Canadian Insurance Congress 2002: Spotlight on Efficiency

Although property and casualty insurers have taken action over the past 12 months to boost premium rates, the question remains, “is it enough?” This thought was conveyed by Paul Kovacs, chief economist of the Insurance Bureau of Canada (IBC), at the 12th Annual Canadian Insurance Congress which was recently held in Halifax, Nova Scotia. Notably, Halifax seemed the ideal location for this somber industry gathering as the Atlantic provinces have proved to be the “darkest cloud” for insurers as claims costs have soared beyond control.

Atlantic Canada is not the only problem child frustrating insurers, Kovacs observes, with every province except Quebec having produced alarming underwriting losses during 2001. The Ontario auto market, as well as the Atlantic provinces with New Brunswick in the lead, have been the industry’s soft underbelly as the loss tally stemming from mostly auto bodily injury claims has gone unchecked. Kovacs points out that the insurance industry has sustained four consecutive years of poor financial results, with the 2001 financial year being the worst on record. Action on several fronts is needed now, he adds, “we have to work really fast and very hard”, to achieve adequate profitability for the 2003 financial year.

Confronted by a dismal investment environment, insurers have to get the combined ratio to less than 100%, Kovacs says. He outlined an elaborate “best case” economic scenario factoring in lower claim losses, higher investment returns, reduced industry capital and a further 30% on average rate increase for this year – all of which in total did not add up to the magical “10% return on equity” that companies are hoping to achieve going into next year. “I don’t think that the industry will make a 10% ROE next year,” Kovacs says, although disciplined action taken now will set the stage for longer-term recovery.

Kovacs believes the industry is confronted by two major obstacles: excessive capital, and lack of support by the provincial governments to bring about auto product reform. With the federal regulator looking at implementing new minimum capital testing requirements next year, it is unlikely that insurers will be able to shed any capital, he adds. The only area the industry can maneuver on is product reform, he notes, with the IBC already having entered extensive discussions with the Atlantic provincial governments and that of Ontario. “The biggest issue is with the governments. We need to get support from the [provincial] governments [for product reform].”

INVESTMENT OUTLOOK

The good news for insurers is that the bond market is expected to offer fairly robust returns for this year, comments Jeff Rubin, chief economist for CIBC World Markets. Although interest rates are unlikely to rise much in the year ahead as the federal government nurses the weak economy back to strength, Rubin predicts a total return from the bond market this year of between 7% to 8%. “This will be more than the overall stock market’s performance.”

The bad news, Rubin notes, is that equity markets are likely to languish until renewed momentum is found in the technology sector. This will limit the scope of insurers to utilize capital gains to support their financial results. Also, Rubin expects the Canadian dollar will begin to slide back after its recent recovery against the U.S. currency. This will add yet another complication for insurers with U.S. exposures.

Although the Canadian economy produced a “stellar performance” for the first quarter of this year, which saw higher gross domestic output and greater job creation than that of the U.S. economic recovery, Rubin believes this initial run will slow dramatically by the mid-year. Much of the gain made in the first quarter, he points out, came through inventory stockpiling, which can only carry the economy so far. As such, he expects a mild fallback in economic output before a new surge begins from the manufacturing sector. From a stock market perspective, Rubin believes that manufacturing, and specifically the energy sector, will show the most gains. The IT sector still has to “reach its bottom”, he adds, which will have an adverse impact on the equity markets overall. “The issue with the stock market isn’t about GDP, but where the bottom to the tech sector is.”

CHANGING ENVIRONMENT

Not only is the risk environment changing, but the structure of the p&c insurance industry as well, observes Mathew Mosher, group vice president of p&c at A.M. Best Co. The financial ramifications of the September 11 terrorist attacks have caused insurers and insureds to evaluate the financial security of their underwriters. This is leading to a “flight of capital” to companies with a “quality reputation”.

Excluding the impact of September 11, Mosher notes that the firming price cycle has set the stage for a new wave of consolidation. “Companies are focussing on their core business and selling off the rest.” That said, Mosher holds the view that the p&c insurance industry in both Canada and the U.S. remains over-capitalized. Plus, with new capital having entered the reinsurance market through Bermuda subsequent to September 11, he is concerned whether the current momentum behind the industry’s price recovery will hold up against the competition. “Generally, we do expect the market will sustain the price recovery into 2003.”

The rise in rates has also generated renewed interest in alternative risk transfer (ART) mechanisms, Mosher says. In this respect, premiums may move out of the traditional insurance market, thereby exascerbating the competitive environment. “We see this area [ART] growing significantly over the next two years.”

ATLANTIC IMPASSE

“Government will not be on your side without the support of popular public opinion,” says Don Forgeron, vice president of the Atlantic region at the IBC. The IBC has been engaged in discussions with the Atlantic provincial governments for some time toward achieving auto product reform, he adds.

The bureau also initiated a series of public awareness and market research campaigns to gauge the public’s perspective and understanding of insurance. The bad news, he notes, is that most insurance buyers believe that the cost of insurance has risen without being aware of the heavy claim losses incurred by insurers. At this point, about 40% of insurance buyers in the Atlantic provinces believe that insurance pricing should be set by insurers and not the governments. But, without this popular “voter” support behind product reform, the governments will not take action, Forgeron concedes.

