Primary Insurer Strategies 2003: The Next Round

The year past was marked by financial downgrades of insurers and reinsurers, investment write-offs, falling capacity, multi-million dollar reserving adjustments and a scarcity of new capital. And, oh yes, this year was the first “real round” of the so-called “hard market” as the property and casualty insurance industry pricing cycle rocketed upward in the aftermath of 9/11. Yet, despite strong price adjustments, the industry’s financial outlook for this year and 2003 remains bleak, the victim of unrelenting claims costs that continue to eat away at the bottom-line. With insurers preparing for the “next round”, those still competing in the ring will be thinking of two broad factors that could ultimately decide the winners from the losers: the availability of capital, and the impact this will have on their ability to write new business as the benefits of higher pricing begin to show in financial returns, CEOs participating in CU’s annual primary company “state of the market” survey say.

TT his year saw international media headlines of huge company reserving adjustments for prior year claims, insurers announcing plans for multi-billion dollar capital raising issues, and the financial rating agencies either downgrading or placing on “negative watch” many global blue-chip insurance companies.

Some of these industry players have either announced exiting from certain sectors or lines of business altogether, some have sold off their operations in countries where returns have been dismally low, while others have begun drastic restructuring plans with the hope that downsizing will enable them to outride their losses. At least one major international insurer operating in Canada recently retrenched a significant portion of its workforce as part of a global restructuring plan, according to industry reports.

While much of the restructuring activity has taken place at the global level, pressure has remained high at local levels – not just for international “branch offices”, but for domestic underwriters as well – as rising claims losses continue to dampen net financial returns and the appetite of investors backing the property and casualty insurance industry. In Canada, the loss environment is particularly complex due to the political sensitivity of the auto product which by far accounts for the lion’s share of premiums countrywide. Specifically, the Ontario personal lines market, which adds up to nearly a quarter of all premiums across Canada, has been most vexing to insurers as fraud and claims mostly arising from minor bodily injuries continue to push the loss ratio to new highs. Insurer CEOs partaking in CU’s annual “state of the market” survey (see below for individual commentary) have mixed feelings with regard to the recent Ontario product reform legislation put forward, many believing that it is only just a step in the right direction. Regardless, nearly all believe that the reform measures came in too late to provide noticeable relief to company bottom-lines for 2003.

As insurers prepare for the next round of battle, the competing environment is going to be shadowed by two domineering issues: capacity shortage, and the ability of companies to raise capital to support writing new business, the CEOs concur. The consequence will be further restructuring and consolidation within the industry over the next 12 months, while the “hard market” is expected to maintain its current momentum for the next year to a year and a half, they predict.

Michael Donoghue, president of Allstate Insurance Co. of Canada

There are still profits to be made in Canada’s insurance industry but we are going to have to work with incredible clarity, vision and hard work to realize them.

In fact, the current market has begged the question of whether radical review of both strategy and execution is necessary in the areas of underwriting and claims. Those who did not ask this question missed an opportunity to explore and affirm their operations. Our business analysis in these areas tells us that, in fact, now is the time to grab hold of traditional principles that underlie success in our industry: measurement, claims file management, risk selection, and above all, relationship management.

Adherence to traditional principles does not mean retrenchment. Strategies must be forward-looking. We continue to firmly believe in a multi-channel strategy, implemented in a manner that is relevant to each of our brands. Our agents have been key to achieving profitability in tough markets. Our Internet and call-center offer support by providing customer choice for different steps of the insurance-buying process. We launched a broker brand just in advance of the market hardening, and have had to step back from our aggressive growth plans in light of market conditions. But, we firmly believe in the “points of difference” that are part of the channel strategy and look forward to maximizing this approach in the future.

Resources under pressure must be clearly pointed in the right direction. We have seen regulatory reform but impacts are only assumed, not realized. Reinsurance and reserving issues have our attention. The industry must work together to mitigate the escalation and abuse evident in personal injury awards, and the resulting impact this is having on our ability to achieve adequate returns. In terms of growing marketshare, the best customer remains the existing customer – for now. A stellar ability to identify our highest value customers may continue to yield as much in competitive advantage and revenues over 2003.

