The Design of Auto Insurance Systemsassets.ibc.ca/Documents/Auto Insurance/CISL/Ontario Final...
Transcript of The Design of Auto Insurance Systemsassets.ibc.ca/Documents/Auto Insurance/CISL/Ontario Final...
FINAL REPORT TO INSURANCE BUREAU OF CANADAAugust 23, 2012
Sharon Tennyson
Associate ProfessorDepartment of Policy Analysis and ManagementCornell University
Mary Kelly
Associate ProfessorSchool of Business & EconomicsWilfrid Laurier University
Anne Kleffner
Associate ProfessorHaskayne School of Business University of Calgary
The Design of Auto Insurance Systems:Research and Implications for Ontario
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Summary
This study aims to provide guidance in auto insurance system design and considerations for
achieving a well‐functioning automobile insurance system in Ontario. Such a system is characterized by a
number of desirable features, including fair compensation, deterrence, efficiency, and fairness.
However, because system features designed to achieve one of these features may make it harder to
achieve some others (e.g., compensation and deterrence, efficiency and fairness), trade‐offs are often
required to balance conflicting objectives. Different stakeholders may also have conflicting objectives;
for these reasons, establishing whether an auto insurance system is functioning well is not a simple task.
The report describes a variety of combinations of the basic design features of auto insurance
systems are used in Canada and elsewhere, and compares the performance of auto insurance systems in
Canada based on the measures that characterize a well‐functioning system. This comparison
demonstrates that Ontario’s auto insurance system performance is worse than those in other provinces
on many dimensions and much worse in the areas of affordability and sustainability. However, although
the Ontario automobile insurance system exhibits a number of problems, the evidence does not suggest
that the design of the system is fundamentally flawed.
Background research on Ontario’s insurance system and the history of insurance reforms is
presented to shed light on the factors that explain this poor performance. That analysis yields several
key findings. First, reform policies in Ontario appear to have affected outcomes in the short run, but in
many cases inflationary trends quickly reappeared. Second, Ontario claim frequency and severity are
higher than those in other provinces in almost all cases and all years, and the increases over time in both
claim frequency and claim severity have been substantially greater in Ontario than in other provinces.
This is despite having the lowest fatal accident rate and one of the lowest rates of accidents causing
injury of all provinces. A final insight obtained from this analysis is that the claims growth in Ontario
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stems primarily from the Greater Toronto Area (GTA) rather than reflecting province‐wide problems.
Inflationary trends are highest in the GTA, due to increases in both claim frequency and claim severity.
Thus, while the auto insurance product is sustainable across most of Ontario, premiums in the GTA are
insufficient to cover the cost of auto insurance claims in the GTA.
Based on this review and on analysis of problems and solutions in other insurance systems, key
issues in the design of a well‐functioning auto insurance system are discussed. The overall conclusions of
the report are as follows:
Insurance provides many benefits to individuals and to society, but also may increase incentives to
drive, reduce driving precautions, and lead to benefit‐seeking or even outright fraudulent claiming.
The specific design features of an insurance system affect these behavioural incentives. Incentive
problems are greatest when insurance benefits are generous and pricing is socialized so that
premiums do not reflect individual risk of loss. A well‐functioning insurance system must recognize
and attempt to counteract these incentive problems.
When insurance availability and affordability to all consumers are important objectives, adjusting
the insurance system to address cost problems is difficult because many solutions will reduce
availability and/or affordability for some. In jurisdictions in which driving is not considered a right or
an economic necessity, the public policy problems in auto insurance are less complicated.
Auto insurance does not operate in a vacuum: it interfaces with the private and public health
systems, road safety and driver licensing mechanisms, the legal system, demographics and
economics of a region. Recognizing this, policy makers should consider problems and solutions that
lie outside of the insurance system along with those internal to the system when addressing auto
insurance issues.
In the aggregate, rising costs are the source of rising insurance premiums. Because the link between
cost increases and premium increases is not transparent, there is often pressure to reduce
premiums without recognition that the underlying problem is one of cost. However, suppressing
premiums does not lead to cost reductions and may even exacerbate cost increases. Insurer or
public policy responses aimed squarely at underlying cost and incentive problems are more effective
and more permanent responses.
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Because of the threshold, excessive claiming behaviour is more problematic in partial no‐fault
systems than in pure no‐fault systems because benefit overuse arises due to attempts to breach the
tort threshold. The tort threshold, the magnitude of additional benefits available if the threshold is
breached, and the penalties for fraudulent claims should be constructed so that the “lottery”
aspects of partial no‐fault are minimized.
These considerations suggest that the following principles should be observed when enacting
auto insurance reform:
It is important that policy makers clearly articulate the objectives of the insurance system and the
trade‐offs that must be made, recognizing that trade‐offs exist between different design options.
Generous first‐party insurance, and partial no‐fault systems, lead to benefit‐seeking behaviours
which must be monitored and controlled. Claimants have incentives to over‐claim when first‐party
benefits are generous. Measures to reduce fraudulent claiming and reduce claims costs should be
established at the industry level with support of government enforcement mechanisms. These
measures could include harsh penalties for fraudulent healthcare providers, better use of analytics
to detect fraud, and consumer education.
If affordability is addressed via premium subsidies these should be based on income and not on risk:
full premium subsidies should be available to low risk and low income individuals. Subsidies
available to low income but high risk individuals should reflect the underlying poor driving record or
accident experience.
The provision of insurance reduces incentives to take care. Incentives for safe driving and
responsible claiming are better aligned if premiums paid by drivers are commensurate with their
risks. Low‐risk drivers should be provided with opportunities to distinguish themselves from high‐
risk drivers in the rate classification system. High‐risk drivers should be identified by a system of
experience rating that incorporates both driving record and at‐fault claims.
Cost controls on healthcare services are important to prevent cost shifting to the auto insurance
system.
The long run success of changes to system design to achieve policy goals, whether it is
compensation levels, or benefit provision or pricing structure, are impacted by consumer knowledge
of insurance and societal beliefs about fairness and societal attitudes towards excessive or
fraudulent claiming behaviours.
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Government insurance providers have often been more successful than private insurers in
containing claims costs due to their greater control over compensation and indemnification
schedules. However, the trade‐off involves potential under‐indemnification if benefits to those most
seriously injured are capped (as, for example, in Quebec), and the loss of consumer choice of
products and providers. Moreover, the full costs of the auto insurance system are not reflected in
premiums if the government insurer runs a deficit.
Specific additional considerations with respect to Ontario auto insurance include the need to
realign premium structure to reduce cross‐subsidization across the province. Although in theory
premiums are risk‐based, decades of prior approval rate regulation have created cross‐subsidies across
driving record classes and across territories. It is also imperative to develop a distinct pricing mechanism
that is fair to new drivers and maintains incentives for safe driving.
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Contents
Summary ........................................................................................................................................................ i
1 Introduction ........................................................................................................................................ 1
2 Background on Automobile Insurance ............................................................................................... 4
2.1 Economics of Automobile Insurance ............................................................................................ 4
2.2 Objectives of an Automobile Insurance System ........................................................................... 7
3 Design Considerations of an Automobile Insurance System .............................................................. 9
3.1 Mandatory Insurance Coverage .................................................................................................. 10
3.1.1 Residual Markets ................................................................................................................. 13
3.2 Public versus Private Insurance .................................................................................................. 15
3.2.1 Public Intervention in Private Insurance Markets............................................................... 19
3.3 Tort versus No‐fault Compensation Systems .............................................................................. 21
3.4 Pricing Mechanisms .................................................................................................................... 27
4 Automobile Insurance Systems Design and Performance ................................................................ 36
4.1 Insurance Systems in Canada ...................................................................................................... 36
4.2 Comparing System Performance ................................................................................................ 40
5 Automobile Insurance in Ontario ..................................................................................................... 57
5.1 The Current Product ................................................................................................................... 57
5.2 The History of Auto Insurance Reform in Ontario ...................................................................... 59
5.2.1 Bill 68 (1990) ....................................................................................................................... 63
5.2.2 Bill 164 (1994) ..................................................................................................................... 65
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5.2.3 Bill 59 (1996) ....................................................................................................................... 66
5.2.4 Bill 198 (2003) ..................................................................................................................... 67
5.2.5 Elimination of Designated Assessment Centres (2006) ...................................................... 69
5.2.6 Reforms of 2010 .................................................................................................................. 69
5.3 Ontario Claim and Cost Trends ................................................................................................... 70
5.3.1 Bodily Injury Liability Claims ............................................................................................... 71
5.3.2 Compulsory Property Damage Claims ................................................................................ 78
5.3.3 Statutory Accident Benefits ................................................................................................ 83
5.4 System Performance ................................................................................................................... 89
5.5 Summary and Interpretation ...................................................................................................... 95
6 Experience from Other Jurisdictions ................................................................................................ 99
6.1 Insurance Systems in Other Countries ........................................................................................ 99
6.2 Summary of Case Studies .......................................................................................................... 101
7 Policy Considerations for a Well‐Functioning Insurance Market ................................................... 105
7.1 Policy Considerations for Ontario ............................................................................................. 108
7.1.1 Pricing Mechanism Design ................................................................................................ 110
7.1.2 Benefit Provisions ............................................................................................................. 113
7.1.3 Claims Cost Controls ......................................................................................................... 114
7.1.4 Consumer Education ......................................................................................................... 118
7.1.5 Larger Policy Issues ........................................................................................................... 120
8 References ...................................................................................................................................... 122
9 Appendix: Case Studies of Other Jurisdictions ............................................................................... 128
9.1 Alberta, Canada ......................................................................................................................... 128
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9.2 Massachusetts, U.S.A. ............................................................................................................... 132
9.3 Michigan, U.S.A. ........................................................................................................................ 138
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1 Introduction
Automobiles and driving have a fundamental role in our society. Although driving is not a “right”
according to various courts of law in Canada1, car ownership and driving lead to better employment
outcomes and higher wages (Raphael and Rice, 2002). The costs associated with automobile accidents are
equally important to society. In 2009 there were 2,011 fatal collisions and 123,192 additional collisions
causing personal injury across Canada. Over 2,200 individuals died and 11,450 suffered serious injuries in
car collisions (Transport Canada, 2011). It is estimated that the cost of traffic accidents is about 1.9
percent of GDP in Canada (International Transport Forum, 2011). As the primary mechanism for funding
these accident costs, the automobile insurance system is an important concern. In addition, the social
importance of the automobile and the extent of automobile accident compensation in North American
society generate public interest in automobile insurance.
There are many different automobile insurance systems worldwide and 13 different (provincial)
insurance systems across Canada alone. There are significant differences in the insurance product and
regulatory regimes across the provinces. Market conduct regulation of insurance is a provincial (and
territorial) responsibility. As such, each province has its own rules for underwriting and marketing
insurance policies, and its own regulatory approach to product and price oversight. Generally, products
and prices are monitored and controlled, rating and underwriting are regulated, and insurers face
extensive filing requirements.
Regulation of the automobile insurance system may be imposed to achieve a number of different
objectives. In Canada an important objective of regulation is to achieve social goals due to the social risk
created by driving. Drivers are exposed to risk of significant loss from automobile accidents, and in turn
1 See Regina v Tri‐M Systems (B.C.S.C.), note 24: http://sense.bc.ca/disc/stead2.htm.
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impose accident risk and accident costs on others. The purchase of automobile insurance helps to
internalize the costs of accidents through payment of policy premiums that reflect the expected costs of
driving. When a driver chooses to drive uninsured, accident costs are shifted to other drivers or to society
as a whole. The cost to an individual from driving uninsured is small, as the majority of personal injury
costs are shifted to society through taxes and/or levies on insurance policies.
The potential for drivers to shift accident costs to others is one reason for government regulation
of automobile insurance. The existence of publicly funded, universal medical care in Canada makes it easy
for drivers to shift this cost to others, creating an additional reason to make the purchase of auto
insurance compulsory. The cost of providing medical care to those injured in automobile accidents is
substantial. A potential for overutilization of medical care exists if insurance benefits are generous and
there is a separation between the provision of care and the financing of care. Thus, there may be a role
for governments to optimize the use of the medical system. The division of public and private
responsibilities for the provision of auto insurance may be chosen from a wide spectrum of arrangements
and is a critical design element of the automobile insurance system.
Since the early 1990s Ontario has made a number of significant changes to the automobile
insurance product in an effort to control costs and improve compensation. Changes began with the
introduction of no‐fault insurance in 1990 and include the more recent reductions to statutory accident
benefits. Despite a series of regulatory interventions over time, the automobile insurance system in
Ontario has consistently been problematic for the government and for the industry. This report aims to
contribute to the process of creating a more sustainable insurance system for the province.
Rather than focusing solely on concerns in Ontario, this report uses insights from theoretical and
comparative analysis of auto insurance systems to identify principles for designing a sustainable
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automobile insurance system. The analysis reviews insurance theory and evidence on the experiences of
other jurisdictions to identify practices that work well for the insurance industry, consumers, and society.
Section 2 of the report provides the conceptual framework for automobile insurance and
identifies the objectives of a well‐functioning automobile insurance system. These are comprised of
availability, affordability, service quality, cost efficiency, sustainability, fairness, informed consumers, and
adequate competition. In Section 3 the key policy levers that are available when designing an insurance
system are described. These are compulsory versus optional insurance; public versus private provision;
tort versus no‐fault compensation; and pricing schemes. We summarize the evidence from academic
research regarding the strengths, weaknesses, and overall effectiveness of each design feature as
employed in existing insurance systems.
Because an auto insurance system combines choices regarding each of the individual system
elements, there exists a wide range of automobile insurance systems. The systems employed in Canada
are documented in Section 4. We compare the performance of the auto insurance systems in each of the
provinces in Canada, defining metrics to measure the objectives outlined in Section 2. Section 5 reviews
the history of auto insurance reform in Ontario and examines the statistical evidence on the historical
performance of Ontario’s system using the lens of this analysis. We consider the performance of Ontario
in relation to other provinces, and we also compare the performance of different geographical regions of
Ontario. In Section 6 we briefly discuss auto insurance systems and auto insurance reforms in jurisdictions
outside of Ontario. Case studies provided in the Appendix support the discussion in Section 6. We
conclude with policy considerations for a well‐functioning insurance market and specific considerations
for the Ontario insurance market in Section 7.
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2 BackgroundonAutomobileInsurance
2.1 EconomicsofAutomobileInsurance
Insurance is a mechanism by which one can protect against the risk of a future contingent loss.
The buyer pays a fixed sum of money, the premium, to an insurer in exchange for the insurer’s promise to
compensate the insured for a potential financial loss. Because individuals are typically risk averse, they
prefer to purchase insurance instead of facing the risk of the loss. The insurer pools together the
premiums of many individuals to pay for the future losses that will be incurred. At its most basic level,
each insurance buyer is charged a premium that reflects the expected costs that he or she imposes on the
insurance system, and the premiums paid by all buyers are pooled to pay the losses of those who
experience a loss.
Automobile insurance provides compensation to parties who suffer injuries or incur damages due
to automobile accidents and losses. Given the variety of losses which may be incurred, automobile
insurance is actually a package of insurance coverages that provides protection for both damage to
property and injuries to persons. Because there is the potential for causing losses or damages to others as
well as to one’s self, the package includes both liability (“third‐party”) insurance and first‐party insurance.
First‐party insurance covers costs of one's own automobile‐related property or injury losses. Liability
insurance covers damages to other persons or their property that arise in an automobile accident with
the insured, and for which the insured is held responsible. The function of liability insurance differs in
some respects from that of first‐party insurance. In addition to protecting the insured driver from the
unexpected costs associated with automobile accidents that are his fault, liability insurance provides
protection to other drivers by assuring that funds will be available for their compensation in such a
circumstance.
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Insurance has many economic benefits. Insurance reduces uncertainty for risk‐averse drivers by
providing protection against losses from automobile accidents. Insurance also increases the productivity
of financial resources by removing the need for individual drivers to hold large contingency funds (Curak
et. al, 2000). Thus, insurance provides great benefits to individuals and to society. However, the cost of
insurance and the potential solvency of the insurance provider is impacted by moral hazard in both risk‐
taking and claiming behaviours, and by adverse selection.
Moral hazard arises from the fact that in the presence of insurance, individuals have incentives to
take less care than they would otherwise. In auto insurance, for example, individuals may drive with less
care or be less careful when choosing a location to park a vehicle, because they know they are insured.
Moral hazard exists if this change in behaviour increases the likelihood or size of a loss, and if insurers
cannot directly observe the actions of the insured or if it is prohibitively costly to do so. Because
insurance protects drivers from immediately bearing the full costs of accidents that they cause, the
effects of insurance on incentives for safe driving must be carefully considered.
Most insurance contracts are contracts of indemnity – their purpose is to put the insured into the
same financial condition as before the loss. However, the nature of the insurance product creates
incentives to report fictitious losses or exaggerated losses, since receiving insurance payments for a loss
that was not experienced leads to financial gain for the claimant. This negative consequence of insurance
is intrinsic to all insurance systems, and the design of the insurance contract, insurance contract law,
claims handling practices and even the selection of insurance customers must take this into account
(Baker 1994). Fraudulent claiming is often an opportunistic response to the insurance contract. That is,
individuals may decide whether to file an insurance claim, and the amount for which to file, based on the
expected gains from filing relative to the costs of filing. Preventing and detecting this kind of “claims
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abuse” is an important facet of insurance management in both private and public insurance systems.
Fraudulent claiming may also result from organized criminal activity, however.
Moral hazard can be reduced if insured individuals are required to pay part of any loss
themselves, either by having to incur a deductible or by having to pay all costs beyond a certain threshold
amount. Insurance companies also use experience rating (basing future premiums on the past losses of
the insured, or in the case of auto insurance, past losses and driving record) to mitigate both moral
hazard and excessive claiming practices. Moreover, insurance theory indicates that if fault is accurately
determined, charging each driver a premium equal to the driver’s expected losses is the best way to
preserve safe driving incentives (Shavell, 1986).
Adverse selection also reduces the ability to spread risks through insurance. Adverse selection
exists when insureds have private information about their risk levels that insurers cannot observe, or
when insurers are prohibited from using such information to distinguish between risk types. If insurance
is offered at one standard premium to a heterogeneous group of individuals, it will be overpriced for
those who are low risk and underpriced for those who are high risk. This will result in low‐risk individuals
buying less insurance or even no insurance if possible, while high‐risk individuals will be more likely to buy
insurance and will want to purchase more of it. The resulting insurance pool will be dominated by high‐
risk individuals. In practice insurance providers use both risk classification and experience rating to
distinguish between risk types, and governments may require individuals to purchase insurance to
overcome the tendency for low‐risk individuals to opt out.
In summary, automobile insurance is a useful tool for risk‐averse individuals to transfer their risk
of loss associated with driving, as well as to assure that those injured by at‐fault drivers are compensated
for their losses. Adverse selection and moral hazard create barriers to offering insurance because they
reduce the ability to pool risk, increase the costs of claims, and raise the costs of managing the insurance
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pool. The design of an automobile insurance system has important implications for the extent of moral
hazard and adverse selection problems and, more generally, will affect the extent to which incentive
misalignments reduce the benefits and raise the costs of insurance. Such problems are a part of the
trade‐offs which must be considered in designing the automobile insurance system.
2.2 ObjectivesofanAutomobileInsuranceSystem
The discussion of automobile insurance highlights the benefits and costs of insurance, and raises
a number of important issues that must be considered when designing an automobile insurance system.
The following set of specific objectives summarizes key attributes that are relevant to these issues and
that account for the interests of various stakeholders (policyholders, insurers, regulators, taxpayers).
These objectives are widely held to be hallmarks of a well‐functioning insurance system, and may be used
to determine the health of an insurance system:2
Availability: Consumers have timely access to a variety of auto insurance products that meet their
needs. When automobile insurance is compulsory, insurance availability may determine access to
driving.
Affordability: Consumers can acquire auto insurance at appropriate prices. Income differences across
consumers may affect perceptions of affordability.
Service Quality: Consumers are satisfied with their products and services.
Cost Efficiency: Products and services are provided at least possible cost.
2 See, for example, the objectives developed by the automobile insurance working group in the Province of Alberta in 2007; Cummins and Tennyson (2002); Tennyson (2012).
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Sustainability: Products, service quality, costs, and prices are at levels which are viable over the long‐
term.
Fairness: Consumers benefit from fair treatment in the insurance system, both in the pricing of the
insurance product and in the claims settlement process.
Informed Consumers: Consumers understand the automobile insurance product and make informed
decisions about purchasing and claiming.
If insurance is produced and sold by firms in the private market, the additional objective of
competition must be met in order to assure that the operation of the market leads to a well‐functioning
insurance system:
Competition: A number of insurers actively compete to serve consumers’ automobile insurance
needs.
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3 DesignConsiderationsofanAutomobileInsuranceSystem
The ability to achieve the objectives listed above is a function of a number of different
parameters that define an automobile insurance system. This section describes the primary
characteristics of the auto insurance system that will impact the achievement of outcomes. Four design
considerations are of particular importance:
Compulsory versus optional insurance
Private insurance versus government provider
The role of liability in determining compensation
The pricing mechanism
It is important to recognize that specific design parameters are better at achieving certain
objectives and are less effective in achieving others. In the concluding section of this report we will
discuss the trade‐offs that policy‐makers face in designing an effective automobile insurance system. For
example, although consumers are inherently interested in affordable insurance, insurers must be able to
cover their costs and earn a fair rate of return. Those who are injured desire a system with generous
benefits, but this creates affordability issues. Without explicitly recognizing these trade‐offs automobile
insurance reforms often address one problem but create another. Further, auto insurance does not
operate in a vacuum: it interfaces with the private and public health systems, road safety and driver
licensing mechanisms, and the legal system. The availability of public transportation, household wealth
levels, societal acceptance of fraud, and the importance society puts on holding at‐fault drivers
accountable also impact the auto insurance system. Any attempts at reform should recognize this
interrelationship.
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3.1 MandatoryInsuranceCoverage
The economic rationale for compulsory auto insurance arises from the same rationale that gives
rise to government intervention in insurance markets: part or most of the costs of accidents fall on other
parties. Due to potentially inadequate resources, in the absence of liability insurance an at‐fault driver
may not be held financially responsible for damage caused to others. In the presence of both universal
health insurance and private medical benefits, injuries to one’s self or to others will be paid by taxpayers
and/or the insurance company. Some costs may also fall upon employers for employees who have
disability and health benefits from work.
Because (uninsured) drivers do not bear the full cost of their driving, they will drive if the
marginal individual benefit to them of driving is greater than the marginal individual cost. Compulsory
insurance, if priced appropriately, is a mechanism that forces people to internalize the full cost of their
driving and thereby give up driving (and reduce associated costs) if the marginal benefit is not greater
than the marginal cost. A second argument for compulsory insurance relates to improving safety
incentives. Liability insurance that is priced in relation to driving risk can encourage greater safety
because drivers know that by driving more safely their premiums will go down, or by having an accident
their premiums will go up.
The main argument against compulsory insurance is the regressive impact on the distribution of
income. Compulsory insurance laws are more likely to affect low‐income individuals since they are the
ones most likely to go without coverage. Without insurance, their costs would have fallen on (primarily)
the publicly funded health insurance system. This income shift from low‐income drivers to high‐income
drivers is a common criticism of compulsory insurance laws. Mechanisms for reducing the regressive
impacts include rate regulation or some degree of social pricing that subsidizes the cost of coverage.
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A second consideration with compulsory insurance is the ability to enforce compliance. Greater
numbers of uninsured drivers increase the cost of insurance for insured drivers, potentially increasing the
problem of affordability; this in turn may result in more uninsured drivers (Smith and Wright, 1992).
Evidence on the extent of this problem is mixed, since some estimates show no relationship between
uninsured driving rates and the cost of automobile insurance (Ma and Schmit, 2000; Jaffee and Russell,
1998). However, Smith and Wright (1992) find a positive relationship between uninsured driving and
average premiums using data from 27 large U.S. cities. Using state‐level data from the U.S., Tennyson and
Weiss (2011) also find a positive relationship, with estimates suggesting that a 10 percent increase in
uninsured driving leads to a 2 percent increase in automobile insurance premiums. These authors also
find some evidence of a feedback effect whereby higher premiums lead to higher rates of uninsured
driving.
In practice, mandatory insurance coverage typically includes liability coverage, personal injury
protection or first‐party accident benefits (more common in Canada than the United States), and
uninsured motorist coverage.3 Legal requirements generally specify an amount of insurance which must
be purchased, with coverage amounts above this limit available but optional. The argument for
mandating third‐party liability coverage is the potential for parties injured by negligent drivers to be
uncompensated and forced to bear (at least a portion of) their own injury costs. In the presence of
universal healthcare, accident costs that are covered would be shifted on to taxpayers, but would still be
borne by others than the negligent party. In other words, negligent drivers can shift the cost of accidents
to others.
3 A few jurisdictions require coverage for first‐party property damage to one’s own automobile.
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Although mandatory liability insurance helps to ensure that injured parties are compensated by
negligent drivers, the time and expense associated with settling claims and the uncertainty associated
with the value of the settlement is a disadvantage to relying on this means alone for compensation,
especially for injured persons. This is an argument for some level of mandatory first‐party accident
benefits that are paid without reference to fault (no‐fault insurance systems). In Canada, first‐party
accident benefits are compulsory in every province except Newfoundland and Labrador (and in
Newfoundland and Labrador over 70 percent of insureds purchase first‐party accident benefits). Such
benefits are designed to achieve quicker and more accurate compensation, lower settlement costs (by
eliminating many liability claims), and potentially quicker recovery of health (evidence shows that access
to appropriate treatment soon after injury leads to better results).
In an attempt to reduce liability insurance transactions costs, some jurisdictions mandate
compulsory first‐party property damage coverage for not‐at‐fault damage. As noted by Kelly, Isotupa and
Kleffner (2009), key benefits of first‐party as opposed to third‐party recovery for vehicular property
damage are the elimination of the adversarial relationship that often results from two insurers having to
negotiate the fair amount to be paid for a claim involving their own insureds, the elimination of the
majority of subrogation costs for property damage claims, and a better matching of premiums to the
actual potential loss.
Despite the fact that some level of auto insurance is mandatory throughout most of North
America, a substantial percentage of motorists drive uninsured. In the United States, the Insurance
Research Council (IRC) estimated the percentage of uninsured motorists in 2009 to be 13.8 percent
overall, and found that the uninsured motorist problem varied greatly from state to state, from 4.5
percent in Massachusetts to 28 percent in Mississippi (Insurance Information Institute, 2012). Estimates
for Canada are less widely available, but using methods similar to the IRC suggests uninsured driving rates
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of 5 percent to 15 percent across the provinces. Because of this, all jurisdictions in Canada and most in
the United States mandate that drivers buy uninsured motorist coverage to protect against injury caused
by uninsured at‐fault motorists.
