Canadian Insurance Congress 2001: A CULTURAL CRISES

“We haven’t seen [adverse financial] conditions such as this in the last 50 years,” says the Insurance Bureau of Canada’s (IBC) chief economist Paul Kovacs. As one of the opening speakers at this year’s Canadian Insurance Congress, Kovacs points out to the CEO attendees, “the industry is in trouble. We’re seeing numbers [company results] that have not been this bad for a whole generation.”

The industry’s return on equity (ROE) for this year is likely to be less than 5%, he adds, compared with last year’s return of 6.2% and 1999’s 6.8%. Insurer financial returns for the first quarter of 2001 show extreme weakness with an ROE of around 4%, while the loss ratio of most companies rose by between 10% to 15%. “It’s all about trouble on the loss ratio.”

This is not going to be the year the industry turns its results around, Kovacs warns, which the IBC plans on keeping a close watch on returns for the second half of this year. And, should the industry succeed in implementing price corrections over this period, the benefit will only show through in the financial numbers for the second half of 2002. While Canadian insurers were able to prop up their 2000 results with relatively strong investment income growth and realized gains, this side of the business will probably disappoint insurers this year, Kovacs predicts. “It is really going to be difficult to find [realized] gains this year.”

Overall, Kovacs stresses the need for the industry to curtail the stubborn rise in loss ratios which over recent quarters have outstripped the growth in net written premiums. The real “problem-child” in the equation is Ontario auto, he adds, which has witnessed an alarming hike in bodily injury claim costs. Tempering these underwriting costs and bringing in premium rate adjustments are the only effective avenues open to insurers, he emphasizes.

Jeff Rubin, chief economist at CIBC Bank’s “World Markets” offered little hope to the audience in terms of future investment performance and economic growth. Equity markets will be particularly sensitive to economic indicators in coming months, he adds, with all the signs pointing to a “less than soft landing” for the U.S. economy which is already showing signs of a full blown recession in the manufacturing sector. Canada has never escaped a U.S. manufacturing-led downturn, Rubin notes, and this could result in significant output and job loss within Canada’s own manufacturing sectors toward the end of this year.

As such, Rubin says that, despite the drop seen earlier this year in the prices of equity markets, the real impact is yet to come. “Prices are far from the bottom of the pricing cycle.” He also predicts a full percentage point rise in the bank interest rate before the end of the year, which will likely fuel a “rally” in the bond market. Although rising interest rates in such circumstances would benefit insurers’ interest earnings on the investment side, the negative consequence will be declining capital values.

Another factor which will have bearing on the Canadian economy is the declining value of the currency. Unless the Bank of Canada is willing to adjust Canadian interest rates in line with the U.S., the loonie will continue to lose value, he says, with the bottom likely to be struck at around U.S. 60 per Canadian dollar by the yearend. “We don’t have a floating currency exchange rate, we have a sinking exchange rate. As long as Canadian interest rates lag [the U.S.], then we are at risk of losing our currency’s sovereignty… We’re part of a continental economy, the border is disappearing.”

A sore thumb

A four-member insurer/reinsurer panel debate moderated by George Cooke, president of the Dominion of Canada General Insurance Co., provided a healthy dose of “confession time” and plenty of admissions of industry guilt all-round.

The panel members drew sober focus to the poor underwriting conditions of the Canadian property and casualty insurance industry, from the carrier through to the reinsurance sectors. Mark Webb, the former CEO of CGU Group Canada (now heading the global group’s European operations), describes the lack of pricing discipline as, “the Canadian story stands out like a sore thumb”, in relation to actions which have been taken abroad. Specifically, he notes that rates in the U.K. have already moved sharply, and the market there is preparing for a further average 25% to 30% across-the-board rise over the remainder of this year.

The “financial blues” are not only being felt by those in the general carrier market, observes John Phelan, president of Munich Re. Internationally, reinsurers have been reeling over recent years from storm-related catastrophic costs, which the Canadian market thus far has been able to escape the follow-up rate adjustment repercussions. However, rising Canadian cat costs, coupled with a sharp rise in general business claim exposures, have boosted local reinsurance losses to international levels where the combined ratio is in the order of 113%-plus.

The dramatic turn in the fortune of the reinsurance market has a lot to do with “fragmentation”, and excessive competition which undermined rate adequacy. The lack of pricing discipline, Phelan believes, is the real culprit of the industry’s sorry state. When you look at the numbers, “it’s pretty embarrassing stuff,” he adds, “the problem is that the mathematics is always against us, 50% down means 100% up”.

