In Need of Repair

MSA president Joel Baker kicked of the National Insurance Conference of Canada (NICC) in 2008 by likening the country’s property and casualty industry to a car that wasn’t quite firing on all cylinders. This year, in 2009, his metaphor recalled the image of an old clunker in need of going to the shop for repairs. Baker noted results deteriorating in all lines of business, home, auto and commercial. Certainly, members of the industry had much to discuss when it met at the third annual NICC event held this year at the Ottawa Westin Hotel. Below is a sampling of some of the topics and discussions that occurred at the 2009 NICC.

MARKET (MIS)CONDUCT

Administrative Penalties

Remedies available to Canadian financial services regulators span the continuum from the extreme (a quasi-criminal charge) to much more passive (cease-and-desist orders) — but very few jurisdictions enable regulators to fine companies using administered monetary penalties (AMPs).

Vivian Bercovici, a partner at Heenan Blaikie, said regulators need to make sure AMPs are part of their regulatory tool kits. She spoke as a panel member at the NICC session Market (Mis)Conduct –Shades of Grey.

AMPs would sit in the middle of the regulatory response continuum, she told delegates. They “are a tool or a mechanism that gives regulators the power to assess and penalize a breach with a monetary fine,” she said. “The idea is that the fine is going to be commensurate with the seriousness of the breach.”

Aside from being a revenue generator for the regulator, a fine plays against the reputation of an insurer as well, since “no company wants to be fined in that way,” Bercovici said. “It sends a deterrent message and it has a punitive effect.”

The problem, in Bercovici’s view, is that AMPs are not available in many Canadian jurisdictions, including Ontario.

“An AMP is a very positive tool,” she said. “It functions like a pressure valve. It gives the regulator a flexibility that in this day and age can be a very valuable and helpful tool for the regulator to have in the kit.”

Fines would allow regulators to respond to mostregulatory breaches in a strong and appropriate manner, she argued.

“I would hope that what we would see is the development across the country of a very strong AMP system, one that is reasonably consistent in terms of approach. The quasi-criminal response would really be reserved for the most egregious of circumstances.”

PART XIII

Amendments to Part XIII of the federal Insurance Companies Act might make it easier for a bogus insurer to operate outside the Canadian regulatory regime and yet do business in Canada, said Alan Clark, superintendent of the Financial Institutions Commission of British Columbia (FICOM).

Clark was a panel member at the NICC’s Market (Mis)Conduct session.

“Although I can understand the rationale for the changes [to Part XIII], the changes are a significant issue for my office and most other provincial regulators,” Clark told NICC delegates. “In my opinion, a rule change that moves a federal regime from a location of risk to a location of business makes it easier for bogus insurers to operate outside the Canadian regulatory regime and yet do business in Canada,” he said.

Over the years, FICOM has issued two cease-and-desist orders to bogus insurers. Both of these insurers would have been in compliance with the new regime under the Part XIII changes, Clark said.

B.C. has drafted legislative changes as a reaction to the federal Part XIII amendments, Clark said. “Authorized insurers insuring risks located in B.C. will be required to conduct this business in Canada and, unless an exemption is granted by regulation, require a business authorization,” he said. “At the end of the day, I hope that we will have a modern framework for the placement of insurance with unauthorized insurers through qualified licensed insurance agents and a procurement process that meets certain requirements and conditions.”

The qualifications for licensed agents will likely be similar to the special-broker licensing scheme in Alberta, he added.

The requirements and conditions for procuring unauthorized insurance for British Columbians by agents will be established by regulation and will probably be dependent on whether:

• the policy was solicited or not;

• the availability of insurance in Canada by authorized companies;

• any disclosure of the financial strength and credit worthiness of the unauthorized insurer;

• disclosure of the capability of the unauthorized insurer’s primary regulator;

• specific reporting to FICOM and the policyholder; and

• the payment of premium taxes. “Under B.C. law there will be a significant difference between the federal and provincial legislation and how we determine whether insurers are doing business in our province,” Clark said.

