Financial Eclipse

Speaking metaphorically, observers are witnessing a rare form of ‘solar eclipse’ in the Canadian insurance industry: an ailing economy has aligned almost perfectly with a hardening insurance market. This rare event raises obvious questions about the pricing, availability and capacity of insurance in the nation’s home, auto and commercial insurance markets. It also raises questions about consumer insurance buying habits: will consumers, for example, opt for higher deductibles to keep their premium prices low? Will they scrimp on or forgo some forms of insurance? Or will they move to new insurers or stay with their existing ones?

Canadian brokers are well-placed to answer these types of questions. And they note that, despite the panicked tone of media headlines throughout the country, and despite the nightmarish financial results carriers posted in 2008 Q4, the Canadian property and casualty insurance industry is proceeding apace in an orderly fashion. Yes, insurance rates are increasing slightly. But brokers note this has more to do with insurers making up for their increasing claims costs and not because of their terrible 2008 Q4 results. No, there are no availability or capacity issues of which brokers are aware — at least not for the foreseeable future. But yes, consumers’ insurance buying habits are changing somewhat. Particularly in some commercial insurance lines, brokers are starting to see signs of ways in which the economic downturn might affect the industry over the long-term.

Nightmare on Bay Street

Over the past two and a half years, between 2006 and the early part of 2008, Canada’s property and casualty industry experienced boom times. In 2006-07 in particular, natural catastrophes were few and far between, pricing was low and capital was aplenty. MSA Research president Joel Baker noted in a June 2008 seminar that at that time, the Canadian P&C industry had about Cdn$11 billion in excess capacity, enough to underwrite a replica of Canada and fuel a soft insurance market until 2012.

Three months later, the U. S. housing market collapsed, triggered by a number of defaulted loans and credit derivatives based on those loans. The collapse of the U. S. housing and credit markets took down a number of the world’s markets along with them. The world’s largest financial services company, the American International Group (AIG), which harbours the world’s largest insurance operations, was spared bankruptcy only by the largesse of the U. S. government, which now owns 79% of the company and doled out more than US$170 billion in bailout money.

Canada, which sets very high capital standards thanks to a policy established by the federal solvency regulator, the Office of the Superintendent of Financial Institutions (OSFI), seemed to be spared the worst of any bankruptcy concerns. But the financial repercussions of what happened in the United States wreaked havoc on Canadian property and casualty companies’ investment portfolios and consequently their net incomes. Early this year, at the graduation ceremony of this years’ Chartered Insurance Professionals in Toronto, two Canadian insurance company CEOs talked about the markedly declining 2008 Q3 results. One noted to the other that the full impact of the credit crisis on Canadian insurers would not even be revealed until the 2008 Q4 results. True to his word, in 2008 Q4, federally regulated insurers in Canada reported profits in 2008 that were only half of what they were in 2007. Insurers reporting to OSFI reported a net income totalling slightly more than Cdn$2.2 billion in 2008, down considerably from the Cdn$4.9 billion profits in 2007. OSFI figures show the industry’s collective net investment income dropped from just over Cdn$4 billion in 2007 to slightly more than Cdn$2.7 billion in 2008. MSA Research results, which account for 93% of the Canadian property and casualty industry based on premium volume, show more than half (55%) of 141

Canadian insurance companies reported an underwriting loss in 2008. Putting this loss in perspective, as of the end of 2008 Q3, the industry reported an underwriting profit of Cdn$271.1 million. By the end of 2008, the underwriting loss for the year stood at Cdn$752 million, suggesting that in just one quarter, 2008 Q4, the industry saw Cdn$1.02 billion of underwriting income evaporate.

Synchronicity

At the same time insurers experienced huge losses in the fourth quarter last year, consumers were feeling the pinch of the economic meltdown. The March 2009 edition of Swiss Re’s monthly Canadian economic update provides the statistical backdrop for the insurers’ woes. “The Canadian economic recession deepened with real (Gross Domestic Product) GDP falling a sharp 3.4% in the fourth quarter, after a gain of 0.9% in the third quarter of 2008,” Swiss Re notes. It also observed the extent of the nation’s serious job losses: “Jobs declined for a fourth consecutive month in February with jobs falling by 82,600, largely driven by a decline in construction of 43,200, the largest monthly decline on record, and despite a 24,700 rise in manufacturing jobs. Consequently, the unemployment rate jumped to 7.7%, its highest since 2003.”

