Need for Speed

Getting Canadian insurance carriers to agree on anything in the context of a highly competitive environment is often an exercise in herding cats. But if you ask any insurance company engaged in the practice of setting auto rates theses days, you will hear a surprising amount of unison: in the world of regulating auto rates, less is more.

This is probably not a surprising revelation, since most businesses in any field don’t like regulatory red tape impeding their marketplace activities. Indeed, Canadian insurers have talked to everybody and anybody for years about their desire for more flexibility in the establishment of the country’s auto rates.

The difference this time, however, is that the argument seems to be coalescing into the form of concrete political action and lobby efforts. In addition, in theory anyway, the current soft market and the political environment may have created the conditions for politicians and regulators to be somewhat more amenable to the argument; certainly more so now than they were during the hard market in 2001-04. As a politician and/or regulator, it’s easier to be flexible and trusting when auto rates are down, coverage is available and the auto insurance market is competitive. Canadian insurers see the public’s increasing trust in the industry during this soft market cycle as a window of opportunity to discuss more flexible models for setting the country’s auto rates. More flexibility, they argue, would go a long way towards avoiding the kind of hard-market cycles that precipitated less flexible methods of regulation in the first place.

But while regulators are always willing to talk to the industry about appropriate filing methods, the end result is that it’s the politicians who will change the rules, not the regulators, who implement the rules as legislated by Parliamentarians. The bottom line for regulators is that whatever filing system is used, it must protect the public. “Our mandate is to protect consumers by ensuring that auto insurance companies in the province comply with the Insurance Act and Regulations,” the Financial Services Commission of Ontario (FSCO) said in a public statement when contacted for comment on this story. “The regulatory approval process protects consumers not only in terms of the rates charged and what consumers pay but also what factors insurers can use/not use in rating.”

THE UNIVERSE OF RATE-SETTING MODELS

In the public arena, insurance companies’ arguments for improved rate-setting methods are often couched in the broadest terms of requesting “more flexible regulation.”But what does this mean in the context of Canada’s multi-jurisdictional approach to setting auto rates? How are rates established now, and what is it auto insurers would like to see in the future?

The universe of auto insurance rate-setting regulation in Canada can be characterized simply as being inhabited by three different models. These models appear on a continuum, varying according to the degree of government involvement.

On the one side of the spectrum, the highly-regulated side, there are prior-approval models, or what are known as “file-and-approve” models. Such models come in varying shades of grey, but basically they require insurers wishing to change their auto insurance rates to submit their proposed rate changes to the regulator and then wait for approval prior to implementing the rate changes. In some cases, regulators following this model require insurers to submit at particular times of the year; in other cases, the insurers can submit their filings for approval any time they choose. One key feature of these models is the requirement that auto insurers justify their requests for a rate change with full actuarial support and analysis.

Alberta is often cited as the premier example of this sort of approach. Insurers in the province have very little control over how mandatory auto insurance rates get set, since the Alberta Automobile Insurance Rate Board, through a premium grid, has established the allowable percentage change for individual insurers’ rating programs. The rate board will review insurers’ requests for different premium levels as “offset adjustments” to mandatory grid rates by up to 10%, but such changes must be”revenue neutral” for insurers. The board takes a more flexible, “file-and-use” approach when it comes to setting rates for optional auto coverages.

Prior-approval models can also mandate when insurers can ask for rate changes. In New Brunswick, for example, the New Brunswick Insurance Board, a prior-approval system, requires the province’s insurance companies to appear before the board, with full actuarial documentation, if they file more than twice a year.

File-and-use models generally inhabit the middle ground of the regulatory spectrum. Under these models, the market, more so than the government, determines premium pricing. Insurers still file proposed rates changes to the government for approval, but the turnaround times for the company to use these rates are faster. In such models, the government does not presuppose rate adjustments; also, in some instances, insurers don’t have to support their every request with a full-fledged actuarial analysis. In addition, there are fewer restrictions on when a company can file for a rate change.

Insurers generally hail use-and-file models as the most flexible method of setting rates. In these models, the insurers use their new auto insurance rates at the very same time they file them with the regulator, with no waiting time for review. If the regulator has a problem with the rates, it will get back to the company after the fact. But in this model, market forces — another way of saying competitive pricing — will prevent auto insurance premiums from going through the roof. The assumption is that with a lot of competition in the market, consumers can always opt for the insurer with the lowest price.

