By Jeff Sanford
Toronto, Ontario — October 22, 2015 — Critics of the insurance industry were heartened last week by the appearance of a report from the Ontario Trial Lawyers Association that claimed Ontario auto policyholders were overcharged by more than $700 million last year.
According to the report auto insurance customers have overpaid for a couple of reasons. One, they believe that the mandated return on equity (ROE) that insurance companies are allowed to generate by law is too high. Currently this number is 12 percent. According to the authors of the report, this is a wildly inappropriate rate in light of radically low interest rates of 1 percent.
The authors, two York University profs, say a more appropriate cap on ROE would be something like 6 percent, half of what it is now.
As well, Ontario auto insurance companies have benefitted from cuts in benefits paid to long-term injury sufferers. Maximum benefits have, in some cases, been reduced to half. As a result the regulatory environment is remarkably supportive of the insurance industry. In a follow-up to a story on the report that appeared on collisionrepairmag.com last week, we contacted one of the professors involved in the preparation of the report for a bit more perspective.
Dr. Fred Lazar is an Associate Professor of Economics at York University and one of the authors of the report. The story he tells about the origins of the report will be deeply fascinating to anyone interested in Ontario auto insurance.
According to Dr. Lazar, the OTLA report evolved out of a report he originally did for the Financial Services Commission of Ontario (FSCO), the body that licenses and regulates insurance companies in Ontario.
“This report for the OTLA is an extension of the one we did for FSCO,” said Lazar. “The reason we were originally retained to do the FSCO report was that the Auditor General of Ontario wanted us to get into this idea around the high cap on return on equity. I think the Auditor General thought it seemed to be inappropriate. As did we. I think what happened, the trial lawyers got hold of original study and then they contacted us. They wanted us to update the numbers. Which we did.”
What the profs found when they updated the original FSCO report is interesting. They found that the insurance companies have only improved their operating position and profitability since.
“The companies that were profitable in the last report were a lot more profitable than in the earlier period when we did that first study. We weren’t surprised. Interest rates have been, basically, zero for six, seven years. Bond rates have come down considerably.”
Lazar went on to explain that the ROE rate of 12 percent was put in place in the early 1990s. At that time rates were six or seven percent. So a 12 percent return on equity was “not out of line with market realities of that time,” says Lazar. But interest rates began trending down in the years since and have been near zero since 2008. Over this time there has been no change in that equity cap.
“If the report for FSCO had been adopted … that return on equity cap would have dropped. It hasn’t. And that has contributed to significant overpayment by consumers,” says Lazar. “By our calculation, (the return on equity) should be reduced six to eight percentage points.”
How come this hasn’t happened? “I assume the insurance industry would threaten that if the government tried to reduce the ROE allowance the Ontario auto insurance industry would no longer be profitable and they would pull out of province. Whether it was a bluff or not, I can’t say. But the government has continually caved in to the threat,” says Lazar.
He does not hold back in his blunt talk about the insurance industry. “Insurance is regulated at the provincial level across the country. The regulations are quite similar … but no one wants to stick their head and be different. And the insurance industry is well organized.”
The ins-and-outs of the modern insurance are dry, complex and not easily understood by the average person. “It’s out of the public eye. Government can argue we didn’t do this, it was a regulatory agency. No one makes an issue out of it,” says Lazar. “The insurers are not going to publicize this. There are enough scapegoats for the insurance companies to point to.”
According to Lazar, “Any solution on what should be done would have to include some kind of requirement that the mandated cap on ROE should come down dramatically.” When the FSCO report was released, the cap on ROE was lowered from 12 to 11 percent. But that’s still too high for Lazar. He believes it should be about 6 percent considering where interest rates are today.
“The big insurance companies don’t report how profitable auto insurance in Ontario is. I suspect the reason they don’t break this out is that it is really highly profitable. The most surprising we found in the process of updating the report is that the profitable insurance companies comprise about 80 percent of the market. The ones that aren’t profitable are run as loss leaders for the banks, so they bring in other business for the bank and create profits in other ways. The actual returns on equity for some insurance companies have been 18 percent in 2013 and 19 percent in 2014. That’s way above the cap. Look at the publicly traded stocks of the insurers, they’re doing great. No wonder. The insurance industry seems to be doing very well.”
So, if consumers are paying too much for auto insurance according to the report, then where are the funds going? Labour rates for collision repair in Ontario are not excessively high compared to other provinces. In fact, some repairrers have argued that they should be increased. However, Kevin George offers a different view. George is the General Manager of Leamington Collision in Leamington, Ontario.
“Higher labour rates mean we can pay our techs more, but they don’t necessarily mean that our businesses will have more money to invest,” he says. “If our labour rates go up, that’s going to lead to an increase in total losses. Cars we used to be able to fix will instead be written off. What happens if volume decreases to the point where we have to start laying off techs? No one wins in that situation.”