3.1.1 ResidualMarkets
The problem of uninsured drivers raises another important issue related to compulsory
insurance: If auto insurance is mandatory for driving, but private insurers are not bound to offer
insurance to every driver, then what is to become of those drivers who cannot obtain insurance in the
market? Most jurisdictions, and all jurisdictions which mandate insurance purchase, provide some
alternative market or mechanism through which such drivers – generally high‐risk drivers – may obtain
insurance. This is often termed the “involuntary” or “residual” market. Residual markets, which usually
provide insurance at subsidized prices, deal with the problem of drivers who are unable to find an insurer
willing to provide them with insurance. Associated losses from the residual market pool are usually
funded by loss‐sharing among private insurers or through general tax revenues.
The need for residual markets in automobile insurance is generally low, except when restrictions
on market pricing lead to shortages of insurance supply in the market. In a market in which regulation
restricts pricing, insurers will tend to reject drivers for which there are large differences between
expected loss costs and the allowable premium charges. These rejected risks must then receive insurance
through the residual market. In this way, regulatory restrictions on pricing raise the percentage of drivers
insured through the residual market (Ippolito, 1979; Grabowski, Viscusi, and Evans, 1989; Harrington,
2002). The size of the residual market is generally considered to be an important measure of how well
private auto insurance markets are functioning: “Healthy auto insurance markets, where coverage is
widely available and affordable, are characterized by keen competition among companies, widespread
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choice for consumers, and small (i.e. less than 2% of written vehicles) residual markets” (Facility
Association, 2003; p. 1).
In the public insurance markets in Canada, government‐run insurers provide coverage to all
drivers, regardless of their risk. In the private market provinces of Alberta, Ontario, New Brunswick, Nova
Scotia, Prince Edward Island, Newfoundland and Labrador, and the three territories, insurers have
created an unincorporated non‐profit organization, the Facility Association, which serves as a mechanism
to provide insurance to those who cannot obtain insurance through the voluntary market. The operations
of the Facility Association differ between each jurisdiction. The Facility Association operates a residual
market (FARM) in each private market province, and it administers risk sharing pools in Ontario, Alberta,
New Brunswick, and Nova Scotia.
An approach which may be used as a support to the residual market is to mandate that insurers
must accept all applicants. This take‐all‐comers requirement has been used in several U.S. states, and has
been in force in the province of Ontario since 1993 and in Alberta since 2004. Under this requirement,
insurers are legally obligated to offer coverage to those requesting it regardless of age, gender, marital
status or any other characteristic. Alberta’s take‐all‐comers rule is fairly stringent in that the rules for the
risk to be written within the FARM (Facility Association Residual Market) are mandated by the province
and are not based on each insurer’s underwriting requirements. Under Ontario’s take‐all‐comers
regulations, insurers must cover all potential insureds who meet their underwriting requirements, but
firms are allowed to use rating variables such as territory, vehicle types, driving records and driver classes,
accident history, and past convictions to define those risks that they will underwrite.
If residual market subsidies are financed through higher premiums for drivers in the voluntary
market, this results in shifting of costs from high‐risk to low‐risk drivers. Regulations that subsidize high‐
risk drivers will dampen safety incentives for high‐risk drivers. If residual market deficits are passed on to
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drivers in the voluntary market through higher premiums, the link between insurance premiums and
driving behaviour is further weakened.4 This will distort driver safety incentives in ways that may lead to
reduced precautions for all drivers and thus higher claim frequency and higher loss costs (Harrington and
Doerpinghaus, 1993; Weiss, Tennyson and Regan, 2010).
3.2 PublicversusPrivateInsurance
As indicated above, the mandatory nature of automobile insurance stems from the reliance on
automobiles, the social importance of automobile compensation, and the risks that driving imposes on
others. Thus, an important question is what level of government involvement is desirable in the
mandatory automobile insurance market. The government may act as the supplier of insurance, through
public insurance or a public‐private partnership; or when insurance is privately supplied the role of
government may include defining the mandatory product (such as mandatory limits and benefits
provided), and regulating rates, underwriting practices, and claims resolution.
Arguments in favour of public insurance include potential economies of scale and lower
transaction costs. This leads proponents of government‐run automobile insurance to argue that a
government‐run monopoly will lead to lower prices and increased insurance benefits, relative to
premiums paid.
Fronsko (2011) notes that the goal of private insurers is maximization of firm value whereas
public insurers likely have objectives that are aligned with legislative objectives. Typical objectives for a
government auto insurer, for example, include road safety programs and road redesign aimed at reducing
car crashes, and affordability and accessibility of auto insurance – sometimes at the expense of actuarially
4 Harrington (1990) shows that there are subsidies from the voluntary to the residual market in a number of states, while Jaffee and Russell (1998) show that residual market prices in California during the 1980s were lower than those in the voluntary market for a large number of insured drivers, indicating cross‐subsidization.
16
fair premium setting. Another key objective is long term viability, although this is a difficult concept to
measure if there is no transparent accounting separation between the government insurer and the
government itself.
Useful examples of monopoly public insurers are the provincial workers’ compensation (WC)
boards in Canada and the four U.S. states that have monopolistic state WC funds. There are also 21 U.S.
states that have quasi‐public workers’ compensation funds where private insurers compete with the state
provider. A 2009 report found that in the U.S. the 25 public and quasi‐public plans perform better
financially than the private market in a number of performance categories, and at least as well when it
comes to the bottom line. The state funds were also shown to be more effective at preventing losses and
improving safety. Further, although the public programs tend to have higher losses than the WC
insurance industry as a whole, they offset those losses with lower expenses, higher investment returns,
bigger dividends to employers, and better injury prevention efforts (Jablonowski, 2009).
According to Jablonowski (2009) the key to state fund success stems from a dedicated approach
to loss prevention and control.5 Given that they typically work with other state agencies and share
responsibility for health and safety, they are able to incorporate state‐of‐the‐art loss prevention
initiatives with financial rewards tied to the insured’s loss performance. Although public WC funds have
higher loss ratios, they also have lower expenses. This is due in part to the fact that they do not pay taxes
or licensing fees, but also results from efficiencies achieved through use of technology and coordination
of loss prevention, safety and health efforts with other state agencies.
5 In Canada the potential benefits of a public auto insurer and the levers that the government is able to pull in order to reduce automobile accident costs is illustrated by Quebec’s coroner calling on Transport Canada to require manufacturers to equip vehicles with a system for detecting drowsiness and loss of driver alertness. The coroner has also recommended that Quebec’s auto insurer, the Société de l’assurance automobile du Québec (SAAQ), undertake a public education campaign about driving while tired. The coroner recommends that the campaign should caution drivers on the use of cruise control, noting that this might be lulling drivers into “a false sense of security.”
17
In the context of automobile insurance, the monopoly insurer in Saskatchewan, Saskatchewan
Government Insurance (SGI), provides another example of how costs can be controlled. SGI has been able
to control costs both by being strict on what they will pay but also being very proactive on treatment and
getting people better. The Early Intervention program requires an injured person to be committed to a
specially designed treatment program in order to achieve the best recovery. Because it is a Crown insurer
initiative, SGI is able to ensure consistent messaging and reap the benefits from a single, focused
approach. Given that disability income benefits are generous (90 percent of net income), an important
goal is to ensure that people are back to work as soon as possible. The incentives of the insurer and the
injured party are aligned because the injured party only continues to receive benefits if she or he is fully
committed to the treatment plan.
Another potential advantage of a public insurer is the ability to negotiate regulated prices (or set
maximum prices) for treatment from healthcare practitioners. The provincial WC boards in Canada are
able to effectively control costs associated with treatment by using a set fee schedule. The absence of
such a schedule in private insurance contributes significantly to higher costs. For example, in Michigan
higher costs as compared with other states are attributed in large part to charges for medical services.
The Insurance Institute of Michigan (2010) reports that reimbursement costs for no‐fault claims are
roughly three times the reimbursement costs for workers’ compensation and four times the
reimbursement costs for Medicare for the same procedure. Similarly, in Canada private automobile
insurers in some instances pay two to three times the amounts that a provincial WC Board pays for the
same treatment.
Differences in prices charged to private auto insurers as compared with public insurers may be
due to cost‐shifting as well as to differences in cost control mechanisms. Cost‐shifting occurs when
healthcare service providers increase charges to private payers as a means of recouping revenue when
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public reimbursements are reduced. A report by the Insurance Research Council (IRC, 2010) documents
healthcare cost‐shifting from U.S. hospitals to auto injury claims, as a result of low reimbursement rates
from government health insurance programs (Medicare and Medicaid) and the costs of treating
uninsured patients. The Insurance Research Council estimates that U.S. auto insurers pay additional
hospital charges of more than $1.2 billion per year as a result of this practice.
There are very few academic studies on the specific costs and benefits of private versus public
auto insurance, perhaps because of the lack of transparency of government entities. Kennedy and Mehr
(1977) compare the performance of the public insurer in Manitoba with Alberta’s private insurance
marketplace. They find that private insurers clearly outperform the public insurer in terms of product and
service, but that the government insurer can offer insurance at a much lower cost. This price advantage
however is artificial: they note that premiums charged in Manitoba were inadequate and that deficits
were offset by tax dollars.
Quebec’s public auto insurance fund has also run a persistent deficit. Data from the Société de
l’assurance automobile du Québec (SAAQ) show that that annual revenues were less than expenditures in
every year between 1982 and 2004. By 2004 SAAQ reported a $450 million premium shortfall and a $617
million shortfall in assets, attributed to rising compensation costs and the failure to index insurance rates
to inflation (SAAQ, 2006). Despite legislative changes and changes to the rate structure which were
designed to remedy this shortfall, SAAQ reported an overall deficit of $1.6 billion in 2010 (SAAQ, 2011).
Although the recent deficit may be attributed to the 2008 financial crisis, the deficits demonstrate the
ability of government insurers to maintain operations despite persistent shortfalls; and provide further
evidence that premiums charged by government‐run insurance programs may not reflect underlying
claims costs.
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Opponents to public auto insurance raise the following issues that arise when there is a
monopoly provider: potentially poor customer service, lack of competition, and lack of consumer choice.
Government monopolies also have little incentive to operate efficiently, and may lead to lower rates of
innovation. These static and dynamic inefficiencies arise due to the lack of a profit incentive and
protection from competition. A related argument is that lack of transparency and centralized decision‐
making will lead to politicized decisions that redistribute benefits for political reasons (e.g., Besley,
Gouveia and Dreze, 1994).6 Such concerns have recently been raised regarding the Insurance Corporation
of British Columbia (ICBC), British Columbia’s public automobile insurer. In the 2012 rate review (BC
Utilities Commission, 2012), several observers charged that ICBC’s management compensation and the
number of highly‐compensated employees are excessive, and that information disclosure regarding
ICBC’s operating expenses is inadequate.
3.2.1 PublicInterventioninPrivateInsuranceMarkets
Due to the differences in public and private objectives – in public insurance affordability and
accessibility are typically given higher priority than service quality, consumer choice and fairness – private
auto insurance markets are often regulated to achieve social objectives. In order to achieve the objectives
established, the extent of government regulation must be determined. The regulator attempts to balance
the need for a financially stable and competitive auto insurance sector with the need to ensure that
consumers pay affordable premiums, receive fair benefits, high service quality and timely compensation.
The economics of policy analysis deem government intervention to be desirable only when (i)
actual or potential failures of market competition exist; (ii) these failures could or do lead to meaningful
6 A large literature in economics examines inefficiencies in government‐run enterprises, and the results of these studies form part of the basis for the privatization movement in developed and developing economies in the latter part of the 20th century (e.g., Stiglitz, 1998; Schleifer, 1998).
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economic inefficiencies; and (iii) government intervention can ameliorate the inefficiency. Failures of
competition are most likely to arise when one or a few market players control a large share of the market,
externalities arise from market contracting, free‐rider concerns exist, or there is imperfect information.
Failures of market competition are often evidenced by markets with only a few large sellers, high seller
profits, lack of price variation, or consumer lock‐in.
In privately‐run automobile insurance systems sellers of diverse size and characteristics7 operate
in most markets; automobile insurance profits tend to be modest in comparison to other industries; and
price competition is readily apparent. Thus, there is no clear economic rationale for regulating prices in
automobile insurance markets as long as the general legal system prevents collusion among firms in the
economy.
Skipper (1998) notes that imperfect information may be the most significant impediment to
efficient contracting in insurance markets. However, Baltensperger et al. (2008) argue that because
insurers recognize these information asymmetries as a cost of doing business, they have developed
mechanisms to control adverse selection and moral hazard using both contract design and pricing
mechanisms. Therefore regulation of this aspect of the industry is not essential.
Nonetheless, information asymmetries suggest the need for other forms of insurance regulation.
Insurance is the sale of an intangible promise: to pay financial compensation for losses experienced as a
result of some future event occurring. The quality of that promise will necessarily be affected by insurer
decisions that occur after the contract is signed, including investment decisions, capital holdings, and
decisions regarding claims payments. These can’t be perfectly observed and credibly committed to at the
7 In 2009, there were 124 private insurers selling auto insurance in Canada. Ninety‐five companies belonged to a larger group, 25 insurers were incorporated outside of Canada, and 30 were mutual insurers. The largest private insurance company sold $1.75 billion in auto insurance in 2009, whereas the average premium revenue per company was $130 million (Source: Author calculation from A.M. Best data).
21
time of insurance purchase. The difficulty inherent in monitoring the strength of the insurer provides
insight as to why the solvency of insurers is monitored by regulators.
Information asymmetries may also give rise to the potential for insurer misrepresentation of
products or product quality. The complexity of contractual terms and pricing may make it difficult for
consumers to become fully informed about price and quality of insurance products. Regulatory oversight
may be needed to assure that consumers are treated fairly by insurers and that beneficial exchanges
occur. The emerging field of psychology and economics8 provides additional reasons for market conduct
regulation by providing evidence that consumers make biased and error‐prone decisions. For example, it
has been suggested that auto insurance must be mandatory because drivers often underestimate both
the frequency and severity of their potential losses. However, mandatory purchase creates additional
concerns that insurer market conduct must be regulated. Thus, government oversight may be needed to
assure that consumers are treated fairly, and most governments regulate market conduct in insurance
(Tennyson, 2010).
3.3 TortversusNo‐faultCompensationSystems
A fundamental characteristic of automobile insurance systems that varies across jurisdictions is
the scope of liability for automobile accident damages. Compensation is either based on tort or is no‐
fault. In a tort system an at‐fault driver is held liable for injuries and damages caused to third parties.
Under a pure no‐fault approach, there is no tort liability for automobile accidents and compensation is
made through first‐party personal injury benefits. Many no‐fault systems are modified or partial no‐fault,
whereby tort liability is limited but not eliminated. In these jurisdictions persons injured in an automobile
accident have the right to sue at‐fault parties only if their injury or loss meets a defined threshold.
8 See Camerer et al., (2003); Thaler and Sunstein, (2008); and Barr et al., (2008a), (2008b).
22
One of the advantages of a tort system is deterrence of negligent behaviour. However, a primary
disadvantage is that it can be relatively slow and inefficient in providing compensation due to the
necessity of establishing negligence. No‐fault automobile insurance was developed as an alternative to
the tort system and was intended to improve the efficiency of compensation to injured parties.
Specifically, the advantages of no‐fault compared to tort are faster settlement of claims, lower claims
settlement costs, and better matching of compensation to economic loss since benefits are available to
both not‐at‐fault and at‐fault parties. However, two disadvantages of no‐fault are often cited. First, moral
hazard is increased. Greater first‐party benefits for at‐fault drivers and the elimination of tort removes
the personal liability associated with being at fault and may reduce the incentive to take care. Second,
restrictions on the right to sue are viewed as inherently incompatible with basic common law principles.
No‐fault does not imply that fault is not assigned in an automobile accident, but merely that
injured parties are compensated for injuries regardless of fault, typically by their own insurer. By focusing
on first‐party compensation which does not rely on establishing fault, loss adjustment expenses can be
reduced and injured parties can be compensated more quickly. In addition, there is better matching of
compensation to economic loss because benefits are available to both not‐at‐fault and at‐fault parties,
but compensation for non‐economic loss is reduced. Furthermore, no‐fault insurance provides
compensation in more situations, for example, single vehicle accidents. In exchange for these guaranteed
benefits, no‐fault places some or total restriction on the ability to sue others for damages and requires
purchase of first‐party insurance coverage for the insured’s own bodily injury losses.
As indicated above, no‐fault systems for automobile compensation can be either pure or partial.
In a pure no‐fault system persons injured in an automobile accident may not sue an at‐fault party under
any circumstances. Injured parties receive compensation for economic losses according to a schedule of
benefits. Most jurisdictions in North America which have no‐fault insurance have a partial no‐fault system
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whereby a person may sue an at‐fault party only if their injury meets a defined threshold of severity. This
threshold can be verbal and/or monetary. For example, in Ontario an injured person may sue for pain and
suffering only if the person “has died; or has sustained permanent serious disfigurement or permanent
serious impairment of an important physical, mental or psychological function” (Insurance Act, 1990).
Because it is defined in terms of a description of the circumstances which permit a lawsuit, this is known
as a verbal threshold. Monetary tort thresholds permit lawsuits when an injured person’s medical
expenses exceed a certain dollar amount. Monetary thresholds are generally less desirable because they
can become ineffective over time due to medical cost inflation, and can create incentives to overstate
medical expenses in order to meet the threshold.
Some jurisdictions (Saskatchewan in Canada, and Kentucky, New Jersey, and Pennsylvania in the
United States) have a choice system in which insureds can choose to be covered under either a no‐fault
or a tort system. In Saskatchewan, the default is the no‐fault system, and only about 5 percent of drivers
choose the tort system. There is a limited right to sue for pain and suffering in Saskatchewan’s modified
no‐fault regime,9 but a person may sue for economic losses that exceed no‐fault benefits. However, the
no‐fault benefits are generous. In 2012, the cap on medical and rehabilitation coverage is over $6 million
and income replacement is up to $82,804 a year with no time limit beyond normal retirement age. As
such, this modified no‐fault scheme functions more like a pure no‐fault scheme.
As noted above, a potential disadvantage of no‐fault insurance is greater moral hazard because of
increased first‐party benefits for at‐fault drivers. In addition, some argue that the elimination of tort
9 The right to sue is limited to situations in which the at‐fault driver is convicted of impaired driving or is convicted of deliberately using his or her vehicle to cause harm.
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removes the personal liability associated with being at fault10 and may reduce the incentive to take care.
Fronsko (2011) argues that this moral hazard is mitigated in practice through road safety legislation and
enforcement which penalizes those that drive unsafely. He also notes self‐preservation and societal
attitudes guard against a decrease in road safety caused by the presence of first‐party compensation for
automobile accidents. To the extent that this is not the case, no‐fault insurance may lead to higher
accident rates, which will increase insurance costs.
The empirical evidence on this question is mixed. Kochanowski and Young (1985) find that the
adoption of no‐fault auto insurance in the U.S. does not impact fatality rates. Similarly, using the
frequency of property damage liability claims (the number of claims divided by insured exposures) as a
proxy for accident rates, Loughran (2001) shows that overall accident rates are no higher in no‐fault
states than in tort states over the period 1976 to 1998.
In contrast, Devlin (1992) finds that fatal accidents increased by 9.62 percent after the
introduction of no‐fault in Quebec. Cummins, Phillips and Weiss (2001) find that fatality rates were 2.7 to
17.3 percent higher in states with no‐fault insurance for the period 1968 to 1994. Moreover, they find
that among no‐fault states fatality rates were positively associated with the stringency of the tort
threshold: states in which it is easier to sue negligent drivers had lower rates of fatal auto accidents. They
also find that greater use of experience rating mechanisms mitigates some of the moral hazard that arises
from no‐fault insurance. In an Australian study, McEwin (1989) finds that abolishing tort liability increased
fatality rates by 16 percent, suggesting that no‐fault is associated with less road safety.
10 However, the presence of mandatory automobile insurance with relatively low deductibles and relatively high limits of liability carried by most drivers in Canada in effect removes personal liability of at‐fault drivers.
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Because a higher fraction of injuries receive compensation under no‐fault insurance, insurance
costs may be higher than under tort even if there is no increase in accidents. However, per‐injury
compensation should be lower and transactions costs of compensation should also be lower. For losses
below the threshold, greater reliance on first‐party benefits should result in a reduction in transaction
costs because fewer liability claims need to be resolved (given the caveat that legal‐based transaction
costs are not replaced with other administrative costs in assessing the extent of injury). Cost savings also
arise due to reduction in the amounts paid out for non‐economic losses. The trade‐off between liability
costs saved and accident benefit costs incurred will depend on the level of accident benefits mandated
and the threshold set for tort claims. Thus, the predicted net effect of no‐fault on insurance costs is
ambiguous, and will depend on specific features of the system and on responsiveness of behaviours to
incentive changes.
The stringency or level of the threshold in a no‐fault system will be a primary determinant of
whether no‐fault is able to reduce costs and improve compensation. The impact of no‐fault depends on
both the threshold that determines the right to sue and the level of first‐party benefits available to those
who are injured. Threshold no‐fault compensation systems increase the marginal benefits of building up
bodily injury claims in order to exceed the threshold for general damages eligibility (Weisberg and Derrig,
1991, 1992; Cummins and Tennyson, 1992, 1996). Moreover, because no‐fault claims do not face the
scrutiny of the legal system, and because no‐fault states have placed a priority on paying benefits quickly,
exaggeration and fraud have become a problem in many no‐fault states. Cole, et al. (forthcoming) note
that fraud is higher in U.S. states with (partial) no‐fault insurance. States have responded by decreasing
the number of days that accident victims have to report accidents and submit medical bills; many states
have also enacted stiff penalties for fraudulent activities.
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Further evidence on the importance of the threshold is provided by Browne and Puelz (1996).
They find that low monetary, but not verbal, thresholds lead to higher bodily injury liability claim costs.
More recently Cole, et al. (forthcoming) show that in general no‐fault laws are associated with both lower
liability losses and total losses compared with tort states, and “add‐on” measures (mandatory first‐party
benefits) also are related to lower loss levels. However, the level of losses is influenced greatly by the
specific provisions in the no‐fault statutes. In particular, states with a hard‐to‐pierce threshold have lower
total losses and lower liability losses while states that replace a higher percentage of lost wages have
higher total losses. They also find that states with choice systems (similar to Saskatchewan) have higher
losses and liability losses. As demonstrated by other studies, it is not the presence of no‐fault laws alone
that dictates whether costs are higher or lower, but the specific provisions of the no‐fault laws in place.
Several other studies of U.S. no‐fault systems conclude that no‐fault results in an increase in the cost of
auto insurance (e.g., O’Connell and Joost, 1986; Derrig, Weisberg and Chen, 1994; Cummins, Phillips and
Weiss, 2001).
In the U.S., 12 states continue to use the no‐fault approach to automobile accident
compensation, but many constituents there believe that the promise of no‐fault has never borne fruit.
Indeed, the Rand Institute for Civil Justice in 2010 published a retrospective study of no‐fault insurance
with the objective to “help explain why no‐fault was adopted, flourished, and then lost some of its
political luster as a policy option” (Anderson, Heaton and Carroll, 2010; p 3). It concluded that the main
shortcoming of no‐fault insurance was that it has not lowered automobile insurance costs in the way that
was first envisioned. During the time period studied, the 12 no‐fault states in the U.S. (Michigan, Florida,
Hawaii, Kansas, Kentucky, Massachusetts, Minnesota, New Jersey, New York, North Dakota, Pennsylvania,
and Utah) were consistently among the highest‐cost states for automobile insurance. In addition, four
states that enacted no‐fault in the 1970s later repealed it due to high costs.
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A study by Kelly, Kleffner and Tomlinson (2010) examines loss costs per vehicle for provinces in
Canada. They find that government‐run pure no‐fault insurance has lower average costs per insured
vehicle than either private modified no‐fault or private tort insurance, suggesting that the increase in
costs due to generous first‐party accident benefits are outweighed by the savings that stem from lower
claim settlement costs and the elimination of non‐economic damages. An important caveat, however, is
that differences in the statutory automobile insurance product across provinces mean that costs are not
directly comparable.11
3.4 PricingMechanisms
The previous three considerations discussed – mandatory insurance, private versus public
insurance, and the role of liability in compensation – together all influence insurance costs and premiums.
Moreover, these design characteristics also impact the importance of and ability to achieve different
objectives. For example, when insurance is mandatory, affordability and fairness are both deemed to be
essential to a well‐functioning auto insurance system. Here we discuss insurance pricing and the
importance of pricing mechanisms that are sustainable and provide fair, affordable insurance to
policyholders.
Insurance prices are established prior to knowing what the true cost of the product is. Rates need
to be adequate to ensure insurer solvency but not excessive due to affordability concerns. Artificially
keeping rates low will affect both insurers’ ability to pay claims and insureds’ incentives to drive safely.
However if insurance is compulsory, affordability is a legitimate concern because access to an automobile
has been shown to promote economic stability (Raphael and Rice, 2002). Therefore, effective regulation
11 British Columbia, which administers government‐run tort insurance, was not included in the analysis due to lack of data. However, auto insurance premiums in British Columbia are among the highest in Canada, and claim cost increases have necessitated an 11.2 percent rate increase for 2012 (BC Utilities Commission, 2012), suggesting that government‐run insurance does not necessarily lead to lower insurance costs.
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must ensure rates are adequate in order to not put insurer solvency at risk and to not undermine
competition in the market, while also providing affordability for policyholders.
Pricing adequacy in the aggregate is important for the long run sustainability of the insurance
system. If automobile insurance premiums in total are not sufficient to cover the full economic costs of
the insurance system, drivers receive a subsidy from others in the economy. Because the use of
automobiles creates a variety of externalities to society, including accident risks but also pollution and
use of scarce non‐renewable resources (Parry, Walls and Harrington, 2007), public policies should not be
designed to provide a subsidy to this activity in the aggregate.
In private sector insurance systems, pricing inadequacy will distort insurance supply, reducing
competition and insurance availability. If insurer returns are below a competitive rate of return, every
dollar of capacity that an insurer devotes to the regulated market represents a lost opportunity to earn a
higher return on that dollar in unregulated markets or in other ventures. This creates pressure on insurers
to reduce insurance offerings or to exit the market, resulting in potential availability problems for
consumers.
Insurance pricing can be achieved in different ways: the two extreme options are risk‐based
insurance prices that reflect individual expected claim costs, and social pricing that reflects average claim
costs. In a risk‐based pricing model premiums are based on the characteristics of the insured that are
known to impact expected losses or expenses. Social pricing places less emphasis on individual rating
factors and more emphasis on the risk profile of the community, typically through a territorial rating
variable. In practice, most automobile insurance systems fall somewhere in the middle. For example, in
the public insurance provinces prices reflect the risk profile of the insured through factors such as vehicle
type, usage and the insured’s driving record but typically do not reflect individual characteristics that
29
cannot be controlled by the insured – such as age and gender – even if they have been shown to be
actuarially relevant.12
Social pricing schemes, however, tend to lead to higher rates of accidents and claims and thus to
higher average insurance costs. Evidence from Quebec after the 1978 introduction of no‐fault with prices
based only on vehicle type confirm that accident and claims rates were higher than otherwise predicted
(Dionne, 2002). Case studies of U.S. state auto insurance markets with regulated pricing mechanisms that
severely restrict premium differences across driver groups also see higher claims rates and accident costs
(Tennyson, Weiss and Regan, 2002; Grace, Klein and Phillips, 2002; Harrington, 1991, 2002; Derrig and
Tennyson, 2011).