In fact, all of the panel members agree that market fragmentation has caused the most devastation to the industry’s financial wellbeing. In a joking manner, Robert Gunn, CEO of Royal & SunAlliance Canada, says “the reinsurers are at fault, they let this happen”. However, on a serious note, he adds, “this is a fragmented market, there’s no question about it. Our marketplace is out of control.”

Gunn notes that the lengthy period of declining prices the market has undergone has produced a “cultural crises”. He points out that the current set of brokers in the market have never had to sell a real price increase. This “new generation” of professionals within the industry goes beyond the brokerage community to include staff of insurance companies. “We have a whole society of brokers who have only sold declining prices. We’re now suffering our own destiny.”

“We can only blame ourselves,” confirms Yves Brouillette, president of ING Canada. Brouillette points to marketplaces like Quebec, which has witnessed significant consolidation over recent years, where upward rating adjustments have been successfully applied. Today, Quebec offers more attractive financial conditions than most of the provinces. Brouillette also holds the view that a sterner, more professional approach to management has to be taken. “The actuaries are not integrated enough with management, which is really a big part of the problem.”

Cooke notes that bringing about adequate corrections to the marketplace will require going beyond price increases. External issues, such as the regulatory environment that controls rate filings, through to the dire need for product reform (particularly in Ontario auto), all have a role to play, he adds. However, Cooke agrees that much of the problem rests with management of insurance companies. “Prices are generally set behind the glass walls of head-offices, and not out in the field.”

Furthermore, Cooke refers to a recent survey compiled by the IBC showing that, to the end of March this year, rate inadequacy across the lines could be as high as 21%. “Our collective behavior is going to cause further decline this year until someone steps up to the mark.”

“Stepping up to the mark” is definitely the approach which Munich Re will be adopting this year, at least based on the remarks of Phelan. A market survey done by the company on reinsurance rate adjustments made through last year’s treaties shows an increase range of between 10% to 15%. “Which is not good enough,” he adds with resolution. Reinsurance capacity will tighten up this year, he predicts, and it will become more difficult for insurers to find cover. Rate corrections will have to be implemented this year, he says, “if this means being a smaller company for a short time, so be it. I’m confident that we can turn this around, but we can’t do that by sitting around waiting for someone else to move.”

Brouillette supports a harder approach to pricing, and expects that this will be the driving issue for most insurers in the year ahead. However, he believes the most likely approach will be to re-price new business. Also, insurers will likely look at “new cost sharing mechanisms” such as deductible options to alleviate the brunt of price increases. “Ways to give the policyholder the choice of sharing the cost of the risk.”

Legislative barriers

Compliance with the federal government’s new privacy legislation under Bill C-6 is going to be one of the biggest challenges facing Canadian insurers, says Jill McCutcheon of Blaney McMurtry. Although property and casualty insurers have a “grace period” until the beginning of 2004 before having to meet all of the requirements under the new law, there remains a great deal of confusion over the application date, McCutcheon says. “Bill C-6 is not a well drafted piece of legislation. There is confusion about its application date as well as the definition of ‘privacy information’.”

An interpretation of the bill’s wordings also suggests that the federal government is encouraging the provincial legislators to step forward with their own specific regulations on data privacy, she notes. “This means that we are going to have to deal with ten separate pieces of legislation. The best we can do is ‘wait and see’.”

However, McCutcheon emphasizes that “insurers have a lot of work to do”. It will not be good enough to just have an internal “privacy policy”, she adds, companies will have to appoint an individual or department to manage this risk, including holding regular business unit audits.

There is another legislative pall hanging over insurers in Canada’s largest market, Ontario, says Gordon Goodman of Cassels Brock & Blackwell. Goodman refers to the recent release of a draft consultation paper proposing a merger between the Financial Services Commission of Ontario (FSCO) and the Ontario Securities Commission (OSC). The proposed body of the Ontario Financial Services and Securities Commission, read as an acronym, and pronounced out loud, sounds something like “off-sick”, he jokes. However, there is little humor to be found in what the likely impact of the merger will be on the property and casualty insurance industry, he says. Goodman believes that the merger set for this coming fall will result in greater management dominance by the securities commission side. This will likely mean more stringent market conduct investigation and enforcement procedures being applied to the insurance industry. “This ultimately will mean less regulative flexibility for insurers, and the new office will play a more dominant role in influencing the industry.” The current financial services superintendent will be replaced under the planned merger, Goodman says, with the portfolio divided into two new appointments of “insurance” and “pensions” (current financial services superintendent Dina Palozzi has already announced her early retirement).

