Changing the Channel

Canadian Insurance Accountants Association (CIAA)’s 2006 Quebec City Conference

Changing distribution trends toward direct writing (marked by the entry of retailers in the already competitive personal lines business), the need for more sophisticated catastrophe risk modeling and consolidation within the reinsurance industry dominated discussion at the Canadian Insurance Accountants Association (CIAA)’s annual conference in September.

Held in Qubec City, this year’s event featured a CEO panel including Alain Thibault, president and CEO of TD Meloche Monnex (the largest distributor of auto and home insurance and the third-largest underwriter of these products), Nicholas Smith, attorney in fact for Lloyd’s Underwriters (Canada) and Matt Spensieri, the chief agent for Canada at General Reinsurance.

DISTRIBUTION SHIFT

Thibault observed a shift in distribution channels to direct response, noting the shift is creating a formidable challenge to the traditional broker and captive (exclusive agent) networks. To remain competitive, brokers and captive agents need to overhaul their systems to become more cost-effective, he said.

For example, Thibault noted, several big retailers have entered the insurance market, including President’s Choice Financial Services, HBC and Canadian Tire. “They’re savvy marketers relying on the Web and storefront operations,” he said. “This gives them good visibility and helps them chip away at the market and challenge traditional avenues of distribution.”

At the same time this is happening, banks and credit unions already control 15-20% of personal lines business, Thibault observed. In a mature market, brokers and captive agents in urban areas will find it challenging to compete with these new retail players, he said.

Thibault predicted insurance companies would have to team up with these larger retailers, as demonstrated in the current Aviva Canada and President’s Choice Financial partnership.

CLIMATE CHANGE

In addition to facing this increased competition from direct writers, the industry needs to pay closer attention to the growing threat of climate change, Smith told delegates at the CIAA conference. Greater values are exposed to risk as a result of weather-related hazards and the industry needs to understand and actively manage these risks, he said. In 2005, an unprecedented US$80 billion in insured losses were caused by hurricanes Katrina, Wilma and Rita.

Lloyd’s recently published a report entitled, Climate Change, Adapt or Bust, warning that climate change is happening faster than previously thought. Investment in research is needed and a change in industry behavior is long overdue, the report says. As well, recent natural disasters have revealed the inadequacy of capital and pricing models, so catastrophe models must be updated regularly to keep pace with the latest scientific evidence.

Also, the Lloyd’s report concludes, the industry should take a fresh approach to underwriting. For example, underwriters should be looking ahead and factoring in climate change scenarios, rather than basing decisions on historical records as it traditionally does.

REINSURANCE TRENDS

Spensieri observed that in Canada’s reinsurance sector, primary insurers are moving away from proportional treaties to excess loss treaties – especially for catastrophes. In 2005, this resulted in CD$500 million in total written premium disappearing from reinsurers’ books, he said.

As primary insurers become larger and more profitable, their willingness to increase risk is greater, allowing them to retain more of the profitable premium, Spensieri said. As a result, volatility is shifted to reinsurers and adequate pricing is critical, he noted.

Spensieri said the reinsurance market is shrinking as a consequence of consolidation. He noted that over the last few years, eight reinsurance companies have been reduced to three. On the plus side, he said, there’s greater sophistication in risk management and higher retention rates. But there’s also more ‘global’ reinsurance purchasing, because multinationals with resources are willing to accept risk to a certain level. This cuts into the premiums that would normally go into the reinsurers’ pockets, he said.

Underwriting discipline is key, Spensieri told the conference. Reinsurers need to pay attention to business cycles and reduce the extreme cycles in their business and recognize when the market isn’t profitable. They need to ensure they are adequately paid for risk rather than just concentrating on volume growth.

“We need to produce a profit,” Spensieri said. “It’s becoming more important to use a global chief underwriter to maintain standards and accountability, yet be flexible enough to make exceptions for regions as required.

“Low interest rates make it hard to overcome losses, making underwriting discipline even more imperative.”

Agreeing with Smith, Spensieri said the insurance industry needs to increase its use of more sophisticated cat models to help underwrite such hazards as earthquakes, wind, and terrorism.

As for raising capital in the future, Spensieri predicted an increased use of ‘sidecars’ and catastrophe bonds, both special-purpose vehicles designed to protect the reinsurer’s core balance sheet.

According to Standard and Poor’s, “cat bonds are for issuers looking to cover a broad array of risks and are comfortable with the ‘triggers’ that can cause a loss. Sidecars are tailored for reinsurers wanting to keep the bulk of business, but want outside investors to cover specific risks.”

Spensieri said hedge funds are finding more profitable places to invest, putting the onus on the reinsurance industry to turn an underwriting profit. Otherwise, investors and hedge funds will find other vehicles, he warned. Reinsurers will therefore need to better allocate their capital to lines with profitable returns.

GLOBALIZATION

Increasing globalization of the insurance market played a part in a number of other trends cited during the CEO panel.

For example, as insurance develops into a global industry, the regulations under which it operates will be standardized and harmonized internationally, Spensieri said. Regulatory changes are already happening in the U.S. and around the world, and in 2007 Canada will be adopting international standards, he said.

Smith and Spensieri both noted the increased international importance of ratings agencies. Ratings are an important consideration and are a big part of a company’s reputation, Smith noted. The ability to pay claims over time, and to offer products and solutions that meet the needs of the economy and society, are ongoing challenges that affect the ratings of insurers and reinsurers alike.

Spensieri also observed the increasing influence of credit agency ratings. He noted Canadian businesses wishing to work with insurance and reinsurance companies are increasingly asking their partners to meet minimum rating standards, as assessed by rating agencies such as A.M. Best or Standard & Poor’s. In the past, it didn’t seem to matter in Canada whether or not the insurers or reinsurers were rated, Spensieri observed. But it’s different today, he said, especially with commercial lines. “The insurer/reinsurer needs to be more financially sound than the client,” he said. “Otherwise, why do business?

Smith and Thibault both noted examples of how international trends – in litigation and immigration – are affecting trends in Canada’s insurance industry.

Smith, for example, noted the U.S. trend towards increased litigation is spilling over into Canada. An increasingly litigious Canadian legal environment, he said, is making it difficult to predict the cost of claims. Notions of personal responsibility and liability in Canada are changing, and he said this is creating greater legal exposure for businesses and their insurers.

Thibault noted how immigration is a factor in Canada’s pending labor shorta ges. A recent Conference Board of Canada report estimates that 23% of employers are feeling the pinch, but few are dealing with it. “We can’t depend on immigration levels to fill the labor gap and this will have serious implications for our industry,” Thibault said.

In addition, according to Thibault, the makeup of the labor force will change dramatically over the coming years. The semi-retired market will be tapped, he said, and jobs will be streamlined through more efficient use of technology. Greater use of the Web will put the onus of performing administrative tasks on the consumer, who will be filling out on-line forms for auto insurance quotes, he said. Offloading these tasks will allow insurance staff to be used for high-touch jobs.

“As qualified labor becomes scarce, good recruitment practices will become more important than ever,” Thibault said.

That means improving the public image of the industry, Thibault added. “The industry needs to do some serious public relations to combat our poor image in the media,” he said. “There is so much misinformation out there. Hopefully we can attain a level of trust with the general media and get our message across. It’s important that we’re proactive, especially about ‘hot button’ issues that concern politicians and regulators.”

In particular, Smith said New York state attorney general Eliot Spitzer’s investigation into insurance brokerage bid-rigging had a negative impact on the industry’s reputation. These investigations highlighted the lack of transparency in the industry’s workings and the need to move business practices into the 21st century, Smith said.