Driving Economics

The business environment facing Canada’s property and casualty insurers over the year ahead is going to be tough, with the industry having closed the 2000 financial year with its first quarterly net loss since the 1970s and a dismal 6.2% return on equity (ROE), says Paul Kovacs, chief economist of the Insurance Bureau of Canada (IBC) at the recently held Swiss Re Annual Statistical Breakfast.

The industry’s final financial numbers for 2000 were revealed by Kovacs to the breakfast seminar attendees. Highlights include a two percentage point slip year-on-year of the industry’s ROE, soaring claim costs which boosted the combined ratio to around 114% in the final quarter, and stalled investment gains over the same period (see MarketWatch of this issue for further details). On a brighter note, Kovacs points to a strong and consistent rise in written premium growth across nearly all lines over the course of the year, which should translate into real earned premium growth for the 2002 financial year – assuming that insurers maintain upward pressure on pricing and manage to tame the rise in underwriting ratios.

On a more quirky note, Kovacs believes the widely predicted slowdown in economic growth in Canada this year will actually aid insurers in bringing down auto claim costs. Kovacs’ theory of a beneficial economic slowdown is based on a close correlation between miles driven by the insured public and the pace of economic growth. Statistics also show that an increase in miles driven results in higher claims, he observes. Based on U.S. data, Kovacs presented a line chart dating from 1947 to 1997 showing an almost exact movement between the growth of miles driven and that of gross domestic product (GDP). “On the claims side, there is a close correlation with economic performance, this could take some pressure off of the claims ratio this year.”

An added bonus to this scenario, Kovacs says, is historical data suggests that the volume of insurance sales remains relatively stable through the business cycle, in other words regardless of economic dips or peaks. As such, real premium growth should continue throughout this year although the extent of claims growth seen last year as a result of the “unexpected surge in the economy” will not be repeated this year, he predicts.

Kovacs does, however, concede that a noticeable slowdown in the economy does have a drawback in rising fraudulent claims, arson and theft. It also creates greater investment volatility and can negatively impact on the investment side of the business. That said, Kovacs holds the view that the investment markets will recover in the later part of this year as economic signs point to a much softer landing of the economy.

Now for my two-cents worth. I found the correlation between “miles driven and economic growth” to be very interesting. The data would indeed seem to indicate that a reduction in miles traveled will translate into lower claims. However, I believe that the negative impact on auto insurance sales could be far greater than Kovacs suggests. Reports from U.S. auto manufacturers already show a significant slowdown in consumer sales with rising stockpile inventories which will likely see increased “discount promotional sell-offs”. Not only will reduced auto sales and an increasing vehicle “age pool” as consumers hang onto their existing cars translate into slower auto insurance sales, but also a rise in uninsured vehicles on the road. Over the years I have seen various consumer attitude studies suggesting that the insuring public draws a correlation between the “costs” of vehicles and insurance. It therefore stands to logic that reduced vehicle values will see increased pressure to reduce premium rates. At this crucial turning point in the insurance pricing cycle, where the consumer is still very much seen as “king” – particularly in the Canadian market where personal lines comprises a much larger slice of the pie than commercial business – I fear that an economic slowdown could seriously undermine the recovery in premium growth. I also believe that the extent of the expected economic slowdown will be far greater and prolonged than what Kovacs suggests. As a colleague recently observed, “when the politicians go on the air trying to convince us that the economy is in great shape, that’s the time to pack up your bags and run”. But, having said all that, I have to concede that I am not an economist, and the above view on offer is only my humble opinion.

4www.canadianunderwriter.ca CANADIAN UNDERWRITER / APRIL 2001