Editorial: Regulators, leave subscription policies alone

When it comes to regulating “Best Terms Pricing” in Canada, Canadians, politicians and insurance regulators be forewarned: Be careful what you wish for.

Banning the practice in a hard commercial lines market could wind up making things worse for consumers, not better. This point was made generally in a recent email to Canadian Underwriter from the Insurance Bureau of Canada, which represents the country’s home, auto and business insurers. IBC said:

“There is no question that these are especially challenging times and we understand and acknowledge the frustration that businesses are feeling. The issues in the commercial market are global and are directly linked to capacity constraints brought on by increasing severe weather, low interest rates, and pandemic-related challenges.

“Regulation in Canada cannot fix global market issues and will not improve market capacity. In fact, it could hamper efforts to increase capital in the market. Subscription policies have been used successfully for decades to provide coverage for complex commercial risks. Taking action without fully studying the issue and understanding unintended consequences it may cause, at a time when we need to retain and attract domestic and global capital into the market, could have a negative impact on consumers in terms of affordability and availability of commercial insurance products.”

How could banning Best Terms Pricing make it worse for consumers?

Canadian Underwriter sought opinions of several experts in the commercial insurance industry. As regulation is always a delicate topic in the industry, most spoke to us on the understanding that we would not cite them on the record.

Framing the issue in our own words, Best Terms Pricing has come under fire recently from the mainstream media and insurance regulators, who have banned the practice in condo commercial lines in B.C. and Alberta. Now, Canadian insurance regulators want to take a closer look at whether the practice is happening more broadly throughout commercial lines across the country.

In the condo insurance market, as defined by the B.C. insurance regulator, under Best Terms Pricing, the final premium paid by strata corporations on an insurance subscription policy is based on the highest of various insurance companies’ bids, even if the majority of insurance quotes are lower.

Best Terms Pricing has been in the media spotlight recently because of the hard market conditions in the strata/condo insurance lines. Pricing and deductibles have increased substantially, and some carriers have withdrawn altogether from providing capacity in the condo insurance market. In response, brokers have increasingly built condo insurance solutions for clients by having multiple carriers agree to take on certain portions of a single strata risk. This is known as underwriting the risk on a “subscription” basis.

Viewed from the perspective of people outside the industry (who quite frankly couldn’t care less about how subscription insurance policies are put together), the practice probably seems incomprehensible, and perhaps even conspiratorial. The reality, of course, is far different. What’s really happening here is free enterprise — the bedrock of Canadian businesses across the country.

Here’s a characterization of how a subscription policy might be put together. Picture a commercial client trying to find coverage for which there is scant capacity. By “capacity,” we mean funds to pay the insurance claims.

Capacity is typically scarce when insurers’ claims costs increase, as they do during a hard market cycle. In response, to make a profit (without which companies would no longer be in business), insurers must increase prices and deductibles. Carriers will also be more selective about the capacity they offer, if they don’t withdraw it altogether. When that happens, commercial brokers must find carriers willing to fund the client’s risk.

Given the current hard market conditions, instead of finding one insurance company to put up the capacity for the entire risk by itself, a commercial broker will more likely line up multiple insurance companies to take on certain portions of the risk. This is called a subscription solution.

Insurers will set their own rates on a piece of the subscription basis. So you will see several insurers offering individual quotes to fund certain portions of a large risk for different rates. One insurer, for example, might offer to cover a portion of the risk for a rate of 10 cents for every $100 of coverage, for 10% of the entire risk; another may charge 40 cents per $100 of coverage, for 50% of the entire risk.

The key thing about a subscription arrangement is that one insurer will be the lead insurer. This insurer will be responsible for administering the policy and paying out the claims at the time of need. This involves more work on the policy than what the other insurers on the policy would be expected to do.

And so, imagine if you were the lead insurer on a subscription policy, charging 10 cents per $100 of coverage, and you saw that two other insurers on the policy were charging 30 cents or even 40 cents for $100 of coverage. Your first question would be: Why are my competitors charging three and four times more for the same amount of coverage, when I am the lead insurer doing all of the claims and administrative work on the policy?

And so, to reflect the additional work and responsibility of the lead insurer on the subscription policy, the price for the entire policy may wind up being the higher of the insurers’ individual quotes.

Regulators want to review this practice, saying it’s not fair for consumers to pay the highest of all quoted rates on a subscription policy. But here’s the thing: In the current hard market, banning this practice outright is the difference between a commercial client finding coverage for a risk at a higher price, or not finding any coverage at all.

If Best Terms Pricing isn’t allowed to continue in commercial insurance lines, who would want to be a lead insurer on a subscription policy? If the lead insurer gets unfair compensation for a subscription policy for which it bears the full claims responsibility, it may make better economic sense not to write the policy at all — not even a portion of it. And so now you will have no insurers willing to be the lead insurer on a subscription policy.

That’s not good for consumers.

Because, as one commercial broker told us: “Now what are we going to do?”

Commercial brokers turned to subscription policies in the first place because they are running out of other options for getting insurers to agree to take on hard-to-place risks during the hard market. If you take subscription policies out of the mix, that leaves brokers trying to fund large risks using excess policies, which are even more expensive for clients these days than subscription policies.

And so, a caution for regulators. Now is the time to heed the words of Alexander Pope, who warned against fools rushing in where angels fear to tread.

Feature photo courtesy of iStock.ca/Sisoje