So with consumers looking for ways to pinch pennies on insurance, and insurers looking to increase their rates to make up for underwriting losses (due to claims costs and investment losses), there is a strange alignment of forces in the Canadian insurance market. As many brokers and CEOs observe, normally an insurance cycle lags behind the country’s economic cycle. But in Canada right now, the insurance market is showing some signs of hardening, which typically entails higher pricing and stricter underwriting requirements that often lead to availability issues. This is happening at precisely the same time consumers are suffering the worst effects of job losses and economic recession, and are therefore looking for any means to keep their premium payments down. So what happens in the Canadian market when an irresistible force meets an immovable object? Thus far, nothing, Canada’s brokers observe.

All’s Quiet on the Northern Front

“We’re still going along pretty stable,” reports Linda Dawe, the CEO of the Insurance Brokers Association of New Brunswick. “Not to say something won’t change down the road. Maybe a little tightening in homeowners’ rates, and of course auto rates are regulated and closely watched by the New Brunswick Insurance Board. We’re not going to see much change there, I don’t think. And in commercial lines, so far no brokers have brought to my attention that there are concerns yet.” Dawe’s comments summarize the prevailing consensus among brokers throughout Canada. It’s not to say that rates aren’t hardening, but many say the commercial market continues to be soft overall. As for adjustments made to homeowners’ and auto rates, they are more reflective of insurers’ claims experiences (claims costs are up in personal lines generally) and less the impact of the economic downturn.

Of course if the United States is your standard of comparison, Canada appears to be in great shape. For example, in Michigan, where consumers are losing their jobs because of the instability of the auto manufacturing sector, people are trying to save money any way they can — including withdrawing from purchasing auto insurance.

“I can tell you for sure we’re not getting hit as hard here in Ontario business as they are getting hit south of the border,” observes Randy Carroll, the CEO of the Insurance Brokers Association of Ontario (IBAO). “[IBAO President] Peter Blodgett and I came back from a Michigan agents’ conference, and the amount of consumers in Michigan that have opted out of the system is staggeringly high. In Michigan alone, they have estimated that 17% have opted out on average. Just taking no insurance. They estimated that in the city of Detroit alone, it was in excess of 55%. When they said that, I looked at Peter and said ‘I’m glad we flew.’ It’s not significant here, and we ha ven’t heard too many rumblings [of that happening].”

Dan Danyluk, CEO of the Insurance Brokers Association of Canada (IBAC), says despite the current global recession, most countries in the world are still experiencing a soft market. “That’s almost counter-intuitive when you see what appears to be capital draining out of the world economy, but the fact of the matter is that generally property and casualty companies around the world have been pretty solid,” he says. Danyluk cites many reasons for the apparent lack of any pricing, availability or capacity issues in spite of insurers’ apparent fourth-quarter money woes. Among them, he cites strong prudential regulation by OSFI, a pro-active approach by Canada’s guarantee fund, the Property and Casualty Insurance Corporation of Canada (PACICC) and insurers better segmenting their markets now than in the past. “We’re not seeing, at least I have not heard, a lot of issues about availability yet,” he says. “I think that’s probably due in part to the fact that, on the commercial side, there has been some segmentation. Over the last several years, insurers have worked very hard to identify those lines of business and those areas where they have particular expertise and underwriting know-how, and they’ve tried to stick to their knitting. We have not seen the same number of [insurers] trying to do everything for everybody.”

Storm Clouds on the Horizon

Like many others, Ken Myers, first vice president of the Insurance Brokers Association of Nova Scotia, is quick to point out: “I think it’s too early to tell as far as [how the economic downturn is] affecting brokers.” Still, he observes brokers’ clients do mistakenly believe the economy doesn’t significantly affect the business of insurance. “When I speak to my clients, people generically say: ‘Well, you’re in the insurance business, everybody has to buy insurance,'” Myers says. “Well, that [economic downturn] doesn’t affect us — until our clients start going bankrupt. Anecdotally, we’ve seen some of that. We’ve seen some businesses that no longer operate. In my practice, we do a lot of corporate commercial business, so we’re seeing lots of companies whose revenues have dropped. You would see this more in Ontario, particularly with companies that operate cross-border. In 2008, their revenues went down because of the Canadian dollar, so what’s going to happen in 2009, who knows?”

Brokers often cite commercial lines as the proverbial canary in the coal mine, an early warning system of how the economic downturn is affecting the Canadian insurance marketplace.

Brenda Rose of FirstBrook Cassie and Anderson is a past president of the Toronto Insurance Conference, an association representing commercial insurance brokers in Canada. She says the economy’s effect on the insurance marketplace is linked to the fact that commercial insurance consumers pay for liability insurance based on their receipts for the year. “So if the estimate for the customer’s receipts for the upcoming year is down, then the premium will be down as well, assuming the rates are the same as last year,” Rose points out. “Some businesses carry less stock as well. You just see an overall shrinkage of values, not because anybody has decided to cut back, but because you just don’t have as much stock to insure. That’s the way that it works in liability as well. You’re just not doing as much business if you don’t have as much exposure.”