Quebec’s method for setting auto insurance rates is often cited as a Canadian example of a use-and-file model, although it doesn’t really apply to jurisdictions that require insurers to provide accident benefits coverage. In Quebec, the government’s use-and-file system applies only to physical damage and optional auto coverages. The government, not the province’s auto insurance industry, picks up the tab for accident benefits. Quebec would probably not be offering a use-and-file system if this were not the case. Outside of Canada, insurers often point to the states of Illinois, Missouri and New Jersey as successful applications of the use-and-file model.

SHIFTING TO A NEW MODEL

So where on this spectrum do Canadian auto insurers think it’s most realistic to be? Most characterize Canadian provinces as being somewhere in between prior-approval and the most constrained forms of file-and-use models. Virtually all insurers agree prior approval models are definitely not where the industry should be today. “The current system, which is sort of rigid pre-approval, I don’t personally think is working for anybody,” says George Cooke, the president and CEO of Dominion of Canada General Insurance Company. “It’s not working particularly well for consumers. It’s not working particularly well for the company and its shareholders, and I’m not at all convinced it even works all that well for the regulators. To my mind, what we have is about the worst scenario that you could get.”

Prior approval models encourage more volatile swings in the auto insurance cycles, insurers argue, because the time required to approve rate increases (or decreases) does not allow insurers to adapt quickly to changes in the market place.

As Martin Beaulieu, senior vice president of personal lines for ING Insurance, observes: “At the moment, in some provinces it may take as long as three to four months to get an approval. And actuaries have to work for roughly a month before that to prepare a filing. Then there is an implementation that takes another two,
three, four weeks. So in the best scenario, you can change your rates twice a year. And if you compare that to other industries like retail, where some of them change their prices on a weekly or over even daily basis, we have a long way to go before we would even think that we are in that same environment.”

Claims costs drive pricing, insurers note, and so if insurers facing higher costs can’t get a 2% increase in place this year, for example, that may mean the request for a larger increase down the road. But once steep rate increases and dwindling coverage start to happen en masse, politicians’ phones start to ring with consumer complaints, and then regulators start requiring auto insurance reforms and steep rate decreases. And these regulated responses, insurers would argue, are exactly the kind of dynamic that caused the need for steeper prices to begin with.

When it comes to setting auto rates, timing is of the essence. The less red tape, the faster the process goes. “For the file and approve system, it can easily take six months of actuarial time and delays between getting the material ready, filing it, justifying it, responding to questions from the regulators,” observes Jean- Francois Chalifoux, the general manager and senior executive president of Desjardins Group Insurance. “Quite often, you can have a delay going from six to nine months. Whereas in a file and use system, everything can be done in less than 30 days and we move on.”

In one extreme example of how slow turnaround times can affect consumers, one insurer has taken the Nova Scotia Insurance Review Board to court because of the length of time it alleges the board took to approve the company’s proposed 8% premium decrease. The suit is ongoing, but it points to the frustration insurers feel when it comes to setting auto rates.

“We expect the regulators to validate … and monitor the competitiveness of the market and monitor complaints carefully and ensure that we’re solvent,” says Chalifoux. “But micro-regulating the setting of the rates in this market environment is unjustified. Rate approval really delays our ability to respond to a changing environment. And when you run a business, that’s something you’d like to avoid, especially in a highly competitive environment.”

Insurers also question the utility of producing a full actuarial analysis for even the most inconsequential rate filings. That costs a lot of money, they note, which in turn discourages them from filing rate changes as frequently as they would prefer in order to respond to claims costs and other market conditions. “What happens in a regular, competitive marketplace, when we look at economic studies of how fast prices change, [is that]… it could take an industry three months to reflect [a marketplace cost change] and roll it out into their prices to consumers,” says Jane Voll, vice president of the Insurance Bureau of Canada [IBC]. “That’s a lot faster than the way prices adjust in a regulated marketplace, where you have to build up your actuarial evidence.” In a prior approval system, she adds, “you have to have … enough of a change [in rates] that you can warrant the cost of the actuarial filing that you are going to have to make. The whole process itself is time-and cost-intensive. So you save it up so it’s worth it. It’s like housecleaning: you wait until it’s bad enough and you do it.”

