Who’s Driving Auto Rate Turbulence?

Automobile insurance is a continual topic of conversation among politicians, insurance commissioners and the insuring public. In Canada, the delivery is through various methods of distribution, although the private enterprise method is generally the most preferred. There is, however, government involvement in four provinces. It has never been proven that government delivery of automobile insurance is economical, although some political parties believe it is.

Various forms of no-fault plans are available in different jurisdictions in both Canada and the United States. No-fault systems are more costly than tort systems, since additional parties are added to the number of claimants in most no-fault accidents involving bodily injury. No-fault also increases the frequency of fraud. Canada is noticeably socialistic in providing benefits for people whenever there is a choice, and so politicians typically favor no-fault. In contrast, no-fault is less popular in the United States; in many states that had such plans, they have subsequently returned to a total tort system for compensation, which has helped to lower cost. Only 12 states still have some form of no-fault.

In Canada, automobile insurance represents over 50% of the gross written premium income of the insurance industry. It is therefore the greatest contributor to the profit or loss in any given year. When governments interfere, as they have for many years, they change the economic position of the industry and cause inconsistent results from year to year. Their actions hurt the insuring public as well as the insurance industry, because their interference causes rates to fluctuate dramatically. The result is that the insuring public questions the actions of insurers rather than the politicians. Unfortunately, politicians are not good business people; certainly, they do not understand how important it is to maintain a strong and stable insurance industry. They are not interested in determining what is right or good but are more concerned with getting votes.

IGNORING STATS

The action taken in recent years by the Alberta government is probably the worst example of interference and the lack of understanding of insurance. Insurance is based upon the principle of spreading risk by collecting premiums that are statistically sound for each category of risk. This method allows premiums to be lower for less hazardous risks and higher for more hazardous ones. For example, a married, 45-year-old male driver with a good driving record for more than 20 years is less likely to have an accident than a single, male, 18-year-old new driver. Statistical evidence provides proof of that statement. The fact that a young, inexperienced driver finds the insurance premium too high to buy a sports car he wants to own will encourage him to be an occasional driver on his parents’ car until he gains more experience. This reduces the number of young unsupervised drivers on the road and reduces accidents, injuries and deaths.

Unfortunately, ignoring an abundance of statistical evidence that points in a different policy direction, uninformed politicians in Alberta introduced a “rate grid.” The grid forces insurers to provide coverage for young, inexperienced drivers at inadequate rates, making the roads less safe for drivers; it also increases the rates for experienced drivers with good driving records. As a result, Alberta politicians will in time see accident frequency and road deaths increase.

Ontario has introduced poor legislation in the past that has caused automobile insurance rates to be inadequate for several years. They “encouraged” companies to reduce rates at a time when rates should have been increased. As a result, motorists suddenly found their premiums increasing dramatically, which led to further actions by government. Fortunately, the next time around they listened to and worked with the industry to bring about changes that reduced fraud and claims costs. They introduced a bill to stabilize rates, which caused rates to move downward and reduce complaints from the insuring public. However, once the government saw the insurance industry was profitable, they again “encouraged” companies to reduce rates. This will lead to a higher loss ratio for the industry and eventually higher rates. So much for rate stability.

United States governments take similar actions on occasion. However, their actions do not appear to have caused the same fluctuation we have experienced in Canada.

Florida had a fraud problem, but the state commissioner moved quickly to work with companies to identify the problem and create solutions. The rate level has stabilized and companies are now making a reasonable profit after several companies failed during the turbulent times.

THE POLITICS OF AUTO RATES

California is now tinkering with rating classes and will probably cause a disturbance in the market. It is likely companies will find a reduction in profits during the time changes are being made over the next few years. In California, the changes are being introduced for political reasons, not to help the majority of motorists. Commissioner John Garamendi plans to run for a higher office and wants to leave a legacy of lower rates, whether justified or not. Overall, the insurance industry in the United Sates has greater stability of prices and profits than the industry in Canada.

New York Attorney General Eliot Spitzer has also caused problems for the insurance industry in the United States. He has made accusations in the press causing some companies to back down and pay fines even though Spitzer has not won any battles in court. The threat of sanctions is enough to force changes that in some cases do not appear to be justified. There is also a spillover effect: Spitzer’s actions in the U.S. have caused some regulators to question the industry’s actions in Canada. Canadian regulators have not found any wrongdoing that would cause fines; nevertheless, they recommended changes in the area of broker compensation. Spitzer’s actions were motivated by his intention to run for governor of New York and his need to increase his profile. It is evident politicians are similar on both sides of the border.

The insurance industry has performed poorly for a number of years, with a poor return on equity compared to other industries. On the other hand, banks and the oil industry have record earnings with little or no actions taken by government. In 2004, the insurance industry for the first time earned a decent return on investment for shareholders. Unfortunately, it was not made clear to the public that better earnings were the result of commercial rates finally becoming adequate. Politicians immediately attacked private passenger automobile rates, since this is the area of greatest interest to the insuring public. As a result, in Canada, private passenger automobile rates were forced down and the industry was criticized for exorbitant profits – even though their profits were less than those of many other industries. Interest rates began to rise slowly and this was the beginning of another cycle of softer markets.

DECLINING PROFITS

In 2005, the industry became more aggressive; companies started to look for ways to increase premium volume. Given both a lower accident frequency in automobile claims and a higher investment income compared to past years, the industry had a relatively good year in overall profit. It is evident, however, that underwriting profit will decline in future years: earned premiums have reduced as a result of lower rates charged in 2004 and 2005. Since investment income is on the rise, some companies will continue to attract increased business at rates that are lower than previous years. The second half of 2006 will result in higher rates and a firming of the market as companies see their results deteriorating. The first rates to increase will be in automobile, both commercial and private passenger.

The firmer market will be experienced in 2007, when price increa ses are evident in most classes of insurance and some companies begin to restrict volume from their agents and brokers. Experience reviews will result in the termination of some producers; they will again find difficulty in replacing their books of business, particularly automobile. This change in the market will continue into 2008 until pricing has firmed sufficiently to increase earned premiums enough to offset higher claims costs. Government actions are still the wild card, as has been experienced in many of the cycles in the past.

The next few years will be challenging for everyone and the result will be the survival of the fittest.