Slow Turn

An aircraft carrier is regarded as one of the most powerful assets in a military’s arsenal. However, it is also one of the most vulnerable battle craft due to its sheer size. Needless to say, agility is not one of the strong points of an aircraft carrier, which requires kilometers to complete a turn. In this respect, there is perhaps a similarity with the property and casualty insurance industry: risk coverage enables global commercial and social development, yet the industry itself remains vulnerable to external financial vagaries as well as the negative impact of internal competition. Once set on a financial course, the p&c insurance industry is also subject to a slow turn.

The latest industry financial returns from both the Canadian and U.S. markets, which cover the first nine months of 2002, suggest that North American insurers have just begun that slow turn. Underwriting losses on both sides of the border declined markedly during the first three quarters of last year, yet investor returns remain dismal with the Canadian industry producing a measly 2.9% ROE for the nine months and U.S. insurers with 4.4%. With the 2002 final quarter numbers being tallied, many insurer CEOs are no doubt feeling a little queasy in anticipation of yearend reserving adjustments (which typically take place in the final quarter).

Until recent years, Canadian insurers benefited from positive reserve developments and only last year saw some insurers in the U.S. disclosing significant reserve allocations in response to prior-year adverse developments. Many Canadian insurers have also had to strengthen their reserves over the past year to accommodate the worsening claims environment, observes Paul Kovacs, chief economist at the Insurance Bureau of Canada (IBC). Reserving adjustments could have a major impact on the 2002 final quarter and the financial year as a whole, he adds. Notably, insurers writing about 70% of premiums in Canada fell below the “financially strong” score determined by 2002 industry minimum asset test (MAT) ratings (see Editorial of the December 2002 issue of CU for further details on industry financial strength).

The bleak financial picture facing most insurers means that price firming will have to continue through 2003, Kovacs notes. This view is supported by Robert Hartwig, chief economist at the U.S.-based Insurance Information Institute (III) who describes the financial environment of 2002 as the “perfect storm” in terms of the various destructive elements from the investment side to underwriting that conspired to work against insurers. “The results [first nine months of 2002] also seem to suggest that the hard market cannot end in 2003, at least if the industry expects to make reasonable rates of return by 2004.”

The latest financial returns reveal two critical factors: investment performance and the combined/loss ratio. Investment income plummeted for both Canadian and U.S. insurers in 2002, with realized gains slowing down to a trickle compared with past years. Notably, Canadian insurers saw realized gains drop by 60% year-on-year for the first nine months of 2002 (see MarketWatch of this issue for further details).

While the outlook on the investment side of the business is hardly healthy, there is a little light beginning to shine through on underwriting. Kovacs notes that the Canadian underwriting loss fell by $3 billion during 2002, which saw the combined ratio ease back by two percentage points to 105.4%. Of particular note is the fact that the industry loss ratio in Atlantic Canada fell back to 92.2% – the first time the ratio has been below 100% for the last seven quarters, Kovacs points out. U.S. insurers made even greater gains, with the combined ratio falling to 104.9% by the end of September 2002 compared with the 114.4% shown a year before. Premium growth of 13.6% for the first nine months of 2002 is the highest increase in 16 years, Hartwig observes.

It would seem that a quick return to healthy profitability on the back of an investment market recovery is unlikely to happen. Insurers will have to continue to make the turn based on disciplined underwriting. While the results of such a strategy are slow to surface in the bottom-line numbers, and in Hartwig’s words, “disappointing to [insurer] management and investors alike”, the latest industry returns do reflect an underlying financial improvement that should hopefully see the industry complete its turn during 2003.