Auto Claim Costs, Frequencies Acceleration

After a four-year period of plummeting claims numbers between 2001 and 2004, frequencies are finally starting to look up. Well, more specifically, claims frequencies have “flattened out” or “bottomed out” in 2005, according to insurance company claims officers and CEOs, and may have nowhere to go but up in 2006. But what’s really getting a rise out of claims managers these days appears to be the rapid acceleration of claims costs. Why the rapid increase? It depends who you talk to. Some talk of the natural correlation that exists between the number of claims and claims severity. Some blame pending legal challenges against personal injury caps in Alberta and Nova Scotia. Still others talk about recent court decisions in Ontario that appear to have expanded the outer limits of catastrophic damages. Most agree health care costs play a role, because they are increasing at a rate that outpaces inflation.

It remains to be seen whether current signs of greater claims frequency and double-digit increases in severity will develop into long-term trends. If they do, look for insurers to be asking for auto rate increases sometime by the end of 2006 or early 2007.

FREQUENCY RISING

Certainly signs of increasing claims frequency over 2005 are starting to become publicly noticed at insurance industry meetings, conferences and functions. These observations are typically stated against a backdrop of plunging frequency rates between 2001-04. Even in late 2005, seminars were held under the banner ‘Where have all the claims gone?’ Between 2001-04, a hard market reigned, premiums were comparatively high, and governments were implementing new auto injury payout caps and premium decreases to stabilize the auto product for consumers. During this period, companies noted overall frequency dips of anywhere between 10% and 14%. In at least one company, claims frequencies decreased by up to 40%.

Overall, the “frequency [of claims] for auto insurance has leveled off, it seems, around 10 per 100 vehicles, while severity continued to rise in 2005,” Jane Voll, the chief economist at the Insurance Bureau of Canada (IBC), observed at a 2006 Canadian Insurance Industry Outlook Breakfast meeting in Toronto in March.

In terms of severity numbers, Voll added: “Let’s look at the early ’70s, compared to the early 2000s, and see what 30 years has done to the auto product. The average claim, in today’s dollars, was around CD$2,500 for a driver in the early ’70s, whereas now, with our fancier vehicles, the average claim is over CD$4,000 – or an increase of 64%. There’s some good value for the driver.”

Insureds must intuitively know it, because statistics suggest they are finally starting to use the product for which they pay their insurance premiums. George Cooke, the president and CEO of the Dominion of Canada General Insurance Company, told a Canadian Collision Industry Forum (CCIF) meeting as early as January that his company was starting to see overall auto claims frequencies start to rise in 2005.

“Consumers, in a response to rising premiums [during the 2001-04 period], actually decided to self-insure to a greater extent and they purchased higher deductibles,” Cooke noted. “Interestingly enough, through that period, the claims frequency of reported auto accidents went almost downward for three or four years.

“That’s changed over the course of 2005. Somewhere between the second and third quarters, in most jurisdictions, that frequency decline of reported claims from auto accidents not only hit bottom, but it started to increase. It’s increasing more rapidly in the West than it is in central Canada and slightly more rapidly in the east than in central Canada. But nonetheless, it’s increasing for most of our players in all jurisdictions.”

Rob Wesseling, the vice president of personal lines and packaged commercial at The Co-operators General Insurance Company, says he sees the same kinds of frequency increases at his company. But he issued a cautionary note about the numbers. “We’re seeing some indications that the frequency of smaller claims is starting to increase, although it’s too early at this point to say it’s a definite trend,” he said.

John McGlynn, president and CEO of Kingsway General Insurance Company, says the 2005 numbers could be related to something as simple as the weather. He noted the weather in Ontario has been milder in 2006 than it was in 2005. “Last winter was a pretty snowy winter and certainly our first quarter of this year, with better weather, frequency is down again,” he said. “So I can’t say that we have put our finger on any specific reason why frequency would have been up in 2005 than 2004.”

All the same, the experience of increasing claims frequency appears to be widely shared throughout the industry. The same sort of rate-flattening has been reported by some of the country’s most prolific underwriters of the Canadian auto product, including but not limited to the Co-operators General Insurance Company, The Economical Insurance Group, Desjardins General Insurance Group, Royal & SunAlliance Insurance Group, Kingsway General Insurance Company, and Allstate Insurance Company of Canada.

INCREASING CONSUMER CONFIDENCE

Rocco Neglia, vice president, head office, claims at The Economical, broke his company’s numbers down into specifics. Based on the trends in specific claims areas, he said, the 2005 numbers back up a story of increasing consumer confidence.

Neglia noted, for example, that the number of comprehensive claims – claims over which consumers have the most control (such as vandalism, broken windshields or minor theft losses) – stopped falling in 2005, stabilizing at 2004 levels. At the same time, he noted, direct compensation claims (collisions in which the claimant is not at fault) and accident benefit claims in 2005 showed similar signs of an increase.

“Basically on the auto side, you see a reduction in frequency since 2000,” Neglia concluded. “It was steep in 2001-02, and possibly in 2003. In 2004, the reduction decreases, and in 2005 it sort of bottomed out. You’re seeing a slight increase there too. You’re seeing the bottom of the curve and in some cases going up again. Why is that? That’s the million-dollar question.”

Like others, Kenneth Lindhardsen, senior vice president of claims operations outside of Qubec for Desjardins General Insurance Group, believes improved consumer confidence is an important story behind the numbers. “I don’t think there’s been as much negative publicity about insurance; not to mention the fact that many insurers are looking at either disappearing deductibles or true accident forgiveness,” Lindhardsen said, noting the impact of programs designed to encourage consumers to file claims without fear the claim will increase their premiums. “I think that maybe generally has restored consumer confidence and I think people may be a little more reassured, and maybe reporting some more claims than they were before. Those comments are more anecdotal than based on any specifics.”

