Tough Times for Main Street

Small business is often said to be the engine of the Canadian economy. With about 90% of companies officially falling into the definition of “small to medium sized enterprises” (SMEs), this is clearly a prime sector for job creation, growth and economic productivity.

But, several small businesses and one powerful lobby group argue that property and casualty insurers are hampering this “economic engine” by raising coverage rates to unaffordable levels, implementing restrictive terms for what was previously “standard” cover, and otherwise exiting entire lines of business. “Insurance has been a huge problem for our members,” observes Catherine Swift, president of the Canadian Federation of Independent Business (CFIB), which represents more than 100,000 SME owners across the country. “We were quite surprised when we did a membership survey in spring, 2003 – at a time when we were hit with SARS and BSE amongst other things – that 70% of our members identified insurance as their top concern.”

According to Statistics Canada, more than 92% of the roughly 977,000 firms in Canada employ fewer than 20 people. The CFIB says that, although there is no formal measure of Gross Domestic Product (GDP) according to firm size, SMEs account for roughly 45% of total economic output in Canada.

The exact definition of “small business” varies from insurer to insurer, but firms are typically defined by number of employees under 20, annual sales under $3-$5 million, and annual premiums of between $5,000 to $20,000. The businesses fall into two broad categories, according to insurance sources. There are the clusters of standard risks or “packaged” business that most people associate with “Main Street” – such as florists and retail stores – which represent about 95% of the market. And then there are the unusual risks, often trades or contractors, which have been increasingly placed in the non-standard market in recent years. “Underwriters are becoming more aware of the inherent exposures that exist in certain trades and businesses,” says Paul Fletcher, senior vice president of marketing, Aviva Canada. “They have either learned the hard way or they have learned through research.”

BUILDING TENSIONS

The CFIB cites several examples of drastic premium increases, especially in the “unusual risk” category, such as construction, manufacturing, software and website development, and any export-oriented business, particularly to the U.S. In one case, a small exporter of machinery saw its insurance premiums go from $13,000 a year to $33,000 a year to cover risk associated with shipping to the U.S. market, according to the CFIB.

“Many of our members don’t understand what has happened with their insurance,” says Swift. “In several cases, these are businesses that have been insured for decades, with a claim-free history. Suddenly, an insurer announces it is not covering that sector anymore or the client gets a call a couple of days before renewal saying the premium will triple.”

“It’s a tough message to sell, but the insurance industry is cyclical,” says Ken Orr, president of the Insurance Brokers Association of Canada (IBAC). “A lot of people still don’t understand that.” In recent correspondence, IBAC and CFIB have not seen eye-to-eye on how insurance-related problems should be tackled. While Orr says IBAC is supportive of CFIB, he notes that the national broker association has not been asked to formally participate or help with specific concerns. Swift says that although CFIB has involved broker associations in their past discussions, “we have found the response from individual companies more positive. We have had some resistance from associations, it seems that they are reluctant to let someone take a closer look into the industry. I don’t understand why.”

The CFIB, with a long history as an effective lobbyist, has stepped up an aggressive campaign for a federal review of the general insurance industry. A letter dispatched by Swift in early February of this year addressed to Denis Paradis, the Minister of State for Financial Institutions, states that it is “clear that insurance is doing major harm to SMEs across Canada . . . SME owners do not really care to know whether it is a federal or provincial problem but they do expect and deserve answers from their MPs on an issue of such national importance.” This letter is just one in a long line of lobbying from the CFIB for increased political scrutiny of insurance pricing and availability. Swift says the organization will likely turn its attention to provincial regulators this spring.

A federal review is urgently required for several reasons, according to Swift. “First, we need better information – there is not good data on p&c insurance in this country,” she comments. “The second is to look at regulatory changes, such as why Canada has higher capital requirements and a higher tax burden on insurers than other countries. And we also have to look at how provincial auto insurance can be improved, whether that is limiting benefits or reforming tort. We know that when results are poor in auto insurance, they spill into commercial insurance.”

“G-MEN” THREAT

Insurance representatives concede that the market has been “challenging,” but argue that a federal review will not solve any problems. “We don’t believe a federal review of p&c insurance is necessary,” says Jane Voll, chief economist for the Insurance Bureau of Canada (IBC). “Insurance is provincially legislated and the provinces have the levers to control costs. We don’t need any more regulation in this industry.”

Orr concurs that a federal review of the industry does not make sense. “The federal regulator is responsible for solvency and there is no way we want to see a relaxation in capital requirements,” he notes. “While it is difficult for us to discuss premium increases with clients, it would be a lot harder to explain that a claim couldn’t be paid because the insurer was no longer in business. We want financially strong, solvent companies in Canada.”

The IBC’s “Market Availability Task Force” met with representatives from the CFIB several times last year, including a sit-down in early December which involved several insurance company CEOs. “One of the early things we said is that we have to know about specific industries to develop insurance solutions,” Voll points out. “Clearly, the underwriting approach to a roofing contractor would be different than a small retail operation, as would the risk management and loss prevention strategy. We have tried to meet with as many industry associations as possible to figure out their special risks and create a constructive dialogue between underwriters and commercial clients.”

The IBC is also pursuing a regional approach. In Alberta, the bureau has asked the provincial CFIB chapter for a meeting with three or four of the sectors most affected by market conditions, according to Louise Bremness, regional manager, IBC’s prairie office. She expects to hear back by the end of March.