Re-shaping Quebec

One of the marketplaces more stringently affected by the regulators is Quebec, says Jean-Denis Talon, chairman of Axa Canada. The Quebec market has become highly competitive with increased pressure on pricing and formation of “alliances” between financial service players and brokers, he adds.

This situation has evolved over the last three years following the adoption of Bill-188 (which replaced Bill-134) in mid-1998, he explains. Although the legislation, which is currently under review by the provincial legislator, is primarily aimed at the distribution of financial services products, its scope has been broad enough to encompass areas such as restrictions on company “tied-selling”, and opening the door to convergence of banking/insurance products. The end result of which has seen the growth of “bankassurance” within the province with very little distinction between the product providers. “This has increased the importance of branding.”

The smaller, regional insurers have mostly been adversely impacted by the new regulative environment, Talon says, with many of them having either entered into alliances with bigger players, or diversified their business by expanding out of Quebec. The broker market has also shrunk, with the number of independent brokerages having fallen by 25% by the end of 2000, he notes. This “vacuum” has allowed broker consolidator networks to move in, who currently control about $1.3 billion in annual premiums (about 30% of the total market) through 20-odd groups. The market’s shift also provided direct writers to adopt an aggressive position in the province, with these operators now holding roughly $1.4 billion in annual premiums versus broker-supporting companies with $2.4 billion.

Overall, Talon stresses the importance of consumer branding in remaining a successful competitor in Quebec. As part of this strategy, companies and brokers also have to consider alliances or partnerships. “Brokers in the province have entered into partnerships with insurers on personal lines, and I expect this trend is likely to stay.”

Speaking from a broker perspective, John Morin the president of Quebec-based brokerage Morin, Elliott Associates Ltee, confirms that “these are challenging times for brokers”. The biggest problem in Quebec’s ultra-competitive marketplace is that there is no such thing as a policy “renewal”. This situation is being exasperated by the harder line insurers have recently adopted to pricing and risk appraisal. “Insurers are pushing rates and outright denial of coverage. As an industry, we have sinned, rates have been way too low. But, we can’t crucify the insurance buying public [with excessive price reactions]. It’s somewhat like my grandmother’s hemline, raise too high and too fast and it becomes indecent.”

On the legislative front, Morin supports the concerns of insurers with regard to the direction the Quebec market is being pushed. “The dust still hasn’t fully settled” since the introduction of Bill-188, and the government is once again on the prowl of revamping the regulatory landscape applying to financial services product distribution, he confirms. What this future may hold is anyone’s guess, he surmises, but many issues pertaining to the existing rules have yet to be legally tested – areas which could have severe consequences for brokers. Notably, he points to section 28 of the bill, which pertains to upfront disclosure of policy exclusions. “This is something that could put hairs on the palms of your hands, it basically requires the broker to disclose all policy exclusions to the client before signing. Can you imagine reading and trying to explain every exclusion over the telephone? It remains to be seen how this section [of the legislation] will be interpreted by the courts.”

Another “hot potato” raised by Bill-188, which is yet to be applied, is disclosure of comany/broker relations with regard to commissions and other incentives. No move has been made to implement this requirement – yet, says Morin. However, the potential disruption, or shakeup, that could result for brokers and their markets is immense, he warns. “Just how far the legislator intends to apply disclosure of commissions and company/broker relationships, no one knows yet.”

The current dismal financial state of the Canadian property and casualty insurance industry and the dire need to bring about price corrections served as the nucleus of debate in presentations made at this year’s Canadian Insurance Congress, which was recently held in Mont Tremblant, Quebec. The North American industry’s financial ailment can be attributed to a wide range of external causes, from overly restrictive regulation to reduced economic growth, the speakers observe, but the real destruction lies within the industry itself: fragmentation. Excess competition in the Canadian marketplace – which is relatively small in the global picture – has eroded underwriting discipline and set a busine ss stage for a “cultural crises”, where few in the management of the industry today have the experience of dealing with the adversity of shoring up against declining markets.