Rate Setting: is this a regulator’s job?

When reviewing the role of insurance commissioners in Canada and the U.S., one must wonder why they became involved in rate approvals. The original role of the insurance commissioner was apolitical, to make sure that companies were properly capitalized, were adequately reinsured, and followed the regulations. The role of the commissioners has since been extended to cover policy forms and the reasonableness of rates within a certain range. This, however, has evolved into a “politically sensitive” area of a complete approval system. Can insurers afford external political influences in matters determining whether they make a loss or profit?

Over the years the role of insurance commissioners has changed dramatically. In many cases, they have developed large offices of staff, covering a growing multitude of projects. Sometimes it appears as though these “projects” are added merely to support the extension of the regulatory offices in question.

An example of which is the Ontario Insurance Commission’s creation of a division to mediate and arbitrate insurance claims. In numerous cases the arbitrators have made decisions that have extended protection beyond the original intent of an automobile policy. The extension of such responsibilities has increased the cost to insurers, and as such, the costs have been passed on to the consumer.

Increasing the cost of insurance was clearly not the original intention behind the role of the insurance commissioners. However, as the issue currently stands in most provinces of Canada and many states in the U.S., insurance commissioners are appointed by government and therefore take on a very political role. As a “politician”, commission decisions are sometimes made that are not necessarily right for the people but appear to be favorable at a time when the politicians running the game are facing re-election. In that respect, the involvement of insurance commissioners in determining the level of insurer rate filings has become a serious issue, one which in some instances, could prove financially crippling to companies.

Rate filings

Inadequate rates can cause insurers to become insolvent. A delay in rate approval, which sometimes takes months, can cause companies to face serious financial hardship. The problem of inadequate rates caused by delays can put a company into an insolvent position, contrary to the purpose for which the insurance commissions exist. As such, it is difficult for an insurance commissioner to be critical of an insurer that is in an insolvent position because of inadequate rates when the commission approved the rates — this is particularly true when rate approval had been held up for months because of pending changes in regulations.

Rate approval systems have also become costly for insurers in that they have to employ actuaries to justify the rates. This also means the insurance commissioners have to employ actuaries to approve rates based on statistical evidence that may be inadequate in certain territories and classes. In an open and competitive market environment, it is not unusual to see a great variance in prices or products, whether it is insurance or other types of consumer goods. For this reason, it is not unusual to see a specific rate quoted by one company of $800 and others varying up to $1,200 or more for the same category of risk. In that respect, it becomes extremely difficult for insurers to justify to the commissioner the reasons behind the rate variances. As a result, the approval system gains a “lack of credibility” on part of the insurance commissioner when prior approval is required.

Experience in rate setting

Another factor thwarting insurers is that many territories and classifications do not have a sufficient number of risks to create credible statistics. Also, rate filings are based on future expectations rather than past history. Since statistics are based strictly on past performance, they are not totally reliable for rate development. Many items have to be reviewed in creating rates for the future.

For example, the trend of court awards cannot be actuarially demonstrated although higher rates may be indicated. Likewise, changes in past or proposed legislation may have a dramatic effect on the rate level required. Again, these items cannot necessarily be quantified, but an experienced insurance professional can recognize them and will know how they will affect the trend in future settlements and claims costs. As such, when filing rates, an insurer must estimate on the high side if rate approval is required, thereby distorting true competitiveness of the market. However, if a more efficient filing system were applied, allowing insurers to react in a responsive manner to claims experience, the result would be a more active and consumer-focused marketplace.

File and use

In Canada, Quebec is the only province that still has a “file and use” system. It works very efficiently and has over the years reduced the cost of red tape to the consumer. The commissioner relies on the competitive nature of the insurance marketplace, a system that has worked extremely well in the current cycle of over-capitalized companies hungry for business. Between the “no-fault” system that was introduced many years ago, and the very efficient rate system they have in Quebec, consumers have enjoyed substantially reduced rates over the years for automobile insurance.

The same can be said for Illinois, which also applies the file and use system. In the last ten years the Chicago market has hardly seen a rate increase for automobile insurance. Reviewing the American states, it appears that 29 of the 50 states have file and use, or “no-file” rate systems, for commercial automobile insurance, and 24 states use the same approach towards private passenger automobiles. These states also appear to operate in a very efficient manner and make it easier for insurers to do business in a competitive manner. The practices applied by these jurisdictions shows that heightened competition in the marketplace is the best possible way to control rates.

Extreme rate variances are hard to justify to consumers in an openly competitive environment. As a result, a file and use rate system creates stability, particularly if the system is one where rates filed cannot be used for a period of, say thirty days. Such a delay mechanism would allow the commission to review the rates and determine if they are within a certain acceptable range for the jurisdiction. Everyone stands to benefit from a file and use rate system. An insurer is in a position to become more competitive and at the same time protected from insolvency, while consumers benefit from an active competitive marketplace. Insurance commissioners also would benefit by not being in the awkward position of approving rates without adequate statistical information to support the approval.