We must craft and deliver just the right combination of services that will retain customers as well as attract new ones. Customer activity must be marketed in ways that overcome the financial fatigue of consumers who believe they have done their part to reduce risk but are not seeing their rewards. And of course, knowledgeable and motivated employees make all of the above possible. As an industry, we need to address the need for new blood in the areas of underwriting and claims adjusting. Some of this may sound obvious, but these are the steps that will succeed in turning modest projections for the next few years into sound profitability.

Igal Mayer, president of CGU Group Canada Ltd.

In commercial lines, our underwriters and brokers have been advised that we are seeking average 20%-25% rate increases. There are two drivers for these increases, the rising trend in casualty losses where even the most innocuous, low hazard business in today’s legal environment has significant exposure. Given that this line has been persistently under priced over the last decade, we have to get rate adequacy. The second driver, although we are encouraged by commercial property results in 2002, much of the improvement was as a result of low frequency levels and remarkably good weather. Going forward we are pricing for a more normalized level of weather and frequency. There will be continued turmoil in the market as companies re-underwrite their books, and for many with weaker balance-sheets and insolvency margins, capacity will be reduced. This will result in more business being in the market, resulting in strained service levels for most insurers.

For personal lines, as usual much hinges on the automobile line, specifically Ontario auto. The most recent actuarial study completed by the Insurance Bureau of Canada (IBC) indicates that rate increases taken through the end of the third quarter of 2002 project a profitability gap for 2003 of approximately 10%. The hope is that product reform will bridge a significant portion of this gap. All stakeholders are working feverishly on the reform package, which will hopefully come into effect late in the first quarter of 2003.

Our underlying problem in the long term is that the automobile product cannot continue to have full access to tort. With social inflation and expectations for awards rising, the product is quickly becoming unaffordable in many jurisdictions. We must work on a solution that limits access to tort to the truly serious and permanent injuries. The no-fault system in O ntario, whilst not yet working well, I believe is the right framework upon which to build and expand into the full tort provinces. We must win the support of both consumers and politicians before we can move forward with this.

Janice Tomlinson, president of Chubb Insurance Co. Canada

One can find many different viewpoints among industry participants and observers as to what key factors trigger shifts in the property and casualty insurance market cycle, with industry ROE, capitalization, cash flow, catastrophic activity and the investment environment being those most commonly cited.

Proponents of any of these can find support for their position in this most recent transition to a hard market, as a decade-long soft market deteriorated all key industry statistics, bond and equity markets suffered significant declines, and of course 9/11 changed forever key assumptions about catastrophic losses. As we head into the second full year of hard market conditions it should come as little surprise that the industry is suffering from deteriorating credibility, as after years of “commoditization” of the insurance product, the industry is now scrambling to make up lost ground through dramatic price increases, significant tightening of terms and conditions, cutbacks in capacity, and other similar measures.

Given the current state of the investment environment the industry can no longer target combined ratios in the low triple digits, and hope that investment returns will make up the difference. No matter how you run the math, it is now going to take combined ratios in the low to mid 90%s to generate sufficient returns to meet investor expectations. There are no quick fixes that will get the industry there overnight – clearly this is going to be a multi-year endeavor.

As scores of recent conference agenda topics and media reports have suggested, 2003 will bring to the Canadian p&c insurance industry more than its fair share of challenges. Fraud, terrorism, asbestos, mold, corporate governance, rating downgrades, daunting tort trends, increasing regulatory burdens and terrible market conditions for auto in certain jurisdictions are just some of the issues on the industry’s radar screen.

At Chubb, we will continue to adjust our pricing to ensure we achieve appropriate levels of underwriting profitability. We will also focus on our various niche markets, develop and train our staff to meet the needs of the emerging market environment, and enhance strategic partnering with our broker force. Chubb’s goal is to come out of this hard market with clients that we would write throughout the market cycle and with broker relationships that are stronger than ever.

