Enduring Change…?

Market feedback from commercial brokers and risk managers indicates that insurance pricing has peaked in most non-personal lines, including the volatile directors’ and officers’ (D&O) coverage. In fact, brokers and risk managers lament that the current conditions of the insurance marketplace are deja vu of past dramatic cycle swings between a “hard” to a “soft” market.

The trauma associated with the sudden and deep shifts of the insurance industry’s infamous price cycle is the cause of concern to brokers and risk managers. Both parties argue that they would rather deal with higher, but consistent pricing of insurance coverage if insurers were able to break away from their past destructive practice of hyper-competition and “cashflow underwriting”.

Over the past two years, which marked the peak point of the hard market cycle, many leading insurer CEOs were quick to speak out against the adverse impact of the traditional pricing cycle and appeared adamant that this time around would be different – “the cycle will be broken” was the message put out. However, the present actions of insurers in the marketplace suggest that the mistakes of the past are likely to be repeated, brokers and risk managers fear. ‘We [risk managers] don’t mind paying rates that will provide a consistent underwriting return, but we expect to pay a fair price…the conditions that created the last soft market are beginning to creep back in again,” observes Ed Martingano, director of risk management at Oxford Properties (see cover article of this issue for further details). Craig Rowe, risk manager at the City of St. John’s, also expresses doubts that insurers will be able to maintain underwriting discipline and “break the cycle” (see article on page 24 of this issue).

But, despite hearsay commentary from the commercial insurance marketplace, the question remains to whether this is indeed the beginning of a true soft market – particularly in Canada. Risk managers generally agree that, despite price weakening, insurers seem to be taking a tough stand on underwriting terms. Some argue that the reduction in rates coming into the marketplace is a corrective reaction to excessive price increases implemented over the past two years.

The latest quarterly financial returns of Canadian insurers – based on industry data collected by the Office of the Superintendent of Financial Institutions (OSFI) – suggests that company profitability based on ongoing firm pricing and reduced loss experience remains strong (although, bear in mind that over 60% of Canadian premiums are derived from personal lines, and that the OSFI data reflects only the returns of federally regulated insurers). Canadian insurers produced a net profit of $1.2 billion for the latest quarter return, achieving a return on equity (ROE) exceeding 25%. Much of this net gain was made through underwriting. Notably, the industry’s claims costs for the latest reporting period rose by a moderate 4% year-on-year compared with the 9.5% annual increase in loss cost experienced in the first quarter of this year (see MarketWatch of this issue for specific details).

Perhaps more importantly, the 2004 second quarter return of insurers indicates that growth in premium income remains robust. Insurers saw net earned and written premiums for the latest reporting period rise by 16% year-on-year, with the ongoing strong performance of the latter suggesting that companies are still achieving higher pricing on cover renewals.

At the same time, insurers’ underwriting losses have been progressively declining, with the loss ratio for the latest reporting period clocking in at 63% – reflecting a 10.4% drop over the past 12 months (the loss ratio for the first quarter of this year was 66.2%, 2003 4-Q: 70.4%, 2003 3-Q: 69.9% and 2003 2-Q: 70.3%). Although not exclusively related, the drop in underwriting loss reflects a rise in the industry’s pre-tax profit margin, which for the latest quarter came in at 16.8%, and the first quarter of this year at 18.4%. This compares with an average pre-tax profit margin of just over 8% over the course of 2003 (it is interesting to note that the pre-tax operating margin for the second quarter of this year is 1.6 percentage points lower than the first quarter, indicative of higher operating expenses).

The views of brokers and risk managers of a sudden turn to a soft market, in other words a financially precarious environment for insurers that would threaten long-term market stability, would seem unfounded. But, then, the financial state of the industry as described above is based on Canadian results, whereas the reports relating to a sudden turn to a soft market apply mostly to the global stage. Ultimately, global market trends do catch up in Canada.

In the words of the Insurance Bureau of Canada’s (IBC) chief economist Jane Voll, “we’ve [the Canadian insurance industry] made an enduring change” in the way companies approach underwriting. The current underwriting strength of the industry points to a period of stability, she predicts. I guess time will tell…