Decision Time

It’s decision time, National Insurance Conference of Canada (NICC) chair Joel Baker told more than 330 delegates attending the NICC in Montreal in September 2009.

Baker opened the conference talking about a wide variety of decisions facing Canada’s property and casualty industry. As the conference drew to a close, the number of decisions multiplied far beyond the few that Baker mentioned in his speech.

Should Canadian property and casualty insurers buck the status quo and start to offer coverage for overland flood? Are insurers pricing the product correctly now that investment margins are razor-thin? How best can the industry overcome the choices of consumers wishing to cheat the system? What kind of models would put a stop to Ontario’s seemingly never-ending cycle of auto insurance reform? How should companies prepare for a pandemic? Should insurers be using credit scoring, insurance scoring or none of the above?

All of these questions took centre stage at the NICC.

OVERLAND FLOOD INSURANCE

Canada’s property and casualty insurance industry is conducting research into the possibility of offering overland flood insurance as part of a homeowner’s policy.

Panelists at the NICC noted an important distinction between what consumers and insurers define as “flood.”

Whereas insurance policies cover basement flooding related to sewer backup, they do not cover damage caused to homes arising from overland flood.

Paul Kovacs, CEO of the Institute for Catastrophic Loss Reduction (ICLR), moderated a panel on water damage, ‘Water and Brimstone.’ He said an ICLR study of 2,000 homeowners across the country a few years ago indicates Canadians are clearly confused about whether flood is covered under their homeowners’ policies. “Seventy per cent believed they had [over- land] flood insurance,” he said. “They [insurers] don’t sell any.”

Now that water is about five times more likely than fire to cause damage to a home, it is important for insurers to be on the same page as their customers on the issue of flooding, the panelists said.

“When we think about the challenges today, and you put yourselves in the shoes of the consumer…the most frustrating and least understood peril is water,” said panelist Kathy Bardswick, president and CEO ofThe Co-Operators. “I want to suggest that we are very intently focused on flood, as we should be, but we need to keep in perspective that ‘flood’ is really our term. We understand what that means. But the consumer sees ‘flood’ as sewer backup and water damage…and what it does to their homes. That is an important issue that we need to start thinking about.”

The big question for insurers when it comes to overland flood coverage is how to deal with ‘adverse selection.’ Essentially, how will insurers cover the water risks of homeowners fairly, without shouldering a competitive disadvantage by agreeing to insure high-risk homeowners living in areas plagued by water damage incidents?

A joint study by Swiss Re and the ICLR, soon to be released, suggests the problem might be addressed by way of “bundling.” That is, water coverage would be bundled into the homeowner’s policy along with coverage for fire, theft and other perils. “The bundling effect is really the more appropriate way to go,” noted panelist Sharon Ludlow, president and CEO of Swiss Re Canada. “We came to the conclusion that in the United Kingdom, which is the jurisdiction that had the most ideal model, that is something we could use here in Canada.”

Another consideration would be to have a type of ‘facility association’ or risk-pool approach for extremely high water damage risks, along the lines of what is offered in auto insurance.

Extensive and consistent flood mapping across the country would be a prerequisite for being able to offer coverage for overland flood, Ludlow said.

INVESTMENT: THE RAZOR’S EDGE

Extremely low investment yields, a product of the financial crisis, means the Canadian property and casualty industry has very little margin for error on the underwriting side, Canada’s solvency regulator told delegates at NICC.

“The investment yields are just so miniscule today that any misstep on the underwriting side is going to have implications much greater than what we saw years ago,” Bruce Thompson, director of the Office of the Superintendent of Financial Institutions (OSFI), said in the first NICC presentation on Sept. 20.

Thompson noted investment yields for capital yields hovered around 4.1% for the six years leading up to the financial crisis in 2008-09. Now they currently sit at about 1.8%.

“One doesn’t have to be a rocket scientist to see what that implies,” Thompson said, adding it will therefore be much more difficult to use investment income as a means to bail out poor underwriting results.

Underwriting profitability is already “stressed,” Thompson said. He noted the industry as a whole posted an underwriting profit of just 1% in the first half of 2010, despite optimistic statements that the global recession is turning for the better. “That is a long, long way from underwriting gains that we saw a couple of years ago,” he said.

CHEATERS NEVER PROSPER

Research on cheating indicates a lot of people cheating a little bit is much more likely — and costly to society — than a few people who cheat a lot.

This research is especially germane to the topic of insurance fraud, as noted at the NICC by Insurance Bureau of Canada president and CEO Don Forgeron.

If insurers are willing to change their approach and remind policyholders about their moral obligations before the purchase, that could help staunch the flow of insurance fraud, suggested Dan Ariely, a keynote speaker at the NICC.

“Is the cheating around us really driven by bad apples, people who are inclined to cheat a lot?” Ariely asked in his keynote speech. “Or is it driven by lots of people cheating a little?”

Ariely said research studies suggest about 10% of people in any given sample size cheat.

He conducted his own research in which people wrote a test. The test subjects were asked to solve as many puzzles as they could in five minutes.

After five minutes, they were asked to stop writing the test, shred their test results and throw them away. Then they were asked to report the number of puzzles they completed.

Unbeknownst to the research subjects, the researchers knew exactly how many puzzles their subjects had actually finished.