Under a risk‐based pricing scheme consumers who have higher expected claim costs are charged
higher insurance premiums to reflect the greater risk they impose on the insurance system. Risk‐based
pricing that reflects true costs (differences in expected claim costs across policyholders) provides proper
safety incentives for policyholders to take care. If insurance premiums reflect the expected marginal costs
of coverage, consumers have appropriate information on which to base their decisions to purchase
insurance and to drive (Harrington and Doerpinghaus, 1993). Thus, an important theoretical principle of
insurance pricing is that the premiums charged should reflect the expected value of a driver’s insured
losses. If insurance premiums cannot fully adjust to a driver’s choices regarding safe driving, for example
because these are not perfectly observed or because they vary over time, insurance ownership may lower
a driver’s incentives to take care. Economic theory also predicts that the safety investments of drivers
12 In Saskatchewan driving record is used but not a driver's age, gender, or place of residence. In Manitoba rates are based on where the insured lives, vehicle use, vehicle type, and driving record. In British Columbia premiums vary with location, rate class, and claims history.
30
may be diminished when premiums do not reflect past accident experience or driving record (Shavell,
1982, among others).
One practical difficulty in implementing risk‐based insurance pricing is the difficulty in measuring
a driver’s expected losses. In practice, insurers must set premiums based on observable characteristics
that they find to be correlated with loss experience. This results in grouping drivers into categories and
charging the same base premium to all drivers within a category. Insurers also adjust premiums over time
based on an individual’s observed loss and driving experience, since losses provide a signal of the
expected value of future losses (Boyer and Dionne, 1989). These mechanisms – underwriting (sorting by
observable characteristics) and experience rating (premium changes based on observed losses and driving
record) – help to link auto insurance premiums to drivers’ risk, but are not perfect.
Providing incentives for safe driving is an important advantage of risk‐based pricing models.
However, collecting and analyzing data for the purpose of estimating individual expected claim costs is
also costly; thus there is a limit to how much risk classification is beneficial. Finger (2006) notes that risk
classification systems become more complex as competition among insurers increases. To the extent that
more complex classification systems can better match premiums with expected losses, this will result in
less adverse selection and moral hazard among insureds. However, it is also possible that competition
leads to excessive risk classification from society’s perspective. This can occur if classification is costly to
undertake (Crocker and Snow, 1986; Harrington and Doerpinghaus, 1993).
Another practical difficulty with risk‐based pricing of automobile insurance is that it can make
insurance unaffordable for some drivers, particularly high‐risk and/or low‐income consumers. Although
risk‐based pricing is fair in that it charges the highest‐risk policyholders the highest price, this can
compromise the objective of achieving affordability for all drivers. However, unless driving is considered a
right rather than a privilege, it is difficult to argue that the most unsafe drivers should be subsidized by
31
other drivers. Nonetheless, risk‐based pricing reduces access to insurance and to driving for certain
populations, and in practice this may include some who are not high risk. This occurs because premiums
are based on driver categories and imperfectly linked to individual risk, and because some determinants
of risk (such as location) are not specific to the driver. For this reason risk‐based pricing often faces social
objections.
Powers (2010) provides an argument for social pricing for mandatory insurance. He notes that if
insurance is mandatory, risk classification is not essential to prevent market failure. In addition, for
individuals (as opposed to corporations), risk classification likely does not provide the right financial
incentives for policyholders to reduce their risk levels. As well, normative social justice arguments do not
support the use of risk classification systems when the likelihood of a loss is small. He argues against the
unfairness of individuals being compelled to accept premiums based upon classifications such as age,
gender and territory, characteristics which cannot be changed through reasonable risk control efforts.
Due to potential affordability problems especially given the mandatory nature of the product, and
fairness concerns as they relate to individual characteristics that are not controlled by the insured, many
jurisdictions employ some degree of social pricing in order to address the perceived shortcomings of risk‐
based pricing. Thus, in practice auto insurance pricing uses a combination of both risk‐based and social
pricing, with various types of regulation in place to address affordability, fairness and sustainability.
Restricting underwriting practices or rating variables is a common social pricing mechanism used
in various provinces across Canada. In Alberta driving record, driver training, age, gender, marital status,
territory, type and use of vehicle, and years licensed are all valid risk classification variables, but the
premium grid sets a maximum premium for basic coverage for any driving record. In Newfoundland and
Labrador rating based on age, gender, and marital status was eliminated in 2005. In Nova Scotia insurers
may not use age or marital status as of 2004, and it has been recommended that gender also be
32
eliminated. In contrast, Ontario has fewer risk classification restrictions and doesn’t prohibit gender, age,
or marital status. However, several rating criteria may not be used to determine automobile insurance
rates: credit history; bankruptcy; employment status; ownership of a credit card; how long the driver has
lived in his or her current home; accidents occurring on or after September 1, 2010 for which the insured
is less than 25 percent at‐fault; not‐at‐fault accidents; whether the vehicle is owned or leased; and
whether there was a period of time in which the insured had no automobile insurance coverage.
The use of age and gender as risk classification variables to price auto insurance is a contentious
issue. In private Canadian insurance marketplaces, a set of legal precedents has resulted in auto insurers
being allowed to use age as a basis for pricing. The landmark case on this point is Zurich Insurance Co. v.
Ontario (Human Rights Commission (1992) 16 C.H.R.R. 3D/255 S.C.C.). In that ruling, the Supreme Court
declared that the insurance industry could continue to use criteria such as age and marital status as a
bona fide means of assessing risk, but that the industry could not do so indefinitely because of the
discriminatory tendencies of the practice.
The correlated relationship between age and accident frequency is well known: younger and
older drivers have higher crash risk. Nicoletta (2002) reports that in the year 2000, persons aged 16 to 24
accounted for 15 percent of Canada’s population, 13 percent of total driving licenses, and only 7 percent
of the total kilometres driven. For elderly drivers, Dellinger, Kresnow, White and Sehgal (2004) find that
fatal and non‐fatal risks to others increase with a driver’s age, particularly for drivers over 75. This
relationship can be seen Figure 1 below provided by Kelly, Nielson, and Snoddon (2012). The U‐shape
curve shows the greater crash risk at both the older and younger driving ages, revealing the
disproportionate percentage of young and old drivers killed in traffic accidents in Canada from 1999 to
2009.
33
Figure 1 – Percent of Accidents Leading to Fatalities by Age
Source: Kelly, Nielson and Snoddon (2012)
Government restrictions on the use of certain category variables (such as age and gender), and/or
restrictions on price differences across categories, have the unintended consequence of reducing links
between insurance pricing and driver risk. This may alter incentives to drive and to purchase insurance,
and may reduce incentives for road safety. The evidence from Canada supports the idea that these
incentive effects are important. Pricing restrictions on individual rate differences lead to more high‐risk
drivers on the road. Accident data in British Columbia show a higher proportion of young drivers who are
the principal owners of vehicles; injury collision rates among young drivers are higher than in other
provinces; and the rates of injury per million passenger kilometers are consistently higher than found in
provinces where risk‐based pricing is used (Leadbetter and Kovacs, 2004). Higher rates of injury per
million passenger kilometres in government‐run provinces than in private provinces result in potentially
higher costs per insured vehicle.
-
0.500
1.000
1.500
2.000
2.500%
Driv
er F
atal
ities
/ %
Driv
ers
By
Age
Driver Age
Relative Accident Frequency by Driver Age
2009 2008 2007 2006 2005 2004
2003 2001 2002 2000 1999
34
To achieve affordability objectives, all Canadian provinces with private auto insurance markets
use prior approval rate regulation. In Canada, prior approval rate guidelines typically contain provisions
on how rates or risk classification differentials can be modified. For example, in Ontario, “insurers should
cap differential changes at +/‐ 10% from the current differential in the direction of the coverage
indication” (Financial Services Commission of Ontario, 2011; p 7). The dampening of differentials flattens
the premium structure and creates cross‐subsidies across risk classification groups similar to social pricing
models. Prior approval regulation also weakens the links between claims experience and insurance
premiums, creating greater premium volatility (Leadbetter, Voll and Wieder, 2008) and as noted with
social pricing, increases incentives for claiming.
Experience rating of premiums based on a driver’s history of accidents, claims, or moving traffic
violations may help to counteract the negative incentive effects of social pricing schemes. All jurisdictions
in Canada use some degree of experience rating that is based on a driver’s at‐fault claims history. Insurers
may also levy premium surcharges based on an insured’s driving record. In attempting to balance the
objectives of affordability and incentives for safe driving, Alberta established maximum benchmark
premiums for any driving record in response to dissatisfaction from new drivers automatically being
classified as high‐risk drivers and paying high premiums. In Alberta, drivers move up and down a rate grid
based on whether their driving experience produced an at‐fault claim or a claim‐free year. After six claim‐
free years premiums reach the maximum discount of 65 percent. This mechanism maintains incentives
for safe driving and achieves affordable premiums for new drivers. As long as the grid prices are
sustainable such that the benchmark premium and the incremental amounts charged for at‐fault
accidents are sufficient to cover the claim costs of high‐risk drivers, this pricing model is able to meet the
stated objectives.
35
In Ontario the experience rating mechanism assigns drivers to a driving record class based on the
number of years without an at‐fault claim. By law not‐at‐fault claims may not be used to modify
premiums and therefore do not affect the driving record class assignment. A discount is earned for each
additional year of driving that is free of at‐fault claims. Drivers with six or more consecutive years without
an at‐fault claim are placed in class 6. Some insurers offer an additional discount for class 6 drivers with
10 or more consecutive years of driving that are free of at‐fault claims. Insureds with more than one
minor driving conviction in the preceding three years are usually not eligible for discounts. This
mechanism of assigning drivers to a class provides incentives for safer driving.
Government insurance systems may also incorporate accident experience or driver demerits in
determining individual premiums; such pricing reforms were introduced in Quebec after 1992. In
jurisdictions with private insurance markets, government may mandate that insurers employ a
government‐determined bonus pricing scheme. This was the case in several European countries
(including France, Belgium, and Germany) prior to European integration and deregulation of insurance
pricing in the single market (Dionne, 2002). Empirical studies demonstrate that such pricing schemes are
effective in increasing road safety and reducing insurance claiming (Dionne, 2002), and that drivers’ past
experience is predictive of future claiming behavior (Boyer and Dionne, 1987). Thus, the use of
experience rating in premium determination should be an important part of social pricing schemes. More
generally, pricing models should be designed to maintain the incentives for safe driving, treat different
policyholders fairly based on their risk characteristics, and provide affordable insurance and a fair rate of
return to insurers to ensure solvency and a competitive market.
36
4 AutomobileInsuranceSystemsDesignandPerformance
An automobile insurance system combines all of the choice components discussed in the previous
section. The functioning of the system will depend on both the benefits and drawbacks of each design
element, and the effects of pairing the different elements together. The choice of different combinations
of design features produces great potential for variety among end‐use automobile insurance systems. We
first summarize the different system designs that exist in jurisdictions in Canada. This is followed by an
examination of the performance of Canadian auto insurance systems.
4.1 InsuranceSystemsinCanada
Table 1 illustrates the spectrum of different automobile insurance system characteristics across
Canada’s provinces. Three provinces operate government‐run auto insurance for mandatory coverage
(British Columbia, Saskatchewan, and Manitoba). One province (Quebec) employs a combination of
government insurance for auto bodily injury risks and private insurance for property damage risks. In the
remaining provinces and territories auto insurance is sold by private companies, with these jurisdictions
imposing varying levels of regulation of pricing, practices and products. However, even in the provinces
with private insurance, the automobile insurance policy itself is a statutory document.
37
Table 1 – Canadian Automobile Insurance Plans
British Columbia
Alberta Saskatchewan Manitoba Ontario Quebec New Brunswick
Nova Scotia
Prince Edward Island
Newfound‐land and Labrador
Mandatory Coverages1
BI/PD, AB, UM, UA, DC‐PD
BI/PD, AB, UA
BI/PD AB, UA, FPF BI/PD AB, UA, FPF
BI/PD, AB, UA, DC‐PD
PD, DC‐PD, AB, UA
BI/PD, AB, UA
BI/PD, AB, UA
BI/PD, AB, UA
BI/PD, UA
Admin Public w/ private for optional coverage
Private Public w/ private for optional coverage
Public w/ private for optional coverage
Private Public for BI;Private for PD
Private Private Private Private
Regime Tort Tort Choice – No‐fault default
Pure No‐fault
Modified No‐fault2
Pure No‐fault3
Tort Tort Tort Tort
Compulsory Min. Liability
$200,000 $200,000 $200,000 $200,000 $200,000 $50,0004 $200,000 $500,000 $200,000 $200,000
Right to Sue for Non‐economic Loss
Yes Yes6 No (No‐fault);Yes (Tort)5
No Yes – verbal threshold2,8
No Yes6 Yes6 Yes6 Yes8
Right to Sue for Economic Loss
Yes Yes Yes7 (No‐fault);Yes8 (Tort)
No Yes7 No Yes Yes Yes Yes
Medical and Rehab Payments per Person
$150,000 $50,000 $6,250,817 (No‐fault); $24,440 for non‐catastrophic, and $183,308 for catastrophic (Tort)
No limit $50,000/$3500 if minor/ $1 million if catastrophic
No time or amount limit
$50,000, time limit 4 years
$50,000, time limit 4 years
$25,000,time limit 4 years
$25,000, time limit 4 years
Funeral Expenses
$2,500 $5,000 $9,376 (No‐fault)$6,110 (Tort)
$7,753 $6,000 $4,142 $2,500 $2,500 $1,000 $1,000
38
British Columbia
Alberta Saskatchewan Manitoba Ontario Quebec New Brunswick
Nova Scotia
Prince Edward Island
Newfound‐land and Labrador
Maximum Disability Benefits
$300/wk (max), 75% of gross wages
$400/wk (max), 80% of gross wages
90% net income; max income gross $82,804/yr (No‐fault); $368/wk (Tort)
$85,500/yr (max), 90% of net wages
70% of net wages to max $400/wk
90% net wages; max income gross $55,000/yr
$250/wk (max)
$250/wk (max), 80% of gross wages
$140/wk (max)
$140/wk (max)
Time Period 2 years partial, lifetime total disability
2 years total disability
No limit (No‐fault); 2 years partial, lifetime total (Tort)
No limit 2 years, longer if unable to pursue any suitable occupation
3 years partial, lifetime total disability
2 years partial, lifetime total disability
2 years partial, lifetime total disability
2 years partial, to age 65 if totally disabled
2 years partial, lifetime total disability
Not‐at‐fault PD Recovery
First‐party
Third‐party Third‐party Third‐party First‐party First‐party First‐party since 2004
Third‐party Third‐party Third‐party
Table adapted from Kelly, Kleffner and Tomlinson (2010). Sources: Provincial auto insurance boards 1 BI/PD – Third‐party liability for bodily injury and property damage; PD – third‐party liability for property damage only; AB – accident benefits which is first‐party bodily injury coverage that applies regardless of fault; UA – uninsured auto protection generally provides BI coverage only to the extent that the insured is not at fault; UM – underinsured motorist; DC‐PD – direct compensation property damage which is first‐party compensation for auto damage to the extent that the insured is not at fault; FPF – first‐party all‐perils (similar to collision and comprehensive coverages). No‐fault provinces have a BI/PD component to cover accidents that happen either outside the province, or that involve motorists from outside the province. 2 The right to sue for pain and suffering only exists if the injured person dies or sustains “permanent and serious” disfigurement and/or impairment of important physical, mental or psychological function. A dollar threshold for monetary damage exists for losses in excess of statutory accident benefits (Insurance Act, 1990). 3 Lawsuits are not permitted with respect to injuries sustained in automobile accidents in Quebec. Victims are compensated by their government insurer for their injuries whether or not the accident occurs in Quebec 4 Applies to property damage claims in Quebec and personal injury and property damage claims outside Quebec. 5 Under the no‐fault option, insureds may sue for non‐economic losses in three specific incidents: the at‐fault driver was impaired, the at‐fault driver was convicted of using an automobile to deliberately injure the party, or there exists a third party such as a car manufacturer whose negligence was implicated in the accident. An insured may also sue for expenses not covered by the no‐fault benefits provided. A list of benefits, more detailed than the summary provided in this table, can be found at http://www.sgi.sk.ca/sgi_pub/vehicle_insurance/coverage_information/pdf/guide_nofault.pdf. 6 Cap exists on general damages for “minor injuries.” 7 Monetary loss must exceed first‐party benefits. 8 Award is subject to a deductible.
39
Manitoba’s public insurance system and Quebec’s mixed system determine compensation on a
no‐fault basis; Saskatchewan’s public system allows choice between no‐fault and tort with no‐fault as the
default option; and British Columbia’s public system is tort‐based. Five of the six private insurance
provinces – Alberta, New Brunswick, Nova Scotia, Prince Edward Island, and Newfoundland and Labrador
– are tort‐based, with only Ontario using a (partial) no‐fault approach.13 Automobile liability insurance is
compulsory in every province and first‐party accident benefits are compulsory in all provinces except
Newfoundland and Labrador.
Rate controls also occur in all provinces. The provinces with public systems (and Quebec) utilize
government‐determined social pricing schemes which greatly limit price variation across drivers, while
most of the private systems impose less prescriptive prior‐approval regulation of rates. The one exception
is Alberta, which uses a grid system for primarily high‐risk drivers that is more akin to social pricing,
although it applies to less than 10 percent of drivers. Affordability and accessibility concerns have arisen
in all provinces with private insurance systems, with the exception of Prince Edward Island. In response,
regulators in these provinces have imposed risk classification restrictions and have periodically mandated
rate freezes.
This brief comparison illustrates that the key insurance system elements combine in various ways
across the provinces, but it also highlights that Ontario’s system is unique within Canada. Ontario is the
only province with a privately administered (partial) no‐fault system; all other private systems operate on
a tort basis. Compulsory first‐party injury insurance and risk‐based pricing modified by government rate
13 The three territories have tort‐based compensation mechanisms and employ actuarial‐based pricing methodologies to the extent possible. We do not analyze the territories here because of their geographical location (the three territories lie above the 60th parallel of latitude and geographically consist of sub‐arctic and tundra regions) and small population (the population density of the territories is 0.039 persons per square kilometre). The Northwest Territories is the most populous territory with a population of 41,462. Almost half of the inhabitants (19,234 people) live in the capital city of Yellowknife.
40
regulation are common to all of the privately administered systems, however. Given the differences, it is
instructive to compare the performance of auto insurance systems across the provinces.
4.2 ComparingSystemPerformance
The performance of different auto insurance systems can be compared using the objectives of
auto insurance systems outlined in an earlier section. Such a comparison requires defining and obtaining
observable measures that represent each desirable outcome. This is difficult in some cases for example,
measuring whether consumers are informed because measures are simply hard to construct or there is
a lack of data. In other cases measures can be defined but are likely to reflect two or more outcomes of
interest. For example, the extent of uninsured driving is a measure of insurance availability but is also
affected by the affordability of insurance. Finally, in many instances performance measures are available
for private insurance systems but not for public systems, either due to lack of public reporting (e.g.,
insurance costs for total bodily injury) or to differences in system design (e.g., measures of uninsured
driving). Subject to these limitations, we propose evaluating the success of a province in meeting the
objectives of an auto insurance system using the measures discussed in the following paragraphs.
Table 2 compares the performance of the provincial auto insurance regimes in terms of the
measures described below. Data for provinces with public insurance systems are limited, but are
presented where obtainable.
41
Table 2 – Performance of Provincial Auto Insurance Regimes
Administration Private Public Private Mix
Public
Regime Modified No‐fault
Tort No‐fault Tort Choice/No‐fault Default
No‐fault
Province ON AB NB NS PE NL QC1 BC SK MB
Availability
Uninsured Auto Claim Rate (2009)2
15.3% Not reported
5.35% 4.69% 10.38% 6.55% Not reported
Not reported
Not reported
Not reported
FARM (residual market) Size (2011)3
0.1% 0.3% 1.9% 0.8% 2.1% 4.1% Not
applicable Not
applicable Not
applicable Not
applicable
Risk Sharing Pool (2011)4 2.6% 6.6% 1.7% 1.9%
Not applicable
Not applicable
Not applicable
Not applicable
Not applicable
Not applicable
% GIO Complaints Labelled as “Availability” (2011)5
4.64% 0 0 4.17% 0 0 5.56% 7.69% 0 0
Affordability
Average Premium (2010)6 $1,433 $1,087 $813 $807 $758 $986 $719 $1,118 $856 $949
% GIO Complaints Labelled as “Affordability” (2011)5
2.63% 3.82% 7.14% 0 0 0 8.33% 0 0 0
Service Quality
% GIO Complaints per 10,000 Population (2011)5
1.013 0.757 0.146 0.159 0.137 0.431 0.123 0.026 0.009 0.0016
Cost Efficiency – Private Insurers
Market Share of Direct Sellers (2009)7
20.14% 22.30% 15.28% 12.40% 18.20% 30.02% 0.04% 1.47% 0.16%
Market Share of Commodity Sellers (2009)8
16.36% 15.91% 10.77% 14.02% 15.60% 4.00% 1.11% 0.07% 0.05%
Market Share of National Insurers (2009)9
29.33% 40.37% 32.36% 44.15% 53.80% 33.01% 1.38% 2.75% 0.79%
Sustainability
Average Loss Ratio (2006–2010)10
84.10% 68.87% 58.15% 54.63% 49.85% 70.31% 82.11% Not
reported 76.97%
10‐Year Growth in Losses per 52.71% 4.07% ‐41.57% ‐32.46% ‐23.22% 12.73% 5.12% Not ‐22.66%
42
Administration Private Public Private Mix
Public
Regime Modified No‐fault
Tort No‐fault Tort Choice/No‐fault Default
No‐fault
Province ON AB NB NS PE NL QC1 BC SK MB
Vehicle (2000–2010)11 reported
10‐Year Growth in Premium per Vehicle (2000–2010)12 65.85% 34.04% 9.09% 31.65% 25.99% 36.52% 14.13% 3.37%
Not reported 37.60%
10‐Year Growth in Average Claim Severity (2000–2010)13 152.36% 15.41% ‐2.39% ‐7.13% 7.38% 11.37% ‐8.80%
Not reported ‐11.17%
Injury Accidents per 100,000 Licensed Drivers (2009)14 678.3 701.7 700.2 1109.2 787.5 647.3 856.6 648.4 943.5 929.6
Fatal Accidents per 100,000 Licensed Drivers Driver (2009) 5.9 12.8 12.1 10.6 12.4 8.8 10.2 12.1 21.2 11.1
Fairness
CV of Premiums Across Territories (2009)15
104.5 21.0
CV of Loss Ratios Across Territories (2009)16
19.7 6.8
CV for BI/PD Loss Ratios by Driving Record Class (2009)
12.9 9.6 13.2 8.6 19.1 14.3
Competition – Private Insurers
Insurers with Positive Writings (2009)
85 73 63 60 47 51 44 37 39
Market Share of Largest Four Insurers (2009)
31.11% 44.26% 38.62% 39.05% 47.40% 56.27% 3.60% 3.28% 0.54%
Herfindahl‐Hirschman Index (2009)17
427 687 636 638 781 1055 1673 1654 859
Sources: General Insurance Statistical Agency (for private market provinces), Facility Association, General Insurance OmbudService, Manitoba Public Insurance, Saskatchewan General Insurance, Insurance Corporation of British Columbia, AM Best Ltd. and Transport Canada Entries for which data exists but are not publicly available are labelled “Not Reported”. If a particular data element is not relevant to a particular province, the entry is labelled “Not Applicable”. 1 In 2006, the Quebec government altered the mechanism for both reporting bodily injury losses and for pricing the expected losses in the auto insurance premium. Thus QC
insurance figures are not comparable to other provinces and are labelled with a “”. We also do not report competition among private insurers in Quebec, as many insurers are provincially regulated and are not included in AM Best Ltd. 2 The uninsured auto claim rate is calculated as the number of uninsured auto claims divided by the number of bodily injury liability claims. In some provinces, property damage to
43
Administration Private Public Private Mix
Public
Regime Modified No‐fault
Tort No‐fault Tort Choice/No‐fault Default
No‐fault
Province ON AB NB NS PE NL QC1 BC SK MBvehicles can be claimed in specific situations only. 3 Rules for admitting drivers into the Facility Association residual market differ by province. Alberta and Ontario have very stringent rules, and in contrast, there are few rules in Prince Edward Island. Thus results are not directly comparable across provinces. 4 The risk sharing pools in Ontario and Alberta are for “grey risks” and the risk sharing pools in New Brunswick and Nova Scotia are for new drivers. 5 The General Insurance OmbudService is a dispute resolution service that is available to all Canadians who have concerns with their auto, home, or business insurance. They classify complaints received in over 20 different categories, relating to affordability, availability, billing problems, claims issues, policy concerns, and cancellations. We report just the percentage of complaints listed as “availability” concerns, acknowledging that likely understates concerns as policy cancellation, non‐renewal complaints, and inability to purchase a coverage or endorsement may also be a sign of availability issues. Issues of affordability are similarly understated using the percentage of complaints listed as “affordability” concerns, because issues with policy rating, policy renewal, and premium increases may also be indicative of affordability concerns. 6 The average premium is calculated as total earned premiums for both mandatory and optional coverages divided by number of earned vehicles in the province. British Columbia does not separate out private passenger vehicles from other vehicles in their publicly available data. 7 An insurer is classified as a direct seller if it sells insurance via its own sales force or exclusive agents, face‐to‐face to consumers. 8 An insurer is classified as a commodity seller if it sells insurance over the Internet, by telephone, or by direct mail. 9 An insurer is classified as a national insurer if it has positive direct written premiums in auto insurance in all 10 provinces. 10 We first calculate the annual loss ratio (total incurred losses and adjustment expenses divided by earned premiums) for each of the five years and then calculate the average the annual loss ratios. 11 The 2000 and 2010 loss costs are calculated as total incurred losses and adjustment expenses divided by number of earned vehicles for each of the two years. The growth rate is calculated as (2010 loss cost – 2000 loss cost)/(2000 loss cost). 12 The 2000 and 2010 premiums are calculated as total earned premiums divided by number of earned vehicles for each of the two years. The growth rate is calculated as (2010 premium – 2000 premium)/(2000 premium). 13 The 2000 and 2010 claims costs are calculated as total incurred losses and adjustment expenses divided by number of reported claims for each of the two years. The growth rate is calculated as (2010 claims cost – 2000 claims cost)/(2000 claims cost). 14. From Transport Canada, “fatal collisions” include all reported motor vehicle crashes that resulted in at least one death, where death occurred within 30 days of the collision, except in Quebec (eight days) and “personal injury collisions” include all reported motor vehicle crashes which resulted in at least one injury but not death within 30 days of the collision, except in Quebec (eight days). 15 The CV describes the dispersion of a variable in a manner that does not depend on the variable’s mean, with a higher CV indicating higher dispersion. A CV of zero would imply that there is no variation in loss ratios across territories. CV is the coefficient of variation which is calculated as 100 times the standard deviation of a variable divided by the mean of the variable. A small CV for premiums would imply that premiums are socially fair – there is little variation by location across the provinces. 16 We first calculated the loss ratio (total incurred losses and adjustment expenses divided by earned premiums) for all coverages for the statistical reporting territories in Ontario and Alberta. We then calculated the weighted mean loss ratio and weighted standard deviation of loss ratios for each province. Territorial weights are the number of earned vehicles in each territory divided by the total number of earned vehicles in each province. The CV for TPL loss ratios by driving class uses third‐party liability incurred losses and earned premiums for the seven driving record classes (class 0 through to class 6) in each province. A small CV implies that premiums are actuarially fair. 17 The Herfindahl‐Hirschman Index for each province is 10,000 times the sum of the squares of direct written auto insurance premiums for each firm operating within the province divided by the square of total direct written auto insurance premiums for the province. A higher number implies greater concentration and less competition.