Ernst Notz, president of The Citadel General Assurance Co.

The Citadel, like most insurers, faces a number of challenges – diminishing investment returns, rising claims costs, reinsurance costs, fraud, increased administrative burdens (e.g. corporate governance, accounting changes, actuarial peer review, etc). There are so many things I want to say here, but due to the limited space available I will stick to addressing what I view as the two most critical issues: private passenger automobile and government controls.

One of the biggest challenges facing us right now is improving our private passenger automobile results. The increased pricing of repairing cars, higher auto theft and insurance fraud, are all contributing factors to both The Citadel’s and the industry’s poor results. But, by far the biggest cost pressure facing us is the rising cost of healthcare. For the past several years the number of auto accidents has actually declined. Yet the number of injury claims has gone up.

While there is little hope for immediate reform on the east coast with several of the provinces facing elections, the good news is that the Ontario government is finally responding to the pressures from the insurance industry for change to the existing Ontario auto legislation. While we wait for legislative changes for Ontario auto, we have taken steps within The Citadel to address the problem of poor performance for auto with a move away from an annual auto policy to a six month policy in Ontario. This will give us an opportunity to expedite the rate increases necessary to improve profitability. With healthcare costs for auto insurance claims continuing to rise in the Ontario market, we are fighting an uphill battle to keep premiums in line with costs.

In Ontario we face a real challenge in trying to seek adequate rates. The current Financial Services Commission of Ontario (FSCO) process is overly bureaucratic, creating a time-consuming and expensive obstacle that hampers our ability to fulfill our needs and respond to market demands. The minutia required for rate filings causes extensive delays in getting rates approved. We eagerly anticipate improvements to the efficiency of rate regulation to reduce the current regulatory bottleneck we face when filing for rate changes.

I believe that the hard market will remain with us for a further 12-18 months. The Citadel will continue to take hold of the opportunities that a hard market affords. We continue to offer a full range of support for our target commercial lines business including capacity to cover clients’ accident and sickness and other associated needs. And, we will continue to pursue profitable personal lines business.

Charles Lawrence, chief agent for CNA Canada Group

It appears that many, if not all of the factors and challenges we faced this year, will continue into 2003. The primary insurance industry’s combined ratio will not produce an underwriting profit despite significant price increases and an industry committed to a return to underwriting profit. Perhaps more importantly, the industry ROE will remain well below double-digit acceptability.

These factors will again result in double-digit pricing for next year, and in certain classes and industry groupings, we can expect price increases of 30% and higher. This under- performance may however be hardest felt in the area of reduced capacity. Capacity will continue to be a critical issue through all components of our industry, insurers, brokers and customers. Our ability as insurers to meet this challenge may set the stage for how we are seen as an industry by our customers in the years ahead.

In one sense, CNA Canada is in a unique position, as it does not have to address the many challenges currently faced by personal lines insurers. However, it would be extremely short sighted to assume the health of the industry could be returned by “fixing” one segment of our business.

Our inability to sustain adequate pricing and manage rising claims costs is not unique to personal insurance. Therefore it is our position to continue to execute a pricing strategy that will not only improve 2002 and 2003 results, but will result in sustainable underwriting profit over the long-term. Our strategy will focus on continuing to create opportunities where products, value-added services and expertise will be key components of the customer’s buying decision, and pricing will be only one element of that.

In addition, we must also recognize the key role reinsurers will play in bringing us back to profitability. Reinsurers have been operating in a similar environment resulting in poor underwriting results and unsatisfactory ROE. Reinsurers will require further price increases in 2003. We have already witnessed a reduction in reinsurance markets and we believe we will see further market concentration in the short term. For 2003, CNA Canada will continue to leverage cross-border and international expertise, maintain adequate pricing and focus on the development of our broker relationships.

Kathy Bardswick, president of The Co-operators Gerneral Insurance Co.

While results generally for non-auto lines have greatly improved, serious concerns about auto insurance continue to preoccupy Canadian insurers and to cripple their bottom-lines.

