Number-Crunching

Taxes, consolidation and predictive modelling all came to the fore at the inaugural Canadian Insurance Financial Forum (CIFF), held in Toronto on May 19.

The day-long event featured a number of seminars on various issues affecting the financial side of the insurance business. Here is a sampling of some of the event’s seminars.

Will HST decrease company outsourcing?

Insurers looking to save money on outsourced contract costs might consider bringing more of their work in-house, thus cutting down additional expenses related to the new Harmonized Sales Tax (HST), a panel of industry financial experts said at the CIFF.

Former PwC partner Dean Summerville, the moderator of the panel discussion ‘Key Tax Issues,’ said insurers might start to hear this same kind of advice coming from their accountants in the future. “There’s incentive now to avoid outsourcing stuff,” he said. “We’re dealing with clients that have a lot of outsourcing arrangements and saying: ‘You should consider, maybe, whether the cost-benefit is to in-source.'”

The newly introduced HST in Ontario and B.C. applies to a broader range of services, and more tax will be unrecoverable under the HST, compared to the situation in which the GST (5%) is separate from PST (8% in Ontario, and 7% in B.C.).

Prior to the implementation of HST, only the 5% GST is unrecoverable. But the new HST tax is applicable to several insurance costs, including occupancy costs, claims contractors, legal services, consulting services, tech support and call centre services.

The Insurance Bureau of Canada projects the introduction of the HST in Ontario and B.C. will cost the industry $268 million in 2009, $436 million in 2010 and $484 million in 2015.

“Knowing now that contract costs are 13% more [under the HST] than internal, using our own employees, as opposed to 5% more [under GST], that does change your dynamic,” Mark Novak, Aviva Canada’s head of tax, told people attending the CIFF seminar.

“There is no HST on salaries, so you could save merely by keeping more inhouse or bringing more in-house.”

CFOs see Top 10 insurers owning up to 65% of Canadian P&C market over the next five years

Three chief financial officers, representing some of Canada’s largest property and casualty markets, predict the country’s 10-biggest insurers will control about 8% more of the market sometime over the next five years.

The CFOs from Intact Financial Corporation, Northbridge Financial Corporation and RSA Canada Group spoke as panelists at the CIFF.

The CFOs were asked to guess a specific number representing how much market consolidation would occur over the next five years. The panel moderator, Graham Segger, a retired partner of Deloitte and Touche, asked the question. In asking it, he noted Canada’s Top 10 P&C insurance companies controlled 57.6% of direct premium volume as of the end of 2009.

Nick Creatura, CFO of RSA Canada Group, said he “wouldn’t be surprised” to see that number climb up to 65% by 2014. He further noted it would only take about one or two major deals to reach that mark.

Craig Pinnock, CFO of Northbridge, and Mark Tullis, CFO of Intact Financial Corporation, each provided numbers in the range of 62-66%.

“I don’t really see a pattern or a trend, but I do believe [M&A] deals are likely to happen over the next few years,” Creatura said. “The market remains fragmented, investment yields are likely to remain low for some time, returns are inadequate for many companies and there’s excess capacity.

“There’s an increasing divergence in financial results among top tier and bottom tier performers. There are a number of players who are well-positioned as potential acquirers.”

Growth through M &A would certainly be attractive in the above environment, since companies are having a tough time achieving growth internally.

In the broker space, there is much more M&A activity, Creatura said.

“Demographics is driving much of that [M&A] activity, as senior principals of brokerages look to retire,” he said. “I think they will naturally look to a sale transaction.”

Pinnock said the strategic timing might not be right for many brokers to sell. He said a five-to-10-year window would be more likely, since the multiples the brokers are now seeking might be too high to interest prospective insurance company buyers.

Pinnock added financial corporations looking to acquire are less likely than insurers to “kick the tires” on a deal for a brokerage, since they might not consider the underlying insurance drivers for a deal.

How credit scoring heated up competition in U.S. auto lines

Credit scoring played a key role in heating up the competition in the United States auto insurance market, according to a U.S. researcher of insurance analytics.

David Cummings, vice president of research at ISO Innovative Analytics, a unit of Insurance Services Office Ltd. (ISO), made the observation during his presentation on ‘Actuarial Predictive Modelling’ at the CIFF.

“The [U. S.] auto rate plan, prior to the introduction [of credit scoring], had been a fairly static entity… for decades,” Cummings said. “But then the introduction of credit really revolutionized the way that companies looked at their risks. It changed the way they segmented them and created a substantial increase in competition. That continues today when you see all of those auto insurance ads on TV in the United States. There’s plenty of competition going on today.”

Cummings linked Progressive’s rapid accumulation of market share in the United States with the company’s aggressive use of credit scoring.

In his presentation, Cummings showed an example of how competition is stoked through companies being selected against.

For example, Company A does not use credit scoring. It has three policies — a $600 policy, an $800 policy and a $1,000 policy — amounting to total revenue of $2,400. Company A does not use credit scoring to segment these risks, and so it offers an average $800 rate to three of its policyholders.

Company B, on the other hand, uses credit scoring to accurately price the risk. It offers a $600 policy to Company A’s $600 policyholder (who is paying the average $800 premium to Company A).This causes the $600 policyholder to switch from Company A to Company B.

Company A now has two policyholders, an $800 customer and a $1,000 customer. Still not using credit scoring, the company offers an average premium of $900 to both.

Again, Company B uses credit scoring to segment its pricing. It offers a rate of $800 to Company A’s $800 policyholder, causing him or her to switch.

Company A is now left with only one policyholder, worth a total revenue of $1,000 — less than half the revenue with which it started.

“The early adopters were really able to take off with [credit scoring], because of that ability to price accurately,” Cummings said of the U.S. market. “There were lower-cost risks and they were able to steal them out from under the slower actors, some of whom were much larger than they were. So it created a real opportunity for that profitable growth earlier on. As soon as everybody realized that’s why Progressive moved so quickly up to the top of the ranks — they were one of the early adopters — that got everybody’s attention. They said, ‘Hey, I’d like to do that, too.'”

———

Prior to credit scoring, the U.S. auto rate plan had been a fairly static entity for decades. The introduction of credit revolutionized the way companies looked at their risks.