44
Availability: The rate of uninsured driving in a province is a good indicator of consumer
participation in the automobile insurance market. Uninsured driving may arise because of problems of
insurance availability, if drivers choose to drive uninsured because they have difficulty finding an
insurance agent or company, or if they find the application process confusing or burdensome. Problems
of insurance affordability may also be a cause of uninsured driving if drivers feel that they cannot afford
insurance. Uninsured driving is typically measured in the literature by the number of insurance claims
filed under uninsured auto coverage divided by the number of bodily injury liability claims. Some of the
differences in uninsured auto claims rates may arise because of provincial differences in both the ability
to access the tort system and in the level of first‐party accident benefit coverage available.
The percentage of cars that are insured through the residual automobile insurance market is
another commonly used measure of the availability of insurance in private insurance markets. Markets in
which insurers are reluctant to insure some drivers at prevailing or allowed premium levels will see larger
percentages of drivers who must obtain insurance through this involuntary market mechanism. As above,
differences in the eligibility criteria for placing a risk in the residual market between provinces will also
generate differences between the provinces. We account for both the percentage of cars insured through
the residual market and the percentage of cars insured through the provincial risk sharing pools. The risk
sharing pools in both Ontario and Alberta which are open to “grey risks” were established in response to
the introduction of take‐all‐comers rules in these provinces. The risk sharing pools in New Brunswick and
Nova Scotia are for new drivers only, and as such are not directly comparable to the risk sharing pool
mechanisms in Ontario and Alberta.
We also record complaints made with the General Insurance OmbudService (GIO). The GIO’s
mandate is to provide a cost‐free, independent, and impartial process to resolve complaints about
general insurance products and its services are available in all provinces – those with private market and
45
those with government‐run insurers. The GIO classifies complaints into more than 20 categories as can be
seen in Table 3.
In Table 3, we capture the percentage of complaints categorized as “availability” complaints. This
measure understates true availability concerns, as we do not include other complaint categories such as
policy non‐renewals or policy cancellations as part of this measure.
Using the uninsured auto claim rate, Ontario has the highest reported rate of uninsured driving
among the private market provinces. However, because of the threshold to access the tort system, the
claim frequency for bodily injury liability claims in Ontario is much lower than the other private market
provinces. Thus the high uninsured auto claim rate in Ontario could also arise because of the lower bodily
injury claim frequency. Insurers in all private market provinces make some use of the residual market
mechanisms available in each province. Because of stringent regulations on the use of FARM, the
combination of the FARM and risk sharing pool in Ontario (2.7 percent of total vehicles) is the best
measure of the residual market in this province. Thus Ontario ranks fourth out of six provinces with
respect to this variable. Nova Scotia (0.8 percent), New Brunswick (1.9 percent) and Prince Edward Island
(2.1 percent) have lower use of the residual market mechanism while Newfoundland and Labrador (4.1
percent) and Alberta (6.9 percent) have higher usage.
46
Table 3 – Summary of GIO Complaint Data 2011 for All Provinces
Number of Complaints
Complaint Heading BC AB SK MB ON QC NB NS PE NL
Affordability 12 38 9 1
Availability 1 67 6 1
Billing problem (broker related) 5 6 1 1
Billing problem (company related) 5 30 2
Claims, accident benefits, disputes 8 57 1 1
Claims, accident benefits, questions/entitlement 12 66 1 1
Claims, delay 1 31 55 9 1 1 3
Claims, dispute over liability/fault rules 1 38 229 9 1 6 2
Claims, other 3 37 35 4 2 1 1
Claims, repairs/settlement unsatisfactory 2 64 179 22 2 3 1
Claims, rights/entitlement 51 1 78 26 2 6 1 4
New business, misquotes 3 32
No category provided 1
Non‐renewal, accident/claim frequency 1 43
Non‐renewal, driving violations 13
Non‐renewal, other 27
Policy cancellation, non‐disclosure on application 40 1 1
Policy cancellation, non‐payment of premium 97 3 1 1
Policy cancellation, other 14 78 4 1
Policy cancellation, refund calculation 2 37 1 1 1
Policy rating 1 13 123 4 1 2
Policy renewal, premium increase 59 2 1
Question, coverage 2 15 27 1 1
Question, underwriting 1 4 13 1 2
Refusal to provide a coverage or endorsement 16 1
Source: Private communication with General Insurance OmbudService
47
The FARM and risk sharing pool market shares indicate some concern in terms of consumers’
ability to purchase insurance in the voluntary market. Further problems of availability are indicated by the
percentage of GIO complaints related to availability for Ontario auto insurance. We note that there are
also availability complaints in the government auto insurance provinces of Quebec and British Columbia,
where the government mandate is to ensure availability to all drivers.
Affordability: Insurance affordability is measured using the annual average premium expenditure
(for all coverages) per insured car in a province. This average does not capture the price of insurance for
drivers in all territories of a province, and it does not measure affordability of insurance relative to
household income. However, since the average cost of claims is the primary determinant of premiums,
this average measure is relevant for understanding the overall performance of the insurance system. It
should also be borne in mind, however, that differences in average premiums across provinces
fundamentally reflect differences in insurance benefits provided.
Our second measure of affordability is the percentage of complaints that the GIO categorizes as
“affordability” complaints as provided in Table 3. As with the above measure for availability, we
acknowledge that counting only the category “affordability,” and not categories on policy rating or policy
renewal, will underestimate concerns.
Ontario has the highest average premiums of all provinces, with the average Ontario premium
being more than 30 percent higher than Alberta and more than 70 percent higher than premiums in the
Atlantic provinces. Ontario premiums are 28 percent higher than British Columbia premiums, and British
Columbia has generous first‐party benefits and unlimited access to the tort system. As noted previously,
comparison across provinces is problematic due to the different benefit provisions in each province, yet
the fact that the 10‐year growth in premiums in Ontario is 65.85 percent is an indicator of affordability
problems. This is more than double the average growth rate of 27.46 percent in the other private market
48
provinces. Even though only 2.58 percent of GIO complaints relate to affordability, and Alberta has a
higher rate of affordability complaints per 10,000 population than Ontario (0.33 versus 0.30), the
explosive growth in premiums is of grave concern.
Service quality: Measuring insurance service quality is difficult, both because of the diversity of
insurer services provided and the lack of available summary statistics measuring quality. Researchers
have often used consumer complaints as a rough measure of insurer service quality, and we provide
some evidence on complaints here. We were unable to obtain data on the number of complaints made to
insurers or to provincial regulators. Thus, the complaint data reported here is the number of consumer
complaints recorded by the GIO. We normalize the number of complaints from each province to the
provincial population.
The number of complaints per 10,000 population (1.013) is noticeably higher in Ontario than
other provinces, the next highest being Alberta (0.757) and the other provinces being much lower. To
examine where concerns exist, we again examine the complaint data in Table 3. We focus here on
Alberta, Ontario, and Quebec.
For all three provinces, the largest fraction of complaints arises from the claims settlement
process, despite all provinces having very different settlement processes. In Ontario, 48 percent of
complaints (5.44 complaints per 10,000 population), in Alberta, 77 percent of complaints (6.61
complaints per 10,000 population) and in Quebec 66 percent of complaints (0.9 complaints per 10,000
population) are related to the claims settlement process. We observe that that the tort process of Alberta
gives rise to the highest proportion of complaints by population, the pure no‐fault system of Quebec gives
rise to the lowest proportion and the partial no‐fault system in Ontario falls in the middle. This is not
surprising as claims outcomes are more predictable in a no‐fault environment.
49
However issues of non‐renewal and policy cancellations are of more concern in Ontario (23
percent of all complaints) than in either Quebec (8 percent) or Alberta (5 percent). The issues of policy
cancellation and non‐renewal in Ontario are further indications of availability and affordability concerns.
Cost efficiency: To minimize the cost of service provision, the most efficient sellers who are best
able to meet consumers’ desires must be present and successful in the market. Following the U.S.
literature, we measure the percentage of overall market share held by national insurers (insurers who
write in all 10 provinces) and direct writers. We use the term direct writers to capture those insurers that
sell insurance face‐to‐face to their customers through exclusive agents or their own sales staff only.
Following from Kelly and Kleffner (2006), we also measure the market share held by commodity writers.
Commodity writers are insurers who sell auto insurance directly to consumers through indirect means
such as affinity groups, the Internet, and over the phone.
The market share of commodity sellers is higher in Ontario than other private provinces,
indicating that consumers have a cost‐efficient option for purchasing their insurance. However, the
market share of national insurers is lower than other provinces: 23.3 percent compared to 40 percent in
Alberta, 44 percent in Nova Scotia, and 53 percent in Prince Edward Island. Despite the concerns about
the auto insurance product because of the size of the auto insurance market, there are many more
insurers in Ontario than in other provinces. This can also be seen in the Herfindahl‐Hirschman Index (HHI)
for Ontario compared to the other provinces.
Sustainability: In both private and public insurance systems, long run sustainability requires that
premium revenues cover losses and operating expenses (after taking into account investment income
earned and taxes paid). The ratio of earned premiums to incurred claims and loss adjustment
expenditures (the loss ratio) is therefore a rough measure of premium adequacy. Because the loss ratio
does not account for investment income, taxes, or other expenses which are not related to the
50
settlement of claims such as underwriting and general overhead expenses, there is no specific value of
the loss ratio which can be used as a target for premium adequacy.14 Moreover, because accidents and
claims expenditures are stochastic and evolve over time, the loss ratio from a single year may be a poor
measure of premium adequacy. Nonetheless, the average value of the loss ratio over time provides some
evidence of premium adequacy (or excess).
Other measures of insurance system sustainability are the rates of growth in premiums and
claims over time. High rates of inflation in premiums will lead to problems of affordability over the long
term, and are indicative of underlying problems with cost growth (in claims or other expenses). We use
the total percentage growth in premiums per insured vehicle for the decade 2000–2010 to measure
premium inflation across provinces. We also capture the growth in average claim severity for the same
period.
A final indicator of the potential for sustainability concerns is the automobile accident rate in a
province. High underlying rates of accidents lead to higher costs of claims, which pose a threat to
sustainability. Moreover, a well‐functioning insurance system should not measurably decrease incentives
for road safety. We use two variables to capture the automobile accident rate in each province – the
number of accidents with personal injury (but no fatalities) and the number of fatal accidents. Transport
Canada collects these accident statistics from police reports, and as such these statistics are distinct from
insurance claiming behaviour.
Table 2 clearly indicates that the Ontario auto insurance system is not sustainable. The five‐year
average loss ratio was 84.10 percent which is significantly higher than other private market provinces,
14 The expense ratio for the entire U.S. property/casualty insurance market in 2011 was 29 percent (Insurance Information Institute, 2012). MSA Research Inc. (2012) reported expense ratios of 30 percent for personal and multi‐line insurance companies in Canada. Using this as a benchmark implies that without accounting for taxes and investment earnings, insurers with loss ratios greater than 70 percent would lose money.
51
whose average loss ratio was 60.36 percent. The Ontario loss ratio also exceeds that of the government
insurers in both Manitoba and British Columbia. With loss ratios this high, enough premiums are not
being collected to cover all expenses and as such insurer equity must be used to cover operating losses.
This creates concerns that firms heavily involved in underwriting Ontario auto insurance could suffer from
solvency concerns in the future. Indeed, Leadbetter and Stodolak (2009) in a study on Canadian
insolvencies note that the majority of Canadian insurer insolvencies from 1990 to 2007 were Ontario
insurers who were primarily writers of auto insurance.
As well, the 10‐year growth in average losses per insured vehicle was 52.71 percent in Ontario
compared with 4.07 percent in Alberta and negative growth in New Brunswick, Nova Scotia, and Prince
Edward Island. Therefore it is not surprising that the 10‐year premium growth rate in Ontario (65.85
percent) is also significantly higher than the other private market provinces’ 10‐year average premium
growth rate of 27.50 percent. The growth in both losses and premiums is clearly driven by increases in
severity, as the 10‐year growth rate in average claim severity in Ontario is 152.36 percent. Insurance
Bureau of Canada notes that the number of catastrophic injury insurance claims is rising faster than other
claims, even though hospitalizations from motor vehicle accidents are falling. From 2004 to 2010 the total
number of no‐fault accident benefit claims rose 28 percent but the number of large claims has more than
doubled.15 Severity growth is much flatter across all other provinces, ranging from ‐7.13 percent in Nova
Scotia to 15.41 percent in Alberta.
15 http://www.canadianunderwriter.ca/news/claims‐costs‐for‐ontario‐auto‐insurers‐still‐out‐of‐control‐ibc/1001413525/.
52
Figure 2 – Number of Auto Accidents in Ontario: 1999 to 2009
Source: Ontario Ministry of Transportation, 2009
This is indeed puzzling as vehicles and roads have gotten safer over the past decade, and in 2009,
Ontario had the second lowest injury accident rate and the lowest fatal accident rate among all of the
provinces. And as can be seen in Figure 2, even with a growing number of road users there has been an
overall decline in the number of auto accidents causing injury or death over the past decade.
Fairness: In general, measures of fairness may be conceived of horizontally (similar individuals
receive similar outcomes) or vertically (individuals in different circumstances receive outcomes that
reflect their circumstances). These different conceptions may lead to different judgments regarding the
fairness of a system. Similarly, with regard to insurance pricing there are two dramatically opposing views
of fairness. The concept of fairness underlying social pricing requires that differences in premiums
charged to individuals in different locations or of different ages or genders should be minimal – only
those characteristics that are controllable should be used in pricing of insurance. Another definition of
0
10,000
20,000
30,000
40,000
50,000
60,000
70,000
0100200300400500600700800900
Num
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53
social pricing is that prices should reflect the underlying ability to pay.16 Risk‐based or actuarial pricing
relies on a different metric of fairness – namely, that differences in premiums charged to different
individuals should vary based on differences in their expected accident probabilities and claims costs. The
first notion implies that within‐province variation in premium charges should be small; the second implies
that within‐province variation in premium charges relative to claims expenditures should be small. We
compare both of these measures across provinces.
For Ontario and Alberta we collect premium and loss data by GISA territories for total coverages,
and for all private market provinces we collect third‐party liability coverage by driving record class. As
discussed in Section 3.4, the experience rating mechanism in all private market provinces assigns drivers
to a driving record class based on the number of years of driving that are free of at‐fault claims. Drivers
with zero years of no at‐fault claims are placed in driving record class 0, drivers with one year of no at‐
fault claims are placed in driving record class 1, and so on up to driving record class 5. Drivers with 6 or
more consecutive years of no at‐fault claims are placed in driving record class 6.
We measure fairness in social pricing (horizontal fairness) by the coefficient of variation (CV) of
premiums across the statistical territories in the provinces of Ontario and Alberta. The CV describes the
dispersion of a variable and is calculated as one hundred times the standard deviation of the variable
divided by the mean. If social pricing exists, there should be little difference in the premiums charged
across territories and therefore the CV should be relatively close to zero. As can be seen in Table 2,
significantly more horizontal equity or fairness exists across the four statistical territories in Alberta than
the nineteen statistical territories in Ontario. In 2009, the CV for Alberta was 21.0 compared to a CV of
104.5 for Ontario.
16 Many social insurance products such as healthcare for the elderly or poor, or employment insurance are priced in this manner.
54
Vertical fairness reflects the extent to which individuals pay premiums commensurate with their
risk. If individuals in each statistical territory are paying a premium commensurate with their risk levels,
then the loss ratios across different territories should be fairly similar, and thus the CV of loss ratios
should be relatively close to zero. With respect to vertical fairness across territories, we note that Alberta
has fairer premiums than Ontario. This is surprising given the observation about greater horizontal
fairness in Alberta. This implies that although premiums vary greatly across the different statistical
territories in Ontario, losses vary even more and premiums have not been set in Ontario to capture the
differences in loss experience across the different statistical territories.
We next examine fairness in risk‐based pricing using the CV of loss ratios across driving record
class for all private market provinces. Fairness in risk‐based pricing would result in similar loss ratios
across each driving record class and therefore CV values relatively close to zero. Overall, because of the
stochastic nature of losses, if premiums are actuarially fair, then larger provinces should have smaller CVs.
This is reasonable because if some driving record classes have very few drivers, then there is less
predictability in incurred losses (for example in Prince Edward Island, there were just over 1000 drivers in
driving record class zero compared to almost 60,000 drivers in driving record class zero in Ontario). This
relationship between provincial size and the CV exists for the Atlantic provinces. However, the CV of
Alberta loss ratios by driving record class (9.6) is higher than for the next smallest province Nova Scotia
(8.6), reflecting the cross‐subsidization of the grid pricing mechanism. In addition, Ontario’s CV of loss
ratios by driving record is 12.9 and is closer in size to that of New Brunswick. Thus it appears that there
are more cross‐subsidies and less fairness across driving record class in Ontario than in most provinces.
Competition: A competitive market requires a large number of firms with no single firm
dominating the market through a large share of business. Competition is measured by the number of
insurers active in automobile insurance sales in a province; the combined market share of the largest four
55
private insurers in the market (the four firm concentration ratio); and the Herfindahl‐Hirschman Index of
market concentration (HHI). The HHI is calculated as the sum of the squared values of each firm’s market
share. By squaring the market shares before adding them, firms with larger market shares are weighted
more heavily in the index. This leads to a higher HHI when there is a smaller number of firms in the
market and when market shares are unevenly distributed across firms. By convention the HHI is
multiplied by 10,000: a value near zero indicates many small firms of equal size, while a pure monopoly
yields a value of 10,000.
Lack of competition is not a problem in the Ontario market. There are more insurers writing auto
in Ontario than any other province and there is a lower concentration of the top four insurers (31.1
percent in Ontario as compared to 44.3 percent in Alberta and 56.3 percent in Newfoundland and
Labrador). The HHI of market shares is lower in Ontario than in other markets with private automobile
insurance: 427 in Ontario versus 687 in Alberta and 1055 in Newfoundland and Labrador. This heavy
competition in Ontario is to be expected. Tennyson (1997) found similar results with respect to California
– it was one of the most stringently regulated states for auto insurance, but its large size made it very
attractive to insurers.
Overall there exist concerns with respect to affordability and availability as evidenced both by the
percentage of affordability and availability complaints as noted in Table 2 and the further analysis of
complaint data given in Table 3. There also appears to be great variability in loss experience across the
province. Ontario has greater variability in premiums across territories than does Alberta, and even
greater variability in loss ratios. This suggests that the differences in premiums across different territories
are not sufficient to cover the differences in losses incurred in different regions of the province.
An examination of the sustainability criteria highlights the fact that the Ontario automobile
insurance system is not sustainable. Ontario clearly has the most expensive insurance product in Canada
56
and the costs of this system continue to grow. Most troubling is that the growth in claims costs is at odds
with improvement in road safety that has been evidenced in the province over the last decade.
The next section of the report examines these issues in more detail. We look at the change in the
Ontario auto insurance product since the introduction of no‐fault insurance in 1990. We examine the
claims experience of Ontario compared to other provinces over this time period and we examine the
claims experience within different territories of the province.
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5 AutomobileInsuranceinOntario
To provide greater insight into the factors that underlie the explosive claims and premium growth
of Ontario’s auto insurance system, in this section we review the auto insurance system in Ontario. We
start with an overview of the current product and then review the history of auto insurance reform in
Ontario. We conclude this section with a discussion of claims costs and trends for the province, paying
particular attention to any differences between the four largest metropolitan areas and the rest of the
province. Statistics Canada lists the four largest Census Metropolitan Areas in Ontario as
Toronto/Mississauga, Ottawa/Gatineau17, Hamilton/Burlington, and Kitchener‐Waterloo/Cambridge. To
examine the claims costs trends, we use the statistical territories developed by the General Insurance
Statistical Agency and define the Greater Toronto Area (GTA) as statistical territories 710 (Oshawa,
Aurora, Newmarket, and Orangeville) and 717 (Metropolitan Toronto and Markham, Richmond Hill,
Vaughan, and Peel), Ottawa is statistical territory 711, Hamilton/Burlington is statistical territory 704
(Halton and Hamilton‐Wentworth) and Kitchener‐Waterloo/Cambridge is statistical territory 706
(Brantford, Guelph, Kitchener‐Waterloo, and Cambridge). The GTA is by far the largest metropolitan area
in Ontario (and Canada). In 2009 (the latest year for which we have data for different geographic
territories), the GTA accounted for 37 percent of earned vehicles and 45 percent of total premiums
collected in the province.
5.1 TheCurrentProduct
As in other jurisdictions in Canada, auto insurance is a mandatory product in Ontario. There must
be proof of insurance before license places can be attached to a vehicle or registration can be renewed.
17 Statistics Canada categorizes the combined area of Ottawa, Ontario, and Gatineau, Quebec as a single Census Metropolitan Area.
58
Those who operate a vehicle without insurance are guilty of an offense and can be fined between $5,000
and $25,000 for a first offense and between $10,000 and $50,000 for subsequent offenses.18
Currently, drivers in Ontario are required to purchase four mandatory auto insurance coverages:
a minimum ($200,000) of third‐party liability coverage for both bodily injury and property damage,19 first‐
party (no‐fault) statutory accident benefits, first‐party coverage for not‐at‐fault damage to one’s own
automobile (direct compensation/property damage) and first‐party coverage against damage caused by
at‐fault uninsured drivers. Optional coverage includes at‐fault collision damage for the vehicle,
comprehensive insurance for non‐collision losses, underinsured motorist coverage as well as additional
limits for liability and additional coverage for first‐party accident benefits.
Statutory accident benefits are relatively generous. A unique aspect of the Ontario system is that
the maximum amount of accident benefits available is a function of the level of impairment of the
individual, and individuals with catastrophic impairment are entitled to up to $1 million in medical and
rehabilitation benefits and $1 million for attendant care benefits. The current standard auto insurance
policy, effective since September 1, 2010, is summarized in Table 4. The current policy provides $50,000
for medical and rehabilitation benefits (including assessment costs) and $36,000 for attendant care
benefits. Additional limits can be purchased for both non‐catastrophic and for catastrophic injuries.
Finally the tort deductible associated with court awarded compensation for pain and suffering may be
reduced to $20,000 from $30,000, and for Family Law Act claims to $10,000 from $15,000.
18 http://www.mto.gov.on.ca/english/dandv/vehicle/register.shtml
19 The Financial Services Commission of Ontario reports that over 99 percent of Ontario drivers purchase more than the mandatory minimum.
59
Table 4 – Statutory Accidents Benefits in Ontario
Coverage Current Standard Auto Policy Options Available to Increase Benefits
Medical, rehab, and attendant care benefits for non‐catastrophic injuries
$50,000 for medical and rehab benefits, including assessment costs; $36,000 for attendant care benefits
$100,000 or $1,100,000 for medical and rehab benefits, including assessment costs; $72,000 or $1,072,000 for attendant care benefits
Medical, rehab, and attendant care benefits for catastrophic injuries
$1,000,000 for medical and rehab benefits including assessment costs; $1,000,000 for attendant care benefits
An additional $1,000,000 for medical, rehabilitation, and attendant care benefits including assessment costs
Caregiver benefit Up to $250 per week for the first dependant plus $50 for each additional dependant; available only for catastrophic injuries
Up to $250 per week for the first dependant plus $50 for each additional dependant; available for all injuries
Housekeeping and home maintenance expenses
Up to $100 per week, available only for catastrophic injuries
Up to $100 per week, available for all injuries
Income replacement benefit 70 percent of gross income up to $400 per week
Weekly limit can be increased to $600, $800, or $1000 per week
Dependant care benefit Not provided Up to $75 per week for the first dependant and $25 per week for each additional dependant to a maximum of $150 per week
Death and funeral benefits $25,000 lump sum to an eligible spouse; $10,000 lump sum to each dependant; maximum $6,000 funeral benefits
$50,000 lump sum to an eligible spouse; $20,000 lump sum to each dependant; maximum $8,000 funeral benefits
Indexation benefit – applicable to income replacement benefit, non‐earner benefit, caregiver benefit, attendant care benefit, or medical and rehab benefit
Not provided Annual adjustment according to the CPI for Canada
Source: Financial Services Commission of Ontario (www.fsco.gov.on.ca)
5.2 TheHistoryofAutoInsuranceReforminOntario
Since 1989 significant reform of the Ontario automobile system has occurred on six separate
occasions, the most recent going into effect on September 1, 2010. A summary of key changes and the
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motivation for reforms is given in Table 5. Here we detail the major changes in the auto insurance
product and the regulation of said product over the past 25 years.
As noted by the Auditor General of Ontario (2011), each legislative reform was enacted primarily
to contain rising accident benefit costs (and their impact on premiums), and each reform has provided
only a temporary reduction in premiums (and losses) as illustrated in Figure 3 below.
Figure 3 – The Impact of Auto Insurance Reforms on Average Premiums
Source: Ontario Auto Insurance Anti‐Fraud Task Force, 2011
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Table 5 – A Summary of Auto Insurance Reform in Ontario from 1990 to 2010
Year Bill Rationale for Reform Wording for Verbal Threshold
Right to Sue for Non‐economic
Losses
Right to Sue for Economic
Losses
First‐party Accident Benefit Reforms
1990 Bill 68 Improve accessibility and affordability, correct shortcomings in tort system.
Sustained permanent and serious disfigurement or sustained permanent serious impairment of an important bodily function
Yes, if injury meets verbal threshold
Yes, if they exceed first‐party benefits
$500,000 limit on medical benefits, disability benefits for both employed and unemployed
1994 Bill 164 Cover more injured claimants, move closer to pure no‐fault coverage.
Sustained permanent and serious disfigurement or sustained permanent serious impairment of an important bodily function
Yes, if injury meets verbal threshold, $10,000 deductible applies
No $1 million limit on medical benefits, increased disability benefits, introduction of caregiver and housekeeping benefits
1996 Bill 59 Reduce costs associated with high first‐party accident benefit claims.
Sustained permanent serious disfigurement or serious impairment of an important physical, mental or psychological function
Yes, if injury meets verbal threshold, $15,000 deductible applies
Yes, if they exceed first‐party benefits
Introduction of two‐tiered benefits: $100,000 limit on medical benefits for most injuries, but $1 million limit for catastrophic impairments
2003 Bill 198 Improve affordability and accessibility by decreasing assessment costs.
Introduced definitions for “serious,” “ important,” and “permanent” to tighten threshold
Yes, if injury meets verbal threshold, $30,000 deductible applies
No change from Bill 59
Small change in benefits, but expansion of the definition of “catastrophic”
2006 Elimination of DACs
Reduce costs by eliminating Designated Assessment Centres (DACs).
