Riverboat Gambling

Ontario’s auto insurance reforms, to be implemented Sept. 1, 2010, are intended to create some measure of cost certainty for auto insurers. How ironic, therefore, that the anticipated result of the reforms — at least for the first six to 24 months — is a period of profound pricing uncertainty. Why? Because insurers are now preparing to implement the reforms without knowing the shape or size of several of the reform’s key components.

Despite the pricing uncertainty, property and casualty insurers, many of which are losing money in the Ontario auto lines, are applauding the government for addressing their concerns about escalating claims costs — particularly in the no-fault accident benefits side. For example, Ontario’s reforms will impose a $3,500 cap on medical/rehabilitation and assessment/examination expenses for minor injuries. They will cap the cost of each assessment at $2,000. They will also allow Ontario consumers to customize their insurance policies. Consumers will see their standard accident benefits package reduced to $50,000 for medical and rehabilitation benefits related to non-catastrophic injuries (down from the current level of $100,000). Consumers will also have an option to pay higher premiums to buy back higher limits (back to $100,000, for example, or the Cadillac package of $1.1 million); they might also purchase optional benefits — such as caregiver, housekeeping and home maintenance, for example — that were once part of the mandatory package.

“This is all good,” George Cooke, president and CEO of The Dominion, said of the overall reform package. “It’s a way better scenario now, in my view, than where we were.”

And yet, there is that pesky problem of how to price the new product. In particular, Ontario auto insurers are vexed right now about how to price the product without knowing at least four key aspects of the reforms.

First, the Financial Services Commission of Ontario (FSCO), Ontario’s insurance regulator, has made it a priority in 2010 to nail down a definition of what constitutes a ‘catastrophic impairment.’ The regulator has called for a panel of industry stakeholders to review and refine the definition, which is important to insurers, because anyone with a catastrophic injury arising from a motor vehicle collision is subject to a higher level of accident benefits ($1 million). That has a huge impact on an insurer’s claims costs.

Second, also up in the air is the direction of the government’s proposed new Minor Injury Guideline (MIG), which will determine the types of injuries that are subject to the $3,500 minor injury cap. The MIG is intended to replace the existing Pre-Approved Framework (PAF) Guideline for Grade I and II Whiplash Associated Disorders

Third, many insurers are trying to figure out whether cost savings on the AB side of the equation will be lost on the tort side, as lawyers pursue litigation to make up for what they can’t secure for their clients in the form of accident benefits.

Finally, there is background uncertainty related to how consumers respond to their new options. Essentially, insurers will have to price the product without reference to any historical data about what the take-up rates of these options will be.

And so where pricing the auto product is concerned, over the next two years, Ontario auto insurers will essentially be thrust into the role of riverboat gamblers. Insurers and their actuaries will essentially be pricing the product with the same scientific rigor as a Mississippi riverboat gambler playing the roulette wheel, or betting the house on Lucky Number 7s.

“Until these [post-reform] claims start to close, and you get a broad-based perspective on the exposure on these claims, you have no idea [how to price],” said Steve Smith, president of the Farm Mutual Reinsurance Plan, echoing the views of many other insurers. “It’s not like everybody else is going to be starting to reserve and handle their claims consistently, so there’s no way as an industry… we are going to know for at least 24 months what the effect of the reforms will be. You’re going to have people reserving conservatively. You’re going to have them reserving optimistically. The early indications are easily going to be a guess at best.”

Adds Cooke: “I don’t want somebody out there thinking I have a negative tone [about the reforms]. I just think that anyone thinking that [the outcome] is anything other than uncertain is crazy.”

ROOTS OF UNCERTAINTY

The Catastrophic Impairment Definition

It’s commonly acknowledged insurers will not know how catastrophic impairment is to be defined until well after the Sept. 1, 2010 implementation date. Best guesses are that the province will take at least six to nine months to undertake its proposed review, with an outside time-line of one year.

The new definition is important. As Cooke points out, scientists who developed the definition of a catastrophic impairment currently in the Statutory Accident Benefits Schedule (SABS) never really intended the definition to be used to determine access to medical benefits in an auto accident. “They were developed as a preliminary screening technique so that medical people would know how to treat people who were suffering from a brain injury or a serious type of injury,” Cooke said. “And we’ve effectively turned them into a padlock on a gate for benefit access. It really, I think, puts an inappropriate level of pressure on that guide and definition.”

Insurers are concerned that recent court and arbitration decisions have mutated the definition in a way that makes it difficult to gauge how many consumers may be subject to a catastrophic injury determination. Such a determination expands an insurer’s exposure multi-fold, since it entitles those with severe brain or spinal injuries to a much higher level of accident benefits than they would receive for more minor injuries. By the standard of the new reforms, it’s the difference between a $50,000 non-catastrophic claim and a $1-million catastrophic claim.