Post-economic meltdown, Rose says she is also seeing a lot of activity in the area of trade credit insurance. Businesses carrying trade credit insurance use it as an alternative to arranging pre-payment or cash-on-delivery terms with their clients. With trade credit insurance covering them in case of a default, businesses can afford to let clients generate income from sales to pay for the product or service the business offers. “There is a lot of interest, a lot of people buying trade credit who previously wouldn’t have thought it was necessary,” Rose says.

But consistent with a recent report by Marsh on this phenomenon in the United States, Rose notes insurers in Canada offering this form of insurance are being careful now in their underwriting, based on the new economy. “The risk [associated with underwriting trade credit insurance] is higher, not because there is increased demand, that is one factor, but because…there is a good chance there is an increased danger of suffering a loss,” she says. “And so certainly underwriters are being very cautious. Some of the name companies who write that business are being very careful in their underwriting of it.”

Johanne Lamanque, executive director of Quebec broker association Regroupement des cabinets de courtage d’assurance du Quebec (RCCAQ), says the economic downturn has also caused a ripple effect in the area of insurance premium financing as well. AIG’s economic situation caused it to withdraw abruptly from the premium financing market in Canada (see story on Page 24), leaving the field open for two or three of its competitors in Quebec.

Although there have been no availability issues in the market caused by AIG’s departure, the event did cause Quebec’s brokers to operate a little differently than before, Lamanque notes.

“At the moment, a few brokers are seeing that companies are more strict on the conditions to finance commercial insurance premiums,” she says, noting that Quebec’s brokers have picked up the slack. “Some businesses cannot be financed to pay their premium. For example, we have a car dealer that pays a premium of $50,000 a year. Usually you will have that premium financed by one of these [premium financing] companies. If they do not finance that industry anymore because of the downturn, the insurance brokers have to pay the insurance premium to the insurance company in 60 days. It’s an indirect effect [of the economic downturn], but it’s disturbing. One day we will have a problem with that. It’s particular to big accounts in commercial business.”

All of the brokers interviewed for this story say these observations should be placed in proper context. The commercial insurance market in Canada remains soft, Danyluk notes, and Rose says there is still a great deal of competition for commercial accounts, suggesting low rates are hardly a thing of the past. Carroll notes that in Ontario, although commercial insurers have shown signs of being more selective about the risks they will write, there are currently no availability issues in the commercial insurance market.

Having said that, Carroll and others note the economic downturn might be playing a role in masking the effects of an anticipated hardening commercial insurance market.

“I was talking to a broker last night,” Carroll recalled. “I asked how are things going on the commercial side and she said it’s like companies are trying to take rate, but it’s a phantom rate. I said, ‘What do you mean by that?’ She said companies are trying to get more selective. They are taking rate where they think that they can take rate, but the consumers seem a lot more selective in terms of what coverages they require; they are more willing to self-insure to a certain degree. So what we’re doing in part on the one hand, with insurers trying to build up, the consumers are taking that rate away because of the economic downturn, by removing cover business and/or increasing deductibles to offset any potential rate increases.'”

Or as Rose puts it: “If commercial businesses are shrinking, you have less to insure, so rate increases are less apparent, because the two somewhat offset each other.”

But while this may be true, it all might ultimately come out in the wash. “Theoretically, you would think if the actuaries are doing their jobs, it should work itself out,” says Blake Craig of the Insurance Brokers Association of P. E. I. Craig observes that even if insurers’ commercial rate increases are offset by their clients’ withdrawal from certain coverages, insureds are “absorbing more of the claim,” and thus reducing insurers’ claims costs. “That would be my sp in on it,” Craig says.

Rose notes that during this economic recession, commercial brokers are under increased pressure to make sure clients are aware of the impact of reducing their coverage for certain risks. Commercial clients should have more on their minds than simply seeking out the cheapest insurance prices during tough economic times, she says.

Personal Lines ‘Stabilizing’

Commercial pricing has been softer than in personal lines for some time, so how has the downturn in the economy affected pricing, availability and consumers’ buying habits in the home and auto insurance lines?

“I don’t see at this stage there’s much in our economy that’s going to affect rates,” says Dawe, again reflecting the general consensus among many brokers. “There hasn’t been any discussion that I’ve been privy to that says we are going to see any significant increase in rates. We’ve seen a little bit of tightening here on rates, maybe a little bit closer underwriting, but nothing dramatic at this time.”