No change from Bill 198 No change from Bill 198
No change from Bill 198
No change from Bill 198
2010 Bill 16 Reduce costs associated with high first‐party accident benefit claims. Reduce expenses in assessment process.
No change from Bill 198 No change from Bill 198
No change from Bill 198
Sharp reduction in benefits for “non‐catastrophic” impairments; $2,000 cap on fees and expenses for conducting an assessment; restriction on caregiver benefits and housekeeping for catastrophic injuries only; caps on minor injury claims
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For example, the 2003 reforms resulted in a decrease in average premiums of 16 percent over the
period 2003 to 2007. The average premium fell from approximately $1,499 per vehicle in November 2003
to $1,260 in June of 2007. However, the removal of the Designated Assessment Centres in 2006 increased
the number of assessments per file. Cameron (2011) noted that the cost of assessments on a per vehicle
basis increased from $39 in 2004 to $141 in 2009. The impact of the 2010 reforms cannot be fully
assessed yet, but McGillivray (2011) comments that slower growth of accident benefit costs in the second
half of 2010 was evidence that the reforms were having the desired effect.
The report of the Auditor General of Ontario (2011) in its review of the Financial Services
Commission of Ontario (FSCO) provides a concise summary of the spiralling costs of auto insurance claims
in Ontario. From 1999 to 2009 the number of people killed or injured in auto accidents in Ontario
declined by 25 percent. However from 2005 to 2010, the total cost of injury claims rose 150 percent even
though the number of injury claims in the same period increased only 30 percent. The number of
personal injury claims in 2009 was almost 75,000, 20 percent higher than the number of people who
reported having been injured in an automobile accident that year.20 Across the province in 2010, there
were approximately 584,000 auto insurance claims, with claims costs totalling $8.7 billion: 52 percent of
costs were for accident benefit claims, 23 percent were for third‐party liability and the remaining
amounts were for property damage to automobiles (both not‐at‐fault and at‐fault).
In 2005, statutory accident benefits accounted for one‐third of auto insurance claims costs; by
2010, they accounted for one‐half of all auto insurance claims costs in Canada. Claims costs for the other
lines of auto insurance grew 16 percent during the same five‐year period, while Statutory Accident
20 The Auditor General’s report does not provide references for the data it presents. However, road safety statistics are typically reported through the Ministry of Transport, whereas General Insurance Statistical Agency (GISA) collects data on auto accident claims.
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Benefit claims grew by 92 percent. The high cost of pre‐treatment examinations and assessments
(roughly one‐third of every dollar spent on accident benefit claims) was inconsistent with assessment
costs in other provinces. Toronto was identified as particularly problematic. Between 2008 and 2009,
statutory accident benefits payments rose 37 percent in the Greater Toronto Area (GTA), compared to 23
percent in other Ontario cities and just 14 percent in rural areas. The Ontario Auto Insurance Anti‐Fraud
Task Force (2011) notes that although the GTA accounts for only one‐third of insured vehicles, it
accounted for more than 80 percent of the growth in accident benefit claims.
To provide greater insight into the intended effects and actual consequences of the various
reforms, we briefly summarize the reforms and discuss what the anticipated outcome would be (in terms
of frequency and severity of claims) if the reforms were successful. We then examine claim frequency,
claim severity, and loss adjustment expenses over time in light of these predicted effects.
5.2.1 Bill68(1990)
After years of rising auto insurance prices and concerns about affordability and availability of
insurance, auto insurance reform was the main election issue in the 1987 provincial election (Baetz, 1993)
and the Liberal government’s win was partially due to their promise to effect rate reductions. In February
1998, the Liberal government introduced the Ontario Automobile Insurance Board Act, establishing both
the Board as the rate control agency and introducing controls on the rate classification process used by
auto insurers. As chronicled by Lascher (1999), the Liberals’ ability to reduce premiums was damaged by
the December 1988 government‐commissioned Mercer Report which recommended that to restore
profitability to the sector, auto insurance premiums should be increased by 35 to 40 percent. Devlin
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(1993) concludes that given the political environment and the presence of strict rate regulation, the
insurance industry was forced to lobby for no‐fault auto insurance provisions.21
On September 15, 1989, the Liberal government announced the proposal for the adoption of the
Ontario Motorist Protection Plan (OMPP) which despite vigorous objection from various political and
grassroots parties took effect on June 22, 1990, and remained in effect until December 31, 1993. This
reform was based on the recommendation by the Ontario Task Force on Insurance lead by David Slater in
May 1986. The task force recommended that the Ontario government adopt a pure no‐fault system of
compensation for automobile accidents, similar to existing schemes in Quebec and Saskatchewan, due to
the shortcomings of the tort system. Key shortcomings listed by the task force were the high
administrative cost of providing insurance and the unpredictability of compensation under the tort
model. It was recommended that the new auto insurance regime impose mandatory first‐party coverage
and eliminate liability between drivers, but still allow for liability claims from pedestrians. The report
cautioned that introducing no‐fault insurance would increase moral hazard as first‐party benefits would
increase substantially.
The OMPP adopted was a partial no‐fault scheme with a verbal threshold. The verbal threshold
meant that insured parties had access to legal recovery for non‐economic damages if they sustained
permanent and serious disfigurement or sustained permanent serious impairment of an important bodily
function. Those injured would receive benefits as defined by the no‐fault benefits schedule. In this
schedule, the benefits for many groups of people – unemployed, caregivers and students – were minimal.
The weekly benefits to employed persons were much more generous: 80 percent of gross weekly income
21 No‐fault was not a novel idea in Ontario. Because of soaring auto insurance premiums since the early 1980s, many government‐sponsored commissions have examined ways to contain costs and improve coverage. The Slater Report in 1986 recommended a pure no‐fault system. Two years later, the Osborne Report strongly supported a pure tort system but with expanded mandatory first‐party accident benefits.
65
up to a maximum of $600 a week for three years. If the verbal threshold was met, the claimant had full
right to sue for recovery of monetary losses that exceeded the first‐party benefits. Collateral benefits
such as payment received under an employee’s disability or supplemental health plan were deducted
from any damages awarded to the plaintiff. OMPP also introduced direct compensation for not‐at‐fault
property damage to the insured’s vehicle. It was estimated that the introduction of OMPP should reduce
insurance costs by $500 million per year.
These reforms were expected to reduce the frequency of bodily injury liability claims, but
increase average severity of these claims due to the stringent liability threshold. The average severity of
accident benefit claims would increase as first‐party benefits were more generous. However it is unclear
whether the overall average severity of accident benefits plus bodily injury liability claims would be
higher or lower than prior to the reforms depending on whether first‐party benefits were more generous
than what was paid under tort. With respect to damage to automobiles, because of the new direct
compensation – property damage (DC‐PD) coverage, a decrease in third‐party property damage claims
was anticipated, and a corresponding increase in first‐party DC‐PD claims. Overall, cost savings were
expected due to a reduction in loss adjustment expenses associated with shifting claims from third‐party
to first‐party compensation.
5.2.2 Bill164(1994)
The newly elected NDP party introduced Bill 164 in January 1994 (and this bill remained in place
until October 31, 1996). The key modification was a change in the verbal threshold to encompass an
insured’s serious disfigurement or serious impairment of an important physical, mental, or psychological
function. This is a lower threshold than under OMPP, due to the absence of a “permanent” requirement
and the inclusion of non‐physical injuries, allowing more injured persons to sue for non‐economic
damages.
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The right to sue for economic loss was eliminated in its entirety, but first‐party benefits were
greatly increased. For example, weekly income replacement benefits were set to 90 percent of net
income to a maximum of $1,000 per week. Weekly benefits were also introduced for caregivers, students
and the unemployed. In addition the upper limit for medical and rehabilitation costs was significantly
increased to $1 million. Collateral benefits were no longer deducted from a claimant’s tort award.
However, a $10,000 deductible was introduced for non‐economic damages (those whose losses were
assessed to be less than $10,000 were not allowed to recover).
These reforms were expected to increase the frequency of bodily injury liability claims arising
from the lowered eligibility threshold. However, because the right to sue for economic loss was
eliminated, it is unclear whether bodily injury liability claim severity would increase under Bill 164. In the
absence of moral hazard, a change in the frequency of accident benefit claims should not be expected,
but increased benefits could attract more claims, leading to higher claim frequency. Overall, the increased
first‐party benefits should lead to higher claim severity, but the reforms should have no expected impact
on property damage claim frequency or severity.
5.2.3 Bill59(1996)
The Conservative government introduced further changes in 1996. On November 1, 1996, Bill 59,
the Auto Insurance Rate Stability Act became law. This bill restored the right to sue for economic
damages if losses exceeded the compensation available under statutory accident benefits. The verbal
threshold was tightened from Bill 164, re‐introducing the word “permanent” into the threshold for both
disfigurement and impairment. The deductible for non‐economic damages was increased to $15,000 and
was applied before any split in liability. Statutory accident benefits were reduced from Bill 164; for
example, weekly income benefits were capped at 80 percent of net income up to $400 a week. Collateral
benefits were deducted from tort awards for monetary losses only for pre‐trial collateral benefits.
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Most importantly, Bill 59 introduced a two‐tiered schedule of payments based on the level of
injury of the claimants. Individuals who are catastrophically impaired (as defined in the Statutory Accident
Benefits Schedule) had access to a higher level of medical and rehabilitation benefits ($1 million instead
of $100,000), and only those catastrophically injured could claim future care costs. To contain costs,
medical providers could not start therapy until they had approval from the insurance company for the
treatment plan.
The two‐tiered system was introduced to contain claims costs by reducing the average severity of
losses paid under the Statutory Accident Benefits Schedule. However, the two‐tiered system also would
increase loss adjustment expenses because it creates a greater need for assessment for benefits
purposes. The reforms were not expected to impact the frequency of accident benefit claims unless the
reduced benefits also reduced moral hazard in claiming. The expected impact on bodily injury liability
claim frequency is ambiguous. Because the verbal threshold was tightened again, this should decrease
the number of bodily injury liability claims; however the reintroduction of the right to sue for economic
damages combined with the reduction in statutory benefits could lead to an increase in liability claims
and an increase in liability claim severity. No change in frequency or severity of property damage claims
was expected.
5.2.4 Bill198(2003)
The Liberals won the 2003 election, having campaigned on a promise to freeze soaring insurance
rates immediately if elected and then reduce them by an average of 10 percent. Shortly after being sworn
in on October 23, Ontario's new Liberal government froze auto premiums effective that day. On
November 26, the government introduced the Automobile Insurance Rate Stabilization Act which froze
insurers' rates at levels approved on or before October 23 and prevented further approvals from taking
place for 90 days.
68
Reforms were introduced as part of the “Keeping the Promise for a Strong Economy Act.”
Although the wording of the verbal threshold was unaffected, the revised Insurance Act provided
definitions for the threshold to reduce moral hazard. Serious was defined as “substantially interfere with
a person’s ability to continue regular employment, interfere with most of the person’s activities of daily
living.” Importance was defined as “important to most of the person’s usual activities of daily living” and
permanent was defined to mean “expected to continue without substantial improvement when sustained
by persons in similar situations.” The definition of catastrophic impairment was slightly expanded.
The most significant reforms were associated with reducing expenses associated with the
assessment process, restricting fees that could be charged by healthcare professionals, and reducing
excessive or abusive claiming behaviour associated with accident benefits claims. Other reforms included
an increase in the deductible for non‐economic damages, and the removal of the need to have a
catastrophic injury to claim future care costs. Pre‐trial collateral benefits were deducted from awards on
a matching basis (i.e., lost income for lost income) but future losses were not reduced by collateral
benefits.
The major focus of these reforms was to decrease assessment costs and costs arising from
medical treatments. If successful, the reforms would lead to lower loss adjustment expenses for accident
benefit claims, and a decrease in the severity of these claims. The frequency of accident benefit claims
would not be impacted. The guidance given to the terms in the verbal threshold was meant to decrease
the number of bodily injury liability claims, and the increase in the deductible for non‐economic damages
was expected to decrease the average severity of liability claims. No change in the frequency or severity
of property damage claims was expected.
69
5.2.5 EliminationofDesignatedAssessmentCentres(2006)
Designated Assessment Centres (DACs) were created in 1994 to provide neutral opinions on
injuries and treatment plans in Ontario auto insurance. On March 1, 2006, the Liberal government, acting
on an election promise, eliminated the DACs and new procedures were put in place. Insurers and the
government insisted that the DACs had outlived their purpose – they were expensive and their existence
did not improve health outcomes. The medical profession argued that the DACs provided consumer
protection and minimized delays until treatment. They argued that removing the DACs would actually
increase costs in the system. Thus, the expected impact of the removal of DACs is unclear. If the insurance
industry and government were correct, then loss adjustment costs would decrease and there would be
no other impact on accident benefit costs. If the medical profession was correct, then the removal of
DACs would result in poor health outcomes, higher accident benefit claims, and increased loss
adjustment expenses.
5.2.6 Reformsof2010
The 2003 changes in the Insurance Act required FSCO to undertake a review of the effectiveness
of auto insurance in Ontario at five‐year intervals and make recommendations to the Ministry of Finance.
2008 marked the first statutory review, and the results of the review led to changes being enacted in
2010.
Reforms included the implementation of a cap of $3,500 on minor injury medical‐rehabilitation
expenses, the development of standardized guidelines for treatment of minor injuries, including
assessment costs in coverage limits, and stricter monitoring of fees charged by healthcare providers and
assessors. The new policy provides $50,000 for medical and rehabilitation benefits (including assessment
costs), compared to $100,000 (excluding assessment costs) under the previous policy, and $36,000 for
attendant care benefits, compared to $72,000 previously, if the insured is not catastrophically injured.
70
There was no change in benefits for those who are catastrophically injured. More consumer choices
(higher limits and varying deductibles) for accident benefits, DC‐PD, and recovery for non‐monetary
losses under tort were added.
These reforms should decrease the severity of accident benefit claims as first‐party benefits were
reduced, but frequency should be unaffected. However, it is possible that there will be an increase in the
frequency of bodily injury liability claims due to the reduction in benefits for non‐catastrophic injuries.
These reforms should produce no change in frequency or severity of property damage claims. However, if
moral hazard is reduced because of the decreased benefit for non‐catastrophic injuries, then a reduction
in claims for non‐catastrophic injuries is expected.
5.3 OntarioClaimandCostTrends
Using data provided by the General Insurance Statistical Agency (GISA), we examine trends in
Ontario claiming behaviour and insurance costs. These data will provide insight into the effects of the
reforms and will highlight the key drivers of auto insurance cost growth. We analyze trends both in claim
frequency (number of claims divided by number of insured vehicles) and severity (total loss and loss
adjustment costs divided by number of claims) for each of the compulsory automobile insurance
coverages. We first look at provincial level data for the years 1991 through 2010. Data for Ontario are
displayed along with data for the private auto insurance markets of Alberta, New Brunswick, and Nova
Scotia to facilitate comparison of trends in Ontario relative to external market factors (such as
countrywide trends that reflect changes in cost of services and the number of road users). Premium and
claim severity data are converted to constant 2010 dollars using the Consumer Price Index (CPI) for each
province in order to net out general price changes within and between provinces from auto insurance
cost growth. We examine GISA data of premiums and claims history by statistical territory from 2000 to
71
2009 to further distinguish between the experience of the largest urban centres within Ontario (the GTA,
Ottawa, Hamilton/Burlington, Kitchener‐Waterloo/Cambridge) and the remainder of the province.
5.3.1 BodilyInjuryLiabilityClaims
Figure 4A displays annual average claim frequency for bodily injury liability (BI) claims. The sharp
decrease in claim frequency in the tort provinces is driven by two effects: the increased safety of vehicles
which has resulted in less severe injuries for those involved in accidents and success in automobile
insurance reform in each of the tort provinces. Countrywide there has been a decrease in the number of
fatal collisions, and the number of collisions causing bodily injury. This is reflected in the falling BI claims
frequencies in Alberta, New Brunswick, and Nova Scotia, but not Ontario, although there is a slight
decrease in frequency rates since 2000.
Figure 4A – Number of BI Claims per 100 Vehicles – Provincial Comparisons
Source: Authors’ calculations from GISA data
Relative to the pure tort provinces, the Ontario data show the expected low frequency of claims
due to the verbal threshold, but a constant upward trend in claims over the period. Overall, in Ontario
0.00
0.20
0.40
0.60
0.80
1.00
1.20
1.40
BI Claim Frequency
Ontario Alberta New Brunswick Nova Scotia
72
average BI claim frequency increased 150 percent during this time period, suggesting that the auto
insurance reforms have been generally ineffective by this measure. The one exception is over the period
2003–2006 when there was a decrease in BI claim frequency, suggesting that the strengthening of
definitions in the verbal threshold had the desired effects.
Figure 4B displays annual average claim frequency for BI claims for the major metropolitan
centres versus the rest of Ontario. In every year, the frequency of claims in the GTA exceeds the
frequency of claims in the rest of the province. The volatility of claim frequency in the GTA is also much
greater. It is also evident that the tightening of the verbal threshold in 2003 had a greater impact on
claims in the GTA than in the rest of the province. However, the impact was short lived as claims
frequency increased dramatically in the following years.
Figure 4B – Ontario Comparison Number of BI Claims per 100 Vehicles
Source: Authors’ calculations from GISA data
Higher population density has also been shown to be correlated with fewer serious accidents
(Kochanowski and Young, 1985; and Kelly, Kleffner and Tomlinson, 2010), especially if it is associated with
-
0.05
0.10
0.15
0.20
0.25
0.30
BI Accident Frequency
GTA Halton/HamiltonOttawa KW Guelph CambridgeRest of ON
73
more inner‐city and less rural interstate driving (Cummins, Phillips and Weiss, 2001). Because of the
threshold for tort claims in Ontario, BI claims arise from accidents severe enough to pierce the threshold,
which would arguably imply that jurisdictions with a higher frequency of bodily injury liability claims have
more serious accidents. Except for Ottawa, the results of this graph are opposite to the expected. We had
anticipated that less urban and rural areas (i.e., the rest of Ontario) should have the highest rate of
liability claims and the jurisdictions with the most congested roads (i.e., the GTA) should have a much
lower frequency of BI claims.
Figure 5A shows trends in annual average BI claim severity (cost per claim) for Ontario versus the
other provinces, and Figure 5B provides the GTA versus the rest of the province. As expected, the verbal
threshold in Ontario leads to high average claim severity relative to other provinces. We also observe
large variations in average severity over time, suggesting that the auto insurance reforms did affect claim
severity. From 1991 to 1993 bodily injury liability severity trended upward, implying that in real terms,
even with the strict verbal threshold, claims costs were growing. A sharp drop in average severity is
observed in 1994 with only a slight uptick in costs through 1996. The removal of the right to sue for
economic loss greatly reduced the size of claims payments. However, settlements for non‐economic
damages continued to grow slightly. The right to sue for economic losses was restored in 1996, and
average claim severity rose in every year between 1997 and 2002, before experiencing a slight drop in
2003.
74
Figure 5A – Average BI Costs per Claim in Constant 2010 $ – Provincial Comparisons
Source: Authors’ calculations from GISA data
The auto reforms in 2003 had an immediate, but short‐lived impact of reducing claims costs.
However, in 2004 and 2005 severity rose rapidly before trending downward from 2006–2009. In 2010 BI
severity increased again, although in real terms average BI claim severity was 3.25 percent less in 2010
than in 1991. This growth in liability severity is concerning. Opponents of no‐fault insurance argue that
the adversarial process of the tort system is more effective in containing claims costs. Yet in Ontario we
observe a lack of cost containment for even those claims settled through the tort process. This has not
been the experience in the other three provinces, which saw much lower average claim severity, slower
growth in severity over time, and reductions in claims severity after insurance reforms during the 2003 to
2005 time period.
$0
$20,000
$40,000
$60,000
$80,000
$100,000
$120,000
$140,000
$160,000
$180,000
$200,000
BI Claim Severity in Constant 2010 $
Ontario Alberta New Brunswick Nova Scotia
75
Figure 5B – Ontario Comparison Average BI Costs per Claim in Constant 2010 $
Source: Authors’ calculations from GISA data
Figure 5B depicts the severity of accidents within different parts of Ontario. The GTA has on
average the lowest severity of all claims, and the smaller towns and rural areas that create the “rest of
Ontario” have the highest claim frequencies. Severities for other cities generally fluctuate between these
two boundaries, and it is evident that the various reforms have not had a uniform impact on the size of
claims over the various regions in Ontario. The random fluctuations in claim severity over time do not
contradict the hypothesis that the adversarial nature of the tort process is efficient in minimizing the
impact of excessive claims behaviour, at least at an individual claims level. Overall, these claim severity
results are more consistent with expectations from the literature. However when combined with the
results from Figure 4B, it is likely that there are many nuisance claims filed in the larger urban centres.
Because different insurance compensation rules may lead to shifting of costs between BI and
first‐party accident benefits (AB) coverages, it is possible that the increases in BI claim severity are
mirrored by corresponding reductions in AB severity. Figure 6A and Figure 6B explore this hypothesis,
plotting the average injury cost per insured vehicle for the study period.
$0
$50,000
$100,000
$150,000
$200,000
$250,000
BI Claims Severity
GTA Halton/Hamilton
Ottawa KW Guelph Cambridge
Rest of ON
76
Figure 6A – Average AB+BI Costs per Insured Vehicle in Constant 2010 $ – Provincial Comparisons
Source: Authors’ calculations from GISA data
The 1994 reforms in Ontario (more generous first‐party benefits and a reduction in the tort
threshold) resulted in an increase in the injury claims costs per vehicle, as expected. There was a 15
percent drop in injury costs from 1996 to 1997 after the introduction of the two‐tiered benefit schedule
in Bill 59. However injury costs per vehicle rose steadily until reforms were enacted again in 2003. From
2002 to 2004, injury costs per vehicle fell from $690 (constant 2010 dollars) to $555, yet claims costs
began rising steadily in 2005. Fundamentally, the average cost per injury in Ontario is much higher than
what is paid in the tort provinces of Alberta, New Brunswick, and Nova Scotia.
$0
$100
$200
$300
$400
$500
$600
$700
$800
$900
$1,000
$1,100Average AB+BI Loss per Vehicle 2010 $
Alberta New Brunswick Nova Scotia Ontario
77
Figure 6B – Ontario Comparison Average AB+BI Costs per Insured Vehicle in Constant 2010 $
Source: Authors’ calculations from GISA data
Figure 6B graphs the accident benefits and BI loss per vehicle for the four largest urban areas and
the remainder of Ontario. Except for the GTA, there has been very little change in claims levels from 2000
to 2009. The average annual combined growth rate for the regions is less than 3 percent. It is possible
that there is some expansion of benefits over the nine years. Additionally, if price inflation in the medical
sector exceeds the general level of price expansion, then we would also see growth over time. If we
examine the non‐GTA regions only, we see a decrease in overall costs in 2003, indicating that those
reforms were successful. There is a slight increase again in 2006 when the DACs were eliminated.
Although average claims costs increased overall between 2008 and 2009, only in Ottawa do 2009 claims
exceed claims levels in 2002 and 2003.
Despite the experience in the remainder of Ontario, claims costs are growing exponentially in the
GTA and have been consistently higher than in the other regions. The 2003 reforms provided short term
relief to claims growth, but by 2007 claims were again at 2002 levels. The average loss per vehicle grew
$0
$200
$400
$600
$800
$1,000
$1,200
$1,400
$1,600
Average AB+BI Loss per Vehicle 2010 $
GTA Halton/Hamilton
Ottawa KW Guelph Cambridge
Rest of ON
78
by 14 percent between 2007 and 2008 and 26 percent between 2008 and 2009. However, according to
the Ontario Road Safety Annual Reports for 2008 and 2009 produced by the Ministry of Transport, there
were 7.7 percent fewer accidents, 18 percent fewer fatal accidents, and an increase of 3 percent in
accidents in which individuals were reported to be injured. Thus it does not appear that the rapid claims
growth is caused by a dramatic increase in the number of serious accidents.
5.3.2 CompulsoryPropertyDamageClaims
The next set of figures show comparable data for property damage (PD) claims under compulsory
coverages (third‐party liability and DC‐PD combined) for Ontario versus other provinces. The data in
Figure 7A show that PD claim frequency is higher in Ontario than in other provinces, but follows a
generally downward trend during the study period. The PD claim frequency rate was nearly 30 percent
lower in 2010 than 1991. Although PD claim frequencies are falling in all provinces, the fact that Ontario’s
claim frequency is the highest in almost every year is puzzling, since statistics collected by Transport
Canada suggest that there are significantly relatively fewer accidents on Ontario roads than in the other
provinces. In 2009 (2003), the percentage of road fatalities per 100,000 population was 4.1 (6.9) in
Ontario, 7.7 (7.5) in Nova Scotia, 8.8 (12.4) in New Brunswick, and 9.6 (12.2) in Alberta.
Figure 7B shows the provincial distribution of direct compensation property damage claims only,
and as such is not directly comparable to Figure 7A. This graph is consistent with expectations: there is a
greater frequency of claims in more congested urban areas, and a lower frequency in rural areas. The
greatest decline in frequency is in the GTA.
79
Figure 7A – Number of PD Claims per 100 Vehicles – Provincial Comparisons
Source: Authors’ calculations from GISA data
Figure 7B – Ontario Comparison Number of PD claims per 100 Vehicles
Source: Authors’ calculations from GISA data
The declining property damage claim frequency suggests that the increase in BI claim frequency is
not due to an increase in accident rates. In fact, comparing trends in Figure 4A to those in Figure 7A
0.00
0.50
1.00
1.50
2.00
2.50
3.00
3.50
4.00
4.50
5.00
PD Claim Frequency
Ontario Alberta New Brunswick Nova Scotia
-
1.00
2.00
3.00
4.00
5.00
6.00
DC-PD Claim Frequency
GTA Halton/Hamilton
Ottawa KW Guelph Cambridge
Rest of ON
80
reveals that the number of BI claims per PD claim (both DC‐PD and PD liability) in Ontario increased
nearly 250 percent between 1991 and 2010. This is displayed in Figure 8A. Again, because fewer claims
pierce the threshold in Ontario, liability claim frequencies are much lower in Ontario. Also evident from
this graph is that the auto insurance reforms of 2003–2005 in New Brunswick, Nova Scotia, and Alberta
were largely successful in containing growing BI claims.
