As we turn the corner into 2010, Ontario’s 1997 CAD $ 700,000 average reported large motor loss now stands at CAD $ 3.2 million; a four-fold increase over 11 years. Given such inflation and the absence of redistributory index-linked clauses, upward non-proportional reinsurance pricing adjustments are essential to avoid a future crash in capacity and healthy balance sheet for all parties.

PartnerRe’s recent study¹ of motor claims in Ontario, Canada, showed that the average reported large third-party liability and accident benefit motor loss in 1997 was CAD $ 700,000; this developed into a staggering CAD $ 3.2 million by 2008 without trending. The average non-trended large claim in accident year 2008 also stands at a similarly high CAD $ 2.8 million (see figure 1). And it’s not just the severity that’s on the up; an increasing number of claims are falling into the large claim category (figure 2).

We have to first consider why this is happening, so that the future trend can be estimated – for example what lies in store for a CAD $ 2 million reported loss in accident year 2008 after ten years of inflation? - and second, how can the effects of this trend be accommodated and distributed within the insurance and reinsurance industry?

Inflationary factors
For every year from 2004 to 2008, both the annual Ontario Private Passenger (bodily injury & accident benefits) and Commercial Automobile (bodily injury & accident benefits) indexes were higher than the annualized rate of overall inflation as measured by the Consumer Price Index (CPI)². The observed claims inflation reflects medical and social costs that continue to rise at higher rates than the rate of economic inflation; a major problem given the long-tail nature of these claims (see section titled “Impact of interest rate change”).

One of the principal driving forces behind the observed loss inflation is the escalating cost of medical care and rehabilitation. Other social inflationary factors are the legislated increases in benefit levels (in some case retrospectively), new concepts of tort and negligence, increased liberal treatment of claims by the courts and higher amounts awarded by juries, as well as rising legal and regulatory costs associated with motor insurance. Under the current tort and no-fault benefit regime, it is also now not necessary for multiple claimants to be involved in a single occurrence for the claim to reach the CAD $ 3 million level; there are many cases of large claims involving a single injured party.





Sharing the inflation
The indexation clause does not exist in Canadian motor and casualty reinsurance treaties. As a result, all of the inflation risk is transferred to the excess-of-loss treaty. A non-indexed motor excess of loss cover correspondingly requires constant price reassessment to keep up with this inflation.

Impact of interest rate change
Any change in the risk-free rate (the rate that corresponds to the risk-free, high quality government bond rate) has a direct impact on the investment income that can be earned on reinsurance premium assets and reserves before claims are paid; the lower the risk-free rate, the lower the return on equity. The impact of risk-free rate on reinsurance pricing is much greater for long-tail business such as motor, compared to short tail business, as it applies over a relatively longer claims payment duration.

Figure 3 shows the results of an internal study into this effect. In the study, we assumed a claims-duration of 8.65 years for motor non-proportional business and a drop in the risk-free rate from 4.5% to 3.5%. Based on such a fall, the reinsurer would have to correspondingly raise the reinsurance rate by 8.7% to maintain return on equity.

For short-tail business, such as property non-proportional covers, assuming a claims-duration of 1.47 years and based on an even larger fall in the risk-free rate from 4.5% to 1.5%, the reinsurer would only have to raise its rate by 4.3% to uphold return on equity.



Safely around the corner
Estimating how motor losses will develop and how economic factors will influence the income that can be earned on reserves, are both critical stages in the evaluation of an appropriate, adequate price for reinsurance cover – essential for continued quality capacity and the ability to pay claims. These estimations require a number of assumptions to be made and also an understanding between the parties involved as to what the assumptions are and the reasoning behind them. Studies such as this one for Ontario are an important part of this process.

¹ 2009 PartnerRe research on 266 Ontario motor losses (71.2% market share), accident years 1997 to 2008, with a minimum reporting level of CAD $ 2.5 million.
² Source: IBC – AU10 Report and Statistics Canada – Consumer Price Index, health and personal care by province. The cumulative inflationary factors for the Private Passenger and Commercial Accident (bodily injury and accident benefits) Indexes were respectively 55.3% and 82.6%. The cumulative inflationary factor for the Health Care Service Index was much lower at 20.1%.