Auto and homeowners insurance rates were expected to increase even before the economy took a turn for the worse, Lamanque notes. “At the end of 2008, even before the announcement of the economic crisis, we were seeing that an increase (in personal property lines) was coming,” she says. “I would say the crisis has accelerated the process, but we were in that process even before the crisis.”

Whether or not the economic downturn has affected insurance consumers’ buying patterns seems to be up for grabs, depending upon where you live.

“Personal lines insurance, from what I understand from our member brokers, has been really slow for new business, which tells us that people aren’t shopping,” says John Penney, president of the Insurance Brokers Association of Newfoundland. “They are not buying those things that would cause them to go out and look for more insurance, toys [like vehicles] or whatever. But our retention has been very high. It means people are perceived to be somewhat satisfied with their current providers.”

Ontario is the flip side of the Newfoundland experience, Carroll notes. “On the auto/property side, there’s a lot of business moving these days,” he observes. “Consumers are seeing increased premiums and as a result they are shopping. There’s a lot more shopping happening on the auto and property side over the past three to four months. They are increasing deductibles, taking some coverages off in regard to their collision coverages (autos that might be a little older, for example). There is a change of direction in terms of let’s see what I can do as a consumer to lower that premium.”

Measure of Stability

Changes to the Canadian insurance market based on the shift in Canada’s economic fortunes are not expected until later this year or next year. But despite the absence of anything to report now, there is a palpable sense that brokers are waiting for the other shoe to drop. Carroll says the IBAO’s economist is predicting that whatever happened in January of this year is due to repeat for the rest of 2009. That’s not comforting news for those reading Swiss Re’s monthly economic forecast in January 2009, when the reinsurer reported 34,400 job losses and a 0.1% drop overall in the GDP. And certainly Canadian insurers, although still well capitalized, cannot afford to keep sustaining losses of the type reported in 2008 Q4 without eventually altering consumers’ insurance rates. “This is problematic if personal lines rates go up at a time when people are experiencing job loss,” Danyluk notes. “It puts pressure on government to regulate, and it’s really important for them to regulate responsibly. Regulators have to worry about the consumer, but also recognize that if these [insurance] businesses are going to be there for a long time, they have to have sustainable premiums.

“The longer I’m in this job, the more I realize, there are less and less villains. I have empathy for the tough job regulators have to do, the tough job politicians have to do and the tough job that insurers have to do. The challenge as a broker is, all of these folks’ actions at times impact the way we look after our clients and that can be frustrating.”

Certainly brokers are taking a keen interest in insurers’ financial results, and how these results might play out in terms of capacity or availability issues for consumers down the road. As many brokers in Ontario note, AIG maintained a double-A credit rating a short time before its financial products segment got the rest of the organization into a financial predicament. It should be reaffirmed here that AIG’s property and casualty operations were not affected in terms of capacity and remain on solid financial footing, according to regulatory agencies. But the event clearly has brokers and consumers nervous. A well-heeled U. S. client insured with AIG recently called up his Canadian broker and said he no longer wished to be insured with AIG. “That’s not even something we would have contemplated six months ago,” the broker observed.

And so, if there’s no other difference the sour economy has made to the Canadian insurance market, it has got brokers talking openly about the best financial indicators for determining the health of the country’s insurance markets. “The solvency of insurers is a great concern,” Carroll says. “On the personal lines and commercial side, the majority of problems we’re hearing from our brokers is with regard to the solvency of insurance companies and we are trying to get a good understanding of what is a good standard test. What can we rely on in regards to data in which we can be confident?”

Myers agrees that the recent confluence of an economic downturn and an evolving hardening of the insurance market has brought the solvency issue into high relief. “We’ve really taken it [solvency] for granted,” Myers says of conditions over the past five years. “I think brokers generally are going to have to examine that more closely, as to what we have to do to examine how healthy the insurers are that we represent. We’ve got to make sure the insurers we deal with are as healthy as we believe they are.”

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“It’s almost counterintuitive when you see what appears to be capital draining out of the world economy, but the fact of the matter is that generally property and casualty companies around the world have been pretty solid.”

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“When I speak to my clients, people generically say: ‘Well, you’re in the insurance business, everybody has to buy insurance,’ Well, that [economic downturn] doesn’t affect us until our clients start going bankrupt. Anecdotally, we’ve seen some of that.

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“This is problematic if personal lines rates go up at a time when people are experiencing job loss. It puts pressure on government to regulate, and it’s really important for them to regulate responsibly.”