Product Reform

Following the disappointing financial returns Canadian property and casualty insurers produced for the first quarter of this year – a time which a year ago many in the industry had projected would see a recovery in earnings – the latest financial results up to the end of the first half of this year point to an unfolding tragedy – one of apathy.

Insurers brought home a measly 2.6% return on equity (ROE) for the 12-month period to end June, according to Insurance Bureau of Canada (IBC) data. However, the real tragedy facing the industry lies in the fact that the unfolding figures reveal the true lack of attention by companies last year to apply appropriate pricing and cost control measures when it had become clearly obvious that the “road traveled of past” could only lead to financial ruin. The result of this apathetic response has brought the industry to its current “crisis management” position, against a financial backdrop which the IBC’s chief economist Paul Kovacs describes as likely being the worst year facing insurers since 1975. In this respect, he points out that an earnings recovery for the remainder of the year is next to impossible.

Although there were signs of price firming last year, the actions taken were inadequate, Kovacs concedes. And, while this year’s returns point to fairly strong growth in rate increases, with net written premiums rising by 11.5% to the end of June, and a 10.3% increase for the second quarter over the first three months, this gain will only reflect as earned premium growth for the 2002 financial year. The industry’s net earned premiums for the first half of this year did rise by 8.6%, however, this achievement was over-shadowed by a 10.7% jump in claims costs (Ontario auto notched up a 25.5% increase in claim costs).

One of the biggest challenges of our industry is trying to understand what happened to the numbers, Kovacs observes. The huge jump in claims costs had not been anticipated last year, he adds, although an important factor coming into play is the role of provincial regulators in influencing the direction of rates. “This is an intriguing industry in terms of what happens to price. A key factor is government rate approval.”

In this respect, Kovacs notes that a recovery within the industry will require more than upward rate adjustments. Action has to be taken to control costs and reduce the loss ratio, which for the first half of this year rose by more than four percentage points over the same period in 2000 to reach 76.9%. With the expense ratio currently running at a low not seen in many years, the only solution is to look at a combination of loss control and rate adjustments. But, as long as claims costs continue to rise unabated, insurers will hit a ceiling of consumer and regulator tolerance to further price increases, Kovacs observes. Notably, an independent research report sponsored by the IBC in October of last year to identify rate adequacy in Ontario auto determined that the market was under-priced by about 26% – since then, the sudden increase in claim costs will have worsened this picture.

It is in light of this quandary that the IBC has engaged insurance regulators in Ontario, Alberta and the Atlantic provinces to look at product reform, Kovacs says. Developments are underway in Atlantic Canada to bring in a combination of rate increases and cover changes over the next six months. Part of the Atlantic project involves a consumer study to test public opinion to the cost of insurance and their willingness to accept policy changes. Similar actions are being looked at in the other troubled provinces, with Ontario auto being the biggest thorn in the side of insurers.

The industry realizes that it cannot pull through this financial crisis by price alone, Kovacs comments. Companies and regulators need to sit back and assess whether certain items covered in standard personal lines policies really need to be included. By introducing product reform, insurers may be able to cushion the impact of price increases while regulators would avoid a potential political backlash resulting from last minute sharp rate hikes and possibly financially insecure underwriters operating in these markets. However, these discussions take time, Kovacs notes. For instance, the IBC is still waiting on Ontario’s provincial government to respond to the auto product reform suggestions forwarded nearly a year ago. “We’re running out of creative ideas, and there’s no time.”