Dr. Fred Lazar and Dr. Eli Prisman, from the York University Schulich School of Business, conclude in a recent study that for the period of 2001 to 2013, consumers in Ontario have likely overpaid for auto insurance by between $3 and $4 billion. This money has not gone to accident victims nor to lower premiums for consumers – instead this money has gone straight to the insurance companies coffers. In 2010, deep cuts were made to auto insurance benefits payable to those injured in auto collisions. Those cuts resulted in $2 billion in costs savings for the auto insurers. A large majority of this windfall to the insurers was the reduction of medical and rehabilitation benefits payable to injured auto accident in victims. The standard coverage was reduced from $100,000 to $50,000. But more troubling was the introduction of the Minor Injury Guideline that in practice has seen medical and rehabilitation benefits slashed for most-injured victims from $100,000 to $3,500.
In 2013, the Liberal government promised to bring auto insurance rates down by 15 percent by August 2015. This report clearly demonstrates that this target can be met without further sacrificing benefits to accident victims.
In Ontario, auto insurance is mandatory – if you drive you must buy insurance. The mandatory nature of auto insurance provides a guaranteed market for insurance companies – they always have a customer who will pay to drive. In an effort to manage the auto insurance industry, Ontario’s insurers are regulated by the Financial Services Commission of Ontario (“FSCO”). One area for regulation has been the acceptable profit margin for insurance companies. FSCO has historically set the benchmark for auto insurer profits at 12 percent return on equity (“ROE”). In the independent study prepared for FSCO, Drs. Lazar and Prisman concluded that the 12 percent benchmark ROE is much too high given the low interest rates that have prevailed for the past several years. They concluded that based on the economic evidence, a more realistic and appropriate ROE benchmark is in the range of 5.8 percent. In response, FSCO reduced the benchmark to 11 per cent.
As a result of the inflated ROE benchmark that has been in place in Ontario for the past 20 years, notwithstanding the economic realities of a low interest rate environment, Drs. Lazar and Prisman conclude that as result of the inflated ROE, auto insurance companies in Ontario have had a free ride during part of the past 20 years. In 2013, if the ROE was 5.8 percent, premiums could have been reduced by $685 million.
Insurer operating costs is a factor that Drs. Lazar and Prisman target. As they explain, in setting the benchmark ROE for auto insurance companies, FSCO assumes operating costs of 25 percent. This assumption has not changed in over 15 years. However, as Drs. Lazar and Prisman conclude, with the use of the Internet and multiple distribution channels and overall increased efficiency, a reasonable move would be to reduce the cost assumption from 25 percent to 23 percent.
Combining a ROE cap of 5.8 percent and an operating cost assumption of 23 percent, auto insurance premiums could reasonably be reduced by at least $840 million, or 7.9 percent based on 2013 data. Most importantly, this reduction can be done without further reducing auto insurance benefits!
There should be no concern that reducing the benchmark ROE to 5.5 percent for 2015 will result in auto insurance companies fleeing Ontario. As Drs. Lazar and Prisman reveal in their report, the study by KPMG suggested that auto insurance companies ROEs were well below the 5.5 percent recommended benchmark for the years 2008 to 2012. This being the case, if the ROEs were as low as KPMG believes, auto insurance companies should have been leaving in Ontario. However, this does not appear to have happened. Indeed, according to KPMG, capital investment by auto insurance companies in Ontario increased steadily between 2008 and 2010. While capital levels decreased slightly in 2011, they have recovered in 2012, despite very low ROEs, according to KPMG. As stated by Drs. Lazar and Prisman:
“For all companies in our sample, there appears to be a surplus of capital (i.e. equity) allocated to auto insurance in Ontario. It does not seem as if the companies in this industry have been earning uncompetitive ROEs on their auto insurance operations in Ontario; otherwise, they would not have allocated excess capital to the auto insurance line in Ontario.”
Setting the ROE benchmark for auto insurance companies in Ontario to a more reasonable level of 5.5 percent will have no impact on auto insurance companies leaving the Province. Any suggestion that this will be the case is fear-mongering by the insurance industry.
We all need to speak out against the misleading information being fed to us by the insurance industry and its paid lobbyists. This report prepared by prominent business professors Dr. Fred Lazar and Dr. Eli Prisman reveals the truth behind the numbers. The auto insurance business in Ontario is very profitable. Reasonable premium reductions should occur without any further erosion to accident benefits.
You can access a full copy of the report here. I urge you to contact your local MPP and tell her/him about this report and how insurance companies have not been telling us the truth about the profits they have been earning over the past 12 years in Ontario.
Contributed by Kris Bonn, an OTLA Director and lawyer practising with Bonn Law Office PC in Trenton, ON.