Figure 8A – Number of BI Claims per 100 PD Claims – Provincial Comparisons
Source: Authors’ calculations from GISA data
Values calculated in Figure 8B are the ratios of accident benefit claims to DC‐PD claims, and as
such examine all accidents that give rise to claims. Consistent with earlier graphs, the GTA has the highest
ratio of AB to DC‐PD claims, although there is evidence that the 2003 reforms curtailed the number of
personal injury claims in the GTA. It is difficult to reconcile why the average rate of personal injury claims
in the GTA is significantly higher than the rest of the province. The higher ratio in the GTA is even more
difficult to interpret when the ratio of accidents with personal injury (including fatality) to total accidents
using Ministry of Transportation collision data (2009) is 0.23. For Ottawa, the corresponding ratio is 0.20
and for the combined regions of Waterloo and Wellington (similar to GISA statistical territory of
0.00
0.05
0.10
0.15
0.20
0.25
0.30
0.35
0.40
0.45
Ratio of BI to PD Claim Frequency
Ontario Alberta New Brunswick Nova Scotia
81
Brantford, Guelph, Kitchener‐Waterloo, and Cambridge) the ratio is 0.21. The Ministry of Transportation
ratios are expected to be lower as they will account for all accidents reported to the police, but the data
in Figure 8B would not include (in the denominator) single vehicle accidents which give rise to property
damage only. There may be other reasons related to claiming behaviour that would also give rise to slight
differences between the two sets of ratios. However, it is difficult to reconcile the differences in ratios for
the GTA.
Figure 8B – Ontario Comparison Number of BI Claims per 100 PD Claims
Source: Authors’ calculations from GISA data
Figure 9A reveals that property damage claim severity increased at a rate slightly higher than the
general inflation rate in each province, but the increases in Ontario are similar to those in other
provinces. These data show that the auto insurance reforms had little or no effect, as expected. Although
there are some variations in the trends over time, the time patterns are largely consistent with those in
other provinces. Similarly, as shown Figure 9B, claims in the GTA were slightly higher than the rest of
Ontario, but that could also reflect a higher cost of repairs, or a higher quality of car.
-
0.10
0.20
0.30
0.40
0.50
0.60
Ratio of AB to DC-PD Claim Frequency
GTA Halton/Hamilton
Ottawa KW Guelph Cambridge
Rest of ON
82
Figure 9A – Average PD costs per Claim in Constant 2010 $ – Provincial Comparisons
Source: Authors’ calculations from GISA data
Figure 9B – Ontario Comparison Average DC‐PD costs per Claim in Constant 2010 $
Source: Authors’ calculations from GISA data
$0
$1,000
$2,000
$3,000
$4,000
$5,000
$6,000
PD Claim Severity in Constant 2010$
Ontario Alberta New Brunswick Nova Scotia
$0
$1,000
$2,000
$3,000
$4,000
$5,000
$6,000
DC-PD Claims Severity
GTA Halton/HamiltonOttawa KW Guelph CambridgeRest of ON
83
5.3.3 StatutoryAccidentBenefits
We now turn to analysis of trends in claims for statutory accident benefits (AB). To provide
greater insights we present the data separately for medical costs benefits and non‐medical benefits such
as income replacement and attendant care. Data for the territorial comparisons within the province are
not separated by medical and non‐medical benefits and thus are not presented here.
Figure 10 and Figure 11 display provincial trends in medical cost claim frequency and severity,
respectively. Figure 10 shows that for much of the study period, the frequency of claims for medical
benefits in Ontario was about the same as that in other provinces. Again, this is problematic given the
lower accident rates in Ontario compared with other provinces. Claim frequency increases through 1994,
declines in 1995–1997, increases again from 1998–2002, begins to decline in 2003 then declines sharply
in 2004–2008. In 2009 claim frequency again begins to rise. Notably, mandatory first‐party accident
benefit coverage was in place over the entire time frame and as such, absent moral hazard, there should
be no relationship between claim frequency and specifics of the auto insurance product.
Figure 10 – Number of Medical Benefits Claims per 100 Vehicles – Provincial Comparisons
Source: Authors’ calculations from GISA data
0.00
0.20
0.40
0.60
0.80
1.00
1.20
Medical Benefits Claim Frequency
Ontario Alberta New Brunswick Nova Scotia
84
Figure 11 shows trends in average medical coverage claim severity over time. The data show the
costs of these claims in Ontario are much higher than other provinces, and that Ontario has experienced
dramatic increases in costs over time both relative to general inflation and relative to other provinces. It
is reasonable, however, to expect that Ontario has higher claims severity than the tort provinces, both
because first‐party coverage limits are higher in Ontario but also, if the verbal threshold is effective,
fewer claims will be settled under the tort mechanism and injured parties will be compensated primarily
through first‐party accident benefits.
Figure 11 – Average Medical and Rehabilitation Expenses Costs per Claim in Constant 2010 $ –
Provincial Comparisons
Source: Authors’ calculations from GISA data
The effects of auto insurance reforms are nonetheless evident in the data. For example, there is a
notable increase in claim severity in the 1993–1996 period, with a marked decline in 1997. Since Bill 164
in 1994 enhanced accident benefit coverage and eliminated the right to sue for economic loss, claim
severity was expected to grow. In November 1996, Bill 59 introduced a two‐tiered schedule of accident
benefit payments, and fewer claimants had access to the more generous benefits.
$0
$10,000
$20,000
$30,000
$40,000
$50,000
$60,000
$70,000
Medical Benefits Claim Severity in 2010 $
Ontario Alberta New Brunswick Nova Scotia
85
Beginning in 1997, average claim severity trended gradually upward until 2003 when the rate of
increase relative to CPI became more rapid. Between 2003 and 2009 average medical coverage claim
severity increased 33 percent in real terms. However, there is no inflection point observed after 2006,
contrary to the suggestion that elimination of the DACs led to higher claim costs. The reforms of 2003
were associated with reducing the assessment costs and tightening the verbal threshold. The rapid
growth in claim severity would indicate that these reforms were largely unsuccessful. In 2010 average
claim severity declined in real terms. Thus preliminary results indicate that lowering benefits available to
those that are not catastrophically injured had a real impact on claims costs.
Figure 12 and Figure 13 display the between‐province trends for income replacement, attendant
care, and other non‐medical benefits. The frequency of non‐medical benefits claims declines markedly
over time, from 0.14 per 100 vehicles in 1991 to 0.08 per 100 vehicles in 2010. Comparing the trends in
Figure 12 to those in Figure 7A for property damage claims reveals further that non‐medical benefits
claims per property damage claim decreased by nearly 43 percent over the period. This suggests a real
decline in these claims, over and above the decline in accidents over this period.
Moreover, the patterns over time suggest that declines occurred in response to insurance
reforms. Non‐medical benefit claims declined from 1991–1993, spiked up in 1994 and then declined
sharply until 1996. This growth in 1994 is consistent with the introduction of weekly benefits to a larger
group of insureds (unemployed, caregivers, and students). The reduction in 1996 coincides with the
introduction of the two‐tiered benefit schedule and the requirement that the claimant must be
catastrophically injured to receive future care costs. The frequency of claims increased gradually after
1996 until 2003, when another steep decline was observed. Although those not catastrophically injured
could claim future care costs after 2003, other initiatives aimed at reducing moral hazard associated with
86
accident benefit claims appear to have been successful. Non‐medical benefits claim frequency has been
relatively constant since 2004.
Figure 12 – Number of Non‐Medical Benefits Claims per 100 Vehicles – Provincial Comparisons
Source: Authors’ calculations from GISA data
Figure 13 – Average Non‐Medical Benefits Costs per Claim in Constant 2010 $ – Provincial Comparisons
Source: Authors’ calculations from GISA data
0.00
0.10
0.20
0.30
0.40
0.50
0.60
0.70
Non-Medical Benefits Claim Frequency
Ontario Alberta New Brunswick Nova Scotia
$0
$10,000
$20,000
$30,000
$40,000
$50,000
Non-Medical Benefits Claim Severity in 2010 $
Ontario Alberta New Brunswick Nova Scotia
87
Average claim severity for non‐medical benefits claims, seen in Figure 13, also appears to be
sensitive to the auto insurance reforms. Claim severity increased gradually from 1991–1993 and at a
more rapid pace from 1993–1996. In 1997, after the introduction of the two‐tiered schedule of payments
in Bill 59, average claim severity fell in real terms back to about 1991 levels. However, inflation in claim
severity outpaced general CPI increases each year, so that claim severity rose in real terms in every year
since then. The Ontario Auto Insurance Anti‐Fraud Task Force (2011), notes that the biggest increases
from 2006 to 2010 in these non‐medical benefits costs per insured vehicle have been in housekeeping
awards (an increase of 178 percent) and attendant care (increase of 67 percent). Overall, during the
period 1991–2010 average non‐medical claim severity increased nearly 110 percent in real terms.
We now examine the frequency of accident benefits claims in Figure 14 and the severity of claims
in Figure 15 for the four largest urban areas compared to the rest of Ontario. As with the earlier analyses,
Figure 14 also shows that the claiming behaviour in the GTA is markedly different than the rest of the
province. The frequency of accident benefit claims in the GTA is almost double that of the rest of the
province. According to the Ontario Ministry of Transportation (2009), the number of people injured in
accidents per 100 vehicles registered is 1.58 in the GTA compared to 0.78 in Ottawa and 1.87 in Waterloo
and Wellington regions. However, the rate of accident benefit claims per 100 vehicles for both Ottawa
and Waterloo‐Wellington is substantially lower than the number of individuals who are injured. In the
GTA, the rate is higher. The fatality rate is also lower in the GTA than in either Ottawa or Waterloo‐
Wellington.22 Thus again, the higher claims in the GTA do not seem to be associated with actual road
conditions or accident rates. Therefore it is not surprising that reforms introduced in 2003 to reduce
excessive claiming behaviour had more of an impact in the GTA than the rest of the province.
22 The fatality rate is often used as a measure of overall accident severity in a jurisdiction because there is no moral hazard associated in the claiming behaviour for fatalities.
88
Figure 14 – Ontario Comparison Accident Benefits Frequency
Source: Authors’ calculations from GISA data
Figure 15 graphs the average AB severity per claim for the four largest urban areas in Ontario and
the remainder of the province. All territories exhibit an upward growth, even though overall inflation
levels have been removed from the data. This is an indication that reforms have not been successful in
containing first‐party benefit costs at the individual claims level. Before 2006, the levels of losses were
fairly comparable across all regions (with Ottawa having the consistently lowest costs). However, after
2006 claims costs grew dramatically across the province, indicating that the DACs were serving a valuable
role with respect to cost containment. The growth in the GTA is particularly explosive with accident
benefit claims growing at an annual rate of 23 percent. Given that we expect less severe accidents in the
GTA and that there is no external indication that the severity of accidents was growing at this rate, this
would indicate that either there is excessive claiming behaviour or outright fraudulent behaviour in the
GTA.
-
0.50
1.00
1.50
2.00
2.50
3.00
Accident Benefits Claim Frequency
GTA Halton/Hamilton
Ottawa KW Guelph Cambridge
Rest of ON
89
Figure 15 – Ontario Comparison Accident Benefits Costs per Claim in Constant 2010 $
Source: Authors’ calculations from GISA data
5.4 SystemPerformance
As we noted earlier, the issues of affordability and availability are crucial when auto insurance is
compulsory. For this reason, auto insurance often becomes a politically charged issue. The criteria of both
fairness and informed customers, regardless of the underlying auto insurance mechanism adopted, are
also important criteria that are often overlooked, especially when there are more severe problems with
the product.
Figure 16A shows the average premium per province for Ontario, Alberta, New Brunswick, and
Nova Scotia for 1991 to 2010 and Figure 16B shows the average premiums across the different territories
in Ontario. Similar figures have been calculated by consumer groups and the public press to promote a
$0
$10,000
$20,000
$30,000
$40,000
$50,000
$60,000
$70,000
Accident Benefits Severity
GTA Halton/Hamilton
Ottawa KW Guelph Cambridge
Rest of ON
90
discussion about the auto insurance premiums across the country and within the province.23 These
figures show that across the private market provinces drivers in Ontario, and especially drivers in the
GTA, pay the highest premiums. In the absence of unbiased information on costs, drivers may assume
that high premiums are being driven by insurers earning higher profits. Without knowledge of the
underlying claims costs, drivers in Ontario, and especially drivers in the GTA, believe that they are paying
too much for auto insurance.
Figure 16A – Average Premium All Coverages in Constant 2010 $ – Provincial Comparisons
Source: Authors’ calculations from GISA data
23 See, for example Arbitrage Magazine at http://www.arbitragemagazine.com/general/paying‐higher‐auto‐insurance‐premiums/; the website Autos.Ca.Msn.Com at http://autos.ca.msn.com/editors‐picks/canadas‐highest‐auto‐insurance‐rates; and the Consumers’ Association of Canada at http://www.consumer.ca/index.php4?id=1696.
$0
$200
$400
$600
$800
$1,000
$1,200
$1,400
$1,600
Average Premium in Constant 2010 $
Ontario Alberta New Brunswick Nova Scotia
91
Figure 16B – Ontario Comparison Average Premium All Coverages in Constant 2010 $
Source: Authors’ calculations from GISA data
To determine whether premiums are too high requires comparing premiums to losses, however.
Figure 17A shows loss ratios, which are calculated as total incurred losses divided by total earned
premiums, for Ontario, Alberta, New Brunswick, and Nova Scotia for 1991 to 2010. The figure
demonstrates clearly that drivers in Ontario are not paying higher premiums so that insurers can earn
greater profits. Although Ontario drivers pay the highest premiums, insurers earn the least amount of
profit from this book of business.
The loss ratios for Ontario are too high to be sustainable: insurers cannot continue to offer the
product at current pricing levels given the level of benefits paid out. Insurers, being private companies,
must earn a fair rate of return or they will have to withdraw from the market. Figure 16A provides further
insight on reforms in the other private market provinces. Reforms enacted in other provinces have
generally been successful. Other provinces have experienced declining or relatively flat premiums (with
respect to overall inflation) since 2003 and yet as shown in Figure 17A, insurers have also experienced
$0
$500
$1,000
$1,500
$2,000
$2,500
Total Premium per Vehicle
GTA Halton/HamiltonOttawa KW Guelph CambridgeRest of ON
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large declines in loss ratios. Reforms in other parts of the country have addressed affordability concerns
without threatening the sustainability of insurers.
Figure 17A – Auto Loss Ratio by Province
Source: Authors’ calculations from GISA data
Fairness, where consumers benefit from fair treatment both in the pricing of the insurance
product and in the claims settlement process, is also a goal of a healthy insurance system. Because the
product is different in each province, it is difficult to evaluate fairness in pricing across the country. It is
more straightforward to consider fairness within the same jurisdiction. Figure 17B shows loss ratios for
Ontario only and provides a basis for discussing both sustainability and fairness. Most evident is that
there are issues in terms of sustainability. Insurers cannot provide the rate of return required by their
shareholders when loss ratios are in excess of 100 percent. Thus, as was illustrated in Figure 17A, there
are province‐wide sustainability concerns.
The auto policy, and the benefit provisions provided, is the same in all territories across Ontario.
Thus fairness would imply that drivers pay the same for insurance, relative to their expected losses,
0
20
40
60
80
100
120
Industry Auto Loss Ratio in Percent by Province
Ontario Alberta New Brunswick Nova Scotia
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across the province. Figure 17B illustrates that this is not the case, especially in more recent years. From
2000 until 2005, lower loss ratios in Ottawa clearly indicate that this territory was in some part
subsidizing the rest of the province. Since 2005, the entire province has been subsidizing the GTA. The
growth in premiums in the GTA has not even come close to covering costs within this territory. This is
clearly not vertically fair for drivers living outside of the GTA. As well, a fairness concern also arises due to
low‐risk drivers in a high loss territory having to pay higher premiums due to where they live. Across
territories, this pricing structure is not sustainable. Because of rate regulation, even in the presence of a
take‐all‐comers rule, insurers will have an incentive to minimize their presence in the GTA in order to
compete within the more profitable territories. This will create an availability issue in the GTA.
Figure 17B – Ontario Comparison of Auto Loss Ratios
Source: Authors’ calculations from GISA data
Figure 18A shows the combined impact of the trends in frequency and severity of Ontario auto
insurance claims on loss costs per vehicle in constant dollar terms and compared to other provinces. The
data show that Ontario auto insurance costs in 1991 were comparable to costs in other provinces (lower
0
20
40
60
80
100
120
Drivr Age
Industry Auto Loss Ratio
GTA Halton/HamiltonOttawa KW Guelph CambridgeRest of ON
94
than Alberta, 11 percent higher than New Brunswick, and 22 percent higher than Nova Scotia). By 2010
average auto insurance loss per vehicle was dramatically higher than in other provinces. In addition,
Ontario is the only province in which loss costs had increased in real terms. In 2010 Ontario’s average loss
cost per car was 173 percent of Alberta’s average loss cost, 270 percent of New Brunswick’s, and 290
percent of Nova Scotia’s.
Figure 18A – Total Losses per Insured Vehicle in Constant 2010 $ – Provincial Comparisons
Source: Authors’ calculations from GISA data
Figure 18B graphs the total losses per vehicle for the different territories in Ontario. Except for
the GTA, the results are encouraging: claims costs have been largely contained, and there has been little
real growth in losses per vehicle since 2000. The story in the GTA is different. Losses fell sharply with the
2003 reforms, and since then have been increasing at a rate of roughly 12 percent a year.
$0
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$400
$600
$800
$1,000
$1,200
$1,400
$1,600Losses per Vehicle in Constant 2010 $
Ontario Alberta New Brunswick Nova Scotia
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Figure 18B – Ontario Comparison – Total Losses per Insured Vehicle in Constant 2010 $
Source: Authors’ calculations from GISA data
5.5 SummaryandInterpretation
Ontario’s private market auto insurance system offers generous first‐party benefits and the right
to sue for injuries sustained in an automobile accident when injuries exceed the verbal or monetary
threshold. Insurance is mandatory for all drivers, and therefore consumers need to have access to an
affordable product that suits their needs. Insurers must be able to provide the auto insurance product in
a manner that is fair and efficient to consumers, and must sell insurance at prices that are viable in the
long run. However, the analysis presented above and in Section 4 clearly indicates that these objectives
for a well‐functioning insurance market are not being met in Ontario.
Even with a take‐all‐comers rule in place, we find some evidence in Table 2 and Table 3 that there
are availability concerns. Given the mismatch between losses incurred and premiums charged as
evidenced in the fairness measures in Table 2, and the graph of loss ratios (Figure 17B), we anticipate that
these availability concerns, especially in the GTA, will increase in the future. Service quality is also an
$0$200$400$600$800
$1,000$1,200$1,400$1,600$1,800$2,000
Total Loss Per Vehicle
GTA Halton/Hamilton
Ottawa KW Guelph Cambridge
Rest of ON
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issue, as evidenced in Table 3. Additionally, Insurance Bureau of Canada notes that currently there are
30,000 unresolved claims in Ontario awaiting dispute resolution services.24
A 2012 survey by InsurEye Inc., however, found that drivers in Quebec, Saskatchewan, and
Ontario were the most positive about the quality of auto insurance in their provinces. In spite of the high
cost, Ontarians were in general happy with their claims experience. Drivers in British Columbia and
Manitoba had the lowest consumer satisfaction with auto insurance, and in particular drivers were
unhappy with their limited choices for auto insurance.25
Auto insurance reforms over the past two decades in Ontario have been aimed at reducing the
cost of insurance. But now the average premium in Ontario is over $1400, and as can be seen in both
Figure 3 and Figure 16, past reforms have been ineffective at reducing premiums. Reform policies in
Ontario appeared to affect outcomes in the short run, but in many cases inflationary trends quickly
reappeared, especially in the GTA. Two exceptions to this are in bodily injury liability claim severity and
disability income claim frequency. Trends in these cost elements appear to have been affected over the
longer term by the auto insurance reforms.
The high premium cost in the GTA is particularly problematic; however it is important to
emphasize that premiums are not being driven by insurer profits, as can be seen by the high loss ratios in
Figure 17B. There are many insurers operating competitively in Ontario. High premiums stem from the
fact that Ontario claim frequency and severity are higher than in other provinces in almost all cases and
all years, and especially across the GTA. The higher claim severity may be due to higher cost‐of‐living in
24http://www.canadianunderwriter.ca/news/claims‐costs‐for‐ontario‐auto‐insurers‐still‐out‐of‐control‐ibc/1001413525/
25http://www.canadianunderwriter.ca/news/quebec‐drivers‐most‐satisfied‐with‐auto‐insurance‐b‐c‐drivers‐the‐least‐survey/1001353834/
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the GTA and more generous benefits in the Ontario auto product, but this cannot be determined with
certainty from the comparisons here. Moreover, the increases over time in both claim frequency and
claim severity have been substantially greater in Ontario than in other provinces. An equally problematic
observation is that compared with the other provinces, Ontario has a lower frequency of reported
collisions, making the higher frequencies for first and third party bodily injury and property damage
claims difficult to reconcile. These underlying claims pressures threaten the entire provincial auto
insurance market.
A further insight obtained from this analysis is that the auto insurance product is sustainable
across most of Ontario. Total losses per vehicle have been relatively flat across all parts of Ontario (except
for the GTA). It is the GTA that is creating sustainability issues and the GTA is being subsidized by drivers
in the rest of the province. The impact of decades of prior approval rate regulation has led to a
supposedly risk‐based pricing system that no longer adequately separates insureds by their accident
costs. To ensure affordability, changes to differentials for rating variables have been capped increasing
cross‐subsidization across different risk profiles of insureds.
Most concerning is that there have been no successful cost containment measures within the
GTA from any of the previous product reforms. This contrasts with the experiences in the tort provinces,
where there have been sustainable reductions in the frequency and severity of bodily injury liability
claims, and therefore premiums, since enacting reforms. These trends highlight the reality that regulatory
reforms may address today’s most easily observable problems while masking larger systemic issues. Some
current proposals for solving Ontario’s auto insurance problems are susceptible to this criticism. In 2012,
three bills were introduced by two GTA members of parliament in the Ontario legislature: Bill 43
“Insurance Amendment Act (Elements in Classifying Risks for Automobile Insurance)”; Bill 45 “Insurance
Amendment Act (Risk Classification Systems for Automobile Insurance)”; and Bill 71 “New Drivers'
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Insurance Rate Reduction Act.” The aim of all these bills was to reduce the price of insurance in the GTA
by removing various risk‐based rating variables such as territory, age, and gender of driver. The discussion
of pricing mechanisms in Section 3.4 of this report, and the evidence presented here regarding higher
claims costs in the GTA relative to the rest of Ontario, demonstrate that these proposals address only the
symptoms of the problem and will not improve outcomes for the auto insurance system.
More thoughtful reforms are needed. Gambrill (2009) sums up the problems succinctly: “The
system is too complex, nobody understands or wants to fill out the paperwork, there are too many health
professionals’ assessments for minor injuries, most of the insurers’ money is propping up the system
(including cottage industries for assessment) rather than going to the claimants, the system
disproportionately caters to minor injury claimants, etc. etc.” (p. 26).
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6 ExperiencefromOtherJurisdictions
As noted previously, different jurisdictions choose varying combinations of auto insurance design
features which leads to important differences across auto insurance systems. Different jurisdictions also
place different weights on the various objectives of automobile insurance. Nonetheless, all auto
insurance systems pursue the same basic objectives and adjust the same set of decision variables to
determine the final system design. Moreover, the effects of auto insurance design on the incentives and
behaviours of participants is an issue that must be dealt with in all systems. Considering the experiences
of other jurisdictions may therefore yield insights into beneficial or problematic system design features,
and lessons regarding solutions to auto insurance problems. This section of the report describes the
characteristics of auto insurance systems in a range of comparison countries, and summarizes lessons
obtained from more detailed analysis of several of these auto insurance systems. The case studies of the
selected systems are presented in the Appendix.
6.1 InsuranceSystemsinOtherCountries
In the U.S., much like in Canada, auto insurance systems are determined at the state level. All
states have privately administered systems, and the majority of states employ tort‐based compensation
and optional first‐party injury insurance (with compulsory minimum liability insurance requirements). A
few states employ partial no‐fault systems in which first‐party injury insurance is mandatory, but benefit
limits are typically low. Michigan is the only no‐fault state with compulsory first‐party insurance which
provides for unlimited medical benefits. Michigan is also unique among the states in providing for
automobile accident property losses on a no‐fault basis. Several states allow drivers to choose between
no‐fault and tort‐based compensation, and others allow optional purchase of first‐party injury benefits.
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In most states, auto insurance pricing is largely risk‐based but about one‐third of states actively
regulate rates. A few states have statutes or regulations that require rate differences across groups to be
capped or leveled, or that restrict rating territories; but the restrictions are generally modest. A larger
number of states place restrictions on the use of age and gender as rating factors (Weiss, Tennyson and
Regan, 2010). Historically, several U.S. states have experimented with regulated insurance pricing
mechanisms that provide significant premium subsidies to some consumer groups. However, these
systems proved unsustainable and the social pricing mechanisms were largely abandoned (Bartlett, Klein
and Russell, 1999; Derrig and Tennyson, 2011).
Auto insurance systems in Europe are also privately administered tort‐based systems. Liability
insurance for both bodily injury and property damage is compulsory, but first‐party injury insurance is
optional. While the European Union (EU) single market initiatives have led to some standardization of
systems across countries, allowable damages and injury compensation vary in accord with national tort
laws (CEA, 2010). Minimum liability limits tend to be much higher in Europe than in North America, with
compulsory per person injury liability in the range of €2.5 million and property damage liability of
€1 million (CEA, 2007). EU directives mandate that auto insurance pricing is risk‐based and not subject to
government regulation, although prior to 1994 auto insurance prices were extensively regulated and
often set by government or an industry association (CEA, 2010). The transition to market‐based pricing
was unevenly paced across countries but by 2005 all EU members had deregulated auto insurance rates.
Like Canada and the U.S., Australia’s auto insurance systems vary by state. Third‐party liability
insurance for bodily injury is mandatory in all provinces. Compulsory third‐party liability insurance is
provided through a government monopoly in several states, including Victoria, South Australia, and
Western Australia. In these states third‐party liability insurance is funded through fees levied on vehicle
registrations, and benefits are determined by the state. In South Australia and Western Australia
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compensation is available through the government insurance fund only for not‐at‐fault drivers. Victoria’s
government fund administers a no‐fault system. The fund compensates all injured parties for medical and
rehabilitation expenses. Private lawsuits (against at‐fault drivers) for pain and suffering or loss of earnings
are permitted in cases of serious injury, but damages are capped. New South Wales, in contrast, has a
privately administered system of compulsory third‐party injury insurance in which claims are
compensated on a no‐fault basis, with private lawsuits allowed only in cases of serious injury.26
New Zealand operates a government‐run pure no‐fault system of injury compensation, under
which all litigation is barred. The Accident Compensation Corporation (ACC) provides personal injury
insurance for all injuries – not just auto‐related injuries – which is funded through vehicle registration
fees and gasoline taxes. Benefits cover a broad range of services including medical care and
rehabilitation, home care and wage replacement, all subject to government‐determined compensation
schedules.27
This brief consideration of auto insurance systems in other countries illustrates the variety of
systems in use. However, it also illustrates the commonalities in auto insurance systems across the world.
