Canada’s Leaning Toeer of Pisa

The Canadian property and casualty industry could have been mistaken for the Leaning Tower of Pisa in the way it was described at the 2010 Swiss Re Breakfast held in Toronto.

The breakfast featured the Insurance Bureau of Canada (IBC)’s annual state of the union address. IBC’s portrait suggested an industry groaning under the weight of still-increasing auto insurance claims costs, an excessive tax burden and expanding regulatory costs.

Swiss Re opened the breakfast noting how international regulatory responses to make the world safe after the global recession may in fact run the risk of punishing the global insurance industry — i.e. by requiring more capital to address solvency concerns — for sins committed mainly by the banking industry.

Ontario auto bleeds more red ink

Canadian property and casualty insurers writing Ontario auto lost an astounding $907 million in 2009, said Barbara Sulzenko-Laurie, IBC vice president of policy, in her ‘State of the Industry’ address.

The continued escalation of the “excesses and abuses” of Ontario’s no-fault SABS system resulted in a 23.5% increase in the direct loss ratio in Ontario AB lines, she continued. Between 2008 and 2009 the loss ratio increased from 124% to 148%.

Sulzenko-Laurie observed companies that had more exposure to Ontario auto — based on 50% or more of direct earned premium — were much more likely to have returns on equity (ROE) of less than 9%.

“For those companies that had more exposure to Ontario auto, 75% of those companies had an ROE of less than 9%, whereas those companies that were less exposed, almost 50% of those companies achieved an ROE greater than 9%,” she said.

The Financial Services Commission of Ontario remains “very optimistic” that the reforms coming into place Sept. 1, 2010 will meet its projected savings target of 31%, but Sulzenko-Laurie said she’s holding judgement.

She noted the plaintiff bar is already “trying to undermine the reforms” by holding information sessions on “how to get around” them. She read from a sheet of proposed legal seminars entitled, ‘How to Squeeze the Most out of $50,000,’ and ‘Catastrophic Impairment: New Directions.’

In her view, the reforms may have simply come too late.

Sulzenko-Laurie noted IBC approached the government as early as 2006 to take remedial action to curb rising AB costs. Between that time and 2010, when the reforms will actually be implemented, the loss ratio in Ontario auto increased by 19%.

“The results of the slowness of responding to obvious problems in the system is that in the past two years, Ontario insurers have lost $1.3 billion,” Sulzenko-Laurie said. “Ontario consumers have seen their average premiums rise by 10.5%.”

Consumers paying the price for insurers’ tax burden

More than 13% of the average cost to consumers of an insurance policy in Canada goes to fixed taxes and regulatory costs, Sulzenko-Laurie said.

She noted the IBC commissioned PricewaterhouseCoopers (PwC) in 2009 to survey the regulatory and tax costs borne by insurers.

In its report (due to be released in April), PwC found Canada’s P&C insurance sector has a total tax rate of 67%. This is much higher than the 30% rate for the nation’s six largest banks and the 27% rate for major Canadian corporations.

“In fact, the property and casualty total tax rate is among the highest around the world,” Sulzenko-Laurie said.

The total tax rate is so heavy because the property and casualty industry is “forced to bear an extremely heavy load of fixed provincial taxes that are unresponsive to whether the industry was profitable or not,” she continued.

In 2008, a weak financial year, 85% of the taxes borne by the industry was unresponsive to industry conditions, she said.

Last year, IBC measured the regulatory costs borne by P&C insurers for the first time. In 2008, the industry incurred $84.7 million of these types of costs, nearly half ($44.7 million) of which were spent on assessments.

“After looking at the latest results from OSFI, it appears that base assessments for the industry from OSFI went up 40% over the past five years… It would seem that at our expense they are sparing no expense.”

Unnatural disaster: HST

The impact of the Harmonized Sales Tax (HST) on Ontario and B.C. property and casualty insurers’ reserves in 2009 — estimated to be $268 million — is equivalent to that of a large catastrophic loss, according to the IBC.

Sulzenko-Laurie noted the effects of the HST in slides presented at the breakfast.

One slide showed a number of projected effects of the HST on Ontario and B.C. insurers between 2010 and 2015.

For example, retail sales tax (RST) on claims and operating costs for Ontario and B.C. insurers in 2010 is projected to total $436 million.

But add to that $34 million in operating expenses due to the HST, as well as an extra $83 million in claims costs due to the HST, IBC figures show.

Suddenly, total RST paid, as well as increases to operating expenses and claims costs due to the HST, balloon up to $553 million in 2010.

IBC figures show the effects of the HST are even more pronounced in 2015.

In 2015, the IBC projects RST alone paid on claims and operating costs for Ontario and B.C. insurers would amount to $484 million.

Add the HST, however, and operating expenses would increase by $73 million in 2015. In addition, claims costs would increase by an extra $186 million.

And so in 2015, Ontario and B.C. insurers would pay an extra $259 million on top of the $484 million in RST alone, bringing the figure up to $743 million.

Banks sin, insurers punished?

It’s very important for financial services industry regulators to think about the differences between the banking and insurance industry models when proposing “broad brush” solutions to the world’s economic financial crisis, Swiss Re CEO Stefan Lippe cautioned at the 2010 Swiss Re Breakfast in Toronto.

“It’s very important to talk about the differences between the banks and the insurance because it’s vital to our survival… that regulators don’t get it wrong what our business models are about,” Lippe said.

Lippe noted that the banking model, based on liquidity, is different than that of the long-term financing model of the insurance industry.

“Our model is based on assets, based on long-term financing by our policyholders, and not by short-term debts and commercial papers like [one would see on] the balance sheets of banks,” Lippe said.

The global financial crisis was more of a liquidity issue than a capital issue, Lippe said. Even the one insurer experiencing the greatest difficulty arising from the global financial recession, AIG, did so because of its “banking-like activities.”

“The only problems we saw worldwide in the insurance industry came from banking-like activities, the most famous example is AIG,” Lippe said. “They didn’t stumble over their insurance activities, but rather from their [use of] CDS [credit derivatives]…”

But even though the insurance model held up well during the crisis, regulators nevertheless face pressure from the politicians to make the world safer, Lippe said later in an interview after his speech.

International regulators are raising capital requirements for both banks and insurers throughout the world. But the impact of doing this has a distinct impact on the banking and insurance models.

For insurers, the costs associated with carrying additional capital will lower a company’s return on equity (ROE), and this will not sit well with shareholders.

If companies have more capital, the financial sector overall may be safer, Lippe cautioned, but for insurers, holding excess capital is bad for business. This is because of the drag effect of excess capital on a company’s ROE, which effectively reduces the value of the insurer in the eyes of its shareholders.