Prior approval methods also discourage innovation, insurers note. Even if a company comes up with the most creative insurance product on the market, if it must meet a heavily regulated price requirement, the product may end up being too costly to offer to consumers. In this case, regulatory pricing constraints may discourage products that don’t fit within the regulators’ narrow bandwidth.

So if Canadian insurance companies want to move away from prior-approval regimes, what is it that they want? Some form of file-and-use system would be the next best step on the continuum, they say.

The bottom line, says Voll, is that the model for setting auto rates should support an auto insurance market in which rates are available, affordable, stable and competitive. And by far, insurers believe file-and-use systems are the way to achieve these aims. “The theme would be anything that allowed the companies to react quicker and faster [to market conditions] will

have more positive impact for consumers at the end of the day,” says Shawn DeSantis, the senior vice president of Royal & SunAlliance Canada. “I would suggest to you that given the size of the marketplace in Ontario, we should move a lot faster on file-and- use than just a simplified [prior-approval filing]. It’s kind of making a marginal gain … From our perspective, we clearly think a file-and-use process would allow us to increase affordability, react quicker and bring more consistent prices to consumers over the long run.”

Ontario’s model might be classified as a form of “file-and-use” system, although most insurers liken it to a hybrid model that contains elements of both a prior approval system and a file-and-use. Once companies in Ontario file for a rate change, the government has a 30-day time period in which to respond. If the insurer hasn’t heard within this period, the rate change is deemed approved and may proceed to market.

In 2001, Ontario introduced a rate filing process known as the “Respond to Market” (R2M) process. This allowed insurers to bypass the step of doing a full actuarial analysis if their proposed rate changes were consistent with those offered by other insurers and fell within a narrow bandwidth. (The band at the time ranged between a 7% decrease and a 3% increase). But the R2M was abandoned after the Liberal government came to power in 2004, promising a 10% insurance rate decrease. The thinking inside some insurance circles is that the Liberals didn’t want insurers to be able to bypass the mandatory 10% rate decrease through the use of the R2Ms, which allowed insurers small increases on a quarterly basis without full actuarial analysis.

Ontario now has a “simplified” filing system, similar to the R2M. “In order for companies to implement rate changes more quickly, FSCO has developed Simplified Filing Guidelines,” FSCO noted in a statement. “Even though these rate filings fall under a prior-approval system, these filing types have a quick turn around time for reviewing and approving as they are less complex than a major filing.”

Insurers generally acknowledge this as an improvement, but they also note the simplified filing method can’t be used if a premium increase is proposed. “It’s very restrictive in the sense that it doesn’t allow you to respond to areas of your book in which you may need to increase rates by 5% or maybe even 10%,” says Scott Lennox, director of national pricing of The Co-operators. “In this day and age, companies are focussing so much more on segmentation and doing so much analysis on the interaction of

rating factors that having that flexibility to pull some factors up and some down is really important. By not having that, you can’t respond that quickly [to market conditions].”

Some have suggested insurers, as a matter of principle, would probably prefer to have no regulation at all. But insurers beg to differ, saying regulators are necessary to make sure the companies are actually using the rates they file. “I don’t think anybody wants the Wild West out there,” says Michael Donoghue, the president and CEO of Allstate Insurance Company of Canada. “There is probably some fear among my colleagues that some, for whatever reasons, might say ‘Here’s our chance to go after market share,’ and do some things that would not in other times be done. That takes me back to [the fact that] you have to have some principles…

“In our mind, we think there is a difference … between regulators who approve rates [i. e. in file-and-use systems] and regulators who think their mandate is to make rates. It’s those who stay in the latter, who make rates, that I think go beyond their mandate.”

Establishing
systems for executive oversight and accountability would be an essential role for the regulator in any file-and-use system, says Cooke, whose professional background includes working for a regulator. Cooke said he would not support any system of file and use if it did not include some way to hold insurance companies and their chief executive officers accountable for inappropriate variations in premium rates. He likened an appropriate system to the one evolving out of the Sarbane’s-Oxley Act, in which corporate executives and officers in the United States are held personally responsible for any financial misstatements the company makes. “What you need to go with [file and use] is an administrative system of fines and penalties that was created sometime after the mid-1930s,” he says. “If somebody does somewww.

thing wrong, there’s some discretion that can be applied by the commissioner. But for somebody who’s grossly, maliciously and flagrantly abusing the system, there’s a whole different set of penalties, including personal sanctions against the officers.”

