Do insurance companies ever lose money on auto insurance?

…They can and do in Ontario – Here’s proof

Auto insurance premiums in Ontario continue to go up, and there’s been a lot of talk that it’s just insurance companies lining their pockets. Well, here’s the thing: They’re not.

Just like any business, insurance companies would like to make as much money as possible, but the fact is that auto insurance in Ontario is heavily regulated by the government, and insurance companies are only allowed to make a certain level of profit. If they make too much, the government forces them to cut their rates.

That’s easy to say, right? We are part of the insurance industry, so of course we would say that insurance companies don’t make excessive profits. OK. So we’ve done a little bit of digging to come up with 3 things that prove that auto insurance companies don’t always make money on auto insurance, and that they sometimes actually lose money in spite of high premiums.

Exhibit A – doing the math

Whenever you’re trying to figure out how much profit a company is making on something, of course what you do is you look at how much they’re charging, and compare that to their costs. In auto insurance it’s a little bit more complicated than that, but not much.

Most of the profits made by insurance companies are paid back in claims

The single biggest cost for auto insurers is claims. According to the General Insurance Statistical Agency (GISA), in 2018, the average premium per vehicle in Ontario was $1,468, and on average, insurance companies paid $1,120 of that back in claims and claims-related expenses. That’s 76% of premiums accounted for. This number is quite volatile from year to year, and can range from the mid 60s to the high 70s.

“In 2018, the average premium per vehicle in Ontario was $1,468, and on average, insurance companies paid $1,120 of that back in claims and claims-related expenses.”

Given that 1 in 10 of us will make a claim on our auto insurance every year, and even the most insignificant claim is likely to cost well in excess of the average premium charged, it is perhaps no surprise that the vast majority of our premiums are paid right back out in the form of claims payments.

Beyond claims, it’s a little harder to assign costs to a particular line of business like auto insurance, but in 2018, insurance companies spent about 31% of the premiums they collected (not just for auto insurance) on operating expenses like employee salaries, marketing, commissions, taxes etc. This number is more predictable than claims, and has been between 28% and 33% for 20+ years. Auto insurance commissions are lower than for home, business and other types of insurance, so let’s assume about 25% for expenses. That means that between claims and expenses, auto insurers paid out about 101% of what they took in in 2018.

That doesn’t mean auto insurers lost money overall. The difference between insurance and most other industries is that insurers actually invest part of the premiums you pay into government bonds etc. In past years, when investment returns were as high as 10%, this could make a major difference in how much profit insurers were able to make. In 2018, the average return on investment for auto insurers was 2%.

So auto insurance in Ontario made money in 2018, but barely 1%. And because there are 50+ companies that sell auto insurance in Ontario, and some made more than 1%, that means that some companies absolutely lost money.

Exhibit B – rate filings

In insurance speak, the percentage of premium that is paid out in claims is called the “loss ratio”. When you add expenses to that, it’s called the “combined ratio”. Generally, given the current investment environment where insurance companies can only expect 2 or 3% returns, they want to keep the combined ratio well below 100, because, well, that’s the profit. If the combined ratio is above 100 for an extended period, then insurance companies are losing money, and they will ask for rate increases. Because the government wants these companies to remain financially strong and able to pay claims, they will approve increases when it’s clear that the company is losing money.

On the other hand, if the combined ratio gets down close to 90 or below, the government steps in and essentially tells the insurance companies that they are making too much profit, and that they need to cut rates.

The fact is that in heavily regulated market like Ontario auto insurance, if rates are going up significantly, that in itself is proof that companies are losing money. That’s exactly what we’ve seen over the years with the
rates that the Ontario government approves. When insurance companies are making good returns, rates come down. When they are making less money or losing money, rates go up.

We don’t have access to the same details that the government gets when insurers file their rates, but we do know a few things:

• When overall profit drops below 8%, that usually means that profits on Ontario auto insurance are just about non-existent, and that means some companies are actually losing money.
• When companies lose money on Ontario auto insurance, rates go up.
• When companies make money on Ontario auto insurance, rates go down or stay flat.

There’s usually a one-year lag time, but the pattern is pretty clear. For example…

• Profits were between 6 and 7.6% from 2008 to 2010. Predictably, rates went up by 9, 8 and 12% from 2009 to 2011.
• On the other hand, profits averaged over 9% per year from 2012 to 2015, and rates went down every year from 2013 to 2016.

Of course government gets much more detailed reports from each company and then approves rates individually, but there is a clear pattern.

Exhibit C – straight from the regulator

If you don’t believe the above numbers from GISA, Canada’s independent statistical agency for insurance, then consider the 2018 year-end report from FSCO (the regulatory agency for insurance before FSRA), which includes financial results for more than 180 companies that sold insurance in Ontario that year. The report doesn’t show auto insurance results specifically, but more than 50 companies reported an overall loss in 2018.

Maybe profits should be higher for insurance companies

This is not likely to be a popular statement, we know, but the fact is that the nature of insurance is such that there will be times when insurance companies lose a bunch of money all at once. Think of major storms, widespread flooding or wildfires like we’ve seen quite recently. Companies buy re-insurance to protect themselves from the largest such events, and they try not to concentrate their policies in one geographical area for this reason, but this isn’t always possible. A major event can still lead to millions, even hundreds of millions, in losses.

Nobody is asking you to cry for the insurance companies, but if you were looking to invest your own money, and someone told you that there was a very good chance that every few years you would lose millions, then you would probably expect a higher return in the good years. So if aiming for 10% profit seems excessive, it’s really not.

Conclusion

Here’s the thing: We’re not saying that insurance companies don’t make money. They usually do. But a highly regulated market like Ontario auto insurance is not a license to print money. The government lets insurers target a moderate profit (lower than if they got to choose themselves), and then if claims go up or there’s a big flood etc., yes, it’s absolutely possible for insurance companies to lose money. They have before and will again.

The theory that insurance companies jack up rates and then rake in the profits is half true. They do increase rates to be profitable, but if an insurer is already making a good profit, there’s no way the government ever approves an increase.

Sources

• IBC Facts Book
• FSCO