Grounhog Day

The Canadian private auto insurance industry is well aware of the following mythology: a ground hog working in Canada’s auto insurance industry wakes up in 1998-99 and sees the long shadow of increasing auto insurance claims costs just outside its door. The ground hog compensates by raising auto insurance rates, dumping some low-risk drivers into the facilities pool and tightening coverage. As a result, drivers throughout the country — drivers who must have insurance in order to drive — cringe at their escalating auto insurance premiums. They broadcast to the media and local politicians tales about high rates and the absence of coverage. The country’s regulation climate suddenly turns stormy; a huge squall of government legislation and auto insurance reform packages attempt to bring stability back to the country’s provincial private auto insurance markets.

And for a time, it works. Relative stability is brought back to the auto insurance marketplace. For example, auto insurance premiums in Canada’s largest private auto insurance markets are generally 10-16% lower now than they were four years ago. Private auto insurers’ loss ratios — the division of premium revenue by claims costs — went from a Canadian average of 86% in 2001-02 to 64.4% in 2005. The Insurance Bureau of Canada (IBC) noted in a recent press release that Canadian drivers have saved up to Cdn$6.8 billion in rate reductions during 2004-06, the period

after government auto reforms were introduced

in Alberta, Ontario, New Brunswick and Newfoundland and Labrador.

Fast forward to 2007. The ground hog is out of its hole again and sees the long shadow of claims costs just outside the door and — well, you know the rest. Or do you?

In the 1993 movie Groundhog Day, comedian Bill Murray’s TV weatherman personae, Phil, wakes up each morning to re-live the same day over and over again. But, although everyone around Phil forgets each day as soon as it begins again (dooming them to repeat forever the same dialogue and activities), Phil is able to remember what happens each time he re-lives the same day. He then gets the idea of trying to apply his memories and knowledge of the past to correct his past mistakes. Finally, at long last, he achieves his dream, which is to get the girl, played by Andie MacDowell…

Will Canadian auto insurers “get the girl,” in the sense of avoiding the kinds of legislative and rate upheavals seen during the 2001-03 hard market? Or is the industry headed for another ‘Groundhog Day’ repeat of 2001-03, which at the time caused a great deal of angst not only among consumers and legislators, but among Canada’s private market auto insurers as well?

Only time will tell, of course, but signs are present that these are timely questions. For example, in a June 2007 report entitled ‘Canadian Property and Casualty Insurers Should Heed the Past to Avoid Market Instability,’ ratings agency Standard & Poor’s (S&P’s) reported the Canadian industry’s 2006 loss ratio jumped to 67.7% from 64% in 2005. “This should signal to the market that further premiums declines might not be prudent,” S&P’s noted, in reference to the “generally well-capitalized soft market” observed in 2006.

S&P’s isn’t the only one to document the rise in auto claims costs. The Office of the Superintendent of Financial Institutions (OSFI), the federal regulator of financial institutions, routinely posts the quarterly results of insurers subject to federal regulations on its Web site. Although its 2007 Q2 was not available at press time, a look at OSFI’s auto industry statistics for the past three years bears out a definite trend upwards in auto claims costs and loss ratios. According to OSFI, auto claims costs incurred in 2005 Q1 totalled Cdn$1.963 billion. That figure went up to Cdn$2.145 billion in 2006 Q1. One year later, in 2007 Q1, the figure inched upward again to Cdn$2.247 billion.

Likewise, OSFI notes, overall auto loss ratios increased from 61.7% in 2005 Q1 to 71.14% in 2006 Q1, and again to 74.13% in 2007 Q1.

Familiar terrain

Noting a similar trend in IBC’s industry loss ratio statistics, Jane Voll, vice president, policy development and chief economist at IBC, observed: “It’s interesting, because where we’re at right now — at this 73.6% [loss ratio] — is similar to the first quarter of the hard market in Q1 2000,” she says. “We were right at 73-74% at that time, so it really shows a parallel to the start of the last hard market and a turning point in auto results.”