This situation has led to an impasse, where some insurers have withdrawn entirely from the region, creating market disruption for brokers and consumers alike. At this stage, Forgeron notes, there is concern that upcoming government elections in the region could stall the small gains that have been made on the legislative front.

New Brunswick remains the insurance industry’s biggest headache, with auto rates still about 30% below adequacy relative to the loss experience. Prince Edward Island has, however, shown some improvement based on rate hikes with a few insurers making a modest profit, he observes. “However, the market adjustments have to continue. I expect capacity will continue to drop, and the hard market will continue [within the region] for the next 12 to 18 months.”

The sharp rate increases implemented by insurers while others have pulled out of the Atlantic region has not enamored the insurance industry in the eyes of brokers and the buying public, says Mike Brien, president of Macdonald Chisholm Insurance. “Atlantic Canada is indeed in the ‘doo-doo’. Brokers are concerned that companies [insurers] don’t seem to know what’s going on…Customers are feeling abused, and insurers have no credibility in the marketplace.”

Brien notes that there are about 2,900 registered brokers operating in Atlantic Canada, which generates about $2 billion a year in premiums. The recent withdrawal of some insurers from the marketplace, combined with underwriting restrictions placed by others, has created a “huge problem” for brokers, he adds. “Capacity is a serious issue out there for brokers. We’re hoping this isn’t just the tip of the iceberg, but I’m afraid that it might be.”

The stern position of insurers in dealing with the Atlantic markets is inviting further government intervention, Brien warns. Also, with the limits being placed on brokers, there is a real fear that the very independence of the brokerage community could be at risk. “Is there any loyalty left in this business, are we only as good as the last set of results?…Insurers should ask brokers to assist in solving the problem,” he laments. Ultimately, unless an immediate solution is found to break the current impasse, Brien says brokers may be left with no choice but to look at new alternatives to the traditional insurance markets serving the region.

TESTING RESOLVE

“I know for brokers we are causing a lot of disruption,” comments Igal Mayer, president of CGU Group Canada Ltd. Mayer’s observation was made with regard to the stricter placement of business conditions insurers have enforced over recent months on brokers. Mayer took part in a five-member CEO panel debate moderated by George Cooke, president of the Dominion of Canada General Insurance Co.

The CEO panel members, drawn from both the primary and reinsurance ranks, all agree that the Canadian insurance industry still has a long way to go before it is likely to achieve healthy financial returns. As such, the panel was confident that the business cycle’s price firming would continue into 2003.

Toby Stubbs, a property reinsurance writer for Lloyd’s syndicate Wellington Underwriting, points out that over the past year in particular, the Canadian market has produced terrible underwriting results at both the primary and reinsurance levels, despite the fact that companies escaped any real losses from the World Trade Center (WTC) attacks. “I don’t see this hard market as a 24-month exercise.”

Partner Re Canada’s chief agent Patrick Lacourte concurs with this view, noting that reinsurers in Canada have not seen a return on the business for five years. “We had to stop the bleeding.” Although the Canadian market has been relatively “cat free” over the last two years, Lacourte points out that reinsurers have still sustained heavy losses. Normally, reinsurers rebuild there reserves during cat-free periods to balance out the heavy loss years – this has not been possible over the last couple of years, and it became inevitable that strong pricing action would have to be taken. Despite the hefty price adjustments made by most reinsurers to 2002 programs, Lacourte expects insurers will face further rate adjustments for next year’s covers.

“We are victims of our own making…We [insurers] lost our way in terms of underwriting skills,” admits Mayer. Although the pricing action taken by companies is beginning to produce gains, he notes, there remain several problems within the industry. The most obvious of these being the need for auto product reform, reducing capital within the industry, and concerns that the momentum behind the price firming may falter as new money enters the marketplace and/or stronger investment returns allow insurers to slip back into tardy underwriting practices. “If we see the Dow [Jones] returning to 15% returns, then all bets are off [with regard to sustainability of the hard market]”.

At this point, insurers are writing about one dollar in premium to a dollar in capital, Mayer notes. “We should be writing $2:$1 in premium to capital,” he points out in highlighting the excess level of capital awash within the industry. With the federal regulator pushing for even higher reserving under the proposed changes to the minimum asset test, the situation is unlikely to get much better, he says.

While there would seem to be an excessive level of capital within the industry, the “spread” is not even between companies, observes Robert Landry, president of Zurich North America Canada. “I don’t think in this sense that we need further reduction in [capital] capacity [within the market].” Furthermore, he notes that the threat of class-actions as seen in the U.S. could well take a heavy toll on the reserves of Canadian insurers moving forward if these actions spill over the border. “The potential for class-actions is a huge concern. This is what keeps me awake at night. The severity is not the problem, but the frequency.”

Larry Simmons, president of Royal & SunAlliance Insurance, agrees that the industry would seem over capitalized. However, he points out that that the Canadian environment is part of a bigger, global picture. Despite the level of capital in the industry, he believes insurers are taking the appropriate actions to regain profitability. This is not only occurring through rate adjustments, but corrections to terms of cover, he adds. “I think we are returning to the disciplines that are needed.”