Irene Bianchi, vice president of claims and corporate services at RSA, represented the view of many other insurers when she said she was “quite disappointed” not to see a real strengthening of the catastrophic impairment definition prior to the Sept. 1 implementation date. “Prior to this reform introduction, the cat definition had been significantly diluted, I think, from its original intention,” she said. “We were starting to see a significant number of cat applications, a real jump from what we had seen over the past two or three years. That really is a huge, huge spend for insurance companies. When a lot of different types of claims are being deemed catastrophic, our exposure kind of goes through the roof.”

Leonard Sharman of the Co-Operators General Insurance Company says the cat definition has been “diluted” by court and arbitration decisions that have deemed accident victims to be catastrophically impaired, even though their injuries come in below the 55% minimum threshold for a Whole Person Impairment and Mental and Behavioral Disorder. “With the reduction in standard benefits [from $100,000 to $50,000], we expect to see more applications for a determination of a catastrophic injury in the hopes that the impairments will meet the definition,” Sharman said.

Cooke has a somewhat different take on the cat definition. He believes the industry, which has focused so much on tightening the cat definition over the past two decades, may in fact have got it backwards.

“I think we should have spent way more time defining what the minor injury actually is, and putting boundaries around it, and found a way to open the policy limits up to allow access for the more seriously injured people,” he said. “The reason for that is two-fold: first of all, if you make a mistake by being too exclusive at the minor injury end, the chance of doing harm to somebody is much less. Let’s say somebody with a WAD-II whiplash and lower back strain, which is a very common occurre nce in an auto accident, ends up two physio or chiro treatments shy [of their full prescribed treatment, after their limits are used up]. That’s $90, not the end of the world. But if by tinkering around with the cat definition, you end up actually [depriving], say, 250 people a year that deserve access to benefits in excess of whatever the lower limits are…those people are in a very awkward spot, because they’re not going to have the kind of care that they need.”

Cooke acknowledges his opinion may not represent the majority view of the industry, and it doesn’t. But the government will be including these kinds of views, plus those of health care service providers, in its future deliberations. In the meantime, how is an insurer supposed to price a product for Sept. 1 without knowing exactly who is entitled to the higher limits?

It might be difficult, but it’s not impossible, said James Russell, chief underwriting officer for Aviva Canada. “Typically, you like to see things play out and see how they cost, but you know we’re not in that environment, so there’s definitely uncertainty around [the cat definition],” said Russell. “But you have to make an estimate. You have to go with what you feel the intent is. It does appear that the intent is to have a robust definition in place and to put measures in place to make sure that the product is affordable. Sometimes you have to go by the intent, and that’s the place for you to start.”

The New Minor Injury Guideline

As part of its reform package, the government is establishing a new Minor Injury Guideline (MIG). Minor injuries falling within the guideline are subject to a benefits cap limit of $3,500. The MIG is nowhere near in place, and the creation of the new regime appears to be a long-term project for the government. A final, definitive version of the MIG is not expected until after years of consultation. In the meantime, the province is expected to release interim guidelines in June 2010, and these guidelines appear likely to look like a variation of the Pre-Approved Framework (PAF) guidelines now contained in the SABs. PAF guidelines cover whiplash and whiplash-associated injuries. Insurers are concerned that if the interim guidelines for the MIG closely resemble what is now contained in the PAF, not many claims will fall under the MIG’s caps, since very few claims right now actually fall within the PAF guidelines.

“The MIG seems to resemble very closely the PAF,” observes Ken Lindhardsen, vice president of claims operations for the Ontario, Western and Atlantic regions of Desjardins General Insurance Group. “The premise of the PAF, like the MIG, was that a majority of minor injuries — the intent was probably somewhere around 80% — would be treated in PAF. But our experience, and the experience of other insurers, I’m sure, is that a significant portion of claims that we had anticipated to be covered under the PAF were not covered by the PAF. And that had to do with the fact that the PAF didn’t explicitly include psychological issues. So there was an opportunity there, when psychological issues came into play, for those injuries to be moved outside the PAF. For us, it was a significantly lower portion than the 80% that ended up being treated within the PAF. And with the MIG, there still seem to be some issues that need to be addressed there in terms of whether those psychological issues will result in [minor injuries] being treated within the MIG or not. It is another X-factor or level of uncertainty for us in terms of what the overall impact is going to be.”