AUTO RATES: TAKING A PROACTIVE APPROACH

Ontario auto insurers need to be proactive in setting appropriate rates instead of relying on a vague hope that imminent government reforms will bail out the industry, Canada’s solvency regulator told people attending the NICC.

Julie Dickson, superintendent at the Office of the Superintendent of Financial Institutions (OSFI), cited automobile insurance in Ontario as a major area of concern at OSFI.

Specifically, she noticed that direct loss ratios have worsened by five points over the past year, “to an unsustainable 85%.”

Also, she observed the historical pattern of automobile claims ratios for any province follows a traditional ‘U’ shape. In other words, the worst results typically happen during the winter season, and results improve during the good weather seasons.

“In Ontario, this relationship has disappeared,” Dickson said. “The second quarter this year did not bring any discernable relief, and now certainly suggests that, overall, 2009 will be materially worse than 2008, which itself had an unpalatable loss ratio in the mid-80% range.”

At the time of the conference, OSFI was awaiting Ontario’s widely anticipated changes to the auto insurance product. [The reform package was announced just at press deadline — see editorial in this issue for an immediate reaction to the reforms.] Due to be implemented in early 2010, the reforms are part of the provincial government’s mandated five-year review of the auto insurance product.

In the meantime, Dickson encouraged auto insurers to do more than simply wait passively in the hopes that Ontario makes appropriate changes to the product. “Companies need to be ahead of the curve,” she said. “If you sense early that rates are a problem, you need to be proactive with provincial regulators.

“You cannot keep rates lower than would be required to cover your risks, while continuing to write business, all the while hoping that you will get a rate increase that will even things out down the road. Hope is not cold, hard cash that can be called upon to meet your policy claims.”

PUBLIC SHOULD DEBATE FACILITY RISK-SHARING POOLS

There should be a public policy discussion in the near future about doing away with risk-sharing pools, panelists told a seminar about Facility Association (FA) issues at the NICC in Ottawa.

Bob Tisdale, president and CEO of Pembridge Insurance Company, whose subsidiary, Pafco, writes non-standard auto policies (i. e. those that go into risk-sharing pools), says the risk-sharing pools merely lose money for the insurance industry and ultimately subsidize the premium rates of high-risk drivers.

“I am fairly cynical about the risk sharing pools for a number of reasons,” Tisdale said.

For one thing, he said, legislators are not allowing insurance companies to use certain underwriting tools to price high-risk drivers appropriately in the competitive marketplace. As a result, high risks often get shunted off to the risk-sharing pools in the non-standard auto segment, where insurance companies pool their resources to make sure all drivers are able to obtain insurance as mandated by the provincial governments.

But these risk-sharing pools have lost more than Cdn$1 billion for the industry, Tisdale said.

“The first pool was brought into Ontario in 1993,” said Tisdale. “It’s lost Cdn$750 million for the industry since it was [established] in 1993. Alberta comes along with a rate pool that they introduced in October of 2004. The non-grid pool has lost over Cdn$100 milllion. The grid pool, I believe, has lost Cdn$65 million. In New Brunswick, we’ve created a pool for first-chance discount. It’s lost tens of millions of dollars, $14 or $15 million. Now we’ve done the same thing in Nova Scotia, we’ve brought in a pool, and it’s lost millions of dollars. So add it all up, we have subsidized the worst automobile risks in the industry by close to Cdn $1 billion since the first pool was [established].”

For this reason, “some members in our industry say we ought not to call them risk-sharing pools at all, but we ought to call them premium subsidy pools, because that’s what a number of them are,” said panel moderator David Simpson, CEO of Facility Association.