Voll also argues that there is no shortage of data on insurance companies licensed in Canada. “The idea that the industry is not transparent or held to account stems from a lack of information,” she says. “All insurance companies are required to post financial statements on the Office of the Superintendent of Financial Institution’s (OSFI) website, which contain information about loss ratios in specific lines of business.”

INSURERS’ PERSPECTIVE

Mike Jakeman, vice president of commercial insurance for Royal & SunAlliance Insurance Co. of Canada, says the kind of numbers small business sectors want are often not available on an industry-wide basis. “I think the data issue is about the level of detail,” he says. “CFIB and its members are not looking for overall numbers but, for example, the claims experience of roofers in Edmonton with under $2 million in sales. Unfortunately, that granularity of data does not exist, either at the company or industry level.”

Jakeman says as an industry “there could be better information we can provide – it is something I think we can work on.” Oth ers say insurance rates for small business are simply readjusting after a long period of soft pricing. “I think the CFIB has a short memory in that their members benefited from subsidized prices for a long period of time, when insurers were doing well on their investments and losing money on the underwriting side,” says Robin Durrant, president of Kelowna, British Columbia-based Capri Insurance, a brokerage that writes a substantial amount of SME business. “In fact, if you look at standard small businesses, the rate increases have been quite modest, they have likely been spared the most during this hard market.”

Some brokers say clients can make a tough market even harder. “While most clients are serious about coverage and loss prevention, there are insureds who create a lot of difficulty for themselves,” says John Fountain, vice president of Markham, Ontario-based CG&B Group. “Some are not set up properly and do not understand or appreciate how insurance works. Some think it is a rip-off, they basically make themselves uninsurable.”

Another message that small business clients need to understand is the reality of rising claims costs, according to Fletcher. “We have to look at the increasingly litigious nature of our society and the effect of that on claims trends,” he adds. “I think we need to do a better job of educating consumers as to why this has happened.”

Jakeman echoes these concerns. “The fact is that claims costs are increasing, especially on the liability side…Insurers are on the front lines of this litigation trend and it is affecting the cost of the product. Small businesses will have to build the cost of insurance into their business plans and operations.”

TAKING ACTION

Several insurance sources say that, despite claims concerns, the market for small business is improving. This is evidenced by an increased number of markets underwriting small business clients. About one year ago, Royal & SunAlliance launched its “Small Business Solutions” department. It is a specialized underwriting facility focused on four key client segments – retail, contracting, realty and business and personal services.

Jakeman says “we realize that not all small business is homogeneous, there are obviously risks and exposures that differ sharply from one sector to the next. The challenge is that all this business has to be touched by an underwriter, but we have to do that in a relatively low cost environment given the range of premiums for small business.”

Aviva Canada is launching a small business solution called “Fastrax” in April. The packaged policy divides SMEs into seven core “clusters,” Fletcher says. “We should understand that Canada is a small business market, and it makes sense for insurers to invest in understanding the risks.”

For brokers, the renewal of interest in the small business market is an encouraging sign.

“I think the market is a lot better than it was a year ago,” Orr says. “This doesn’t necessarily mean prices have come down, but we have seen a substantial improvement in terms and availability [of coverage]. That is often the first sign that things are starting to turn.”

“Definitely, the market for small business has opened up recently,” says Fountain. “Many of the standard markets are, however, chasing the same classes of business.” In this respect, there are still some problematic areas where standard insurance markets have either cut capacity or completely exited the business. “One of the biggest challenges is getting liability coverage for the U.S.,” observes Fountain. “This is mainly because of things like worker’s comp [compensation] exposure and defense costs for any kind of litigation. For clients with exposures or significant business in the U.S., we go to the non-standard markets.”

This state of affairs is part of the new insurance landscape, according to Durrant. “If you look at comparisons with U.S. firms, Canadian companies were getting quite a break on insurance pricing in the past for export-related business,” he says. “Now the cost of doing business in the U.S. is starting to come close to competitive levels. Small businesses will have to adjust the price of their product according to this new insurance reality.”

There are other areas of concern as well. “One is what I call the pseudo-professional capacity, such as a property manager,” comments Durrant. “More insurers are insisting on E&O [errors and omissions] coverage before they write the CGL [commercial general liability] policy. It can make a difficult issue for brokers and clients.”

Swift says it is precisely the role of insurance to find coverage for these types of risks in our modern economy. “If our society is saying that we deem these services necessary, surely we have to come up with an appropriate way to cover them,” she notes.

The insurance market is covering those risks, but the point is that how it covers them has changed. The markets that existed in the past may no longer be there for certain risk profiles. That makes it incumbent for clients to find the right broker, get to the renewal process early and look at an even broader range of placement options. “Several people in the insurance industry have told us that the worst is likely over, but we want to make sure that this doesn’t happen every five years,” says Swift. “I understand that the industry is cyclical, but let’s get this thing straightened out so there isn’t the same kind of disruption to our small businesses [again].”

SMOOTH SAILING

“There is no question that there have been disruptions in coverage and availability over the past two years,” says Voll. “And we need to focus on how we can do better next time. For example, consumers need to be informed about what is happening in the marketplace and why their broker may not be able to place the same kind of coverage. As an industry, this is exactly the kind of dialogue we need to carry into different kinds of market conditions.”

So, while the “engine” of the Canadian economy is not exactly running smoothly when it comes to insurance coverage, there is a growing sense that the major “knocks” and “pings” are slowly working their way out. However, whether the market will continue to respond without the need for regulatory review or intervention remains to be seen.