Brief summaries of the experiences of Alberta and two U.S. states are presented in more detail in the
Appendix, in order to provide insights into problems and solutions that may be relevant for Ontario. The
following section summarizes and draws implications from these cases.
6.2 SummaryofCaseStudies
The case studies in the Appendix recount the experiences of three different jurisdictions with
auto insurance cost growth problems: Alberta in Canada, and Massachusetts and Michigan in the U.S.
26 This information was obtained from Australian state insurance regulatory websites.
27 The information was obtained from the website of the ACC.
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Most generally, these case studies provide confirmatory evidence that cost problems are not unique to
Ontario or its auto insurance system. While all three case studies are based on private insurance systems,
Alberta has tort‐based auto insurance; Massachusetts has partial no‐fault with a low tort threshold and
minimal first‐party accident benefits; Michigan has partial no‐fault but with a threshold based on serious
permanent injury and unlimited first‐party accident benefits. In each of these jurisdictions, availability
and affordability of insurance have been important objectives to decision makers; thus, their experiences
with problems and solutions are relevant for Ontario.
Problems of affordability and accessibility in Alberta, especially for young drivers, led to
imposition of regulatory restrictions on rates and classification variables. After the 2003 reforms in
Alberta, significant cost reductions were achieved in BI claim severity, in part due to the establishment of
a cap on pain and suffering awards for minor injuries. At the same time accident benefits were increased
and the government instituted treatment protocols for minor injuries. Despite the increase in accident
benefits there was still a decline in total AB + BI costs as shown in Figure 6A, from $573 in 2002 to $318 in
2005, falling further to $254 in 2009. More recently, however, there is evidence that more claimants are
not being treated within the set time periods/number of treatments established in the treatment
protocols. A further concern is recent evidence that claimants are attempting to have claims fall outside
the definition of minor injury. Concerns about cost inflation have returned in recent years.
To protect affordability and consumer access to compulsory insurance, Massachusetts introduced
a strong set of social pricing criteria, strict control over insurance rates, and strict mandates regarding
insurance provision and payment of claims. While successful in promoting access to insurance, the system
worked less well in promoting affordability. High‐risk drivers received large subsidies to their insurance
premiums, but the average cost of insurance rose more rapidly than in other states. Over the longer term
the system’s emphasis on premium leveling and insurance availability severely diminished private
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insurance supply, and reduced all participants’ incentives to hold the line on insurance costs. Organized
fraud rings arose to take advantage of this situation. Coordinated anti‐fraud efforts and relaxation of rate
regulations helped to reverse the adverse trends.
Michigan administers the most ambitious no‐fault auto insurance plan in the U.S., with strict
limits on the right to sue for personal injuries and generous lifetime benefits to those injured in
automobile accidents. The costs associated with catastrophic injuries (those exceeding $500,000) are
spread over all drivers in the state through an annual premium surcharge. The compensation system
works well, assuring that all injured persons receive adequate benefits and without the high legal costs
and delays associated with the tort system. However, there have been persistent cost problems and
residents of urban areas have faced especially high premiums. Experiments with urban rate restrictions
were largely unsuccessful, leading to availability problems in those areas (Bartlett, Klein and Russell,
2001). Legislation to reform the system is currently being considered due to unsustainable growth in the
costs of compensating catastrophic claims (Tennyson, 2010).
Each of these cases helps to illustrate problems of cost growth in auto insurance systems and the
difficulties inherent in maintaining insurance affordability for all drivers. The primary determinant of
insurance premiums is the cost of insurance claims. As costs grow, premiums must follow or insurance
availability will suffer. In the case of personal injury costs, claim costs will grow with medical cost
inflation, better medical treatments, increases in utilization, or cost‐shifting to the auto insurance system.
Cost of income replacement benefits will be increased by wage inflation or increases in work absence due
to auto injuries. Increases In non‐economic damages can occur due to changing court standards for
awards and eligibility, to claimant efforts to gain access to these damages, or to outright fraud. An
important point to recognize is that some cost drivers fall outside of the auto insurance system, and
therefore may be controlled only by benefit limits or changes in benefit eligibility.
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However, another important point is that claiming behaviours are an important cost driver:
changing benefits and benefits eligibility may produce changes in claiming behaviours that reduce or
undermine the cost‐savings intended by the changes. This appears to be occurring in Alberta, as noted
above. Derrig, Weisberg and Chen (1994) document a similar dynamic in Massachusetts after the tort
threshold was increased to restrict liability claims eligibility to those with $2000 in medical costs rather
than $500. These authors document a dramatic upward shift in the cost of personal injury claims after
this change. Where prior to the threshold increase many injury claimants reported just over $500 in
medical costs, after the threshold increase the modal medical cost increased to just over $2000. These
trends provide evidence of benefit‐seeking behaviour on the part of claimants and/or providers. Simple
attempts to “regulate away” cost increases by changing benefits or eligibility are often not successful for
these reasons. Adjustments to monitoring and claims administration are also required and in some cases
may be more important than product changes.
If the insurance system cannot be organized in a manner that aligns incentives of all participants
toward cost reductions, this type of moral hazard in claiming remains an inherent problem. Moreover,
claim participants will not often recognize the link between their claiming behavior and the rising costs of
insurance. Claimants focus on individual benefits received and ignore the effect of their behaviour on the
system as a whole. In the case of medical and other services, claimants may not even be aware of costs
due to the distance between services received and payments made. In the aggregate, rising costs are
passed on to consumers in the form of higher premiums, but the link between cost increases and
premium increases is not transparent. This often leads to pressure to reduce premiums without
recognition that the underlying problem is one of cost. However, providing premium subsidies does not
lead to cost reductions and may even exacerbate cost increases. Insurer or public policy responses aimed
squarely at the underlying cost or incentive issues will be more effective and more permanent than other
responses.
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7 PolicyConsiderationsforaWell‐FunctioningInsuranceMarket
The theoretical analysis of automobile insurance, the evaluation of Ontario’s system, and
examination of other automobile insurance systems as given in the Appendix give rise to many policy
options for designing an auto insurance system. In this concluding section of the report we first outline
these options and highlight strengths and problems with the different system designs. We then outline
some alternatives that can be used to mitigate the inherent weaknesses in different auto insurance
systems. We wrap up with a brief discussion of how these choices might be applicable to the design of
auto insurance in Ontario.
Table 6 provides a summary of the inherent strengths of, and problems with, different policy
options for designing an auto insurance system. The policy choices available relate to compensation
mechanism, both the level of first‐party accident benefits and the role of liability in compensation; pricing
mechanism, social versus risk‐based; and provider, government or private market. We consider the
product design first and then discuss the impact of pricing mechanisms and choice of provider on system
outcomes.
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Table 6 – Models of Insurance Systems
Compensation Mechanism
Main Problems Inherent Strengths Impact if there is Cross‐subsidization of Premiums
Impact if Insurance is Provided by Government Monopoly
Pure tort with no to minimal accident benefits
Mismatch of compensation with losses;
Potential insufficient indemnification;
Extensive use of court system (high claims adjustment expenses)
Safety incentives;
Market efficiencies
Benefits are improved accessibility and improved affordability.
Inherent problems are adverse selection, reduced safety incentives, and potential negative impact on claiming behaviour.
Benefits are access for all and increased claims cost control.
Inherent problems are lack of consumer choice and lack of competition.
Pure tort with moderate to generous accident benefits
Claims cost control;
Unnecessary use of court system
Safety incentives;
Compensation for all
Pure no‐fault with generous accident benefits
Moral hazard – both ex‐ante and ex‐post;
Claims cost control concerns increase
Compensation for all
Partial no‐fault with moderate to generous accident benefits
Threshold issues;
Ex‐post moral hazard;
Claims cost control
Compensation for all;
Safety incentives (less than pure tort);
Market efficiencies
Adverse selection (more high‐risk drivers on the road), ex‐ante moral hazard (all drivers take less care) and ex‐post moral hazard (excessive claiming after a loss) are created by all social pricing systems; but problems of ex‐post moral hazard tend to be greater when social pricing is combined with private market systems. The presence of generous first‐party benefits increases both ex‐ante and ex‐post moral hazard even in the presence of tort compensation. Private auto insurance systems with generous benefits and social pricing contain inherently more incentive conflicts than other systems.
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Beginning at the top, pure tort systems with no to minimal accident benefits (most U.S. states)
provide strong safety incentives for safe driving and efficiencies in both products and services associated
with private insurance, but are weak in terms of matching compensation to losses and costly in terms of
the expense incurred to determine liability and settle claims. The addition of moderate to generous
accident benefits to a tort system (Alberta, New Brunswick, Nova Scotia, and Prince Edward Island)
improves matching of compensation to losses and safety incentives, but creates a potential challenge in
terms of claims cost control given that all parties are entitled to benefits.
The primary advantage of pure no‐fault systems with generous accident benefits (Quebec and
Manitoba) is compensation for all injured parties, but this comes at a cost in terms of an increase in both
ex‐ante and ex‐post moral hazard. Insureds take less care on the road and when an accident happens,
insureds may exaggerate their claims to receive greater compensation. As well, because of this incentive
to exaggerate claims, the more generous are accident benefits, the more important and difficult claims
cost control becomes. When claims costs are not controlled, affordability concerns arise.
A partial no‐fault system with moderate to generous accident benefits (Ontario) also achieves
compensation for all and promotes safe driving choices, but ex‐post moral hazard and claims cost
control remain major concerns. In theory, a partial no‐fault mechanism should reduce costs over a tort
mechanism if claims can be settled more quickly outside the tort system and if the tort threshold is not
eroded. However, in the Ontario system, the settlement process for first‐party accident benefit claims
quickly became very cumbersome and a number of potential problems arose due to defining the tort
threshold and establishing which claims fall within the threshold.
The fourth column of Table 6 examines the impact of introducing social pricing or cross‐
subsidization of premiums. Regardless of the compensation mechanism in place, the introduction of
social pricing should improve accessibility and affordability for all. However, as noted earlier, cross‐
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subsidization of premiums creates adverse selection problems, reduces incentives to drive safely and
increases ex‐post moral hazard in claiming. Finally, the last column of Table 6 shows that if insurance is
provided by a monopolistic government insurer, the greatest advantages are improved accessibility and
more centralized tools to control claims costs. This comes at the cost of lack of consumer choice, lack of
competition, and potentially lower service quality.
In general, pure tort systems are considered to be more effective in providing safety incentives
while pure no‐fault systems with generous accident benefits are more effective in providing
compensation. It is important for policy makers to clearly articulate the objectives of the system,
recognizing that trade‐offs exist between different design options. Because of differences across the
driving population in consumer knowledge of insurance, consumer attitudes towards fairness, and
consumer attitudes towards irresponsible claiming behaviours, some design features will be more
successful in some jurisdictions than in others.
7.1 PolicyConsiderationsforOntario
Insurance provides many benefits to individuals and to society. However, as discussed and
illustrated here, insurance creates adverse behavioural incentives and as such may also lead to a greater
propensity to drive, reduced precautions when driving, and benefit‐seeking or even outright fraud in
claiming. Such incentive problems may be particularly prevalent when insurance benefits are generous,
and when insurance pricing is socialized so that premiums do not reflect the risk an individual brings to
the insurance pool. Well‐functioning insurance systems must recognize negative incentive effects and
counteract them where they occur.
The most direct policy responses would be to raise the entry price of driving (counteracting the
increased propensity to drive); penalize risk‐taking in driving (counteracting reduced precautions); and
provide minimal insurance benefits and implement strictly risk‐based premiums (counteracting benefit‐
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seeking in claiming). However, these solutions will reduce access to driving and create insurance
affordability problems for some consumers, and may leave many without adequate accident
compensation. When insurance availability and affordability to all consumers are important objectives,
as is often the case with automobile insurance, adjusting the insurance system to counteract negative
behavioural incentives is more difficult. In jurisdictions in which driving is not considered a right or an
economic necessity, the public policy issues in auto insurance are less complicated.
Ontario has a private market, partial no‐fault auto insurance system design with a high tort
threshold. The benefits available under first‐party accident benefits are a function of the severity of the
injuries incurred: most injuries are non‐catastrophic and claimants may claim up to $50,000 in medical
payments, but those who are catastrophically injured are eligible for up to $1 million. Generous first‐
party benefits have been enshrined in legislation since the introduction of no‐fault insurance in 1989.
In Ontario and other private insurance markets in Canada, when insurance costs and availability
become a concern, public insurance is often promoted as a solution to the problem. Our analysis does
not indicate that the existing problems are a result of the private market structure, nor do we see in
other private provinces the same problems as in Ontario. Further, government run insurance is not a
panacea to cost problems. Government insurance programs face the same problems of moral hazard
and compensation cost inflation that occur in private insurance markets, and benefit and premium
structures are often adjusted in response. Provinces with government insurance do have advantages in
responding to cost problems due to market‐wide control measures, but these conditions could be
replicated in private market provinces while maintaining the private market structure that ensures
market efficiencies as private insurers compete for customers.
Nonetheless, as is evident from the analysis presented in this report, the Ontario auto insurance
system is not healthy – there are affordability concerns, the GIO receives many complaints regarding all
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aspects of the product, insurers are struggling to make money, and there is a large amount of cross‐
subsidization across insureds, especially between the GTA and the rest of the province. Despite these
problems, the evidence does not suggest that the design of the system is fundamentally flawed.
However, there are significant cost concerns associated with the GTA. Here we make recommendations
regarding the elements of the system that need to be addressed in order to improve performance as
measured by the objectives of a well‐functioning auto insurance system. Our recommendations
encompass pricing mechanisms, benefit provisions, claims cost controls, consumer education, and larger
societal solutions.
7.1.1 PricingMechanismDesign
In a compulsory insurance system, the choice to drive, the amount of driving, and precautions
taken in driving are affected by the price of insurance. Carefully designed pricing mechanisms support
affordability and accessibility, align consumer incentives to support safe driving, and reduce excessive
claiming. We discuss how different pricing mechanisms can be used to achieve these policy goals,
recognizing that purely risk‐based pricing may not support affordability and that purely social pricing
does not support safe driving and responsible claiming objectives.
Within the insurance system, relaxing mandatory insurance requirements for low income drivers
is one approach to addressing affordability. Some U.S. jurisdictions have introduced so‐called “dollar‐a‐
day” policies which are low cost but provide limited liability insurance. The limited coverage has the
effect of shifting costs onto other drivers who may need to supplement insurance protection with
underinsured motorist coverage. If such limited policies are made available, it is important for incentive
reasons to base eligibility solely on income. Another approach to reducing insurance premiums for some
urban drivers is to allow miles‐based insurance pricing: since urban drivers generally drive fewer miles
than other drivers, and since miles driven is a good unit of measure for risk exposure, these policies are
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a way to offer lower costs to low‐risk drivers in high‐risk areas. This “pay‐as‐you‐drive” auto insurance
contract is gaining popularity in Canada, as more insurers are offering these contracts.
Allowing the use of more rating variables, rather than restricting the number of rating variables
as has been suggested in recent Ontario legislation to reduce the number of territories, is another way
to provide premium reductions for low‐risk drivers in urban areas by allowing them to distinguish
themselves from high‐risk drivers. For example, while controversial, insurance scoring in the U.S. has
been shown to be an effective classification variable due to its correlation with claims experience.
Insurance scoring is an underwriting and risk classification tool that uses an insured’s credit, motor
vehicle records and claims history. Currently, Ontario and the Atlantic provinces do not allow credit
history to be used for auto insurance rating and underwriting, while Alberta and Quebec permit the use
of credit history for property damage coverage in auto. In all provinces, regulations are silent on the use
of credit scoring for homeowner’s insurance, therefore insurers are permitted to use it. Insurers argue,
and evidence shows, that credit history, or “financial discipline,” is a good predictor of insurance
experience in terms of driving habits, and restricting its use results in less accurate pricing.28
Adjusting insurance premiums based on claims experience or safe driving record allows low‐risk
drivers to distinguish themselves from high‐risk drivers, and provides financial incentives for safe driving.
Basing premium adjustments on traffic violations, as well as at‐fault claims experience, provides a
stronger signal of driving risk than only using at‐fault claims experience. However, if it is expensive for
insurers to capture moving traffic violation data, they will only do so for those drivers that they suspect
28 It is not likely that insurance scores will be allowable for mandatory auto insurance in Ontario in the future because of the concerns that the insurance score itself might be discriminatory. For example, the Ontario Human Rights Commission (1999; p 27) noted that “Any newly proposed risk classification system, even if shown to be a better measure of risk, should at least not further contravene rights under Part 1 of the Code any more than any current classification system does.” The Commission further asserted that certain factors included in an insurance score, namely credit card ownership, bankruptcy status, employment status and stability, and residence status and stability would likely contravene Ontario’s Human Rights Code.
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are higher risk.29 Thus another policy recommendation is to improve access to provincial driving records
for insurers.
Despite the importance of risk‐based pricing, it is important to recognize that making premiums
even more experience‐rated may also have its disadvantages. Finger (2006) notes that as premium
discrepancies become greater between risk groups, drivers have a greater incentive to manipulate the
risk classification variables. With respect to experience rating, we conjecture that determination of fault
in an accident would become much more difficult, time consuming, and expensive if premiums were to
increase even more after an at‐fault accident. Greater financial penalties would mean that insureds
would question the inflexibility of the fault determination rules, thereby increasing the number of claims
going to mediation. This concern and the difficulties in fault determination suggest that any
strengthening of experience rating should focus on driving record rather than accidents.
In Ontario, the premium charged for new drivers is not distinguished from the experience rating
mechanisms for higher‐risk drivers. It is not evident that this practice is fair or reasonable. Several
provinces and many companies have developed mechanisms to promote affordability for new drivers,
for example the grid in Alberta, risk sharing pools in the Atlantic provinces, and company level pricing
models that retroactively reward new drivers for claims free experience. From a policy perspective, the
point to emphasize is that mechanisms that promote affordability should not lessen incentives for safe
driving since strengthening the responsiveness of changes in insurance premiums to driving or accident
experience has been shown to reduce moral hazard and adverse selection without violating social
pricing objectives.
29 It is easier and less costly for government insurers to include moving traffic violations in pricing because they have instant and costless access to this information. In private market provinces there may be a cost. For example, in Ontario, the cost of a statement of driving record is $12.
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Fundamentally, using rate regulation to protect consumers from insurance premiums that
adequately reflect underlying costs is counterproductive as this reduces the willingness of insurers to
provide the product and it masks the problems that cause cost growth. Regulation of rates may lead to a
higher proportion of high‐risk drivers in the insurance pool and has been shown to lead to higher claims
rates and loss costs. In addition, artificially keeping insurance prices low reduces the incentives for
insurers to police claim cost growth because such monitoring requires costly resources. Instead, a
premium subsidy to low‐income (not high‐risk) drivers is a better policy lever to promote affordability.
In Ontario, two decades of prior approval rate regulation have weakened the relationship
between premiums and expected losses, and have created significant cross‐subsidies between the GTA
and the rest of the province. Evidence from the public market provinces of Quebec, British Columbia,
Saskatchewan, and Manitoba demonstrates that when premiums for higher‐risk drivers are subsidized,
the unintended consequence is an increase in the number of high‐risk drivers on the road. Hence an
important policy lever to maintain and potentially strengthen in Ontario is the risk‐based pricing
mechanism. Although this may require specific measures to achieve affordability as noted above,
flattening of the pricing structure is not optimal.
7.1.2 BenefitProvisions
Generous first‐party accident benefits should be part of the auto insurance system design when
compensation for all injured parties, regardless of fault, is considered to be an important objective.
However, insurance systems with generous first‐party benefits are expensive and the presence of
benefits increases both ex‐ante and ex‐post moral hazard. Thus an obvious solution to reducing costs
and aligning incentives is to reduce the level of benefits provided. For example, some U.S. states have
achieved affordability by not including first‐party accident benefits in the mandatory auto insurance
policy.
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However, depending on the objectives established this may not be a feasible alternative, and a
removal of first‐party benefits is unlikely to occur in Canada. Given that the existence of these benefits is
accepted as the norm, it is not politically feasible to remove them, although the level of benefits could
be adjusted. In addition, the inclusion of first‐party accident benefits allows insureds to internalize a part
of the cost of driving which is particularly important given that all Canadian residents have access to
universal healthcare and many have access to supplemental health benefits.
Since generous benefits lead to greater benefit‐seeking behaviours, cost and utilization controls
must be a part of the system. Over‐utilization of healthcare has been observed in many insurance
contexts. The marginal cost of medical care is more likely to exceed the marginal benefit of additional
medical care (improved health outcomes) when there is a separation between the benefit recipient,
benefit provider, and who pays for the care as providers and recipients have no intrinsic motivation to
minimize costs of claims. When costs of care are not considered, even small gains to a patient’s health
or well‐being from more expensive tests, treatments, procedures, or facilities, may lead to decisions in
their favour. Moral hazard also increases if insurance provides for generous wage replacement benefits
as injured persons are less likely to return to work quickly if they receive generous benefits. If generous
benefits are provided, then cost control mechanisms must be enacted to ensure affordability and reduce
moral hazard.
7.1.3 ClaimsCostControls
No‐fault systems that provide generous auto insurance compensation benefits create incentives
for ex‐post moral hazard and potentially fraudulent claiming. The experience in Ontario, and in
particular the GTA, illustrates that generous accident benefits without sufficient controls in place create
an environment that can lead to unsustainable claims growth. Thus it is essential to develop
mechanisms for controlling claims costs.
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To control costs, the Ontario no‐fault auto insurance policy has been designed with two hurdles
or thresholds: the verbal and monetary thresholds after which the tort system may be accessed and the
catastrophic injury definition which provides a higher level of first‐party accident benefits. A key concern
with a threshold or injury definition in a policy is that over time these are seen as barriers for claimants
to overcome in order to be eligible to receive greater benefits. The experience in Ontario indicates the
difficulty of defining a threshold that will maintain its effectiveness over time. From a policy perspective,
a few points are critical: clarity in defining the threshold; vigilance on the part of companies and
government in enforcing the threshold; and when possible, avoiding the creation of a “lottery” incentive
that will promote fraudulent claiming. If there is not a lot to be gained financially from piercing the
threshold (i.e., if the claimant is able to access great medical benefits but these are based on indemnity
and there is no “money in the pocket”) there is less incentive to attempt to do so.
Costs are controlled in many health insurance policies by transferring some of the treatment
costs to the benefit recipient through the introduction of co‐pays or other cost transfer mechanisms.
These policy tools can be used to reduce over‐utilization as long as providers do not help beneficiaries to
circumvent controls.
Excessive costs may also arise from the deliberate overuse of benefits or from the filing of
fictitious or exaggerated claims, which will be more problematic if claimants receive money directly from
the insurer to pay for treatment. When systems place a priority on paying benefits quickly, when there is
not strict oversight of the benefit providers and when claims do not face the scrutiny of the legal system,
over‐utilization and fraud become especially problematic. Monitors and protocols are needed to detect
and remove ineligible beneficiaries, and periodic evaluations are important when benefits are provided
over a long period of time. The Auto Insurance Anti‐Fraud Task Force will be making recommendations
to the Ontario government in the fall of 2012 and we anticipate that this report will include numerous
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strategies. One example would be that only licensed and approved medical practitioners are eligible to
receive payments from insurance companies. This will reduce the number of exaggerated claims.
The use of treatment guidelines produces many positive outcomes. Well‐designed treatment
guidelines ensure best practices in treatment allowing injured individuals to recover faster. If guidelines
can be easily implemented, then this should also reduce the cost of handling claims. In addition,
guidelines can be written to reduce ex‐post moral hazard – for example, requiring an insured to cover
costs upfront if an insured requires medical treatment beyond what is recommended by the protocol.
Reimbursement by the insurer would happen only if the treatment were later deemed to be
necessary.30
To address ex‐post moral hazard, insurers must have policies in place to verify the validity of
claims and detect potential fraud. We observe, however, that controlling claims costs is more difficult
for a private insurance market than for a government insurer since it is harder for individual insurers to
effectively implement changes to control claims costs. Each individual insurer’s efforts to control benefit
overuse, claim exaggeration, or fraud is generally not sufficient to reach the most socially desired
outcome (Picard, 2008). An insurer will invest in these activities up to the point of maximizing profits;
the insurer will not take into account the potential spill‐over effects that create a “claiming culture”
when overuse, exaggeration, or fraud go undetected and undeterred. Collective action is needed,
especially to mitigate organized insurance fraud.
30 In Alberta, for injuries that meet the diagnostic and treatment criteria under the Diagnostic and Treatment Protocols Regulation, auto insurers are priority payers for accident benefits for the first 90 days or up to 21 treatments. Beyond that, if the injured person has extended healthcare benefits elsewhere, he or she must first pay for the treatments incurred up front and the auto accident benefits pay the difference between what is covered under the extended health policy and the treatment costs.
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Industry‐wide measures to help reduce fraud and control claims costs are required. The 2011
Report of the Office of the Auditor General of Ontario notes that the problem of fraud is worse in
Ontario than elsewhere in Canada. Fraud can arise from individuals or from providers. The more costly
problem is due to providers (healthcare professionals, medical suppliers, and lawyers) who defraud the
system. In Ontario, an infrastructure for fraud has developed. Clinics, paralegals, and healthcare
providers understand how to manage (or manipulate) a claim to maximize the payout. The recent
initiatives in Ontario, such as the Health Claims for Auto Insurance (HCAI) database to detect such
potentially fraudulent activity, and new rules to ensure that consumers are actually receiving the
treatments invoiced by healthcare clinics and other providers, will make it more difficult for providers to
defraud the system.
Organized fraud is important to target due to its systematic and repeated nature. Establishing a
centralized Insurance Fraud Bureau along with mandatory insurer reporting and criminal sanctions for
perpetrators is one approach which has seen success in some U.S. states (Weisberg and Derrig, 1992).
Some jurisdictions such as Louisiana have also seen success from combining criminal justice approaches
with media campaigns to educate consumers about the costs that fraud imposes on them, in terms of
lower insurance availability and higher premiums. Fraud can also be minimized by requiring those that
provide health‐care to auto accident victims to be licensed and regulated. Recommendations
forthcoming from the Anti‐Fraud Task Force that can be initiated on an industry‐wide basis will be
important levers to control claims costs.
Unfortunately, there is limited evidence that competitive insurance market mechanisms have
been successful in the long run containment of claims costs using these control mechanisms. This
problem highlights the need to focus policies to minimize incentives for abusive claiming practices,
rather than simply restricting benefits to claimants.