Tisdale gave a couple of real-life examples of how the risk-sharing pools have subsidized high-risk drivers. “When the [Alberta] grid pool was brought in, we had a 19-year-old with an impaired driving conviction,” he said. “He had an accident, he was an impaired driver, and his premium went down by Cdn$4,500 when the grid pool was brought in. That’s just not sustainable.”

Tisdale said regulators needed to consider allowing insurers to use more underwriting tools that currently are not allowed to be used in auto lines — credit-based insurance scores, and in some cases, age, for example — so that the competitive marketplace could price these high risks appropriately. If the competitive marketplace handled such risks, then risk-sharing pools would not be around to subsidize high-risk drivers.

Rob Wesseling, immediate past chair of FA, said a public policy discussion around risk-sharing pools is required.

Echoing this sentiment, Doug McIntyre, CEO of Echelon General Insurance Company, rose from the floor and issued a call to action. “We have to enlist the help of the 95% of people who end up paying too much for car insurance to subsidize the 5% of drivers who get a subsidy,” said McIntyre. “Politicians not only react to that 5%, but they are also concerned about the clean driver paying Cdn$100 or Cdn$200 paying too much. We need to inform that 95% that they are paying too much and enlist their help in making sure those 95% of drivers call their MPP. They’ll get listened to, more so than the 5%.”

IFRS CONVERSION ‘A STEP BACKWARDS’

The implementation of fair value accounting so far has been a “real net negative” for Canadian property and casualty companies, said Doug Hogan, chief financial officer at the Dominion of Canada General Insurance.

Hogan offered a “victim impact statement” during the session Muddy Waters, Shifting Sands — Implications of IFRS and Solvency II.

In 2007, Canadian property and casualty companies began to use fair value accounting for financial instruments. Fair value accounting, also called “mark-to-market,” is a way to measure assets and liabilities that appear on a company’s balance sheet and income statement. In essence, fair value accounting calls on a company to report what an asset or liability is worth in the market today, as opposed to measuring and reporting the value of assets and/ or liabilities only at the point at which they are bought, sold or otherwise realized.

The conversion resulted in two positive developments, Hogan said. These include the fact that “there is now some degree of meaningfulness and consistency on the balance sheet,” and “accounting equity is much more converged with the regulatory concept of capital that Canada has.”

But “in terms of reporting income, so far, fair value accounting has been implemented so that it’s a real net negative,” Hogan said. “It has been a step backwards.”

Under the new regime, the claims discount rate (or the changes in discounting) is buried in claims expense. Discount rate changes are based on market yields, which fluctuate, creating volatility in claims expense and operating ratios, he continued.

“You didn’t change what you think you’re going to pay out,” Hogan pointed out. “You didn’t change how you think you’re going to handle the claim. You didn’t change anything that has to do with your expectation of how you will settle this claim.

“But, based on market factors, you now have an unrealized gain or loss from period to period as the discount rate changes. The fact that it is buried in claims expense is absolutely not helpful.”

Consequently, Hogan added, “if you looked at an income statement of a P&C company in Canada, you really don’t know how the company performed in terms of underwriting or decision-making. Unless there’s good disclosure, you don’t even know how much of that is caused by market distortions.”

GLOBAL REINSURANE OUTLOOK

If a major catastrophe loss occurred during today’s market conditions, it’s unlikely the reinsurance industry would be able to raise new capital following the event to the same extent that it did after Hurricanes Katrina, Rita and Wilma in 2005.

During the panel discussion Global Reinsurance –Back to Basics, Tad Montross, president and CEO of Gen Re, said that over the past two or three decades, the barriers to entry into the reinsurance industry have dropped significantly; since then, the industry has seen “tens of billions of dollars, mostly from private equity firms and hedge fund activity that have come in to fund different measures,” he said.

Following Katrina, Rita and Wilma, many Bermuda-based reinsurers lost an average of between 25% and 30% of their capital, he continued.

“Most of that was re-generated within weeks of the events,” he said. “That post-event capital raising is very unlikely in today’s marketplace.”

