Ontario Auto – Looking for Rate Savings

Ontario’s new premier Dalton McGuinty, along with several of his provincial counterparts, have made it a cornerstone of the government’s mandate to reduce automobile insurance premiums. New Brunswick is considering the extreme step of switching to a publicly run insurance system similar to British Columbia and Saskatchewan. Thankfully, the Ontario government has no intention of following such a drastic course.

Former Ontario premier Bob Rae briefly considered publicly run insurance but wisely decided the private sector could better meet the wants and needs of Ontario drivers. The Liberals have instead set a goal of an average 10% premium rate reduction. If these lower premiums prove popular with voters, which no doubt they will, further price cuts are inevitable.

An easy target for future cuts is the interest charge consumers incur if they pay their premiums on a monthly basis. The Insurance Act currently allows insurers to charge up to 3% to those customers who choose to pay monthly. The insurers reasoning for this “interest penalty” is simple: they want consumers’ money as soon as possible. Any delay in payment of the full premium at the inception of the policy results in carriers losing valuable investment income.

This investment income is vital due to the limited underwriting margin based on current combined ratios. The Canadian property and casualty insurance industry’s average combined ratios between 1998 and 2002 were 107.5 %, 106.6%, 107.8%, 110.3% and 105.8% respectively. Companies are correct in claiming they are losing much needed investment income. There is no debate that insurers should be receiving investment income on unearned revenue. The question is whether companies are entitled to unearned premiums in the first place.

UNEARNED QUESTION

Canada’s application of the “Generally Accepted Accounting Principles” (GAAP) indicates that revenues must be matched to their related expenses and only recorded as earned revenue once an actual service has been provided to the customer. For example, a $50 gift certificate is purchased from a retail store. The store has the money before a service is delivered or a good has been sold. The gift certificate money cannot immediately be counted as revenue but rather it must be classified as a liability called unearned revenue. Only once the customer purchases a product or service does the unearned revenue convert to earned revenue.

January is traditionally a slow month for retail sales because it follows the busy Christmas season. However in 2004, January retail sales increased 1.6% because of the increased popularity of gift certificates. Retail stores still received the customers’ money in December when the gift certificates were purchased, although these revenues could not be claimed for tax purposes until the gift certificates were redeemed in January.

The same accounting principle holds true for insurance. Full premiums collected from insureds at the start of the policy period must be pro rated over the life of the policy. The full premium cannot immediately be counted as earned revenue because the service is being provided over 12 months and not just in the first month of the policy. Each month a portion of the unearned premium is transferred to earned revenue. The amount transferred is based on historical data of when expenses are incurred in relation to the particular risk (GAAP matching principle). For example, Kingsway General writes motorcycle insurance. Motorcycle risks dictate that a higher portion of the yearly premium is realized during the regular riding season. Claims will be higher in July than in February because more motorcyclists ride during the summer months than in the dead of winter. Kingsway claims expenses must be matched to when the related revenue was earned.

ACTING FIRST

The investment income insurers are afraid to lose is based on unearned premiums. This revenue stream should only be a bonus for companies. Consumers should not be penalized for wanting to wait until a service has been provided (in this case peace of mind from financial ruin in the event of a loss) before paying their premiums. People are not forced to pay their telephone and utilities bills or their bank service charges and newspaper subscriptions for the full year at the inception of the contract. In these examples, a service is provided for a particular month and then payment is requested. Insurance premiums are the only fixed monthly household expense that levies interest if payments are made within the same month that the service is rendered.

In the current political environment, interest charges on monthly premium payments are a poor business practice. It only antagonizes a public already disgruntled with a product they do not fully understand. The solution is for the industry to be pro-active and swallow a “poison pill”.

All insurers should voluntarily stop interest charges on monthly payments. Some carriers, such as The Personal Insurance Co. of Canada, have already done so. If all insurers stop this practice, the provincial government will have no reason to delete the interest charge provision because there will be no additional benefit to their constituents. The public will already be saving an additional 3% on their premiums without the government having intervened.

If, and when, the political climate changes to a more insurer friendly environment, companies can then decide if they wish to reinstate monthly interest charges. However, once this provision is removed, it will be difficult to convince any political party to reinstate it. It is more favorable to allow insurers themselves, some time in the future, to decide if they wish to charge interest fees to their customers. Accounting logic does not support this business practice. Sooner rather than later Ontario drivers will demand that this additional cost be eliminated.