As they have in 2002, consumers and governments will continue to demand an explanation for rising auto insurance premiums. Insurers must encour age this debate and actively participate in the dialogue. We need to advocate a simpler, more stable product, and lobby for change in auto insurance systems across the country – this includes the need for streamlined regulation. Insurers must be a part of the solution and acknowledge that the onus lies not only with the governments and regulators, but also at our own feet. Governments, insurers and consumers need to understand that as long as the auto product remains as is, the profitability and stability of this line is in question.

As an industry we are being called on to set new objectives for 2003 and beyond. As we are seeing longer and more dramatic cycles, we must now act to flatten these cycles for the sake of our clients and ourselves. Wild fluctuations in the auto insurance market are exceedingly difficult on insurers but even more so on the consumer. Our clients’ trust is fundamental to our system, which is based on a promise: that being to advise and a promise to pay. It is therefore imperative that we create a more positive client environment. We can achieve this by exercising underwriting discipline across the industry, providing consistent, outstanding, client service and by distributing a stable product according to the client’s preference.

The Co-operators is well positioned to offer a full range of insurance and financial services products to our clients through multiple distribution channels. These channels will be strengthened in the years to come as we strive to build long-term, multi-product, multi-touch relationships with our clients. By maintaining a focus on underwriting discipline, profitability and leading-edge customer relationship management, the future looks promising. Our track record is solid across product lines and we are seeing improvements in our core performance. We expect continued growth in home, farm and commercial lines in 2003 and stabilization in the auto portfolio. The well-executed plans of 2002 will reap rewards in 2003 and position us very well for sustained growth and profitability.

George Cooke, president of The Dominion of Canada General Insurance Co.

2002 was one of the most difficult years the Canadian property and casualty insurance industry has experienced. A series of circumstances left many companies reeling to a degree not even the most pessimistic pundit would have predicted in mid 2001.

Several years of obsessing about direct distribution and a “marketshare or bust” mentality left many competitors ill equipped to deal with sharp declines in equity markets and abysmal operating results. Ontario auto has been particularly difficult for those that failed to notice deteriorating trends until late 2001.

Although the Canadian market was not materially impacted by terrorism, the global impact is one more factor generating fundamental changes to our business. Market availability, rather than increased pricing, is the distinguishing characteristic of this hard market, although sizeable price increases have been taken in almost all lines and geographic areas outside Quebec.

The question everyone asks is, “how long will the hard market last?” Many believe that the level of price increases taken will surely mean that sometime next year, companies will once again seek to write more business and thus halt the trend to higher premiums. Some argue that as soon as capital markets improve our market will soften. If we have learned anything during the last year, it should be that the products we sell must be adequately priced. I argue not only that further material increases are needed but that the fundamental changes in both the mindset and balance-sheets of companies has resulted in a shift in dynamics which will extend current market conditions.

Ontario auto reform offers opportunity. Proposed reforms address an existing imbalance, by increasing access to benefits for the most seriously injured victims of automobile accidents. Reform will remedy the existing overcompensation for minor injuries and the inordinate related process costs. Although by no means a panacea, the changes proposed will result in a product that directs compensation more equitably and mitigates cost escalation.

Reinsurance prices are expected to increase in 2003, but likely the more critical issues will be related to terms, specifically coverage restrictions and reinstatements, quality of markets and available capacity. The Dominion will continue to focus on profitability, and supporting the independent broker distribution network. 2003 will bring increased pricing in all lines and areas outside Quebec and further reductions in capacity by specific markets. The Dominion will continue to be a stable and consistent company with the capacity to support our brokers in meeting their customers’ needs.

Claude Dussault, president of ING Insurance Co. of Canada

The performance of the Canadian property and casualty insurance industry should improve in 2003 but will nevertheless remain weak, falling short of the returns expected by shareholders and financial markets.