Sound familiar?

If it does, it’s because the industry has seen this movie before. In 2001-02, for example, the plot thickened with a flurry of political action resulting in auto insurance reform packages. Most reforms included a component that focused on capping pain and suffering awards for minor injuries and focusing instead on securing quick treatment for people suffering from serious collision-related injuries. The legislative caps had the short-term effect of keeping insurers’ claims costs from spiraling out of control.

“We said from the beginning that when the reforms came into play, we would have to watch to make sure the system did not erode in terms of effectiveness,” ING Canada president and CEO Claude Dussault says. “I think we were expecting initially that we would get some drop [in claims costs] and we did. In fact, what we got was very much in line with our best-case scenario. But we knew it would stop improving and then the question was how effective would the reforms in containing future inflation.”

In fact, Alberta and Ontario’s accident benefits (AB) claims costs in 2007 Q1 are running just a little ahead of inflation, Voll observes. “In Ontario, they are up 2%,” she says. “What’s interesting about that is, you might think: ‘Oh well, 2%, that’s sort of low.’ But it’s above the current rate of inflation in Ontario. The CPI inflation is running at 1.6% in Ontario and net incurred claims are growing by 2%. And in Alberta, CPI inflation is running at 6.3% but claims are growing at 9%.”

Which raises the following point: in order to mitigate claims costs, the insurance industry must identify where the claims costs are coming from. And this is where the complexity of Canada’s private auto insurance industry makes all that is solid melt into air: claims costs are based on the interplay and outcome of many different variables, including claims frequencies (i.e. how many claims) and claim severity (how much each claim costs).

Claims severity can be further broken down into subcategories. AB payments, for example, are dictated by medical costs, as well as legal and statutory limits on AB court awards.

Severity also entails the legal bills advanced to resolve a claim, often captured statistically under the title of ‘third-party liability costs.’

A third category of severity looks at ‘auto physical damage costs,’ which are basically a measure of how much it costs to fix the damaged vehicles. Physical damage costs are in part driven by the rising costs of car parts and labour costs, which can change upward or downward according to the fortunes of local and provincial economies.

Needless to say, geography, regulation and the composition of an individual company’s book of business all play a role in determining claims costs as well. In terms of geography, echoing comments made by individual carriers, Voll characterizes the rise in auto claims costs as a story primarily driven by results in Alberta and Ontario, Canada’s two largest private auto insurance markets.

So what is driving claims costs to go up in Canada? All of the above categories, according to industry sources. “What’s behind [Canada’s escalating loss ratios] is increases in all of the sub-coverages,” Voll observed. “So the loss ratio is getting worse for third-party liability, it’s getting worse for accident benefit, and it’s getting worse for physical damage.”

Increasing Frequencies

Some individual companies have seen their claims freq
uencies increase, which, they note, has an impact on their claims costs. “We are starting to see a difference in frequency, particularly from 2006-07,” says Irene Bianchi, vice president of claims at Royal & SunAlliance. “In 2006, you may recall, we had a very, very mild winter. That put a lid on our frequency; it was fairly low. Now, in 2007, we have seen much more significant weather in the first and second quarters. Our levels of frequency have gone up and they’ve gone up to normalized levels, whereas I would characterize 2006 as having a very slow first and second quarter.”

Lissa Seguine, vice president of claims at the Co-operators General Insurance Company, says frequencies are also up because “we believe there is less nervousness among clients when it comes to making a claim or contacting their insurer for advice.” She says this is “because of where the industry is in the market cycle, with rates steady or decreasing.”

This is very different from the situation during the hard market in the early 2000s, Seguine adds.

She follows with the observation that The Co-operators is one among several insurance companies that offer “accident forgiveness” programs. A central aspect of these programs is that if a claim doesn’t involve an injury or conviction, and the client chooses to pay the claim, the incident will not result in a premium increase. “The impact is positive from a trust and transparency standpoint,” Seguine says of these programs, “and it impacts claims costs.”

