Capital Power

In the latest edition of “Perspective” – the Insurance Bureau of Canada’s (IBC) quarterly industry financial newsletter – chief economist Paul Kovacs notes (with perhaps a hint of irony): “Not long ago, many [within the property and casualty insurance industry] were concerned that overcapitalization was disrupting insurance practices in Canada and elsewhere. Now some concern is emerging about capital adequacy.” Indeed, feedback from primary company CEOs in CU’s annual “state of the market” survey (see cover article of this issue for further details) suggests that the availability of capital, or lack thereof, is likely going to be the biggest challenge insurers face in the year ahead.

While the reduction in industry capital has already seen a dramatic slump in market capacity this year across nearly all lines of business and geographic regions, the concern for many insurer CEOs as they look ahead is the limitation of capital in being able to write new business – just when the financial indicators and recent legislative product reform measures point at a healthier underwriting environment. “One of the emerging trends that will impact the industry in the coming year is the under-capitalization of some players. As both the profitability of the industry and the value of its invested capital has been eroded, some insurers will see their ability to write new business significantly reduced,” observes Claude Dussualt, president of ING Insurance Co. of Canada. This view is supported by Igal Mayer, president of CGU Group Canada, in pointing out that market capacity will likely decline further in the year ahead. “There will be continued turmoil in the market as companies re-underwrite their books, and for many with weaker balance-sheets and solvency margins, capacity will be reduced.”

Kovacs notes that growth in capital levels within the Canadian p&c insurance industry have definitely declined markedly. The industry’s capital/premium ratio had fallen to 79% by the end of September this year compared with its high of 91% in 1999. “Premiums are increasing rapidly while capital growth is at the lowest level in 14 years,” he says. The last 12 months saw industry capital increase by 2% while the overall gain for last year was 2.3%. This is a stark shift from the average 6.4% annual growth rate in capital over the past 13 years, he adds. “In the U.S., p&c [insurance] industry capital has declined for three consecutive years, reflecting the international pressure on industry capital.”

Years of poor underwriting performance, culminating in the devastating loss from the World Trade Center (WTC) terrorist attacks, played a significant role in the reduction of global industry capital, Kovacs observes. However, the greatest impact has come from falling investment values over the past two years as equity markets have spiraled downward, he adds. Another factor on the local front is, “it appears that some companies have pursued a deliberate strategy to retain capital in Canada closer to the minimum required by regulators”.

While reduced capital creates capacity problems, and limits the ability of companies to grow their business, a more critical factor arising from the current state of the market is the financial soundness of insurers, Kovacs says. The number of companies experiencing poor underwriting results has risen significantly over the last five years, he notes. Notably, in 1997 more than half of the top 100 insurers in Canada produced an underwriting profit, representing about 44% of all premiums earned. So far this year, less than half of the companies in question achieved an underwriting profit, equal to about 32% of earned premiums. As a result, there were “only a handful of companies” that scored less than 15 on the MAT/TAD results in 1997 (scores higher than 15 reflect financially strong operations). In contrast, this year saw insurers writing approximately 70% of all earned premiums slipping below the MAT/TAD score level of 15, Kovacs points out.

The Canadian industry is adequately capitalized to cover existing, traditional risks, Kovacs says. And, while loss preventive actions have been initiated by the industry over recent years against large catastrophe exposures such as earthquake, mold, cyber risks, etc., there remains concern that a fairly large unpredicted loss (for instance, terrorism) could prove devastating based on the industry’s current weak capital position. “…significant shocks would be a challenge in the current market.”

However, the market’s current volatility is not all “gloom and doom”, at least according to some players. Bill Star, president of Kingsway General Insurance Co., holds an upbeat view with regard to the financial performance of the Canadian p&c insurance industry for 2003. As profitability returns to the industry, and therefore attractive shareholder returns, availability of capital will increase, he predicts. From his perspective, the current market offers stronger companies the opportunity to expand their business as others withdraw. “The [Canadian] insurance industry will be split between those companies that will prosper during 2003 and those who will downsize and attempt to get their house in order.”