The Ontario Effect

A quick glance at the 2007 data might suggest things remain favourable for auto insurers in Canada. But a closer examination reveals some troubling signs, especially in light of the fact that Ontario accounts for more than half the private auto insurance business in the country.

AUTO PREMIUMS REMAIN STABLE

The price of the product remains a good news story for consumers all across the country, including Ontario. The out-ofpocket cost of insurance for Canadian drivers fell last year, in many cases for the 4th year in a row (See Figure 1). The largest decline in average premiums was in New Brunswick, where the average rate dropped 11%. Even in Alberta, where rates rose 1%, insurance premiums fell in real terms, considering a rate of inflation of 5% in the province.

Falling rates meant that insurance could remain a modest cost for most households — requiring an outlay of 3% of personal disposable income in most parts of the country. The most significant exception is Ontario, where car insurance premiums amount to an average 5% of personal disposable income.

UNDERWRITING RESULTS – LOSS RATIOS

Outside of Ontario, the underwriting results remain positive. Following government reforms, auto insurance markets in Alberta and Atlantic Canada improved in 2004 and have remained stable, competitive and profitable since then (up to and including last year). Figure 2 depicts underwriting performance for auto lines outside of Ontario using the methodology of Dr. David Cummins of the Wharton School of Business at the University of Pennsylvania. It measures the “next to peak” to the peak in the 1 minus loss ratio. In plain language, the effect of this method on a line graph is that a trend of rising loss ratios is presented as a downward line (deteriorating) and a trend of declining loss ratios is presented as a rising line (improving).

Using the same methodology, we see in Figure 3 that the Ontario auto insurance market, in contrast to the trend in the non-Ontario market, is in the second year of deteriorating underwriting results, drawing ever closer to difficult market conditions. Auto insurance reforms were implemented in that province in 2003 and successfully controlled costs through the following year. Beginning in 2005, however, things took a turn for the worse. Figure 4 — which combines the trends seen in both Figures 2 and 3 — tells the auto underwriting story for all of the provinces combined. As you can see, its downward tail more closely resembles the Ontario-only graph than the non- Ontario graph. The lesson? When it comes to auto insurance, as goes Ontario, so goes the rest of the country.

CLAIMS COSTS

Claims costs declined in most parts of the country. As a result, loss ratios declined or remained steady, and threats to market stability in 2008 remained low (See Figure 5 on Page 32). This was the case in Newfoundland and Labrador, Nova Scotia, New Brunswick and Alberta. Although claims increased and premiums declined in P. E. I, causing the loss ratio to rise, there is still room for these trends to develop before costs become a problem.

Although the data spelled stability in most parts of the country, they suggest the opposite in Ontario. Consumers enjoyed premium reductions in this jurisdiction, but claims grew at a concerning 10.2% rate over the previous year. This brought the loss ratio to 78.4%, a significant leap from the 71.5% posted in 2006.

Year-end financial data reveal few clues as to the causes of claims growth. For this, we need to rely upon actuarial data (at the time of this writing, available only for the first six months of 2007).

Using the half-year actuarial data, we find that although all of the provinces with private auto insurance saw small increases in the frequency of claims (between the first half of 2006 and the first half of 2007), there an accompanying rise in the severity of claims only in Ontario and P. E. I. Figure 6 shows claims severity for all coverages.

The increase in frequency and severity in Ontario and PEI resulted in claims cost growth of roughly twice the growth experienced by the rest of the provinces, at 13.5% in Ontario and 16.9% in PEI.

ONTARIO AUTO -CLAIMS COST DRIVERS

So what are the cost drivers affecting claims costs in Ontario auto?

An Insurance Bureau of Canada study of data from 2004 to 2006 (See Figure 7) indicates that costs on the accident benefits portion of the product are being driven by medical rehabilitation costs — in particular, the number of assessments and ancillary benefits (i. e. homemaking/home maintenance and attendant care).

Stepping back to look at long-term trends in both accident benefits and bodily injury claims, we see both have been steadily rising. The 2004 reforms (Bill 198) resulted in a dip for that year, but both have continued to rise ever since.

EFFECT OF RESERVE RELEASES

Returning to the national picture, it should be noted the underwriting picture becomes more concerning when the positive impact of reserve releases is removed from the equation.

Development on prior-years’ claims was again favourable, producing an undiscounted reserve release of Cdn$1.4 billion. While the reserve releases evident in the financial data are for all lines of business, the majority (68%) is from auto insurance, followed by 12.3% from the liability line and 10.1% from the commercial property line. Favourable development stemmed primarily from the 2004 accident year, for which insurers released 3.5% of previously established reserves for 2004 and prior years. Releases from 2005 and 2006 accident years were -48.6% and 21.4% respectively.

Removing the favourable effect on loss ratios of claims reserve releases provides a more accurate picture of real underwriting performance in 2007. For the past two years, we see that claims net of reserve releases grew 12.4% in 2007. This is much faster than premiums, which grew at 2.6%, personal disposable income, which grew at 6.1%, and the rate of inflation, which was 2.2%.

This situation concerns more groups than just shareholders. If past insurance cycles are any guide, continued deterioration in underwriting performance will also bring the solvency supervisors knocking on the door to request capital increases or reduced writings in order to maintain security ratios.

CONCLUSION

As we’ve seen, the auto insurance story for most provinces remains relatively positive, albeit less so when the effect of reserve releases is removed. The most worrisome exception, of course, is Ontario. In fact, if claims continue to grow in 2008 at the rate at which they accelerated in 2007, Ontario auto insurers could find themselves dipping into capital in order to keep the line of business afloat.

Because Ontarians are already spending more of their disposable income on auto insurance than consumers in any other province (in part because the Ontario product is significantly more generous), it is hoped that this unsustainable trend can be addressed through reduced costs via reforms to the system.