The improved confidence may also have a lot to do with falling auto premiums, as the market cycle shows signs of softening, Neglia noted.

Many, like Irene Bianchi, vice-president, claims at Royal & SunAlliance, observed that increasing frequency may be explained by the mere fact that claims frequency numbers had nowhere else to go but up. “We’re almost at the bottom of the graph, relative to where we were in 2000-01,” Bianchi said of claims frequency at Royal & SunAlliance. “From our experience, we’re seeing a flattening: we’re not seeing it go up, but we’re not seeing it go down. It’s got nowhere else to go, so it’s just flattening out.”

SEVERITY ACCELERATION

But while frequencies are showing signs of rebounding, claims costs have shot upwards. And the severity of claims is certainly under the watch of several claims officers.

To a certain extent, Bianchi noted, the increasing severity of claims costs is a byproduct of the decreasin g frequency of claims. Also, new legislation in Ontario, Bill 198, may be playing a part in the severity of the claims, she said.

“There’s a [inverse] relationship between severity and frequency,” Bianchi said. “If your frequency goes down, that means your severity is going to go up. If you have high frequency, it means you have lots of little claims mixed in there. During the Qubec Ice Storm a few years ago, you had a huge peak in your frequency, but not in the severity, because there were tons of little claims.

“It’s interesting to see a flattening off of the frequency, but we are starting to see a climb in the severity, because those claims that are being presented to us are larger. Certainly in Ontario, Bill 198 is contributing to that because of the high deductible at CD$30,000. So you’re not going to get a lot of those small claims being presented, you’re only going to get those larger ones. The larger claims will always be reported, notwithstanding what the market conditions are.”

Of course, there are many other possible reasons for the increasing severity of claims costs. Insurance company executives and claims officers all note that spiraling health costs, legal challenges against cap levels, recent Ontario court decisions and the increasing sophistication of manufactured cars may all, to a greater or lesser extent, play a role in claims severity.

“Regarding the therapy and medical component of the product, you should expect the cost of that to increase in line with the costs of health care,” according to Wesseling. “The costs of health care have been increasing higher than [the rate of] inflation.”

McGlynn said the cost of treating soft tissue injuries is also up. And people are purchasing more income continuance packages, he noted. For insurers, this means additional claims costs, because the value of lost income as a result of injury is continuing to rise. “The other thing we have seen – well, we haven’t seen it much, but we will start to see it – is there may be capping of disability benefits by life insurance companies,” McGlynn said. “So where there may have been collateral benefits, we’re starting to see those have been eroded to the point where there may be exposure.”

Legal challenges to injury caps established in several provinces are also of concern. Right now, there are at least two known Charter challenges to auto injury caps: one in Alberta and another in Nova Scotia. Insurers are concerned that, if successful, the cases will almost certainly increase the costs of accident payouts,

“2006 and 2007 are going to be big years for all of us that are involved in the claims part of this business,” Rowan Saunders, the president and CEO of Royal & SunAlliance, told a CIP Symposium panel discussion in Toronto in April. “If you just look at the automobile product, it’s the single-biggest product in the industry. We’ve undergone a series of reforms from coast to coast, and there are some significant challenges that we’re going to face, some Charter challenges. It will be key to see whether the legislative intent [for imposing the caps] is going to be held. It’s important, we think, that it does. Otherwise, we will go back into some more challenging times there.”

These challenging times may have already arrived, based on recent decisions in the Ontario courts, according to John Greb, vice president, claims of Allstate Canada Group. “The thing we’re seeing in Ontario…is some recent decisions that are leading to more injuries meeting the catastrophic impairment criteria, which is going to have an impact on the future costs of accident benefits,” Greb said. “We feel more people will pierce that threshold of catastrophic impairment, which is going to drive up our claims costs.

“Certainly we’re going to fulfill our obligations to consumers according to legislations passed and decisions passed down by the courts, but we’ve got to watch that it’s going to add costs into the system.”

Several sources suggested increasingly sophisticated auto technology, which is designed to make a car safe, might also be driving up the cost of repairs. “On the physical damage side, repairing those cars is costing us more money,” Greb noted. “I know the cars are safer now and there are going to be fewer injuries in them, but it’s driving up our costs as well.”

RATE INCREASES?

So insurers are reporting more claims and higher costs to pay the claims. What is the upshot of these developments if they do indeed become longer-term trends?

“If these indicators continue to follow what I see is a current trend, there’s an important decision that needs to be made in 2006,” Greb said. “At what point will it be appropriate for us to approach the decision-makers and ask for small rate increases on auto insurance? We’ve sustained a measure of market stability that has benefited consumers over the past couple of years. The industry should not be afraid to consider small rate increases towards the end of 2006 and stave off larger increase in 2007.”

Most insurance companies are cautious about setting dates on when to ask for increases, because the numbers still aren’t solid. But most seem to agree that if action is to be taken, it would likely be taken sometime later this year or next. “How soon do you have to act?” Neglia said. “Assuming the frequency trend continues to be a little bit more clear, and with corresponding severities, then you’re going to see insurance companies taking action; whether it’s six months out, whether it’s a year out, that will depend on how frequency behaves over the next six to 12 months.”

The key is to make sure that premium increases are gradual and not steep, Lindhardsen said. “If our costs are manageable, then we can balance any potential rate increases,” he said. “Are we looking at any rate increases? For obvious reasons, I can’t talk about any specifics, but we are of course keeping a close eye on the various cost increases and we’ll monitor those closely and see what action needs to be taken. Overall, the industry needs to take a look at a balanced approach. We often see rate increases and then rate decreases. We need to take a more balanced and stable approach.”