Soft Landing

Looking ahead to 2014, it is expected that Canadians will see unprecedented continuation of the soft market cycle, with the exception being catastrophe-exposed property. After 10 years of providing improving terms to policyholders, some insurers are now finding it difficult to continue to better their offerings.

The prolonged soft market environment has led insurance professionals to speculate as to whether the traditional views of the underwriting cycle can continue or if a new model will emerge. Aon Risk Solutions recommends that organizations test the strength of their existing programs, benchmarking against their peers and ensure they proactively develop risk management practices to lower their total cost of risk.

Policyholders can expect that things will not change drastically in 2014. Still, a prudent approach to risk transfer is recommended, since the market can change almost overnight.

FACTORS IMPACTING THE MARKET

Financial and economic drivers

Continuing to drive competition for policyholder business, the insurance industry remains well capitalized with a Q3 2013 Minimum Capital Test ratio of 275.23%, well above the required 150% threshold, and strengthened since the end of 2012 when the ratio stood at 243.44%.

In November 2013, the Bank of Canada announced it plans to maintain current interest rate levels for the foreseeable future. Given that insurers generate significant revenue from investing the premiums written until they are required to pay claims, the prevailing low interest rate environment will have a depressive effect on insurer profitability.

Aon Benfield’s 2013 Insurance Risk Study highlights that for the past 10 accident years, the Canadian property and casualty market has achieved a 98% combined ratio with insurers between the 25th and 75th percentile reporting a combined ratio of 92% to 103%. With investment returns strained by low interest rates, insurers must look to improve their financial results by increasing their underwriting profit, either by writing more policyholder risks, or by tightening underwriting guidelines (thereby reducing claims losses) or both.

Where insurers need to generate revenue from underwriting results, this will manifest itself in a more stringent underwriting philosophy, possibly requiring more detailed information – ensuring that the premiums quoted are adequate based on the risks to be insured.

CATASTROPHE EVENTS

2013 saw some of the largest natural catastrophe events in Canadian history with the June flooding of the Bow River in Calgary, which was shortly followed by the Toronto rains. While losses from these events were severe, it is important for Canadians to know that primary insurers and reinsurers have been able to absorb these losses, leaving available capacity relatively unchanged and the Canadian insurance marketplace comparatively unaltered.

Policyholders are also encouraged to look at the bigger picture when it comes to catastrophe losses. Globally, catastrophic events during 2013 were below the 10-year average on both an economic and insured loss basis. Economic losses for this period were US$192 billion, which is four percent below the 10-year average and is comprised of insured losses totalling US$45 billion – 22% below the average.

As was experienced in Canada, flood was the costliest event type, with 35% of the 296 separate events resultant from flooding.

While these events are likely to shift underwriting discipline around the flood peril, policyholders should be reassured that their overall impact will not be significant enough to alter the marketplace. The insurance market would need to see a prolonged trend of large non-catastrophe losses and a decline in the availability of surplus capital to shift to a hard market environment.

However, it is also important to note that catastrophic events have trended upwards over the last half a century, with 2013 becoming the sixth costliest year, globally, since 2000 and the seventh costliest since 1950. That means more damage from severe weather has been experienced in the last 15 years than in the last 60.

LEGAL AND REGULATORY NEWS

Highlighting the evolving focus towards not just transferring risk, but managing it in order to reduce expenses and disruptions in operations, the Office of the Superintendent of Financial Institutions introduced the Own Risk and Solvency Assessment (ORSA) for insurers operating in Canada. Following from the Solvency II Directive in the European Union, the framework will provide a more effective means for insurers and regulators to assess insurance risk and the capital requirements from a proactive, rather than retroactive, basis – supporting good governance and promoting risk awareness. Essentially, ORSA is an element of an overall enterprise risk management framework that will help formalize existing processes and will become a global standard practice that changes and evolves over time.

COVERAGE TRENDS

Up until now, most insurers in Canada were including flood coverage in their commercial property policies without a surcharge or modified terms for policyholders with a greater risk of flood loss. Most insurers did not realize or understand the level of flood risk a given policyholder presented, nor the flood risk they were insuring on an aggregated basis. Even now, flood maps are only available to most insurers through local conservation areas. As of the end of 2013, there continues to be no recognized flood risk model available to insurers.

With regards to the property line, and given the events of 2013, insurers are looking to restrict capacity or increase the deductible for flood coverage if the property to be insured is in a known flood zone.

Similarly, the earthquake peril has experienced this trend, though policyholders with a positive risk profile can expect stability in the marketplace.

One trend that is working in favour of policyholders is that Canada continues to attract global insurers to invest to achieve premium and profitability growth. Providing that all legal requirements are met, there are no restrictions on foreign investment by insurers in Canada.

As a result, there have been many entrants to the Canadian insurance marketplace in recent years, with several starting operations – including HDI-Gerling Industrie Versicherung AG, Starr Indemnity & Liability Company and Allied World Assurance Company Limited. It is new entrants like these that are driving competition amongst the established firms, which are trying to maintain or grow their market share.

With these new markets entering the fold, capacity remains high within the liability marketplace, driving competition amongst insurers willing to negotiate on price or coverage. Given the competitive nature of the market, it is suggested that organizations take advantage of relatively low pricing and increase program limits. This can be as simple as asking your broker to benchmark program limits against a peer set to determine adequate liability limits for your operations.

PROACTIVE MEASURES

Aon Risk Solutions advises clients to be proactive in their approach to risk, so they will be in a stronger position to negotiate broader terms and more competitive pricing than their peers. Consideration should be given to the following:

•Insurance to value

Determine that the business is insured for replacement cost as most property policies are written on this basis, which is the cost to replace an asset with material of like kind and quality in the event of a loss. In the event of a partial loss, if not insured to full value, a business may share in the loss via the co-insurance clause in the policy.

•Enterprise risk management

Partner with a broker to develop an overall risk management program for the business, one that considers all risk management techniques.

Looking ahead, insurers are expected to demonstrate und erwriting discipline. Accordingly, it is important to prepare and provide more robust information to meet their underwriting requirements, allowing the insurer to provide the best terms possible.

While improved pricing and coverage terms may be available for policyholders who can demonstrate their risk is best-in-class, pricing and terms are expected to remain stable for policyholders with low losses.

As insurers become more selective in deploying their capital, especially in catastrophe-exposure areas, underwriters will focus on policyholders who strive to adhere to a risk management process.