Supplementing government oversight of the overall market, a competitive market will ultimately keep premium pricing at levels the consumer can afford, noted Shaun Jackson, the president and CEO of Kingsway Financial Services. “When you have 80 companies competing, the free market will take care of that (keeping prices low for consumers),” he said. “When you have a competitive, free market, that actually discourages companies from increasing rates sharply.”

CONFIDENCE GAME

One problem for the industry, says Jeff Goy, vice president of automobile underwriting at Wawanesa Insurance Company, is that some regulators vacillate between prior-approve and file-and-use models, depending upon the market cycles. “Part of the issue is the filing guidelines at FSCO or in Alberta have at various times been prior approval, file-and-use, or a benchmark of various amounts, and they change somewhat, flipping back and forth, depending on the crisis and how the regulator thinks [the model] is the best way to handle a crisis,” he says. “There has to be a building of confidence, I think, with the regulators of the industry that to have less regulation would be in everyone’s best interest. I think the interim step would put a bit of a box around the types of the things that would fit into the category of being eligible for a file-and-use; outside of that box, you would still have to have some more rigid approval processes. Hopefully, that box grows.”

How big might the box grow? Even the various file-and-use models proposed for Canada, in which regulators would oversee the market as a whole (and penalizing in some way those whose rate-changing activities fall outside the box), seems a far cry from the kind of use-and-file systems seen in U. S. states such as Missouri, New Jersey and Illinois. In Missouri, for example, the government states explicitly: “The Missouri Department of Insurance does not set insurance rates.” If anything, the government stipulates only that premium increases cannot be obtained immediately after a collision in which the driver was not deemed to be at fault. A state of New Jersey document notes the government will not intervene if insurers file an amended rate increase of no more than 7%. Such maximum allowable rates are sometimes referred to as a ‘hurdle rates.’

The interesting (and counterintuitive) thing about these examples of file-and-use and use-and-file systems, Voll observes, is that premium prices in these deregulated models do not head skyward when the sky’s the limit. “When we look at jurisdictions in the States, only a handful have this hurdle rate system,” she notes. “Those that do have a hurdle rate find that if you set that rate at 7% or 10%, 30% or whatever, the market doesn’t go up to that amount. They compete. So their average price actually stays below what you actually set that hurdle rate to be. That’s the gist of it.”

The market everyone loves is Illinois, Voll added, because they’ve got a ‘just-use-it’ system. “The thing about that is, it shows you it really works,”she says. “They’ve been doing that since the 70s. They’ve had a few cycles over the period between the 70s and now, they’ve ridden them all out fine, without anyone having to intervene. They have 300 insurers there. Even the high-risk drivers are served by the voluntary market. They have a teeny-tiny residual market.”

Canadian insurers are well aware the industry has a long way to go before establishing enough trust with the regulators to move to these sorts of use-and-file systems. Most regulators still remember well the high prices and poor availability characterized by the hard market in 2001-04. As a result, most insurers advocate a transition to file and use first, so that some measure of trust might be established.

“I think regulators, the way I see them, can play a huge role in terms of oversight of the overall system without having to get involved in micro-managing each insurer,” says Beaulieu. “I think this is the role that I see the regulators can play, in managing by exception.” But for the government to be willing to let the market determine pricing, Beaulieu says, “this will require that trust is built between regulators and the industry.”

IBC and its individual member companies appear hopeful the current round of discussions with regulators across the country will ultimately bear fruit. For its part, the IBC is promoting the idea of “industry stewardship,” involving the identification of factors that indicate when price changes will be necessary. If such measures can be created — consider them an ‘early-warning detection system’ that precursors hard and soft markets — then politicians, regulators and consumers alike will be able to determine when claims costs require insurers to make upward or downward adjustments to current rates. Thus informed, the system would move quickly with rate adjustments in order to avoid the kind of “sticker shocks” that breed a pendulum swing towards a more heavily regulated, prior approval form of regulation. IBC is apparently in talks with the Alberta regulator about implementing some form of the stewardship model. “The trick is to get indicators that everyone knows and trusts and believes and are credible enough to warrant action,” says Voll. “We can’t let the indicator that motivates action be headlines in the newspaper and the number of calls to politicians. We need a better leading indicator.”