CAMIC Mid-Year Meeting: Cautious Steps

While Canada’s mutual insurers have enjoyed a long and solid history, it has been many years since a new mutual was formed in this country. The need to expand membership in the Canadian Association of Mutual Insurance Companies (CAMIC) came to the surface at the association’s Mid-Year Meeting in Toronto recently, with board member Robert Forsythe noting the association is looking at increasing membership by including cooperative and reciprocal insurers.

These kinds of organizations, as alternatives to stock insurance companies, “share similar values” to mutuals, Forsythe says. “Ultimately we are all working for the same constituents – our policyholders,” he says of the common bond between mutuals and reciprocals or cooperatives. “We believe CAMIC is a much stronger organization with the addition of these new members.” Specifically he points to the significant growth in reciprocal insurers seen in Canada over the past few years.

Forsythe hopes expanded membership will help increase CAMIC’s role as the “other voice” in an industry dominated by foreign-owned “giants”.

The association has a busy lobbying agenda for the remainder of the year, with CAMIC president Normand Lafreniere saying points of discussion with government will include a push for more federal money aimed at provinces and municipalities. He says this agenda is “based on the mutuality spirit”, as mutual insurers seek to protect the interests of the local communities they serve. He notes with some dismay that although the federal government has been able to reduce debt spending through budgetary surpluses, it is directed much of its spending to new federal programs, rather than increasing payments to the provinces, and thus municipalities. What money does come the way of local governments tends to come with federal oversight, making municipalities accountable to the federal government rather than their own constituents.

Lafreniere says CAMIC is also looking at how it will respond to the federal government’s review of financial institutions legislation, with responses to the recently released consultation paper due this June. These responses will be factored into a white paper on financial institutions reform due in the fall, with new legislation due by fall, 2006.

UNDERWRITING WARNING

Other speakers to the CAMIC Mid-Year focused on the issue of underwriting. Swiss Reinsurance Co. of Canada chief agent Brian Gray says the industry’s strong results make it very tempting to fall into a competitive battle for marketshare. “There’s a lot of smiling faces. Everybody’s in pretty good shape.” so we say “we have to cut our prices a bit to protect our book. It’s only 5%.” But that 5% rate reduction can have serious consequences he warns.

Claims are still costing as much, as are commissions and expenses so almost all of a premium cut comes out of the margin. Based on 2004 yearend data from the federal regulator, the industry’s margin is about 10%, so a 5% reduction essentially cuts the underwriting margin in half.

At the same time, Gray explains, a 5% rate cut means a 3.3 percentage point drop in return on equity (ROE) – with an average industry ROE of about 8%, he says, “we’re wiping out about three-eighths of the industry’s long-term profits”.

Some of the issues leading to the “5% problem” including the fact that many companies are focused on getting a “good rate” for a specific piece of business, rather than on the margin in that piece of business. “Some companies don’t know how much margin is in a piece of business when they write it.”

This may be partly the result of centralized underwriting, specifically in commercial insurance, where the link between risk and margin is not seen. The industry tends to “wait 15 months” for results to come out, realize business has been under-priced and then try to compensate with rate corrections.

“Are we doomed forever to these incredible rate cycles?” Gray asks. There may be some hope for the industry, he says. One key is the creation and use of better pricing technologies to reflect the margin on each risk. The industry also needs to track rate changes, to explain the larger impact of the numbers to staff, and to price with risk-free investment income rather than crediting full investment income with no charge for risky assets.

Gray says he is encouraged the industry can change its ways. “I do think it [the swing of the cycle] will be reduced this time because it is more transparent.” Specifically, capital providers better understand market cycles and are more apt to react to perceived weakness in underwriting.

VALUATION CHALLENGE

One area where better risk understanding is needed is in residential valuation, says Klaas Westera, business manager for the Canadian operations of Marshall & Swift/Boeckh. The company studied actual claims cost versus the replacement cost valuation on total loss homeowners’ claims. The result was that 84% of files reviewed indicated properties underinsured by an average 27%.

And, Westera notes, total loss situations seem to be more common as a result of rising natural disaster losses. In recent years, the residential valuation problem has been highlighted by several events, but most specifically the Kelowna, BC wildfires.

The issue has arisen because of the use of simplistic “square footage” valuations on properties, which are too subjective, lack data and do not take into account factors such as geographical differences in replacement costs and labor, he explains. Data is also not being updated often enough to reflect rising costs, new building codes and renovations to properties.

Prior to recent catastrophes, the problem had been masked by the low level of total losses, and also by the use of “guaranteed replacement cost” in policies. And now, Westera adds, there is a “lack of understand and lack of cohesion” in the industry in terms of addressing the issue.

On one hand, the industry fears increasing the replacement cost on homes will alienate consumers who already have a low opinion of the insurance industry.

But the industry has much to lose if it fails to address residential valuation, Westera asserts. Unpredictable loss costs mean unpredictable profit, potential under-reserving and potential problems with reinsurance limits. As well, is can lead to under-valuation of contents limits tied to property limits, and also poses a potential errors & omissions (E&O) exposure.

“Delay is not a viable option and guaranteed replacement cost should not be used as an excuse not to act,” he says.