The reinsurance industry would likely see capital enter the industry in different formations, he added. “Sidecars have become a very efficient way for capital to come in on a very short duration basis, without having to build up an infrastructure,” Montross said. “Certainly securitization is a form of capital entering the industry, and to the extent that demand is there, I believe we will see an increase in securitization as well.”

Fellow panel member John Berger, president and CEO of Harbor Point Re, added that although it appears the liquidity crisis of 2008 has eased in 2009, the market is still very precarious.

“I’m very uncertain that if big cats had happened last year, when there was a liquidity crisis around the world, there would have been anyone that would have come in. This year, it seems that things have freed up a bit. But I don’t think we are out of the woods on the financial front.”

WHAT DO CONSUMERS WANT?

Ontario consumers are looking to the insurance industry for more information and guidance when it comes to understanding how premium prices are derived, and desiring more leadership in areas such as promoting public safety.

Answering the question, ‘What Do Consumers Want?’ a panel of communications and media representatives at the NICC indicated that consumers generally want the insurance industry to communicate with them clearly, honestly and in a timely manner.

James Daw, a business reporter for the Toronto Star, suggested consumers want to be more involved in the construction of the product.

“Consumers want more information about why things are the way they are,” said Daw. “And they want more infor- mation about what could happen to them, depending on how they drive and how they care for their vehicle…It seems to me that if people knew in advance that if they change cars, or move [into n ew] neighbourhoods, or if they have an accident, they would know just how much their insurance was going to go up.” This, in turn, would give them a better idea of whether or not their premiums were fair, Daw said.

Along similar lines of advanced communication, Lubo Li, senior director at J.D. Power & Associates, said the public would appreciate advance notice of forthcoming rate increases.

Ontario’s insurance regulator, the Financial Services Commission of Ontario (FSCO), reported that Ontarians experienced an average overall rate increase of 5.86% in 2009 Q2. Rates increased in the province by an average of 5.59% in 2008.

Against this backdrop, J.D. Power & Associates published the 2009 Canadian Home and Auto Insurance Customer Satisfaction Study in September. Conducted in August 2008, the survey canvassed the opinions of 7,713 auto insurance policyholders and 5,170 home insurance policyholders.

“Among those [Ontario] customers [who reported a rate increase], 59% did receive advance notice,” Li said. “Among those, their satisfaction absolutely is higher than average, at 717.

“Among those [Ontarians] who did not receive advance notice [of a decrease], their satisfaction nose-dived to a normal 658.

“So clearly the message here is, ‘Yes, a premium increase will bring down satisfaction, customers are going to be frustrated.’ However, they will appreciate an agent or a broker picking up the phone and giving them a call to warn them of the upcoming premium increase, review their policy, review any changes in their family circumstances and discuss premium options to help mitigate the impact.”

Mary Lou O’Reilly, communications director at the Insurance Bureau of Canada (IBC), observed how a little consumer dissatisfaction can go a long way, thanks to the broad and immediate reach of the Internet. She pointed to the instance of a Nova Scotia musician, David Carroll, whose guitar was damaged by United Airlines. Carroll videotaped himself singing a ditty by the name of ‘United Breaks Guitars’ and posted the clip on YouTube.

“How much damage did United do to his guitar? I can’t answer that,” said O’Reilly. [Carroll’s Web site says Cdn $1,200 in repairs had not quite restored his guitar.] “But I can answer the question,’ How much damage did Dave Carroll do to United?’ Six million people know now that United breaks guitars…. That was a PR nightmare for United Airlines. Just imagine what it could be like for our industry. We are just as vulnerable if we don’t treasure and commit to excellence our relationship with consumers.”

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The historical pattern of auto claims ratios follows a ‘U’ shape, with the worst results in the winter. In Ontario, this relationship has disappeared.

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The implementation of fair value accounting so far has been “a real net negative” for Canada’s property and casualty insurance industry.