Strict auto rate regulation hurts consumers, insurers: C.D. Howe

Provinces with stricter rate approval systems are slower to adjust premiums when insurers face rising claims costs due to issues like inflation, severe weather, or supply chain disruptions, a new report by the C.D. Howe Institute finds.  

In fact, insurers in more tightly regulated markets — Alberta, Ontario, and Atlantic provinces, specifically — change their rates by about 2.1 percentage points less than expected in response to losses, compared with those in more flexible regulatory regimes. 

This reduction of “insurer agility” risks long-term competitiveness in the market, which in turn, hurts consumers, says Gherardo Caracciolo, report author and C.D. Howe Institute fellow-in-residence. 

Why regulate rates? 

In Canada, where auto insurance is mandatory, “rate regulation is intended to ensure the best combination of stable premiums and a competitive market,” writes Caracciolo. “The goal is to make sure that insurers adhere to predictable and understandable pricing models and schedules over time while allowing for a competitive environment.” 

This type of rate regulation is called a “first-best scenario” — a market condition in which auto insurance rates are ideally set based purely on actuarial risk, without political interference or other rate constraints. In this scenario, prices accurately reflect costs and individual risk levels. 

However, “it is important to acknowledge that frictions, uncertainty, and unforecastable shocks play a fundamental role in the real world,” such as the COVID-19 pandemic and the trade war between Canada and the U.S., he writes. 

“Financial frictions and sudden and unexpected macroeconomic shocks make it difficult for there to be a long-term commitment from both insurers and consumers.” 

So, Caracciolo says, auto rate regulation walks a “fine line” between ensuring rates are reasonable for consumers without being restrictive for insurers. 

Globally, four regulatory models are available to achieve this goal. But in Canada, only two are used: Prior Approval and File and Use.  

Canada’s models 

In the File and Use model, insurers are required to file their proposed rates with the regulatory authority, but they do not need prior approval to implement them. 

“Once a rate is filed, insurers are free to apply it immediately, though regulatory bodies retain the authority to review it, require further documentation, and take corrective actions if necessary,” Caracciolo writes.  

British Columbia, Manitoba, and Saskatchewan employ the File and Use model. Coincidentally, these models all operate under public insurance systems.  

However, some private insurance jurisdictions in Canada — namely, Alberta, Ontario, and the Atlantic provinces — use a hybrid of the Prior Approval and File and Use models.  

“Within this framework, while insurers are allowed to implement some rate changes quickly (and then have them reviewed later), some other changes (oftentimes the biggest ones) may need Prior Approval, as they often involve significant adjustments for consumers,” Caracciolo says.  

The rationale behind the hybrid approach is that it allows for some flexibility, but ensures regulators have the authority to intervene if they believe prices have been inappropriately set. 

Overregulation risks  

Caracciolo says Canada’s File and Use models are a more flexible way to adjust rates, whereas “hybrid” models have stricter regulatory oversight.  

“The regulatory intensity across Canadian provinces has a significant and relevant impact on insurers’ ability to adjust their premiums,” he says.  

On average, provinces with more stringent rate regulations — Alberta, Ontario, and the Atlantic provinces — approve auto rate adjustments about 2.1% lower than those in the less-regulated provinces. 

“While this percentage difference may seem modest at first glance, it assumes greater importance when considering the broader context,” Caracciolo writes. “As a result, the need to quickly react and adjust insurance rates in response to these shocks becomes paramount for insurer survival.” 

Canada’s auto insurance sector has faced several cost struggles over the past few years, including supply chain disruptions, inflation, and severe NatCat events, which have cost insurers millions in claims costs.  

Rate intervention when insurers’ claims costs jump creates “a mismatch between premium levels and actual risk exposure,” Caracciolo writes. “This limitation could compromise their financial resilience in the long run, especially as market conditions become increasingly volatile.” 

As insurers face increased costs associated with worsening weather events, it’s more urgent than ever for them to be agile with their pricing.  

The quickest rate response 

Pure File and Use systems like those in B.C., Saskatchewan, and Manitoba, alongside Use and File systems — which aren’t currently used in Canada but allow insurers to implement rates first and then file them with regulators after — allow insurers to respond immediately to cost pressures and remain competitive, Caracciolo writes.

“Both systems remove the need for prior approval, allowing insurers to adjust rates with more agility, but the difference lies in the order in which rates are applied and submitted.”