GROWTH SIGNS …But Real Earnings?

On paper, the Canadian property and casualty insurance industry’s earnings performance for the first two quarters of this year would strongly suggest at a rebound in real growth. In fact, Canadian insurers came home for the first half of this year with favorable figures across the performance ratios of almost double that of their southern cousins. International reinsurance CEOs at the recently held Canadian Risk & Insurance Management Society (CRIMS) conference admit that the generally better underwriting ratios of Canadian companies suggests that treaty renewals for the coming year will not be as harsh as the across-the-board corrective actions taken in the U.S – which in some commercial lines has already seen rates rise by 30% to 40%.

However, the current sunny conditions enjoyed by Canadian insurers may just be an artificial respite – the calm in the eye of the storm – according to the local accounts of CEOs, as well as looking to trends developing south of our border. The cause for the current celebration in the Canadian insurance industry relates to the significant rise in net earnings for the first half of this year, plus an estimated 8.5% rise in net written premiums.

In the first instance, CEOs observe, earnings were boosted by capital gains which are almost entirely attributed to the surprising upbeat performance of Canada’s blue-chip equity share, Nortel Networks. Secondly, the rise in net written premiums for the first six months of this year is tempered by several factors – although premiums written grew at 8.5%, the rate of growth in claim costs was significantly higher. According to preliminary industry performance data released by the Insurance Bureau of Canada (IBC), the rise in the cost of claims for the first half of this year was almost double that of earned premiums. The more robust growth in written premiums will only transfer from “paper” to earned premiums in the 2001 financial year due to the time lag in writing versus earned business.

In that respect, CEOs caution that the second half of the year plays a greater role in business volume and, as such, could easily see weakness seeping back into rates before the year is played out. As a result, most CEOs consulted in the cover article of this issue of CU are less than brazen in predicting the beginning of a real rate hardening based on this year’s figures. In addition, many do not expect the investment markets of next year will provide the respite to the bottom-line that the industry took advantage of this year. Summarizing many of the CEO views expressed in this issue, The Dominion of Canada General Insurance Co. president George Cooke notes, “the underwriting ratio for this year will be worse than 1999, and unless insurers want 2002 to be also screwed up, then they had better take action now”.

Looking at the fundamentals of the business, the only thing that would seem to be in the favor of Canadian insurance CEOs is that they are not sitting behind the desk of their U.S. counterparts. The U.S. industry achieved a modest gain in net written premiums but at the expense of soaring underwriting costs which insurers were unable to offset with investment gains – the result being substantially lower net earnings for the first half of this year (see MarketWatch of this issue for further details). The increase in the U.S. industry’s net written premiums was also exceeded by the growth in the country’s real gross domestic product (GDP), the implication being that despite the rate turnaround, the gain thus far made is less than the average economic output from across the industrial sectors.

Ted Belton, author of the Belton Report, points out that the Canadian gain in net written premiums from the first half of this year is also only equivalent to about 3% in real terms (being less the inflation rate measured by the consumer price index and about on par with the real growth rate of GDP). And, with the primary insurer market running at about 42% writing capacity (relative to the capital currently available within the industry), it is unlikely that insurers as a cohesive group will take a hard line on rate corrections next year – particularly in the most important and competitive marketplace of Ontario auto. Until this capital excess is removed, or a certain number of competitors are taken out from the game-board, rate weakness is likely to continue, Belton predicts.

Another unfavorable factor betting against a strong comeback of insurers in 2001 is the steep rise in expenses. This year’s numbers show a sharp rise in the expense ratio, with many CEO’s sharing the view that cost rationalization is unlikely to take hold in 2001. The reason being mainly renewed technology investment projects following the expenditure freeze brought about over the past two years by Y2K upgrades. Overall, the growth in premium income shown in this year’s figures is encouraging, however, insurers will likely face a tough year ahead with those focussing on cost reduction likely to do better.