Cyclical Business…

A press conference recently held by the Insurance Bureau of Canada (IBC) to disclose preliminary earnings figures for the Canadian property and casualty insurance industry, and presumably to achieve maximum “damage control” in anticipation of a negative media response to the above-average results, produced a mixed outcome. While the bureau’s approach to proactively handling an explosive situation is commendable – and I believe this action did significantly dull the edge of the potentially negative publicity that could have followed – it is clear that the general media is not overly impressed by explanations of the industry’s “rich man, poor man” affliction.

The main focus of the IBC’s press conference in revealing insurers’ estimated 2004 net profit of $4.2 billion, which is expected to generate a record 20.6% return on equity (ROE), was to impress upon the media the cyclical nature of the p&c insurance industry’s earnings. Notably, insurers brought home a modest 8.6% average ROE between 2000 to the end of last year, the bureau’s president Stan Griffin observes. The IBC’s vice president of the Ontario region, Mark Yakabuski, notes that “these financial results [the industry’s 2004 estimated return] confirm that the p&c insurance industry has returned to financial health, following a period of the weakest earnings in its history. 1998 to 2002 marked five consecutive years of declining earnings that seriously challenged the financial stability of one of Canada’s oldest and most important industries. Last year we [the industry] returned to profitability and today, with some relief, we can say to policyholders, government and shareholders that the industry is strong again.” In fact, by March of last year, federal regulator the Office of the Superintendent of Financial Institutions (OSFI) had identified 46 insurers in terms of concern over their “financial stability”, says Griffin. The solvency crisis has now been overcome, he adds.

Unfortunately, the bureau’s press conference did little to press home the message that the insurance industry’s volatile financial performance is very much influenced by political interference and “make shift” regulations. As one television network reporter at the press conference pointed out, it appeared as though the IBC – acting on behalf of insurers – was apologizing for the industry having actually made a profit. Political “tip toeing” is not going to address one of the industry’s biggest ailments, that being the public perception that auto insurance – which is the crux of the negative publicity problem and the main source of volatile claims loss experience – is thought to be an extension of a “government service”.

Even politicians seem to now believe that auto insurance is a form of “public utility service” that can operate at a loss (at the cost of private sector investment and not subsidized by taxpayers’ income). Until a means of “separating from government association” can be achieved, and therefore gaining public support against provincial government and political factional interference in how insurers can compete and price their products, the p&c insurance industry will continue to be dogged by extreme experiences in the auto market.

The IBC also went to great lengths through its press conference to emphasize that pricing of insurance – particularly in the auto line – has been declining rapidly over the past year, witnessed by increased competition among insurers for new business which has seen dramatic improvement in coverage capacity (in addition to price increases, the other “negative political factor” that emerged from the hard market was the lack of adequate coverage availability, which saw an “over-population” of the industry’s high-risk auto insurance pool – the Facility Association (FA)). The relief achieved by declining rates and increased coverage availability has seen consumer complaints about insurance premiums having declined by more than 80% over the past year, Griffin notes. And, Yakabuski points out, auto policyholders can expect to see a total $1.4 billion saving in premiums this year as premium rates continue to fall. “In Ontario for example, that [rate declines] means that average [auto] premiums have declined by 12% over the past year, far exceeding the [provincial] government’s own reduction target.”

Indeed, the IBC’s preliminary numbers for the industry’s performance last year show a definite downward shift in premium and claims cost growth (see MarketWatch of this issue for details of the industry’s financial results). Insurers notched up a mere 2.1% year-on-year growth in direct written premiums for 2004 (2003’s annualized direct written premium growth was 20%-plus) which suggests that earned premium growth for this year will likely remain static. Claims cost growth for last year also plummeted to a modest 1.2% from the previous year’s 10% rise. All in all, the “premium to cost numbers” imply that insurers have achieved an acceptable medium that should iron out any financial bumps in the immediate future…or maybe not.

An investment report recently circulated by Scotia Capital Inc. regarding the investment potential of ING Canada’s public listing notes that the p&c insurance industry is currently at its “peak” in the rate pricing cycle, and that the marketplace remains highly “fragmented”. The investment house is therefore wary of the sustainability of the current underwriting strength of the industry relative to the potential of escalating claims costs in light of the unknown true cost-containment benefits of the provincial auto insurance reforms (specifically in Ontario where roughly 25% of the industry’s direct written premiums are derived).

Notably, auto insurance rates in Ontario dropped by 12% between 1996 and 1999 in response to the anticipated cost reduction initiatives under Bill-59, all of which proved hopelessly inadequate, thus resulting in company reserve redundancies, the Scotia Capital report observes. “…in our opinion, given the uncertainty in recent Ontario auto reforms…[there is] the potential for the recent exceptionally low claims frequency levels [of 2004] to return to historically norm levels…While the early impact of the recently imposed measures to reduce claims costs is favorable, we remain cautious, given the history of the [p&c insurance] business.”

The issue is obvious: the political impact on the industry business cycle will continue, and will more than likely result in future adverse claims experience and deteriorating financial performance. Until fundamental change is brought about in terms of the “how” and “where” insurers can conduct their business, the good fortune of 2004 should only be seen as “breathing space”.