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Even in the absence of excessive claiming, the interplay between government mandated and
private provision of medical services also leads to higher costs of auto insurance. Cost shifting takes the
form of higher charges for services when provided as part of an auto accident claim than when those
services are provided as part of a workers’ compensation claim or a general health claim. Higher per unit
service charges will lead to higher claims costs for auto insurance even when services are utilized
appropriately. Higher claims costs for auto insurance may also arise if certain treatments are not
covered by government health insurance, such as services provided by physiotherapists, chiropractors,
and psychologists.
7.1.4 ConsumerEducation
Insurance is a product that is not well understood by many consumers. Furthermore, the
mandatory nature of the automobile insurance product creates a market where uninformed consumers
who may not understand the product and see no differentiation across companies will purchase the
insurance based only on lowest price without understanding the service and benefits provided. Having
consumers that are making informed decisions about their auto insurance and are satisfied with their
products and services will help to alleviate some of the current problems in the Ontario auto insurance
system.
As noted earlier, in an auto insurance consumer satisfaction survey conducted by InsurEye Inc.,
Ontario ranked third amongst the ten provinces in terms of customer satisfaction. Ontarians were
generally satisfied with their claims experience but unhappy with the value for money they receive for
their auto insurance. The fact that, overall, people believe they do not receive adequate value for what
they pay raises two important issues. First, there may be a lack of understanding of what benefits are
provided by the mandatory product, which contributes to the perception that insurance is overpriced.
Consumers need accurate and timely information in terms of what is covered, options available, and
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what to do when there is a claim. Second, individuals who pay what they perceive as too much for auto
insurance are more likely to attempt to “recover” premiums at the time of making a claim. The incentive
for recovery is exacerbated if premiums are not risk‐based. The more informed consumers are about the
insurance they purchase, the less likely they will have unrealistic expectations that are not met.
The Insurance Information Institute lists the following four criteria for developing an effective
and successful insurance education program.31 A successful education program needs to:
Be inclusive with all participants working towards a common goal.
Be emotional and personal, encouraging individuals to become involved and take action.
Provide tools for individuals to make success possible.
Be long term and responsive to changes over time.
The importance of a continual and responsive education program has been echoed by Insurance
Bureau of Canada (O’Reilly, 2008). Insurance Bureau of Canada’s Restoring Consumer Confidence
campaign increased awareness of injury prevention and road safety, and contributed to immediate but
short lasting increases in consumer confidence. However, consumers have little trust in the insurance
industry and have incomplete knowledge of insurance, which necessitates a continual and adapting
education program.
In Ontario if an injured party and their insurance company disagree about the claimant’s
entitlement to or amount of accident benefits, the claimant may apply for mediation. Mediation is a
mandatory first step before going to court or arbitration. The 2011 Report of the Office of the Auditor
General of Ontario indicates that there has been a large increase in the number of applications for
mediation, increasing by 135 percent over the last five years. Currently about half of all injury claims are
31 http://www.iii.org/national‐roundtable‐on‐insurance‐literacy‐best‐insurance‐education‐practices/
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in mediation. In addition, resolutions are taking 10 to 12 months to resolve rather than the legislated 60
days. The majority of mediation applications (80 percent) are from the GTA even though it accounts for
just 45 percent of automobile accidents involving injury.
The cause of the increase in the number of applications for mediation is unknown, but it is
reasonable to expect that if consumers are not well‐informed and do not have access to good
information about their insurance coverage, this will contribute to the number of disputes. In addition,
Cameron (2012) explains that some of the increase in mediation applications is due to a FSCO bulletin
(FSCO Bulletin A 02/11, issued 22 March 2011) which directs auto insurers to more proactively challenge
questionable claims.
7.1.5 LargerPolicyIssues
As noted at the beginning of this report, automobiles and driving have a fundamental role in our
society. Auto insurance exists to provide indemnification for road users who experience losses in auto
accidents. Although beyond the scope of this research, there are other policy options available that will
improve road safety and decrease reliance on the automobile. Both these measures a decrease in auto
accidents and reduction in dependence on the automobile will contribute indirectly to the long run
viability of auto insurance.
Because auto insurance is compulsory, the cost of insurance has become a mechanism that
helps to keep high‐risk drivers off the road. However, the impact of this mechanism is uneven on the
rich and the poor: unsafe but wealthy drivers can still afford the insurance, low‐income drivers may not.
Social equity indicates that other mechanisms, such as more effective driver training and licensing, are
required. Graduated licensing of new drivers has been shown to be an effective mechanism for saving
lives and reducing injuries. For example, the introduction of graduated licensing has resulted in a decline
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of crash rates among sixteen‐year‐olds by 25 percent in Michigan and by 60 percent in Ohio (Sleet,
Schieber and Gilchrist, 2003). Similarly, the introduction of graduated delicensing of elderly drivers may
also promote road safety.
In addition to comprehensive graduated driver licensing programs, Kissinger (2009) notes the
following five effective regulatory and legislative solutions for improving traffic safety: installation of
electronic stability control in cars; enforcement of seatbelt and helmet laws; reduction and monitoring
of speed limits on roads; road redesign including roundabouts, rumble strips, and cable median barriers;
and a reduction in impaired driving. Electronic stability controls are conjectured to decrease deaths in
single vehicle accidents by up to 56 percent. A reduction in impaired driving can be implemented by
changes in car design, specifically the installation of alcohol ignition interlocks. When such safety
enhancements are made, all drivers benefit, and safer roads should lead to lower insurance premiums.
Finally, the need to drive to support economic stability may not be necessary in dense urban
areas. Where other modes of transportation are practical, policy makers should consider solutions that
lie outside of the insurance system – for example, developing better public transportation networks and
encouraging bicycling or walking. Promoting economic development zones which cluster commercial
and residential areas in closer proximity, or providing transportation subsidies to vulnerable groups
based on income and location, are other possibilities.
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9 Appendix:CaseStudiesofOtherJurisdictions
Here we examine the automobile insurance systems in other countries and jurisdictions and
describe what combinations of features of the automobile insurance system have worked well
elsewhere, what features have led to poor system functioning, and what types of reforms have
improved system functioning over the long term.
9.1 Alberta,Canada
In Alberta, private insurers compete to sell the mandatory automobile insurance product (third‐
party liability, first‐party accident benefits, and uninsured motorist coverage) as well as additional
voluntary coverage. First‐party accident benefits for medical payments are $50,000 (as of 2004) and
minimum liability limits are $200,000, although most people buy $500,000 or $1,000,000.
Figure 16A (in main text) shows the growth in average premiums in Alberta during the early
2000s. In 2001 the average premium in Alberta was $845 and increased to $1,123 in 2004. A main driver
was the increase in bodily injury liability severity. Average BI claim severity increased from about
$49,000 in 2000 to almost $57,000 in 2002, a 16 percent increase. As a result of growing consumer
dissatisfaction, especially due to high premiums for new drivers, Alberta instituted significant reforms to
the automobile insurance system in 2004. The key provisions to the reforms included:32 (i) a cap on pain
and suffering awards ($4,00033) for minor injuries resulting from a collision; (ii) treatment guidelines for
minor injuries (prior approval from the insurance company was not required to begin treatment); and
(iii) a pricing grid that established the maximum premium insurers can charge for basic coverage for any
driving record. Although there was a court challenge to the minor injury cap, the Alberta Court of Appeal
32 See www.ibc.ca/en/car_insurance/AB/Reforms.asp.
33 The cap is indexed and in 2012 is $4,641.
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upheld the cap noting that it represented only one aspect of a wider legislative scheme that also
included protocols for diagnosing and treating minor injuries and increased medical benefits available to
minor injury claimants who still required treatment after preliminary medical treatment protocols were
followed.34
The reforms helped to reduce the average premium from $1,182 in 2004 to $1,021 in 2007.
From GISA data, the total estimated savings over the period 2004–2007 for Albertans was $1.13 billion.
The short‐term impact of the reforms is demonstrated in Figure 5A (in main text) which shows that after
increasing steadily from 1991–2003 average BI claim severity then experienced a relatively sharp
decrease from 2003–2005 before levelling out. In addition, average AB+BI costs also declined, as shown
in Figure 6A, from $573 in 2002 to $318 in 2005, falling further to $254 in 2009.
Increasing first‐party accident benefits is one potential way of reducing third‐party liability costs,
in addition to the cap on pain and suffering. Figure 8A (in main text) shows the number of BI claims per
100 PD claims in Alberta, which after peaking in 1999 (0.3818 BI claims per 100 PD claims), then began
to decline and flattened out over the period 2001–2003, then decreased significantly until 2009 (0.1810
BI claims per 100 PD claims) before increasing again in 2010 (0.2145 BI claims per 100 PD claims). More
generous accident benefits also impact claim frequency for medical benefits, as shown in Figure 10 in
the text. The number of medical claims per 100 vehicles decreased from 1999 to 2003, increased until
2006 and then decreased. Such an increase in the frequency of medical benefit claims most likely
34For example, the Minor Injury Regulation was brought in along with the Diagnostic and Treatment Protocols Regulation (DTPR), which provides for 10 or 21 treatment sessions in the first 90 days of the injury without the need to seek approval from the insurer. Assuming the treatment protocols in the DTPR are followed, after a 90‐day period is reached, an injured person can apply to an insurer for further payments, which the legislation increased from $10,000 to $50,000.
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reflects easier access to benefits, since other provinces saw a decrease in this measure during the same
period.
The introduction of injury care treatment protocols in Alberta has had a number of impacts on
utilization of care as well as costs. Sulzenko, et al. (2010) note that over 40 percent of claims were still
open at six months post‐injury. Currently an increasing number of injured persons end up extending
their treatment past the 21 treatment/90 day period, raising questions about whether the protocols are
appropriate based on more recent evidence of best practices in treatment. However, this is to be
expected to some degree since the protocols are based on what works well for most people. Managing
those claimants for whom the treatment under the protocols is not sufficient could become a more
significant concern over time. However, from a cost containment standpoint since additional treatment
has to be approved and the case reviewed, insurers have a built‐in control measure.
As well, there is evidence that claims are trending upward. The Oliver Wyman submission to the
Automobile Insurance Rate Board (AIRB) identifies a number of key issues in 2012 that are impacting
total costs. Medical payment loss costs increased by 5 percent in 2011 and the frequency of medical
expense claims has been increasing since 2010. The Dominion reported that there was a 6.7 percent
increase in accident benefits over 2010/2011. In addition, accident benefit frequency increased 9.5
percent from 2010 to 2011, and 24.3 percent from 2009 to 2010. With respect to liability, BI frequency
increased by 4 percent in 2010 and 3 percent in 2011 after a steady decline and an 11.9 percent increase
in bodily injury liability claim costs (Oliver Wyman, 2012).
This recent evidence from Alberta suggests that the 2003 reforms are less effective in the long
term in controlling claim cost growth. “We see that post reform trends tend to deteriorate after a period
of initial improvement. … the expected increase in claim counts that typically follows after reforms have
been in place for a number of years is now evident for all mandatory coverages.” (The Dominion of
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Canada General Insurance Company, 2012; p. 4). Also noted by this insurance company is an increased
propensity for injured parties to retain legal representation and attempt to look for areas that fall
outside the cap.
The Alberta experience parallels what has been observed elsewhere regarding automobile
insurance reform. Short‐term cost reductions are achieved but over time the effectiveness of the
changes is eroded. A specific concern of insurers in Alberta recently is the impact on injury claims due to
the decision in Sparrowhawk v. Zapoltinsky [2012 ABQB 34]. The question addressed was whether or not
an injury to the temporomandibular joint (TMJ) represents a minor injury such that it would fall within
the cap on soft tissue damages. The Court concluded that the plaintiff’s TMJ injury was not a minor
injury and therefore did not fall within the cap (Moulton, 2012). This is expected to result in an increase
in claims involving TMJ injuries. In addition, given that treatment is not provided under the Diagnostic
and Treatment Protocols Regulation this could also cause an increase in the average size of claims.
Another important element of the Alberta reforms was the introduction of the premium grid.
Since the introduction of the risk sharing pool, the Facility Association has become one of the larger
insurers in the province. Alberta has the fourth‐largest private passenger residual market share in North
America with a 6.9 percent market share (Facility Association, 2012), and the size of the residual market
is a significant concern. The 2012 Facility Association submission to the AIRB indicates that results from
the Grid pool were financially neutral, but the non‐grid risk sharing pool and the residual market are not
financially sustainable and require subsidization from other consumers (Facility Association, 2012).
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9.2 Massachusetts,U.S.A. 35
Social objectives are explicit in the automobile insurance laws of Massachusetts: to achieve
universal insurance coverage and assure reasonable rates for all drivers, while maintaining insurer
solvency. Massachusetts established compulsory auto insurance in 1927, and though insurance was sold
by private insurers, premium rates for compulsory coverages were set by the state insurance
commissioner. Partial no‐fault insurance was adopted in 1971, requiring drivers to purchase first‐party
personal injury protection insurance and restricting the right to file an injury liability claim to those
whose medical expenses exceeded $500 (raised to $2,000 in 1988). Maximum first‐party injury benefits
were set at $2,000 (raised to $8,000 in 1988). Along with compulsory first‐party insurance, uninsured
motorist coverage and property damage liability coverage also became compulsory.
From 1978 through 2007, affordability objectives were promoted by use of state‐set insurance
rates established through an annual hearing process. State set rates varied by territory and driver class,
with classes and territories determined by the state. All insurers were required to use the state‐set rates
unless approval to charge lower rates was sought and granted by the insurance commissioner.
In many years, the insurance rates set by the state were below comparable rates in other states.
This was especially true in periods of high inflation such as the 1980s which were characterized by rapid
growth in auto insurance loss costs (Cummins and Tennyson, 1992). Evidence of this can be seen by
comparing the percentage by which (aggregate) premiums exceeded loss costs, defined as earned
premiums minus incurred losses, divided by earned premiums. Figure 19 below displays the annual
average premium markup for Massachusetts auto insurance versus the U.S. average for years 1980
through 1998.
35 This discussion draws heavily on Tennyson, Weiss and Regan (2002) and Derrig and Tennyson (2011).
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Figure 19 – Premium Markup Over Losses: Massachusetts versus U.S.A.
Source: Tennyson, Weiss and Regan, 2002
To promote universal coverage through affordable premiums for all drivers, age, gender, and
marital status were prohibited as rate classification variables and the state permitted only 26 rating
territories to be used (determined by the state). Rates were also systematically leveled across classes
and territories and annual rate increases for a class or territory were limited in relation to the statewide
average increase.
To protect insurance availability for all drivers, a take‐all‐comers rule was established, under
which insurers could not deny insurance coverage to any applicant. Undesirable policies could be ceded
to the residual market facility (Commonwealth Automobile Reinsurers, CAR), but policyholders insured
through CAR were charged the same rates as in the voluntary market and losses from CAR were shared
by all insurers in the state. Drivers were also strongly protected from cancellation: an insurer could not
refuse to renew a policy for reasons other than fraud, failure to pay a premium, or other technicalities.
Finally, to assure payment of claims the state implemented legislation requiring prompt payment and
imposing treble damages on insurers in cases of bad‐faith handling of insurance claims.
0.000.050.100.150.200.250.300.350.400.45
Premium Markup Over Losses
Massachusetts Countrywide
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The regulatory efforts to assure affordability were frustrated by continued increases in claims
costs. The figure below displays average loss costs per insured vehicle for Massachusetts as compared
with the U.S. as a whole, for years 1973 through 1998; the vertical line in 1978 indicates the starting
date of most of the Massachusetts regulations. Figure 20 documents a startling upward trend in
Massachusetts costs which began just at this time and continued through the early 1990s when reforms
began to be implemented.
Figure 20 – Loss Costs per Insured Vehicle, Massachusetts versus Other States
Source: Derrig and Tennyson, 2011
By the early 1990s it was clear that the system was no longer sustainable and regulatory reforms
began to be considered. Initially reform came in piecemeal fashion, and included a higher tort threshold,
mandatory insurer cost containment programs, stronger experience rating, greater pricing flexibility for
insurers, and establishment of a centralized Insurance Fraud Bureau. Comprehensive reforms took
longer to accomplish, but became effective in 2008 when a system of “managed competition” was
established. Under managed competition firms may set their own rates and offer discounts and product
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Stringent regulation Fraud Bureau
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variations, subject to state prior approval and to restrictions on underwriting.36 In a case study of the
regulatory reforms, Tennyson (2011) finds that the reforms led to a number of positive developments in
the market without leading to increases in insurance prices or reductions in insurance availability.
Insurance premium expenditure growth has declined relative to previous trends; insurance availability
has been maintained; insurer underwriting results have been maintained; and claims rates have
remained at pre‐reform levels.
Several studies have examined the evolution of the Massachusetts auto insurance system over
time, in an attempt to understand the problems that led to its undoing. A number of problems have
been identified. First, as a result of the stringent suppression of rates in the 1980s, many insurers
withdrew from the auto insurance market (Derrig, 1993; Yelen, 1993). In 1980, 62 auto insurers
operated in the state; by 1998 this number had dropped to 38; and by 2006 only 19 auto insurers served
the state. This reduced efficiency and undermined competition (Tennyson 1997), putting upward
pressure on costs and premiums.
Second, the system of social pricing led to further reductions in insurance availability. Capping
and tempering led to cross‐subsidies in insurance pricing: some drivers (low risks) paid more than their
risk‐based rate and other drivers (high risks) paid less. For a private insurer, offering insurance to a
subsidized driver was less profitable than offering insurance to a driver paying a surcharge. When rates
are suppressed, a larger fraction of drivers receive subsidies. Insurers cede subsidized policies to the
residual market, and the residual market grows. Figure 21 demonstrates that the percent of cars insured
in the Massachusetts residual market was exceptionally high, in some years insuring the majority of cars
in the state.
36 For example, age, sex, income, and credit history may not be used in underwriting and state‐determined rating territories remain in force.
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Figure 21 – Residual Market Size, Massachusetts versus Other States
Source: Tennyson, Weiss and Regan, 2002
Large residual markets are a hallmark of lack of insurance availability, and can lead to additional
problems in the market. Because insurers do not bear the full costs of claims from policies insured in the
residual market (due to sharing of residual market profits and losses among all insurers), incentives to
control claims costs are greatly reduced when large portions of the market are involuntarily insured
(Blackmon and Zeckhauser, 1991). This permits moral hazard and fraud in claiming and puts upward
pressure on costs and premiums. Further, social pricing coupled with an emphasis on compensation
(through take‐all‐comers laws, bad faith liability, and limits on cancellations) decreased insurers’ ability
to control claim costs, and decreased drivers’ incentives to control accident and claims costs.
This led to significant moral hazard (and deliberate fraud) in claiming. As summarized in Derrig
and Tennyson (2011, p. 180), “The prediction of fraudulent claim behavior was observed soon after the
1988 Reform Law provision that raised the monetary threshold to file a tort claim from $500 to $2,000
in claimed medical bills. Weisberg and Derrig (1992) document the increase in numbers and intensity of
0%10%20%30%40%50%60%70%80%
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medical provider visits with the result being a much larger‐than‐anticipated 1989 proportion of auto
injury claims with medical bills in excess of $2,000, the new tort threshold. More recently, Derrig, et al.
(2007) discuss auto injury claims with the appearance of fraud and/or buildup37 both countrywide
through the Insurance Research Council (IRC) Study of 2002 Claims and in Massachusetts through the
developments in the town of Lawrence. In Lawrence, Insurance Fraud Bureau (IFB) activities reduced
injury claims per 100 accidents from 141 in 2002 to 60 in 2004 and claim payments from $48.6 million in
2002 to $19.8 million in 2004. Granted, Lawrence was an exceptional case identified as far back as 1991
(Weisberg and Derrig, 1991), but reductions on a lesser scale in other towns have been realized by IFB
efforts since 2002.”
Other studies of the Massachusetts market have examined and commented on the political
evolution of the regulatory system (Yelen, 1993; Derrig, 1993; Tennyson, Weiss and Regan, 2002).
Tennyson, Weiss and Regan (2002, p. 77) conclude that “the various features of the system are logically
linked when viewed from the perspective of the pursuit of social goals. A major objective of the auto
insurance laws in the state is universal coverage of drivers at reasonable rates for all. The universal
coverage aims are what lay behind the laws for mandatory insurance, mandatory offer rules and
limitations on policy cancellation. With mandatory insurance laws in place, affordability of coverage
becomes important and provides the rationale for restrictions on rate class and territory definitions, for
rate subsidies and for the lack of residual market premium surcharges. In periods of rising costs the
suppression of overall rate levels is one way to protect insurance affordability, and insurers’ losses are
mitigated by the sharing of residual market losses. However, with the possibility of rate suppression, and
due to the residual market sharing rules, comes the need to place exit restrictions on insurers. The
37 “Build‐up” is the term of art for excessive treatment for the injury (if any) sustained in an auto accident with treatment usually provided by a chiropractor or physical therapist.
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complexity of this regulatory system thus reflects the difficulty of achieving its objectives within a
market system.”
9.3 Michigan,U.S.A.38
Established in 1973, the system in Michigan is a private, compulsory no‐fault auto insurance
system which contains elements of social pricing for catastrophic injuries. Michigan is the only no‐fault
state in the U.S. to provide for unlimited medical benefits for auto‐related injuries. Injured persons
receive unlimited lifetime medical benefits, including reasonable and necessary expenses for
rehabilitation and long‐term care; loss‐of‐service benefits for up to three years to pay for help with tasks
of everyday living such as laundry, cooking and cleaning;39 replacement of 85 percent of wages for up to
three years after the accident; and survivor and funeral benefits. The costs of catastrophic auto‐related
injuries are funded through annual assessments to insurers, who in turn incorporate these costs as a
fixed assessment on the premiums charged to Michigan’s drivers. The current assessment is $175 per
insured vehicle.
Michigan’s no‐fault auto insurance was designed with three public policy goals in mind: (1) to
increase the benefits paid to injured persons, (2) to ensure prompt payment of benefits, and (3) to
reduce the proportion of premium dollars paid out for administrative (i.e., legal) costs.40 The system has
been highly successful in meeting these goals. Due to unlimited medical benefits, injured persons
receive generous and certain compensation. And, due to the strong restrictions on lawsuits, Michigan
sees a much smaller proportion of automobile injury claims settled through the liability system than in
other states. Liability claims for additional compensation (including pain and suffering) are limited to
38 This discussion draws heavily on Tennyson (2011).
39 Loss‐of‐service benefits are subject to a daily maximum, and wage benefits are subject to a monthly maximum.
40 Michigan Insurance Workgroup Report, 2006.
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situations involving individuals with a serious impairment of body function, individuals with serious
permanent disfigurement, or death. Nearly 80 percent of automobile injury claims in Michigan are
settled with no involvement of the liability system.
The drawback of the system is its expense. Concerns about the high costs of no‐fault arose soon
after its inception, with calls for reform coming as early as 1989.41 But because costs were thought to
reflect the generous benefits provided, only minor changes have been made over the years. Figure 22
provides a stark graphic representation of the resulting cost trends, displaying the average cost
(severity) per first‐party injury claims in Michigan in each year from 1980 through 2009. Costs grew
slowly in the early years, but the rate of growth has increased over time. Between 1997 and 2009
Michigan’s average cost injury claim rose by 252 percent.
The bulk of the claims expenditure growth is due to catastrophic injury claims. Catastrophic
claims may involve injury to the brain and/or spinal cord, and injuries that result in serious and
permanent disability. People who are permanently disabled can require attendant or residential care for
the remainder of their lifespans, in addition to medical care and rehabilitative services. These claims
remain in the system year after year, leading to high claim payment expenses long after the accident has
occurred. Research estimates suggest that catastrophic claims account for less than 2 percent of first‐
party injury claims by number, but for over 45 percent of loss costs (Tennyson, 2011).42
41 See Report on No‐Fault Auto Insurance Reform in Michigan, Senate Commerce and Technology Committee.
42 The Michigan Catastrophic Claims Association (MCCA) claim and loss data are from the MCCA FY ending June 2008, reported in the MCCA’s Annual Statement to OFIR. Total PIP losses for Michigan are from the NAIC 2007/2008 Auto Insurance Database Report. Total PIP claims for Michigan are estimated from 2007‐2008 Fast Track data. Calendar year data for 2007 and 2008 are averaged to estimate fiscal year losses and claims.
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Figure 22 – Cost per Injury Claim in Michigan
Source: Tennyson, 2011
The ultimate costs of catastrophic claims are difficult to predict and create a very risky exposure
for insurers. To help insurers reduce uncertainty associated with these claims, the Michigan Catastrophic
Claims Association (MCCA) was created to act as a reinsurer for large no‐fault claims. The MCCA is a
private, non‐profit, unincorporated association created by the Michigan state legislature in 1978.43 Every
automobile insurer operating in the state is required to be a member. The MCCA reimburses insurers for
the portion of each no‐fault claim that exceeds a specified amount, currently $500,000.44
In 1991, the MCCA was paying about $100 million in reimbursements each year. The annual
payment amounts doubled to $200 million per year by 1997, and doubled again within another five
43 The MCCA was created by Public Act 136 of 1978, which added section 3104 to the Michigan Insurance Code. Its form and operations are governed by the enabling legislation. Information is taken from the MCCA 2010 Annual Statement, posted on the MCCA website http://www.michigancatastrophic.com.
44 Originally, insurers were required to pay the first $250,000 of every no‐fault claim, and the MCCA reimbursed them for any additional payments. Beginning in 2002, the per‐claim loss amount that insurers must retain has gradually increased [Public Act 3 (2001)].
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Cost Per Injury Claim
141
years. By 2010, annual reimbursements had grown eightfold and in 2011 MCCA paid out nearly $1
billion. Annual costs are clearly growing exponentially rather than linearly, due to the long‐term nature
of claims that accumulate in the system. Between 1978 and 2011, 27,169 claims had been reported to
the MCCA and approximately one‐half of these (13,522) remained open in 2011.45
As a result of the claim cost growth, insurance premiums in Michigan have increased more
rapidly than those in other states, so that in recent years Michigan drivers have been paying relatively
more for automobile insurance than they did in the past. In 1997 Michigan had the 18th highest costs of
automobile insurance in the nation, but by 2007 the state had the 11th highest auto insurance costs.
Average premiums per car in Michigan rose by 30.5 percent during that period, more than twice as fast
as the national average. Nonetheless, average insurance premiums in Michigan grew only half as fast as
average loss costs, meaning that the premium increases are not due to higher insurer profit margins.
Auto insurance reform has become an important public policy concern in Michigan as it has
grown clear that the current system is unsustainable. One new element in the current discussions is the
recognition of excessive costs in the system. Insurers document that they pay far more for services than
do other providers, and evidence of fraud and abuse in claims is mounting. One key problem is that
benefit reviews, benefit limits, and cost controls are generally very weak in Michigan’s auto no‐fault
system. Although wage and service benefits are subject to maximum reimbursement rates, medical and
residential care expenses have no lifetime limits and medical reimbursement rates are uncapped. Fee
schedules for medical services and reviews of service utilization are important components of cost
controls in most government insurance programs, but are not a part of Michigan’s no‐fault system.
Coordinated fraud control systems are also not present.
45 Statistics are obtained from the MCCA website, http://www.michigancatastrophic.com.