“What happens?” Ariely asked, assuming the researchers paid $150 to each person who cheated on the test. “Lots of people cheated just slightly. Of 20,000 people tested, 10 people cheated a lot and made about $150 per person. But of the 20,000 people, about 1,000 cheated a little and they stole $30,000 from us. So if you look in comparison, the big cheaters are a tiny drop in the bucket compared to those who cheated a little.”

To change behaviours, insurers would be wise to remind policyholders of their moral obligations at some point early in the purchasing process, Ariely said. For example, insurance policyholders might be asked prior to the insurance purchase if they would be willing to sign a document committing them to contribute money to the creation of an anti-insurance fraud task force. [This was not Ariely’s example, but analogous to it.]

By committing to do this in advance of the purchase, Ariely suggested, those agreeing to do this would in fact not cheat as a result. “If you remind them about their own morality, there’s a chance they will cheat less.”

PANDEMIC PROCRASTINATION

The insurance industry is not prepared for a pandemic and does not know what to expect, Bob Krywiak, executive general adjuster at Crawford Global Technical Services, told delegates at NICC.

During the session, ‘Managing Through a Pandemic,’ Krywiak asked delegates to raise their hand if they have handled a pandemic claim. No one did.

Kirsty Dunn, Member of Parliament for Etobic oke North, also spoke during the session. She asked delegates to raise their hand if their organization had a pandemic plan. A vast majority of the crowd did. However, when Dunn asked how many of those plans had been reviewed since the H1N1 pandemic of 2009, fewer hands were raised. None were raised when she asked how many had actually conducted drills to test their pandemic plan in the wake of H1N1.

“You need to drill those plans and get educated about what we’ve learned that’s new from H1N1,” she said, adding it is no longer acceptable to simply have a business continuity plan in place.

“Any action or inaction on the part of the employer [during a pandemic] can and will be questioned,” Krywiak said. “There is a distinct likelihood that decisions will be reviewed after the pandemic and accountability will be imposed in hindsight.”

AUTO REFORM: PLAY IT AGAIN, SAM

Ontario is entering into yet another optimistic phase of its seemingly perpetual auto insurance reform cycle, but many within the insurance industry appear to want to break out of this cycle and build an altogether new model for auto insurance in the province.

“You get initial optimism,” said defence lawyer Lee Samis, principal of Samis & Company, speaking as part of a panel discussion about the Ontario auto reforms. “Then you start to get a little bit antsy about how the thing rolls out. And then you start to see the other stakeholders play their cards. There are nerves about that because they came up with things we hadn’t thought about. And then we get hit hard with some court decisions and arbitration decisions that are the pathway to abuses. Then we get cost pressure. Then we go back to government and say, ‘Let’s do this again.’ Then we start all over again.

“Expect to see the same thing again,” Samis warned, referring to Ontario’s new reforms implemented on Sept. 1, 2010.

Samis further observed the industry appears to be ready to step off the merry-go-round. He said he personally conducted an informal online survey of people within the insurance industry about the current Statutory Accident Benefits System (SABS). He said more than 100 people in the claims industry responded to his poll. In his survey, no one thought the SABS system in Ontario is “right” as of this moment. More strikingly, 30% of the poll respondents said they thought the whole system should be “scrapped” and future reforms should start from scratch. Forty-five per cent of respondents thought the SABS system required “significant change” in order to work.

There was a great deal of discussion at the NICC as to whether Ontario would benefit from a full-tort system, a full no-fault system, or even a Quebec-style model in which auto insurers pay only for physical damages, while the government is responsible for payment of health care provision.

Still others asked whether Ontario would benefit from models in Alberta, Nova Scotia, New Brunswick or Newfoundland.

INSURANCE SCORES

Canadian auto underwriters would benefit greatly from the use of consumer “insurance scores,” a more sophisticated form of a credit score, Chris Kiah told delegates at NICC.

Kiah, president and CEO of Allstate Canada, was a panel member of the seminar ‘Lessons from U.S. Personal Lines Writers.’

“In spite of a mountain of evidence showing how insurance scoring is probably the single most effective predictor tool for future losses, there remains suspicion and resistance to its use on both sides of the border,” Kiah said.

He cited two reasons for this:

• people don’t understand why it works; and

• people equate insurance score with credit score.

“I can tell you that insurance score is different from credit scoring, in that [insurance scoring] only includes the data from the credit score that have a high correlation with future loss cost.”

Kiah did not specify what those factors were during his presentation.

“One of the more popular recent questions is how credit-based insurance scores fared in the most recession during 2008-09,” he continued.

He drew the NICC delegates’ attention to a graph that showed a blue line representing the credit score of the U.S. population, and a pink line representing the U.S. population’s insurance score. The vertical axis of the graph denoted the scores; the horizontal axis showed a series of years. The pink insurance score line appears relatively flat. The blue credit score line shows peaks and troughs over the years.

“Going into the recession, the credit score goes up as more consumers have issues paying loans and meeting their obligations,” Kiah said. “On the other hand, the insurance score remains relatively stable in historical terms and throughout the recession.

“Clearly this illustrates the differences between the two and the fact that the insurance score is very uncorrelated with credit score and that the insurance score is a highly stable variable.”

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The investment yields are just so miniscule today that any misstep on the underwriting side is going to have implications much greater than what we saw years ago.

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In a study of 2,000 homeowners across Canada a few years ago, 70% believed they had overland flood insurance. Insurers don’t sell any. Now that water is five times more likely than fire to cause damage to a home, it is important for insurers to be on the same page as their customers on the issue of flooding.