Singing the Blues

The words of the Moody Blues album of the same name resonates loudly as the soft market continues in Canada, almost obscuring a very concerning trend shift in loss severity. The balance between premium allocation and loss costs is starting to reflect a dramatic shift between insurers and reinsurers.

Historically, Ontario auto has been the cornerstone both driving and determining the profitability of the Canadian insurance industry. Not so long ago, the Ontario auto results were characterized by loss frequency issues, extensive fraud and political interference. The results were dismal at best and industry return on equity (ROE) was at an all-time low. Welcomed regulatory changes were subsequently implemented and served to improve the overall results, reduce fraud and create an optimistic sense of security for the insurers. The product was fixed. Life was good — good and profitable.

UNPRECEDENTED SEVERITY TRENDS

That was then, this is now. The shift in balance has been moving from a loss frequency issue to a severity issue. Losses are now shifting to the reinsurers, and the reinsurers are beginning to brace for what appears to be unprecedented severity trends. These trends are clearly evidenced by a series of court and arbitration decisions that are both garnering attention and momentum. The message received by the judiciary and arbitrators alike from cases such as Desbiens v. Mordini is that the SABS is remedial legislation that should be interpreted broadly. In the meantime, primary insurers appear to be continuing to enjoy relatively positive net results, leaving the reinsurers to wrestle with escalating losses exacerbated by reductions in reinsurance premiums, a direct result of reducing premiums at the primary level.

The balance needs to found. Rising claims costs will mean rising premiums. Whether driven by primary losses or reinsurer losses, the system needs to support these rising claims costs. As reinsurance rates and premiums increase, the costs will be transferred, first to the insurers then to the policyholders. Regulators’ support will be paramount; this means recognizing the changing climate and allowing the necessary rate increases in the automobile sector to respond to these rising loss trends. If Ontarians and Canadians want increased awards and broad interpretations of the SABS, that’s fine. The insuring public and regulators will need to realize and understand this will certainly come at a cost.

Several factors are at play here. Solutions are not simple. The primary rate levels have seen continuous reductions over the last few years, and these rates drive the reinsurance premiums. Case law has eroded the framework of accident benefit losses as well as tort exposure. The changing rules governing and determining catastrophic impairment under the accident benefits coverage has meant a dramatic increase in the medical and rehab benefits. Suddenly, hundreds of claims that were once thought capped at Cdn$100,000 now face exposure up to Cdn$1 million. Liberal judgments are not only creating unprecedented levels of loss, but unanticipated levels of loss.

Reinsurers rely heavily on primary carriers to recognize losses as early as possible, analyze and report those losses to reinsurers and to be as diligent as possible in the subsequent investigation and adjustment of reserves. Early recognition of losses enables reinsurers to respond to trends and price products appropriately. The gap between primary pricing and reinsurance rates is widening; the solution could prove concerning if correction is not achieved within a very short time frame.

Reserving practices of the primary insurers are under extensive scrutiny. The ability to recognize changing loss exposures early and post adequate reserves is critical. Recognition of these losses is not only crucial to the reinsurers to post adequate reserves on a timely basis, but it is also crucial to primary rate filings. Rate change indications are based on ground-up losses; failing to capture accurate information early results in delays to rate increases, which often leads to “knee-jerk” reactions by insurers, adverse public reaction and then, ultimately, unwanted political intervention.

Several recent cases, including Gordon v. Greig, have resulted in two judgments in excess of Cdn$11 million, illustrating the trend towards increasing claims severity. These losses are falling squarely on the shoulders of the reinsurance community. Undoubtedly, this direction is without precedent and certainly without pricing consideration. We therefore have to ask: where does this stop? If the trend continues, primary pricing may be facing extraordinary adjustments. Reinsurers will have no choice but to recognize the escalating working layers and, of course, price the capacity appropriately.

Upon extensive review of the case law and arbitration decisions, two distinct factors are emerging.

First is the court’s approach in determining Whole Person Impairment under the SABS. The approach is to combine both physical and psychological impairment in order to breach the 55% threshold. This was not originally contemplated under the SABS, in which the physical and psychological determination rules were distinct and separate.

The second trend relates to the escalating costs associated with future and attendant care. In Gordon, both plaintiffs were awarded in excess of Cd$8 million under this head of damages alone. One thing has become abundantly clear during the last few years: care providers have proven to be very opportunistic and have taken full advantage of a very generous first-party benefits system.

The exorbitant cost trends of future care have already been on accident benefit adjusters’ radar screens for several years. The loss costs associated with long-term care, including those illustrated here, while often nothing short of abuse, reflect the increased costs associated with long-term attendant care with hourly rates for professionals increasing from Cdn$21 per hour in 1999 to Cdn$35 per hour in 2007, an increase of more than 65% in eight years. The bar just keeps getting raised. Regulators need to examine this area closely and consider imposing limitations, possibly based on OHIP costing. If not, the claims cost will continue to soar, and policyholders will ultimately pay the price. At this point I will get off the soapbox.

Several other factors are at play in the severity trend. Plaintiff’s counsel are becoming more experienced with the “new” rules. They are more specialized and sophisticated when it applies to catastrophic cases. Unfortunately, the judiciary hearing these serious cases is often not as experienced. It is incumbent upon defence counsel to be diligent in the investigation of a loss, useappropriate experts and recognize the exposure.

Another significant factor is the growing trend of the buying public to purchase higher liability limits. More and more, policies are being issued with limits of Cdn$2 million and Cdn$5 million. Historically, this exposure was considered somewhat innocuous; the pricing reflected this attitude, with increased limits garnering very minor charges of only a few dollars. The Cdn$1 million to Cdn$2 million layer of coverage is without question a working layer. The industry needs to rethink their pricing policy with respect to this increased coverage and charge accordingly and appropriately. In addition to the inadequate pricing at the primary level, this increased exposure is often borne 100% by the reinsurance companies (since primary company retentions have often already been breached), thereby placing further strain between pricing and exposure.

The last issue at hand is the effect of the poor performance of the investment portfolios. The reduced discounting on reserves will drive up both case and incurred-but-not-reported (IBNR) reserves, again driving the scope of the loss severity and distancing the resul ts between the primary and reinsurance market.

The reinsurance market, although currently very stable and secure, will need to address emerging pricing disparities as loss severity trends continue to escalate.

The jurisprudence appears clear: claims are getting larger, awards are subject to more liberal interpretation, and pockets are perceived to be deeper.

At the end of it all, we will need to find the balance.