Reinsurance Beyond Borders

Seemingly innocuous changes to the Insurance Companies Act in Bill C-37 may cause parent reinsurance companies operating outside Canada to question whether they will need to have a Canadian base in which to operate, according to Omega Insurance Holdings president and CEO Philip Cook.

Cook was the keynote speaker at the ‘Industry Trends Breakfast,’ held at the National Club in Toronto, sponsored by the Insurance Institute of Canada. Cook annually makes predictions about key industry developments and reviews his predictions from the previous year.

Among his predictions this year, Cook noted that the federal government’s draft Bill C-37, which is expected to go forward in April 2007, may have a long-term impact on reinsurance companies that have parent companies outside of Canada.

“Up until now, if you had a branch in Canada, and you were a parent company [located outside of Canada], and you wrote a Canadian piece of business, defined as a Canadian risk, it had to be put in the Canadian books of the branch,” Cook said. “What Bill C-37 is doing is redefining what is meant by ‘in-Canada risk.’

“Up until now, it’s meant the location of the risk, the location of the policyholder. Under the new definition, it’s going to be…where the business is placed and the expectation of the placing party.”

One of the upshots of the change is that, up until now, it’s been illegal for foreign insurers who are unlicensed in Canada to offer insurance products in Canada without a license, Cook noted. But the changes contained in Bill C-37 will allow foreign insurers to write business in Canada without a license.

“In so doing, [the Office of the Superintendent of Financial Institutions] has created a new situation whereby reinsurers don’t necessarily have to be licensed in Canada to write premium business,” said Cook.

“I personally think it’s going to have much more impact on our industry over the next couple of years because a lot of parent branches will start to rationalize whether they really need to have licensed branches in Canada or whether they [can write business] from their home jurisdiction.”

As far as compliance issues go in 2006, the draft Bill C-37 represented one cloud in otherwise relatively blue skies. Cook noted regulators in Canada, post-Spitzer, were showing signs of a “slight relaxation taking place.”

Cook noted the Bank Act review was a success for brokers, even though the banks had opted for a relatively “soft sell” this time around. [Instead of asking to retail insurance products from their branches, the Canadian Bankers Association asked instead for new powers to distribute information about insurance products to their branch customers, which is currently not allowed.]

But Canada’s insurance industry must be aware of the political environment that contributed to the victory. He said the very same dynamics that caused the banks to be unsuccessful this time around during the Bank Act review could very well work against the insurance industry during the next Bank Act review.

“The banks were making huge amounts of profits, inordinate amount of profits, actually,” Cook observed. “At the same time, we were coming off a very bad period in the insurance industry, in which we were posting record losses as a result of the storms. For me, it’s not a huge political step to say: ‘Let’s not try and put the two [banks and insurance] together.'”

But consider a situation in which the financial pendulum has swung the other way, Cook added. “Insurers are making a huge amount of money and the banks were losing a huge amount of money – what will be the political imperative to keep the banks out of insurance then?”

For this reason, Cook said, “brokers still have to support their value proposition. You can’t relax if you’re in the broker business.”

Nor can the insurance industry afford to relax when it comes to natural catastrophes, Cook warned. The mild season of 2006 is already over, Cook observed, noting the serious storm losses of Kyrill in Europe in January. Wind damages in the area have caused an estimated US5-10$ billion in damage losses early into the 2007 storm season.

In Vancouver, winter storms in 2006-07 have already caused estimated insured losses of more than Cdn$130 million, according to the Insurance Bureau of Canada. That’s approaching the Cdn$200 million in damages the brush fires in B.C. caused in 2003 – at the time, a record-setting number of claims in that province.

Kyrill was “a very, very substantial storm and it happened in January,” Cook observed. “The insurers – and the reinsurers, certainly – operating in that jurisdiction are seeing the beginnings already…[of] a deteriorating year because of that single footprint. We will see an increase and perhaps a return to levels we saw two years previous [n 2004-05].”

Cook said the 2006 storm season, despite the absence of hurricanes making U.S. landfall, nevertheless was as busy as forecasters had predicted. TSR, for example, predicted 14 named storms in 2006.

“In fact, on the number of storms, they were right on,” Cook observed. “They had predicted around 16-18 tropical storms and there were that many in 2006. Where they fell short on their prognostications was the number of storms becoming hurricanes and that actually made landfall.” [TSR, for example, predicted nine would make landfall, when in fact none of the 2006 hurricanes made U.S. landfall.]

Cook said forecasters knew why their forecasts were off-base, including the unexpected effect of El Nino on the water temperatures of the Atlantic. Also, Cook noted, some forecasters credited African dry air from Sahara storms influencing the cloud formations over the Atlantic. With these conditions accounted for, forecasters are once again expecting the weather to pack a wallop in 2007.

“We’ll have a worse hurricane season this year than in 2006,” Cook predicted, adding that insurers must start pricing their rates accordingly. “There’s no point in getting to that point in the latter part of the year, saying ‘Oops,’ we shouldn’t have done that. Everyone knows a bad season is coming.'”

And yet, Cook noted, rates – in particular commercial rates – are falling and there is no reason to expect differently in 2007, Cook contended. He observed that the mild storm year in 2006 had allowed insurers to significantly increase their capital base last year. Cook said the expectation for 2006 financial results would be very high, with some expecting a return on investment of the high teens or higher.

“There are three major new reinsurers launched in 2006,” Cook said. “They brought over $500 million in new capital. They haven’t come in to make a 5-10% return. They’re looking to make a mid-20s rate of return.”

And since the three new reinsurers only set up shop in Bermuda in 2006 – i.e. long after the 2005 hurricanes caused their damage – they will not have any damage losses from 2004-05 storms on their books, Cook added “Fortunately, in their first year it will be astronomical 80% rates of return.”