Why regulatory intervention in auto markets does not benefit consumers
History shows that the Alberta government’s recent decision to impose a temporary freeze on insurance rate filings for private passenger vehicles could ultimately harm consumers and may create challenges for the province’s auto insurance system.
In the current context of escalating claims costs and cost-of-living pressures, freezing or capping premiums results in insurers having to make tough decisions on new capacity in order to continue to paying out claims for existing policyholders.
If a government compels insurance companies to operate at a loss for a sustained period of time, insurers may move capital to other jurisdictions or other lines of business with more favourable market conditions. This migration of capacity could impact the level of competition in a market, leaving consumers with fewer choices.
Competition helps sustain a healthy auto insurance market. This benefits consumers, who enjoy the advantage of being able to shop around to find the best policy at the best price.
Auto insurance rate setting is prospective; rates are set based on the expectation of where claims costs will be while the policy is in force. Rate setting by insurers is undertaken by professional insurance actuaries who specialize in analyzing financial risks by implementing statistical, financial and mathematical methodologies. Actuaries aid in assessing risks, which helps companies estimate premiums for their policies.
In Canada, insurers can only sell an auto insurance product that is designed, mandated and regulated by the government. Insurers continue to offer alternatives to provincial governments to help reduce premiums and provide greater choice to consumers; however, these measures often get bogged down in lengthy political debates.
A rate freeze or rate cap is a poor substitute for the difficult and time-consuming work of product reform. The only way to ensure that auto rates are held to competitive levels on a sustainable basis is to address the underlying defects in product design and the accompanying systems that administers the distribution of the product and the settlement and adjudication of claims process. Historically, government regulatory interventions have been accompanied with a commitment to product reform.
Examples of previous regulatory interventions in auto insurance
California’s 2020 Rate Freeze
At the onset of the COVID-19 pandemic, the California Department of Insurance refused to approve auto insurance rate filings. During the rate freeze, California drivers and insurers experienced negative consequences. The rate freeze led to reduced options for consumers to buy auto insurance, and when the rate freeze was lifted, some drivers faced large increases in their premiums.
Alberta’s 2017–2019 Rate Cap
During Alberta’s last regulatory intervention – a provincial rate cap from 2017 to 2019 – consumers faced challenges securing the coverage they needed, as insurers were forced to take action to remain viable and continue paying the claims of policyholders. Premiums still increased 12% when the rate cap was in place. When the government imposed the rate cap in Alberta in 2017, it promised to undertake a suite of reforms to help address cost pressures in the system. However, it did not undertake any reforms. As a result, insurers took several measures to reduce losses. The two most common negative consumer effects were:
- Reduced payment plan options, whereby consumers had to pay a year’s worth of premiums up front.
- Reduced availability of optional coverages, which was especially problematic for consumers leasing or financing a vehicle, as car financing
The Impact of Regulation on the Availability and Profitability of Auto Insurance in Canada
An academic study suggests that regulatory interventions aimed at addressing affordability issues may have the unintended consequence of aggravating availability issues, and underlying market conditions may exacerbate this effect. The report is available here.
Summary
Past experience with price caps (rate freeze or rate cap) on insurance rates have not achieved the desired long-term outcomes for consumers. Experience has shown that:
- Capping rates will not reduce claim costs. Claim costs are determined by the number of claims and the cost of settling those claims, not what customers pay for insurance. Claims pressures can only be addressed through product reform, or if there is a decline in the number of claims or a reduction in the cost of settling claims.
- Capping rates is likely to reduce options for consumers. When insurers are unable to adjust prices in response to changes in costs, they may consider options for reducing costs that are within their control such as changes to their product offering or the channels through which insurance may be purchased. This reduces options available to consumers and some consumers may not be able to purchase their desired level of insurance.
- Capping rates leads to a deterioration of financial performance for insurers and withdrawal or change in services. In competitive markets, insurers withdraw services if they are not able to achieve sustainable financial results.
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