1998 in perspective

Last year I predicted 1998 would bring back a deteriorating trend to the property and casualty insurance industry. In addition to the January ice storm, I felt that the continuing “soft market” would have a negative impact on underwriting results. In fact, underwriting ratios deteriorated five percentage points from 102.4% in 1997 to 107.4% in 1998 and expenses ratios climbed from 31.9% to 33.3%. I also predicted that the level of investment yield realized in both 1996 and 1997 could not be maintained. In fact, the industry’s investment yield dropped from 9.7% in 1997 to 7.9% in 1998. Overall, this resulted in a return on equity of 6.9% for 1998 compared with 13.2% in 1997.

The January ice storm resulted in gross incurred claims of about $1.45 billion. The net impact, after reinsurance, will likely represent about two points on the net underwriting ratios, which indicates some significant deterioration, even if the storm had not occurred.

Over-capacity fuelling the

“soft” market?

Several industry pundits have declared that the current excess capacity is driving the “soft” market. If they are correct, then it should clearly be reflected in the “growth leaders”. An analysis of the top 10 growth leaders in 1998 does not, however, support this theory. Six of the top 10 have risk ratios (net premiums to surplus) of over two times. Interestingly, of the 30 insurers with direct written premiums over $100 million, who experienced zero or negative growth in 1998, 22 of them have risk ratios of less than two times. I must, therefore, conclude that it is not over-capacity driving the “soft” market.

Living off the fat

Slightly over 50% of the realized pre-tax profits of the industry were derived from “favorable” development of prior years’ claims. On the surface this implies reserving practices have softened to cushion current year underwriting losses.

However, total claims reserves, as a percentage of net premiums written, have actually strengthened — they now exceed net premiums written for the first time in five years. Remember — these are only averages. Not all companies strengthened reserves in 1998 or benefited from profits on prior years’ losses. In that respect, one must analyze individual company statistics to learn if there are any culprits re-engineering reserves.

Averages are for economists

On the topic of averages, the Canadian p&c industry grew by a simpering .25% of a percent last year. That statistic, however, can be misleading of individual company performance. For instance, one insurer close to a winding-up order two years ago, managed to grow by 242% in 1998, while another, once Canada’s largest insurer, continued to implode with a negative 12.5% rate of growth. As I say, averages are for economists, individual stats are for consultants.

What then is in store for 1999? Results will remain at 1998 levels or perhaps even worsen until premium rates increase and investment performance improves. Essentially, there are too many companies competing for too little business, and there is a need for further industry consolidation. That said, looking at companies writing at least $100 million, it would be surprising to find more than five potential candidates. Unless one of the major “foreign owned” insurers is acquired for “non-Canadian” reasons, I personally do not see consolidation having a significant impact on the soft market trend.

Reinsurance support

One of the factors which caused the so-called “liability” crisis of the mid-1980s was a tightening of reinsurance rates. A similar scenario is unlikely in the current environment with somewhere between 30% to 60% of 1998’s reinsurance treaties issued on a “multi-year” basis at very favorable terms. This legroom provided to insurers will add to the price game playing. Consolidation at the brokerage level will also likely influence lower pricing. With the consolidators eagerly snapping up marketshare and premium, insurers will have to react to increased demands to maintain their own market position — a little extra commission and broader coverages will do wonders in this regard!

The current mindset

The mindset of many company executives at the moment is, “if you can’t buy out your competitor, then buy away his business!” As such, the “silly season” will continue for some time yet. Eventually, reality will bite back, and the industry will get on with the job of fixing the loss and expense ratios, and even enhancing investment yields. Eventually…everyone will be happy again.

And, just maybe when we reach this future “happy point”, the industry will not be over-capitalized and the stock analysts will think we are fully utilizing our capital base.