Soft Landing…

With the “finishing line” for 2004 well in sight, insurers are upbeat that the year will prove to be a “banner event” in terms of industry profitability. But, in looking ahead, there appears to be uncertainty in company ranks to whether the industry will be able to maintain strong earnings growth through 2005. More importantly, some insurers are edgy that next year may not even offer the “soft landing” that is being so much spoken about.

A survey recently conducted by KPMG LLP of insurer senior management offers a very bright and bold view of the future. According to the survey, over 80% of Canadian insurers believe that the industry will be able to increase margins over the next one to three years. Nearly 70% of the survey’s Canadian respondents also expect their companies to perform significantly ahead of expectations over the coming year. In contrast, only 65% of U.S. respondents believe that companies will be able to increase margins moving ahead, with 57% holding the view that their companies will perform above expectations.

The results of the KPMG insurance management survey seem to conflict with the views of company CEOs partaking in CU’s annual “primary insurer strategies” review (see cover article of this issue). While the CEOs seem split concerning the potential of earnings growth next year, all agree that premium rates have peaked, and in many classes of business pricing is already sliding back. However, uncertainty of the future is not only motivated by an easing in pricing, but also a suspicious feeling that the declining growth in claims costs will suddenly reverse as consumers recover from the fear of rising coverage rates.

Furthermore, insurer CEOs are less than confident that the regulatory reforms made by the provincial governments to their auto insurance systems will deliver adequate cost savings to justify the rate freezes that have been brought into place. “Ontario auto will continue to show improved results in the early part of the year [2005] and then deteriorate as the year progresses…Lower premiums due to rate reductions, as well as lawyers and clinics finding new ways to build claims, will cause the [claims] experience to have a dramatic turnaround leading to combined ratios in excess of 100%,” predicts Bill Star, president of Kingsway General Insurance Co.

The second-quarter 2004 MSA/Baron “Outlook Report” took a close look at the decline in claims costs. The report focuses on Ontario personal auto, which accounts for roughly 25% of total direct written premiums in Canada. The report notes that the accident year loss ratio for Ontario private auto fell by 20 percentage points between 2002 and 2003. Approximately 30% of the 20 percentage point improvement is due to a reduction in claims frequency, the report states. Of this, about a third is purported to be the result of higher deductibles, thus eliminating small claim losses. The remaining two-thirds of the “frequency drop” in claims costs is attributed to consumers reporting fewer claims. “As consumers gain confidence that the premium level has stabilized, more of the unreported claims are likely to re-enter the insurance system,” the report observes.

While marketplace conditions for 2005 may appear hazy, the quarterly financial returns of insurers for this year suggests that the industry is on the right track – which assuming that companies are able to hold their nerve and focus on cycle management, could translate into that soft landing that companies are looking for – at least according to Rowan Saunders, president of Royal & SunAlliance Canada. Insurers more than doubled net income for the third quarter of this year, largely as a result of a significant jump in underwriting profit which clocked in at $1.1 billion for the period, according to financial data collected by the Office of the Superintendent of Financial Institutions (OSFI). And, while claims costs are showing a moderate increase, the latest quarterly result indicates that insurers are still maintaining net written premium growth in excess of 15% (see MarketWatch of this issue). In addition, industry feedback suggests that insurers’ final quarter result for 2004 will show more favorable reserve developments than adverse developments, thus presenting the platform for financial stability that is much needed.

Although the financial results of Canadian insurers remain firm, two critical issues cannot be ignored. The first being developments on the global stage: as noted above, the confidence factor of U.S. insurers lags the Canadian outlook. A global outlook report compiled by Swiss Re suggests that the p&c insurance industry will generate profits in 2005, albeit earnings growth will be moderated by price weakening. The MSA/Baron report notes the following with regard to the Canadian landscape: “The question on many a mind is whether this [strong financial] performance is sustainable beyond 2005. We believe not. It is our opinion that the top of the pricing cycle is behind us and that the political and economic forces will serve to reign in profitability going into the latter half of 2005 and early 2006.” The second factor applies to the resolution of companies in maintaining underwriting discipline. In the words of Michael Donoghue, president of Allstate Insurance Co. Canada, “now is not the time to sit back and be complacent”