Revenue growth should continue to be strong in 2003, driven by commercial lines and auto insurance premium increases. However, the spiraling costs of auto insurance claims, notably for accident benefit medical payments as well as bodily injury, will continue to add pressure on the profitability of the industry. Recent price increases will help to improve the industry’s underwriting results but remain insufficient to fill the gap that was created over the last few years in a number of provinces and regions. Investment income will continue to be impacted by the volatility of the stock markets. Controlling the increase in claims costs will remain challenging in 2003 in light of the slow progress made by a number of provincial governments in reforming their respective auto insurance regimes. The recent legislation tabled in Ontario constitutes a step in the right direction, but we remain cautiously optimistic about its impact in 2003.

One of the emerging trends that will impact the industry in the coming year is the under-capitalization of some players. As both the profitability of the industry and the value of its invested capital has been eroded, some insurers will see their ability to write new business significantly reduced. This situation is all the more severe because it affects both Canadian and international insurance companies, which are looking at ways to re-deploy their capital into profitable regions or sectors. In a nutshell, the current changes in the underwriting and pricing practices of insurers will contribute to improve their financial performance. However, the industry will continue to feel the impact of the volatility of the financial markets.

Bill Star, president of Kingsway General Insurance Co.

The insurance industry will be split between those companies that will prosper during 2003 and those who will downsize and attempt to get their house in order. Many companies have worked toward an underwriting profit to offset the decline of investment income while others were slow to increase rates when the hard market started in mid-2000.

The next two to three years will produce some of the largest profits for the industry since the late 1980s. Current opportunities to increase volume at adequate rates are better than they have been in over twenty years. Companies that aggressively increase volume at this time will fare much better than the companies that reduce volume or stagnate. Capital will become plentiful during the latter part of 2003 as profits begin to increase from underwriting profits. This improvement will attract investors who are looking for industries that have unusually high profits.

The changes introduced by Bill-198 in Ontario will lead to improved conditions in the Canadian industry. The long awaited changes will help to reduce fraud and companies will probably take a much stronger stand in negotiating the settlement of third-party claims since no-fault benefits will not be readily available to finance lawsuits. We can expect a few good years before the soft market returns and then it may not be as prolonged at the last one since so much capital has left the market.

Commercial rates in both property and auto will continue to increase since they are the areas most affected by reinsurance costs. The reinsurance industry will recover but far slower than the primary market. 2003 will be another year of consolidation due to some foreign companies either selling their Canadian operations or simply eliminating certain classes of business. Overall, we can expect improved times ahead for those companies that remain.

Nicholas Smith, attorney in fact, Lloyd’s Underwriters

There is good news for the insurance industry as it prepares to enter 2003: compared to the uncertain environment at the end of 2001, there is a new certainty – a certainty that things cannot go on the same way, a certainty that the industry must be guided by the principle of making sustained underwriting profits.

As recent financial results testify, this rather straightforward principle is easily lost. It is unlikely to be forgotten in the environment we foresee for 2003 where a number of factors are combining to form a unique pattern – low investment returns both actual and prospective, spiraling claims costs particularly in liability classes, the impact of historic under-reserving on capital levels, limited new competitive capacity, and burdensome regulatory costs.

Throughout 2002, insurers have focused much more closely on the individual risks they are assuming, ensuring they are covered under the correct conditions and at the appropriate price. This focus has made it difficult to obtain cover in certain jurisdictions and classes. I expect these trends to continue for 2003, and that more lines will experience capacity shortages.

At Lloyd’s, improved profitability will continue to be the goal of underwriters and of Lloyd’s itself as it assumes its new role as franchisor. In Canada, we have seen a move by underwriters from personal lines to commercial classes and a reduction in the number of contracts under which underwriting authority is delegated to brokers. I do not see these trends reversing themselves in 2003. Our total Canadian premium income has continued at record levels, and the total capacity of the Lloyd’s market is predicted to rise again in 2003, meaning that more business can potentially be written here. However, more alluring opportunities elsewhere and high Canadian regulatory costs have recently proven to be obstacles to further growth and will influence underwriters’ judgement next year if they prevail.