Increasing Severity

Accident Benefit Costs

Some sources, however, see severity, not frequency, as the main driver of claims costs.

S&P’s makes a reference in its June 2007 report to rising AB costs in both Ontario and Alberta. “In Alberta, for instance, the average benefit cost per claim is about 7.1%, while in Ontario it rose 1.5% in 2006,” S&P’s notes. “The rise in accident benefit costs is somewhat concerning because one of the major initiatives from the auto reforms was to contain the rise through the adoption of evidence-based treatment for soft-tissue injuries. The industry would be in serious jeopardy if accident benefit costs were to escalate as they did in 2001-02.”

The Alberta reforms capped at Cdn$4,000 court awards for pain and suffering in minor injury claims. At the same time, more money was allocated for the care required to return an accident victim to health. Also, in order to promote quick treatment to accident victims (thereby mitigating long-term health care costs), the Alberta reforms introduced a direct-to-insurer billing system that permitted injured collision victims to obtain treatment with no delays.

Ontario introduced auto insurance reforms in 2003. As part of its reforms, the province introduced new Designated Assessment Centres (DACs), which assess treatment plans for seriously injured accident victims. A variety of new forms are associated with the DAC system, including OCF-22s, which are requests for medical assessment.

Jamie McDougall, vice president of claims at Gore Mutual Insurance Company, says, “we’ve seen now as an industry, and Gore is no different than others, a large number of OCF-22s come in…I don’t think it’s a big secret that there’s a perception that insurers are getting a large number of requests for assessments. The large volume is driving some costs, [also] costs in terms of adjustment time, things like that. That’s something we need to work through and adapt to.”

And of course there is the usual inflationary pressure on medical costs. “I think it’s fair to say that medical costs are not going down,” McDougall says. “I don’t think that would be a surprise to anybody. It isn’t cheaper for people to get treatment for an ailment today than it was two years ago.”

IBC estimates Canadian auto insurance medical claims amount to more than Cdn$1 billion each year. And the insurance trade association says it’s time to figure out exactly where these costs are coming from.

IBC announced the start-up of Health Care for Auto Claims (HCAI) in April 2007. HCAI is a Cdn$20-million technology system that electronically keeps track of medical assessments, treatment costs and insurers’ approvals and expenses related to an accident victims’ medical care. Medical health professionals will be mandated to bill through the HCAI system as of February 2008.

“The HCAI system will certainly help us to understand the sources of costs and capture accurate data associated with the AB claims costs, which will help us make more informed decisions around what are driving costs — and what changes are to be made, if changes need to be made to the product,” says McDougall, whose company, Gore Mutual, is among the first to pilot the project. “It’s about understanding what’s happening at a core level.”

Third-party Liability Costs

Like medical costs, legal costs based on third-party liability appear to be on the rise, although this is not as pronounced a phenomenon across Canada as it is in the AB or physical damage sub-coverages. But it is common knowledge in the insurance industry that lawyers’ bills will begin to increase, post-reforms, once lawyers who represent accident victims find “creases” in the courts’ interpretation of the language contained in auto reform legislation. Plaintiff lawyers’ legal costs figure prominently in cases when an insurer is ordered to pay the plaintiff’s legal fees as part of any award or settlement. George Kalopsis, president and chief operating officer of Echelon General Insurance Company, says the industry and governments must constantly update the auto insurance system, as opposed to implementing wholesale reforms once every four or five years. “Part of [the explanation for increased AB claims costs] is a natural progression in a highly regulated system, if it’s not being evaluated and tweaked and changes being made on an ongoing basis,” Kalopsis says. “Whether they are lawyers or individuals, people will mine every avenue that is available to them. [Auto reform] structures that were set up to deal fairly with people — and strike that balance between payouts, and making sure the system doesn’t get blown away financially — need to be tweaked.

