Coming through rough waters

2012 was a year of relative success for Canada’s property and casualty industry, reflecting the continuing hard work of insurers in risk management and underwriting discipline. That success is important. A strong p&c industry is important for economic stability, enabling Canadian families and businesses to plan for and take on risk. It also enables the sector as a whole to be better prepared for whatever challenges the future might bring.

IN HINDSIGHT

Last year, the Insurance Bureau of Canada (IBC) cited three major forces that would continue to shape our industry: the economy, the environment and regulation.

The economy

IBC noted that gross domestic product (GDP) growth has been trending downward for several years and would likely continue to do so, tempering the pace of growth in premium demand. In fact, GDP growth was even lower than expected, coming in at 1.8%. Growth in direct written premiums slowed to 3.0% from 4.4% in 2011.

IBC also suggested the prolonged period of low interest rates and uncertain financial markets would continue. And, by and large, they did.

The environment

Climate change continued to have an impact. Last year was the fourth year in a row with natural Cat losses of near or above $1 billion. Billion-dollar Cats are now the new normal.

Apart from the size of the losses, extreme weather brings uncertainty to the business. Good results in the first half of the year can be completely undone by a few large events later on, as happened with the storms in Alberta last summer.

Regulation

The third trend mentioned last year was increased attention from regulators. The industry is probably more regulated than any other in Canada, with some 24 bodies that make rules and collect assessments from p&c insurers.

On the positive side, the industry has been able to engage with regulators in all jurisdictions. At the federal level, IBC has been working closely with the Office of the Superintendent of Financial Institutions (OSFI) to help ensure a better understanding of the impacts of revisions to capital requirements.

As a result of consultations on Guideline B-9, OSFI’s proposed revision of the earthquake Probable Maximum Loss measure has been deferred and OSFI is now working jointly with IBC on a revised approach. 

Financial results

Year-end financial results showed a decline in the industry loss ratio from 68.4% to 64.9%, and operating results below the break-even point with a drop in the combined ratio from 98.6% to 95.4%. Net claims incurred for all lines fell by 2.8% from a year ago – the first reduction since 2006.

The drivers of these results were two-fold. First, while nat Cat losses remained historically high, they were lower than in 2011. Second, the industry continues to see the impacts of the 2010 Ontario auto reforms.

As usual, overall results hide a great deal of variability. While most companies had a combined ratio between 85% and 105%, a quarter had combined ratios above 105%.

Loss ratios fell for all major p&c product lines. For property and commercial liability, the improvement was largely driven by a marked reduction in direct incurred claims.

The insurance industry also noticed a change in asset allocation strategies. In 2012, insurers held a higher share of assets in short-term deposits and stocks. The move to short-term assets reflects heightened market uncertainty and regulatory constraints that skew portfolios towards short-term, domestic and triple-A assets. Increased stock holdings reflect lower volatility, renewed risk appetite and a search for better yields.

THE ROAD AHEAD

Economic outlook

What does IBC see ahead? In the short term, continued sluggish growth and low interest rates; in the medium term, a return to normal long-run average growth.

Until recently, Canadian GDP has been driven by domestic consumer and government spending. With these now faltering, a continued reluctance by business to invest suggests moderate growth for the near future.

But looking out 24 to 36 months, a turnaround is expected. First, the U.S. economy is starting to turn the corner. Second, reductions in household and government debt should start materializing, with consequent impacts on final demand. Third, as the economy picks up, interest rates are expected to rise, bolstering the investment environment. With brighter medium-term prospects, stronger demand for p&c products is also expected.

Regulatory concerns

The pace and magnitude of regulatory activity remain a concern. While other jurisdictions are slowing implementation of solvency revisions, OSFI continues to press ahead.

There are other developments on the international horizon that may ultimately affect us, including ComFrame, the designation of Globally Significant Insurers, rules for Cross-Border Operations and so on – which, suggests KPMG, “will likely provide a sense of direction of future regulatory requirements for all insurers.”

At the provincial level, Alberta is carrying out a comprehensive review of the regulatory framework for auto, and Ontario is reviewing the profit provision for rate applications.

Ontario auto

Ontario automobile insurance has historically performed poorly. From 1994 to 2012, the average financial loss ratio was 82%. In several years, it was a lot higher than that.

Following the 2010 reforms to no-fault injury coverage, results improved from the abysmal losses of preceding years. But whether or not savings are sustainable will depend on arbitration and court decisions. The several thousands of cases now in the dispute resolution system suggest a lot of people are betting against the ultimate success of the reforms.

And while the reforms may have addressed the cost pressures facing accident benefits, they did nothing to deal with pressures in the tort system. Bodily injury costs have continued to climb. Over the past year, the loss ratio for third-party liability claims worsened every quarter. At year-end, it stood at 99.6%.

What has plagued Ontario auto for the past 25 years has been politics. However, complex problems deserve real solutions. For premiums to be reduced, the government must seriously address costs on a proactive, committed and ongoing basis.

Climate change impact

The evidence is overwhelming: 2012 was the 16th “warm year” in a row and the fourth warmest for Canada. July through September was the warmest of any three-month period in 65 years. Global temperatures in the 21st century are higher than they were in the 1900s, bringing with them more extreme weather.

For insurers, that means higher claims costs and pressure for more diligent underwriting. IBC must continue advocating for investments in adaptation by all levels of government.

Earthquake

Natural Resources Canada reports that there is a 30% chance of a significant quake in British Columbia in the next 50 years, and a 5% to 15% chance of a major quake in the Ottawa-Montreal-Quebec City region. Is our industry ready for these events?

OSFI’s 2012 Earthquake Stress Test estimated that a magnitude 9 Cascadia quake could lead to about $30 billion in insured losses. Many insurers would fail their Minimum Capital Test requirements; many more would be at risk.

The effects would spread through the economy via mortgage and real estate exposures in the banking system, failures in basic soft and hard infrastructure and interruptions in business operations.

A major earthquake would pose two big risks: one has to do with our industry’s reputation; the other is about Canada’s social and economic resilience. It is about the 55% plus of B.C. residents who do not have insurance, but are going to expect compensation.

The good news is, now we know. And as an industry, we can respond, educate and prepa re.