Don’t pop the champagne cork just yet

Although the 2001 yearend results for both the Canadian and U.S. property and casualty insurance industries are expected to reflect one of the worst financial years on record, there is an excited buzz among the ranks of company CEOs that this is will be a year of renewed prosperity. Indeed, the industry’s business pricing cycle on a global level had already begun firming by the fist half of last year, and the events of September 11 further served to reduce reckless competitive capacity.

However, as bright as the financial landscape may look at this early stage, the vast majority of North American insurers are still likely to face a dismal return for 2002 as a result of the lag between written and earned premium growth. Robert Hartwig, chief economist of the U.S.-based Insurance Information Institute (III) confirms that 2003 will be the soonest before most insurers will be able to achieve a double-digit return on equity (ROE). “It’ll be 2003 before the [insurance] industry is likely to get its ROE to around 12%, which is the level expected by Wall St. [investment brokers].”

Although Canadian insurers were largely spared the cost impact of the terrorist attacks last year in New York, local companies face their own unique cost challenges, particularly with regard to the auto markets in Ontario and Atlantic Canada. With the Canadian industry likely to finish the 2001 financial year with an ROE in the 2% to 3% range, as predicted by the Insurance Bureau of Canada’s (IBC) chief economist Paul Kovacs, it will be a long haul before insurers as a whole will be able to claw their way back to double-digit returns. Specifically, this year’s top priority for many companies will be to reign in the persistent and alarming rise in underwriting costs. Notably, the Canadian industry’s 2001 yearend results will likely reflect a combined ratio of about 115%, according to Kovacs, with the year-on-year increase in the loss ratio expected to outstrip both written and earned premium growth. As such, while claims expenses continue to outpace premium growth, then any gains made on the pricing front remain superfluous.

Even though U.S. insurers bore a heavy cost burden as a result of September 11, which already by the end of the third-quarter financial period had produced an underwriting cost of US$10 billion, the rate of premium growth on both the earned and written levels showed significant strengthening. Excluding the cost of the terrorist attacks, the growth rate in written premiums exceeded the rise in claims costs.

While there will be a lag before earned premiums catch up with the recovery in written business, Hartwig is bullish of the gains that will be made this year. He expects U.S. insurers to notch up an average 15% gain in net written premiums for the 2002 financial year (which will reflect as earned premium growth in the 2003 financial year) while the increase in loss adjustment/claims costs will likely drop back to around a 10% year-on-year rate. Other positive indicators reflect in a significant price hardening last year in the commercial property and liability lines while the September 11 events have scared away excessive capacity. Although the industry’s capital fell by 15% during 2001, equal to about US$36 billion, Hartwig believes that insurers remain adequately capitalized — assuming that exclusions against large catastrophe risks on the terrorism side are applied. “Before September 11, market analysts believed that the insurance industry had about US$125 billion too much capital, you’ll notice they’re [analysts] now silent.”

Overall, Hartwig expects the current hard price cycle will continue through to the end of 2003, whereupon some of the strength behind this drive will ebb away. He agrees that the dips and peaks in the business cycle have become shorter compared with historical performance, which has much to do with the increased level of capacity chasing business. Even though the current environment remains sensitive to capacity, the post-September 11 marketplace has been impacted to a greater degree by uncertainty — which has greatly reduced the amount of “cheap capacity” in the marketplace. “The business cycle is being affected by issues [mostly relating to September 11] that we’ve never before had to deal with.”

The Canadian marketplace presents a different scenario, with excessive capacity remaining a hot point. However, judging by comments made by insurance CEOs (see cover article of the CU December 2001 issue for further details), the amount of capital chasing business is expected to ease off this year, primarily as a result of tougher reinsurance conditions. In this sense, insurer CEOs note that the Canadian marketplace is sensitive to international occurrences, and in this respect rates will have to rise significantly this year. However, insurers will have to respond in a more urgent manner to address claims costs and in applying appropriate price increases if they plan on not missing the boat on the current uptick in the business cycle.