Alignment of Market Forces…

The arrival of 2004 no doubt brought a sigh of relief from many Canadian insurer CEOs in thinking that the climate of the marketplace can only improve going forward after having “survived” the stormy year past. For once, such hopes could prove to be more than just desperate “wishful thinking” as insurers’ financial returns for the first nine months of 2003 point to a long unseen “alignment” of better technical as well as fundamental market conditions that promise at “fairer weather” as the industry journeys ahead.

Canadian insurers ended the first three quarters of 2003 with net earnings of $1.6 billion, producing a return on equity (ROE) of 7.6%. Most importantly, the industry reversed its dismal underwriting performance of recent years to post a modest $50 million underwriting profit for the first nine months of 2003 (despite a hefty cat price tag paid in the third quarter) compared with the $931 million underwriting loss reported for the same period the year prior. The underwriting improvement saw the industry’s combined ratio for the first three quarters of 2003 drop to within easy reach of the magical “100% level” at 100.2% versus the 105.4% ratio achieved over the same period the year before.

The “bonus” for insurers was that net written and earned premiums continued to grow during 2003 at more than 15%-plus while claims costs began to deflate – showing only a 7.7% year-on-year rise for the first nine months of last year. And, even though investment yields remain weak, Canadian insurers are expected to produce a ROE of 10% for the 2003 financial year once the final quarter numbers are tallied.

While the “big picture” of the industry’s fortunes as described above offers a sense of optimistic hope, the real gain for insurers in looking forward lies in the specific underwriting numbers and what they point to. It has been no secret that the industry’s weakest area in underwriting has been the auto product – specifically runaway losses incurred through the “mandatory portions” of coverage under “medical accident” and “liability”. The sharp price increases brought about by insurers over the past two years in reaction to spiraling losses on accident benefit and liability claims culminated last year in the political controversy and public “crisis of confidence” in the insurance industry. As such, 2003 will probably go down as the industry’s worst year in a long time – not because of financial performance, but the unwelcome negative attention brought on by the rate increases and restricted availability of coverage in the standard marketplace.

The good news is that the “pain” endured by insurers last year appears to be producing the desired results. Industry financial data collected by the Insurance Bureau of Canada (IBC) suggests at a dramatic improvement in the underwriting ratios of nearly all regions and classes of business – including the critical (and otherwise pitiful) personal lines auto product.

Notably, the average loss ratio (across the country) on the liability component of insurers’ auto coverage dropped to 88.9% for the first nine months of 2003 compared with the 96.6% ratio reported for the same period the year prior. The loss ratio on the medical accident portion of auto coverage also declined sharply to 93.5% for the first three quarters of 2003 from the 109.1% ratio posted for the same period the year before. The IBC notes that the cost of claims relating to auto repairs fell in value as well during 2003 (vehicle repair costs have not been a significant concern for insurers over recent years). Overall, the loss ratio on auto for 2003 will likely clock in around 91% versus the 103% ratio the industry finished 2002 with.

In addition to the improved technical numbers, insurers are looking forward to auto product reforms expected to kick into effect among several of the provinces this year – with Ontario being the all-important “decider” with the province’s auto market accounting for nearly a quarter all premiums written in Canada. The IBC observes that auto product reform in Atlantic Canada, specifically New Brunswick, has already resulted in improved market conditions, and hence greater availability of coverage in the region. Insurers’ loss ratio on auto in Atlantic Canada declined marginally to 81% during the first three quarters of last year, while the industry’s “market of last resort”, the Facility Association, (FA) began to see depopulation of its policyholder base in New Brunswick as a result of the auto insurance reforms, the IBC says.

However, despite the many reasons for optimism, insurers can ill afford to become complacent regarding the industry’s pace of financial recovery. There are simply too many “wild cards” that could swing the odds against insurers. For instance, one of the biggest problems confronting companies is the FA, which is expected to end the 2003 financial year with an underwriting loss of more than $600 million – this will ultimately come from the pockets of auto insurers (which will be reflected in insurers’ fourth quarter 2003 income statements). The severity of the FA’s loss situation has prompted an industry call to rethink the way the association operates.

Other than the glaring problem-child of the FA, the industry has to achieve greater profitability on auto and bring loss ratios down further, the IBC notes. With Ontario’s auto loss ratio remaining stubbornly high at 93%, the ongoing claims bleeding suffered by companies is simply not sustainable over the medium to long-term – and most definitely cannot be accepted as the “market norm”, the IBC cautions. So, while there is cause to add a little “skip” to the industry’s walk as it moves into 2004, no one is ready to break into “song and dance” – not yet anyway.