Bianchi echoes Lindhardsen’s remarks, putting a rather sobering number on RSA claims that fall outside the PAF. “[The reforms] cap a claim at $3,500 in Ontario now for all treatment and assessments,” she says. “That doesn’t really seem to be much different than our pre-approved framework guideline, the PAF. But unfortunately, in terms of our experience, we have less than 1.5% of all of our AB claims in that pre-approved framework. So okay, the big difference [between the proposed MIG and the PAF] is what? This is what we are struggling with. We’re really not sure if we’re going to see a lot of change, because so few of those claims now actually fit within that band.”

How Will Trial Lawyers Respond?

As they struggle to place a price on the reforms, insurers are left to wonder whether any savings on the AB side will result in higher claims costs on the tort side. “We expect to see tort costs increase, but this was not considered in the reforms,” Sharman said. “No tort costing exercise was done.”

Insurers fully expect creative and inventive trial lawyers to attempt to obtain tort damage awards when they find the door of no-fault accident benefits closed to their clients. For example, given that AB benefit limits in the standard package have been reduced from $100,000 to $50,000, insurers fully expect trial lawyers to put additional pressure on the catastrophe definition and MIG guidelines.

“There’s a lot of speculation that the AB is simply going to get transferred to the tort side,” said Smith. “Right now, when you look at the cat determination rules, and minor injury rules, a lot is wide open to interpretation.” And now that the standard benefits package is down to $50,000, he added: “Everybody is going to want to go cat determination.”

Bianchi likens the relationship between no-fault accident benefits and tort costs to squeezing a balloon. “If you get rid of something on the one side, it’s going to pop up on the other side,” she said. “So we are expecting to see some more activity on the tort side. As plaintiffs are unable to collect on the accident benefits side, they will go to the tort side, if there is an opportunity to have a tort claim.

“Personal injury lawyers are an extremely creative and intelligent bunch. I take my hat off to them, because at every opportunity, whenever there’s new legislation, they are quick to find the loopholes.”

The ‘X-Factor’ of Consumer Choice

Consumer choice is central to the province’s reforms. Widely praised by regulators, politicians and insurers alike, the element of consumer choice does add another, difficult dimension to pricing. Quite simply, Ontario’s auto product has not offered choice before. And so insurers do not have a history of data indicating consumer preferences. Insurers don’t know, for example, how many people will opt for the standard product, how many people will buy options. Without this information, insurance actuaries will have to guess how people will respond to the options from which they will have to choose starting on Sept. 1. “It’s quite an actuarial challenge,” Cooke said of pricing the reforms. “It’s where the actuaries have to park some of their science and draw up a little bit of art, in terms of what they do.”

Insurers are projecting a certain amount of guesswork will be involved when they file the first reform-related rate applications with the regulator. As soon as those approvals are announced, the marketplace will then be able to see what the various insurers have guessed in terms of pricing for the new product. Insurers will also be checking their rate requests against IBC data. Some cite the possibility that insurers will likely re-file rate requests before Sept. 1, making adjustments once they have looked to see how other companies have filed. “Will the whole industry price at the most optimistic level of reductions to start?” Russell said. “I can’t really say that. I’m not sure that would happen, but you have to make an assumption based on what you feel is going to happen.”

Post-Reform Pricing

Once the reforms are implemented, it will take awhile before insurers begin to notice trends in their claims litigation files. At the same time, they will be amassing data on how consumers are selecting their new insurance options. If the government committee comes up with a catastrophe impairment definition and an interim MIG by the end of the year, as projected, then all of the pieces of the pri cing puzzle should start coming together. Insurers suggest post-reform pricing trends will start to manifest anytime between six and 24 months. Several said six months might be too optimistic; most thought two years would be a more realistic timeline for getting a sense of how effectively the reforms will control insurers’ claims costs and thereby stabilize pricing.

By that time, it’s quite possible the window of opportunity for costs savings will be closed. One potential dilemma of a “slow-drip” reform process, as one insurer characterizes it, is that the cost savings on the no-fault side may be sabotaged by higher claims costs on the tort side, or by lawyers’ ability to get around the new accident benefits caps. It’s one reason why some insurers are longing for a “CTL-ALT-DEL” approach to reform, as Baron Insurance Services Inc. president Barb Addie terms it in an article. She’s referring to keys pressed in a computer to get out of a program that has stopped functioning. In the context of auto reform, it would mean jettisoning everything that’s been done before, and drawing up a new auto insurance product from scratch. It’s a pie-in-the-sky dream, some say, but it’s clear that incremental reform creates problems of its own.

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With the reduction in standard benefits [from $100,000 to $50,000], we expect to see more applications for a determination of a catastrophic injury in the hopes that the impairments will meet the definition.

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I don’t want somebody out there thinking I have a negative tone about the reforms. I just think that anyone out there thinking that the outcome is anything other than uncertain is crazy.

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It’s quite an actuarial challenge. It’s where the actuaries have to park some of their science and draw up a little bit of art, in terms of what they do.