform. Instead, New Brunswick’s conservative government has come under fire by the National Democratic Party (NDP) and the Liberal Party for not taking meaningful action to provide the province’s drivers with rate relief. On the eve of a possible election, both parties accused insurers of “price gouging” policyholders and called for the province’s Public Utilities Board to be granted power to set insurance rates. Liberal leader Shawn Graham states that a government under his party will immediately cut auto insurance rates by 25%.

The IBC was quick to respond to the attacks, noting that “forcing insurers to reduce rates by 25% will not serve the long-term interests of New Brunswick consumers. In fact, it would most assuredly remove all incentive for insurers to do business in the province.” The IBC once again called on the provincial government to act swiftly in the implementation of auto product reform. Don Forgeron, vice president of the IBC’s Atlantic office, took exception to Graham’s accusation of industry price gouging. “Right now, the auto insurance product is unsustainable in Atlantic Canada. Insurance companies have experienced losses of $340 million in New Brunswick over the last 10 years.”

Despite the political friction in the Atlantic region, Mayer says the proposed auto product reform initiatives put forward in New Brunswick should provide tort relief. In this regard, he believes that Atlantic Canada does represent a sizeable enough auto market for private insurance companies to want to stay in the region. But, should the political powers-that-be decide to switch to a state-run insurance system, “they can have it if they want it,” he adds.

Simmons also holds a fairly optimistic view for product reform in Atlantic Canada. The industry should begin to see some elements of reform being enacted within the next 12 months, he adds. “Private insurance has been successful for a long time. I think it is still the best system for auto.” Simmons is also hopeful that product reform initiatives underway in Alberta will move closer this year to being put into effect.

With Alberta representing about $2.2 billion in annual auto premiums, this is an important market for insurers, Mayer notes. While auto losses have not been as severe as Ontario and Atlantic Canada, the rise in tort costs has tempered the desire of insurers to increase their business in Alberta, he adds. “I think that, at this stage, Alberta is a ‘yellow light’, it’s next on the list in terms of needed tort reform. If anyone wants to adopt the Quebec model, we’re all for it.”