End of the “Dark Ages”?

Analysis of the 2003 financial returns of Canadian and U.S. insurers reveals several interesting differences in how companies in each of the marketplaces got to their current position. The main fact is that insurers in Canada and those south of the border appear to have now moved onto more solid ground financially after what Robert Hartwig, chief economist of the New York, U.S.-based Insurance Information Institute (III) describes as the property and casualty insurance industry’s period of the “dark ages” between 1999 and 2002. U.S. insurers produced an ROE of 9.4% for 2003 while their Canadian brethren did somewhat better with an 11.3% return.

The rise in revenue of insurers over the last few years of rate increases also shows continuity between the marketplaces, with the U.S. industry based on net written premiums finishing 2003 off at US$406 billion and the Canadian industry at just under $36 billion (Canada’s p&c insurance industry has generally been about one-tenth the size of the U.S. marketplace). Hence, the so-called “dramatic jump” in revenue of Canadian insurers over the past year, as purported by the general media in criticizing the rate hikes of recent years, would seem unfounded. Of course, a fundamental different between the Canadian and U.S. p&c insurance marketplaces is that the latter is driven by a significantly larger portion of commercial business relative to personal lines (which is the likely reason for the greater public and political controversy that surrounded the coverage price increases in Canada).

Where Canadian insurers appear to be ahead of their U.S. cousins in terms of financial recovery lies in the underwriting result. Canada’s insurers closed 2003 with an average 98.7% combined ratio with an underwriting profit of $548 million. In contrast, U.S. insurers produced a combined ratio for last year of 100.1% with an underwriting loss of US$4.6 billion (although this shows vast improvement on 2002’s underwriting loss of US$30.8 billion).

But, where Canadian insurers appear disadvantaged is the ongoing double-digit rise in claims costs which for 2003 grew across-the-board by 10% (once again, the product makeup/exposure of the Canadian marketplace with its heavy reliance on auto would seem to be the prime factor involved). U.S. insurance companies were able to limit the annual growth in claims costs during 2003 at 2.2% – which would have been a 0.3% reduction but for unusually high catastrophe losses (accounting for almost two percentage points of the combined ratio), according to the Insurance Services Office (ISO). That said, Canadian insurers also had to contend with several large cat events such as the B.C. forest fires and Hurricane Juan. However, it is clear that rising claim costs, pertaining mostly to auto, remains the biggest issue of concern for Canadian insurers.

But, insurers (and brokers) from both sides of the border fear that worst disaster of all, the possible return to a “soft market”. The 2003 returns of Canadian and U.S. insurers show a reduction in pace at which net written premiums are flowing into the industries – suggesting that covers are being renewed at lesser margins. A regular pricing survey carried out by U.S.-based The Council of Insurance Agents & Brokers (CIAB) indicates that pricing on commercial risks across the “size spectrum” fell by between 1%-10% during the first quarter of this year. Similar findings were established by the Risk and Insurance Management Society (RIMS) in its own first quarter pricing survey. “One key question at this point is how long can premium growth remain strong…At some point, growth in [industry] surplus and improvement in profitability will reinvigorate competition for marketshare,” observes John Kollar, vice president of research and consulting at the ISO.

Have North American insurers really emerged from their “dark ages”? Hartwig does not think so. Despite the strong rebound in profitability achieved by insurers during 2003, he points out that, not only did the U.S. industry’s ROE of 9.4% follow several of the worst years in history, but that this return falls well short of the average 12.6% return made by the “Fortune 500” companies over the same period. “The 12.6% ROE chalked up by America’s largest corporations in 2003 leaves p&c insurers to ponder a 3.2 percentage point profit deficit in a year in which strong premium growth and tough underwriting should have propelled the industry to a standout performance.”

Hartwig accurately notes that many of the fundamentals of the p&c insurance environment remain volatile. For the U.S., the future of government backing for terrorism insurance hangs in the balance, while other more common “unknowns” threaten the fortunes of all insurers. Notably, Hartwig points to the potential exposure of natural/catastrophe disaster events, rising tort costs and the ever-growing cost of medical treatment. Sound familiar to anyone back home in Canada?