“Rich Man, Poor Man” Syndrome

Canada’s property and casualty insurance industry – inclusive of the primary and reinsurance sectors – appears to suffer from a condition of “rich man, poor man syndrome”, a condition which the insured public whether they fall in the personal lines or the commercial classes of business does not seem to have much sympathy for. As Lord Levene, chairman of Lloyd’s of London, recently observed in an address to Toronto’s Empire Club, the concept of “profitability” appears to have become a “dirty word” when applied to Canada’s p&c insurance industry. Needless to say, the Lord was not impressed with Canada’s regulators and the political interference that has so swayed the course and fortunes of insurers over recent years.

However, it would be remiss to plant the blame of the market’s pricing volatility squarely on the shoulders of the regulators/politicians. Poor management at the “top end” of insurance companies with regard to underwriting discipline has as much (if not more) to do with the extreme conditions of the marketplace, Lord Levene was quick to note. And thus the industry moves forward, having accelerated rapidly from its “poor man” status of just two years ago to what many regard today as being an excessively “rich man” position of import.

Indeed, the financial returns of primary insurers for the first quarter of this year (as reported by the Office of the Superintendent of Financial Institutions (OSFI)) indicates that companies were able to boost net earnings by more than 4.3 times to $589.6 million compared with the $137 million reported for the same period the year prior (see MarketWatch of this issue for further details). The primary industry’s ROE for the first quarter of 2004 is in the region of 15%, which follows on the 11.3% return made by companies for the 2003 financial year. Of perhaps greater significance is that the latest quarterly results suggest that insurers have been able to maintain real growth in premium income, with insurers having notched up a 27% gain in net written premiums for the first quarter of 2004 while claims costs have lagged substantially with a 10% annual rise over the same reporting period.

Reinsurers also appear to have “turned the corner” in their tide of fortune, with companies having finished 2003 with a 5.8 times increase in net earnings to $310.8 million versus the $53 million shown at the end of 2002. Notably, reinsurers were able to claw back the average combined ratio by almost 14 percentage points to 96.4% over the course of the 12 month period, presumably leaving them in stronger stead as the industry overall continues to benefit from firmer pricing. Although, it is interesting to note that pricing momentum in the reinsurance sector appears to have almost stalled, with companies reporting 4.6% year-on-year growth in net written premiums for 2003 (this is significantly below the 20%-plus growth in net written premiums disclosed by primary insurers for 2003, and the 27% gain shown for the first quarter of this year).

The improved financial position of insurers/reinsurers in Canada has seen a marked difference in the overall health of companies, the Insurance Bureau of Canada (IBC) notes in the most recent issue of its quarterly analysis publication “Perspective”. During 2001, about 12% of the total insured marketplace was being underwritten by insurers failing OSFI’s solvency test, observes Jane Voll, chief economist at the IBC. Last year saw only 1.6% of the total marketplace insured by companies failing the same test. Insurers on average finished 2003 with a 43% “safety net” in excess of the capital required under OSFI’s “minimum capital test” (MCT), Voll says (the industry’s MCT score at the end of last year stood at 215% compared with the regulatory target of 150% – being 1.5 times the level of capital availability and the particular business/investment exposure of any company relative to its underwriting liability).

The benefits of a stronger marketplace are translating into price moderation for insureds this year, as well as greater coverage availability, the IBC notes. Voll points out that auto rates (that which attracted the most negative public attention of late) fell in Prince Edward Island by 20.6% in April of this year compared with the pricing peak of August 2003, Nova Scotia auto rates were down by 18% in April versus November last year, New Brunswick has seen current pricing fall by 11.4% against last July’s peak, while Ontario auto witnessed a 6.7% average rate reduction in December 2003.

The IBC notes that the Ontario regulator has approved further rate decreases from insurers representing more than two-thirds of the marketplace of additional rate reductions of between 10%-15%, which should kick in during the course of the second quarter of this year. Auto pricing in Alberta, which is still very much in the midst of a political battle over insurance costs, has seen lower rates of around 9.4% in April of 2004 compared with that of November 2003. However, the pricing and cost exposure of auto remains very much a “wild card” across the provinces, with recent draconian regulative measures introduced by Newfoundland having prompted at least one national insurer to announce its departure from the province.

There will always be “ups and downs” in the fortunes of the insurance industry – this is inherent in the nature of the business. However, whether insurers have learnt from their lessons of the past, and are willing to build a strong and stable foundation based on the financial recovery achieved from the “bloody battle” of the most recent hard market remains to be seen. Unfortunately, industry analysts, brokers, and insurance company CEOs themselves, do not seem overly confident in their outlooks that the industry can break from its “rich man, poor man” mentality. Only time will tell…