BIG & Small….

Both Canadian-owned and foreign-owned branch property and casualty insurers can attest to the challenging local underwriting conditions of recent years – evidenced by the extreme volatility in the industry’s financial performance. While the industry as a whole appears to have crawled onto safer financial ground over the course of 2003 and this year, the surviving veterans of the past “soft market” bear many a scar as testimony of the cruel vagaries of the insurance pricing cycle – and of course, the exacting cost of dealing in a highly politically influenced regulatory environment.

But, in looking back, it is interesting to recall that at the height of the last soft market, where marketshare was “king”, the business focus of senior managers was on attaining “cost efficiencies through critical mass”. The result saw a string of prominent mergers and acquisitions, on both the local and international stages, leaving many of the top-ranked companies of today with names either unknown 10 years ago, or with “bastardized” acronyms and/or coupled identities of their former selves. The idea was “bigger is better” in being able to compete at lower operating margins.

This clearly, on the face of it, appears a sensible strategy approach, particularly in a marketplace such as Canada where more than 56% of the total premium volume is vested in the very regulated and commodity-like auto line. Being a big, national writer means auto (and all its headaches) has to be included in the business plan – whether a company feels comfortable with the operating environment or not.

As we all know, the floor fell out from under the investment markets, leaving many insurers’ “low margin” business plans scuppered by excessively high loss ratios. Again, at the risk of pointing out the obvious, the financial devastation to income statements was felt by all companies – big and small. But, the industry’s taste for acquisitions was lost, and the term “critical mass efficiencies” became akin to blurting out loud in public a string of dirty words. So, now that the worst of insurers’ immediate financial difficulties have been overcome, how did the various ranked players perform during a year of strong recovery?

The first published edition of the annual “Benchmark Report” of the Canadian p&c insurance industry, produced by MSA Research Inc., shows significant variance in the performance of insurers relative to size. The report also highlights the “financial drag” of auto on financial returns. Furthermore, the MSA report reveals a stark contrast in the overall returns fetched by the industry on a per region basis, with Ontario (which represents about 45% of total net written premiums for 2003) producing the lowest return on equity (ROE) and the highest combined ratio based on last year’s figures.

Although the MSA Benchmark Report is not inclusive of all insurers operating in Canada, the broad statistical trends/ratios paint a perceptive picture of the current insurance landscape. While the MSA report indicates that insurers (excluding crown operations) generated an ROE of 11.5% for 2003, a closer look at the performance of companies based on size, line of business, and regional exposure suggests a wide swing in performance of the various industry players.

Notably, the large, top-ranked segment of companies finished 2003 with an ROE of 5.4% whereas “medium sized writers” produced a return of 15.6%, and the “small writers” with 10.6%. The report also points to an underperformance of mutual insurers with an ROE for last year of 6.8%. MSA Research president Joel Baker observes that, besides the heavy adverse impact of auto on the performance of companies, one of the more revealing trends exposed in the report is that the large insurers have yet to achieve the “economies of scale” put forward under the “big is better” concept of the late 1990s. He notes that the top-ranked companies, based on last year’s returns, generally produced higher loss ratios and higher operating expenses.

The exposure of insurers to different regions as well as lines of business will also influence the financial flexibility of the various players in moving forward. Needless to say, auto remains the industry’s poor orphan, with auto writers having generated an ROE of 7.2% for last year while companies engaged in predominantly commercial business achieved a return of 15.3% (with commercial business representing about 25% of total premium volume, this segment alone offers a lean diet for the major players). Insurers mainly engaged in writing business in Quebec fared the best over 2003, with the region generating an ROE of 17.2%. In comparison, business written in the western region (being primarily Alberta) produced an ROE of 10.3%, with Atlantic Canada showing a return of 7.5% and Ontario trailing at 6.5% (Ontario also brought home the highest combined ration at 105.4%).

Insurers’ returns thus far revealed for 2004 point to a much healthier industry – which should benefit further (at least to some degree) by the various provincial auto product reform initiatives that have either taken effect, or will take effect, this year. However, there is a clear danger in assuming improved strength and financial performance based on a handful of collective industry quarterly numbers and ratios. If nothing else, the findings of the MSA report are a sharp reminder that insurers operating in Canada have a long way to go before reaching a comfort zone.