“Arbitrators’ decisions open the door for other people to look at avenues that they may not have looked at in the past. Really, we’re looking at precedents being set, but more than anything, the system needs to be updated constantly. It can’t be looked at every five or six years, when an election is coming up.”

Physical Damage Costs

Ken Lindhardsen, senior vice president of claims at Desjardins General Insurance Group, notes the white-hot Alberta economy has allowed repair shops to charge higher labour rates, which has increased the insurers’ costs for fixing the vehicles. “It is fair to say that in Alberta, we have seen some pressure on the injury side, but we’ve seen probably more significant pressure that increased labour rates have had on the cost of physical damage repairs in auto,” he says. “Of course, there has been some inflationary impact, because the economy is growing at a faster rate in Alberta than it is in the rest of the country.”

Lindhardsen cited statistics in the 2007 Mitchell Industry Trends Report, which shows the average gross severity of a Canadian collision was Cdn$3,121 in 2007 Q1, a $34 increase over 2006 Q1. The same issue contains a chart showing that B.C. was the only Canadian province that showed a fourth-quarter decrease in average body labor rates throughout Canada. Everywhere else showed some kind of percentage increase in labour costs. Leading the way, according to Mitchell, were Alberta (a 2006 Q4 average labour cost of $51.26, compared to $47.38 the previous year), Ontario (from $46.99 in 2005 Q4 to $49.12 in 2006 Q4) and the Yukon Territory ($65 in 2005 Q4 and $69 in 2006 Q4).

Seeing the Shadow

So the ground hog sees the shadow of claims costs. Now what does it do? Sources say the insurance industry has a number of
options, one of which is to take a serious look at increasing auto insurance premiums. “It’s definitely something the industry as a whole needs to consider,” Lindhardsen says. “If you look at the rate changes in Alberta, I think rates have decreased in each of the past three years in Alberta. So when you see a decrease in rates and yet increased pressure on the costs side, at some point it’s going to have an impact on rates.”

Pushing for regulatory reforms is another option. The idea behind this is to give insurers more flexibility to price products and create new products in the periods between auto reforms. Insurers say auto reforms in the past have done what they were intended to do: control insurers’ costs, thus maintaining rate and pricing stability. But governments must take care not to undermine an insurer’s underwriting flexibility in the process, they add.

Dussault said regulation usually comes in one of two forms. “The regulators have been doing a very effective job at making sure that they are on top of managing claims costs,” he says, partly in reference to caps in various provinces on payouts for pain and suffering related to minor injuries. “For that, I would give regulators across the country very good marks, in terms of making sure that all of the policyholders are properly protected in terms of claims costs.” But there’s another side to regulation, he notes, “which is the regulation of underwriting, pricing and product innovation, which we believe needs to be relaxed, because that would allow a more effective, competitive environment than what we have right now.”

Engaging in the political arena is another option for insurers. Noting that regulation is a consequence of a government’s legislative action, sometimes it’s not a bad idea to present legislators with options earlier in the political process, notes IBC incoming president Mark Yakabuski. For example, the IBC doesn’t appear to be waiting for the Ontario government to impose auto market reform upon the industry.

“I think that as we look forward, I think our member companies want us to be solidly involved in working on a new reform package for the Ontario auto insurance market,” Yakabuski says. “It’s a huge market for our industry. We constantly have to be looking at ways to improve that market.

“We already have in place a process here at IBC to arrive at a comprehensive new reform package for auto insurance in Ontario. I hope that would be completed by the end of this year or at the beginning of 2008. We will take that reform package, on which we are currently very hard at work, and we will use it in all of our discussions with the government of Ontario, with the opposition, with interested parties, to make sure we’ve got a system that responds to the 6-million-plus private vehicles that we’re insuring in this province.”

And so will the ground hog react differently this time, having seen once again the long shadow of auto claims costs looming at the front door? “It was fairly recently that we went through a major gyration in our industry, and one would hope that our memory wouldn’t be that short to forget about that,” says Bianchi.