Wild Ride

For the Canadian property and casualty insurance industry, the year 2008 represented a number of dubious achievements.

It was the first time, for example, the industry saw its combined ratio increase by more than 7% over the course of a single year, which it did between 2007 and 2008.

It was the first time the industry reported an overall underwriting loss since 2002 (a Cdn$290- million loss, to be exact).

It was the first time since 2001-02 that industry capital fell. (This has happened only three times since 1975, when such capital statistics were recorded.)

To keep this last point in perspective, though, industry capital in 2007 was at its highest level since capital amounts were first tracked in 1975; at more than Cdn$30 billion, it remains at the second-highest level in 33 years.

The Insurance Bureau of Canada (IBC) observed all of these sobering trends upon opening the 2009 edition of the Swiss Re Breakfast, held on Apr. 2 this year at the National Club in Toronto.

“Looking at summary ratios, it’s clear that the big story in 2008 is the story of claims costs running ahead of premium levels,” said Barbara Sulzenko-Laurie, IBC’s vice president of policy.

The summary ratios compiled by the IBC pretty much summed up the general financial trend for the industry after the U. S. market shakedown in September of 2008. In most of the meaningful financial categories, 2008 represented a tough year.

Even though Canada was not affected as significantly by the U. S. market crisis last year as its American counterparts, the combined ratio of Canada’s property and casualty industry nevertheless increased from 93.8% in 2007 to 101.3% in 2008. Over the same period, the loss ratio went from 64.1% to 71.1%. The industry’s overall return on equity (ROE) plunged from 15.3% to 6.1%, although there was a wide range of varia- tion between individual companies in this regard. And minimal capital test (MCT) scores declined from 234.1% in 2007 to 219.4% in 2008.

IBC noted the severity of the bad news was somewhat blunted by the fact that primary insurers released Cdn$1.42 billion in reserves in 2008.Adjusting for the release of reserves, Canadian primary property and casualty insurers suffered an underwriting loss of Cdn$1.71 billion, the worst such loss since 1995.

CONTRIBUTING FACTORS

IBC linked the 2008 results to four primary factors: the constitutional challenges in Alberta and the Maritime provinces, the lack of government action on Ontario auto in 2008, climate change and the credit crisis and recession. Among the four factors listed, the state of the auto product in Canada dominated the discussion.

[Within days of the Swiss Re breakfast, Ontario’s insurance regulator, the Financial Services Commission of Ontario (FSCO), released a long-awaited report on its mandatory five-year review of the province’s auto insurance product. For industry comment on the review, please see the cover story on page 24.)

Turning to the constitutional status of caps on claims for minor auto injuries, IBC noted the direct impact of the court decisions in Alberta and Nova Scotia on primary insurers’ auto liability loss ratios.

In Alberta, where the province’s Cdn$4,000 cap on minor auto injuries was declared to be unconstitutional and eliminated, insurers’ auto liability loss ratios were 25% higher in 2008 than they were in 2007 (jumping from just over 50% to just over 75%).

In Nova Scotia, where the province’s Cdn$2,500 cap on claims payments for minor auto injuries was found to be constitutional (and since appealed), primary insurers in the province saw their loss ratios jump by 20 points.

Similar constitutional challenges to caps in P. E. I. and New Brunswick are expected to be heard sometime in 2010; pending any decisions in these jurisdictions, IBC said, auto liability loss ratios in these two provinces are up, although not nearly to the degree as seen in P. E. I. (up six points) and New Brunswick (up two points).

IBC also calculated the capital at risk from the constitutional challenges in both Alberta and Nova Scotia. At the time of the decision in Alberta, IBC estimated Cdn$425 million in unrecoverable costs from open claims would be at risk. Going forward, the IBC added, Alberta would see an additional Cdn$330 million of capital at risk each year until the Supreme Court of Canada resolves the issue in the future. In Nova Scotia, Cdn$125 million of capital is at risk each year, assuming no appropriate premium adjustments are made in the interim. Estimates of capital at risk based on future cases in New Brunswick and P. E. I. were not available.

In Ontario, the auto accident benefit loss ratio stood at 124.2%, more than double that of anywhere else in the country. Ontario auto insurers anticipated a Cdn$390-million loss in auto insurance in 2008. Such a loss is particularly alarming, Sulzenko-Laurie noted, because net earned premiums for Ontario’s auto insurance represent 27.2% of the Canadian P&C insurers’ net earned premiums for the entire country, across all lines.

In terms of other challenges for 2009, IBC noted both climate change-related weather disasters — including a series of rainstorms that drove up the frequency of property claims in Canada, in the absence of any single major storm — ranked high on the list. The ongoing credit crisis and recession also figured as a major event, with the global insurance industry collectively writing down more than US$200 billion as a result.

THE RISK OF INFLATION

Brian Gray, chief underwriting officer at Swiss Re, said one upshot of the recession, low interest rates, might present another challenge for insurers to watch for in the future. Not to say that low interest rates are a problem during recessionary times, but interest rates are currently depressed to such an extent that they might pose a problem for insurers when they start to increase in the future.

“For years insurers have benefited from the fact that year after year, as casualty claims unwind, inflation tends to be a little bit less than when the claim started,” Gray said. “That’s not likely over the next decade.”

Nearly all of the values that are used as a basis to determine property damage are the function of values that increase with inflation — including wage and the cost of repairs or replacements for property damage.

For the time being, interest rates do not present an immediate problem, Gray said. “But the challenge is that next year the business we’re writing now gets settled in the claims process about five or six years from now, and it would be settled according to whatever the value of the claim is then.”

The challenge lies in the fact that insurers underwriting the policies now don’t know what claims inflation will look like in the future or what tort environment will exist, as governments get more lenient in terms of settlements given the economic situation.

To protect themselves, insurers can invest in assets that are defensive against inflation, Gray suggested. They can also defend themselves through price, he added.”

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Ontario auto insurers anticipated a Cdn$390-million loss in auto insurance in 2008. Such a loss is particularly alarming because net earned premiums for Ontario’s auto insurance represent 27.2% of the Canadian P&C insurers’ net earned premiums for the entire country, across all lines.