I describe the new certainty that underwriting profit must be obtained as good news in the full knowledge that it is not popular news in all quarters. All in the industry face the challenge of ensuring that our policyholders are aware of the reasons why premiums are increasing and terms and availability of coverage are narrowing. But, there must be a stable and secure industry to give policyholders the protection they need, and it has to be one underpinned by solid financial returns.

Larry Simmons, president of Royal & SunAlliance Insurance Co. Canada

The outlook for the general insurance industry in 2003 is mixed. While some companies and lines may perform well, industry recovery will be dependent upon the performance of the auto product.

Proposed regulatory changes may bring much needed assistance in this area, but we cannot expect significant improvement in the near term. Rising claims costs resulting from prior-year losses, eroding legal thresholds, claims frequency and increasing medical costs are likely to continue. Premium growth is starting to outpace claims growth, but claims costs remain high, especially in auto. According to the IBC, claims costs grew at a rate of 13.4% in 2001. For the 12 months ending June 2002, claims growth was 12.9%, indicating that this trend is continuing.In the year ahead, reinsurance costs will vary by line, but in aggregate are estimated to rise by 10%-20%. Reinsurers must address many of the same pressures as primary insurers and face even greater volatility due to the nature of reinsurance marketplace. Consequently, reinsurers will continue to exercise discipline with respect to selection, aggregation and coverages. These cost pressures will continue to hinder improvement, as will subdued outlooks for the investment markets. Volatile equity markets and a relatively low interest rate environment are expected to place continued pressure on the operating result to generate profits. In 2001, the industry ROE was 3% and a similar result is expected in 2002.

In response to these conditions, insurers will continue to manage costs and rate adequacy in an effort to restore profitability, satisfy shareholders and attract capital. Companies will focus resources on segments and products with better prospective returns. That means reducing commitments to under-performing lines and emphasizing those with better potential for delivering satisfactory returns.

With diminished expectations for investment returns and rising claims costs, profitability must come from operational discipline and performance. The breadth and depth of the challenges we face will continue. The industry will focus on restoring business fundamentals: namely disciplined underwriting and claims. Continued attention to these core skills will enable us to restore profitability to our industry and deliver value to our customers, our brokers and our shareholders.

Gregg Hanson, president of Wawanesa Mutual Insurance Co.

There are clearly a number of factors which we see facing the Canadian primary insurance market as we enter 2003. For our company, the underwriting losses in Ontario and southern Alberta are excessive. It took a number of years to get into this negative situation and improvement is not likely to be immediate, although rate increases and changes in Ontario automobile legislation will be welcome as they take hold.

There has been dismal performance of investments, especially in the equity sector. Nervousness of investors brought on by the shadow of dishonesty over corporate financial results, evident in the likes of Enron and WorldCom. This, coupled with the prospect of war in the Middle East, does not bode well for a quick recovery of equity markets in 2003.

Another more complicated factor that will negatively impact investment income is the renewed commitment to conservatism in reporting unrealized losses. Previously, companies took a charge against income only where the value of an investment was considered to be “permanently impaired”. With so many stocks under-performing over extended periods of time, the emphasis is shifting to taking a charge against income for any investment where it is below its cost and the decline considered to be “other than temporary”. This may result in income losses on the statement-of-operations.

Contraction or complete withdrawal by some companies from lines of business or geographical areas creates a void that others must fill while trying to manage the consequential incurred loss ratio of such new business. We believe that now is the time to support those brokers who have had good frontline underwriting, as demonstrated by their loss ratios and have supported our company through previous soft market conditions. As a mutual company, we have maintained a consistent record of keeping our loss reserves adequate and maintaining our prices at a level that can produce profitability. It has taken a few years for losses in some areas to outpace the growth of premium, and we would prefer to take gradual increases to cushion the impact on the consumer while restoring profitability.

At Wawanesa, we see opportunity in a hard market. We are strongly capitalized and have an appetite to grow in a market where prices are rising. We anticipate that our final written premium for 2002 will show an increase of over 20% for the year. And it is very likely that we will see similar growth in 2003.