Keeping a Steady Hand on the Tiller

The property and casualty (P&C) insurance industry financial results for 2011 show modest improvement in underwriting and profitability in an environment that continues to be very challenging.

The bright spot is lower auto claims costs in Ontario due to the recent SABS reforms. But these gains were offset by a steep increase in property claims costs and lower investment yields. As a result, the industry’s return on equity (ROE) rose slightly in 2011 to 8.0%, a modest improvement over 2010’s ROE of 7.5%. (2011 ROE has been adjusted to reflect merger and acquisition activity during the year.)

Here is a detailed analysis of 2011 results preceded by an overview of larger trends — in the economy, the environment and regulation — that are shaping the near future for the P&C insurance industry.

TREND OVERVIEW

On the economy

The slowdown in GDP growth that began a few years ago is not abating and continues play a role in dampening demand for insurance products. As noted in the December 2011 Swiss Re Global Insurance Outlook report: “Macroeconomic growth in Europe and North America is expected to slow or possibly even turn negative in 2012. Therefore, the non-life insurance industry in these regions will probably face weak demand next year.”

Other factors in the global economy, especially continuing low interest rates and volatile financial markets, have hurt investment income again. We expect this to continue for the next while. The U.S. Federal Reserve plans to keep interest rates low for the next two years and Canada’s rate changes are also expected to be moderate. Moreover, as long as equities markets remain volatile and comparatively lower than their post-recession peak in early 2011, there will be ongoing pressure on industry investment returns.

In the chart Low Investment Environment & UW Pressure (Please see Figure 1 on Page 46), we see how, even with significantly lower average combined ratios since the 1975-2007 period, the recent weaker investment environment since 2008 has driven down ROE. This is why a combined ratio of 95% is sometimes referred to as the new 100%.

On the environment

The last few years have been the worst ever for catastrophic events around the world and in Canada. Recently, IBC commissioned a report by one of the world’s leading climatologists, which documents that Canada has been warming at an average of .24 degrees Celsius per decade over the past six decades. Because Canada is a northern country, it is warming twice as fast as the global average. Higher temperatures mean increased frequency and intensity of precipitation and other forms of extreme weather. For insurers, that means more property claims, including more expensive property claims.

The chart CAT & Property Losses, 2006-11 (Please see Figure 2 on Page 46) shows total claims for property insurance lines for the last six years. Clearly, CAT losses are a major force driving rising property claims costs.

As temperatures continue to rise, this trend is expected to continue.

On regulation

PricewaterhouseCoopers’ annual survey of top risks facing the insurance industry placed regulation as the Number 1 risk in 2011. Although it is difficult to cost the effect of regulation on industry performance, we do have estimates of the impacts of some of the changes. As just one example, the increased cost from changes to the Minimum Capital Test in 2012 and 2013 is likely to be in the hundreds of millions of dollars.

Yet despite regulators’ concerns, the industry is strong and growing stronger as shown by our capital strength. The industry-wide MCT ratio rose again last year to 237%. It is worth emphasizing that the Canadian P&C industry played no part in the economic turmoil of 2008–09 and its ability to meet obligations to policyholders has never been questioned.

2011 DETAILED ANALYSIS

On the underwriting side

Direct premiums written increased, but at a slower pace than in 2010 — 4.4% compared to 5.5% — which is not surprising given the economic environment.

Claims increased by 3.6%, which is less than the premium increase noted above. We can attribute this to the significant decline in auto claims following the reforms introduced in late 2010. On the other hand, property claims costs took a big jump, by 19.3% in personal property and 32.6% in commercial property, driven by severe weather and natural catastrophic events.

Overall, the industry reported positive underwriting income of $587 million compared to a loss of $89 million in 2010. About 46% of companies reported an increase in underwriting income year over year.

At year end, the combined ratio stood at 98.6%, which is slightly improved from the previous year. The loss ratio for Ontario auto showed the largest overall improvement, dropping to 81% from 99.5% a year ago. However, for the major lines other than auto, underwriting performance was worse in 2011 than in 2010.

As discussed above, investment yields dropped. But combined with the improved underwriting results, the 2011 ROE was 8.0% compared to 7.5% in 2010. (Again, 2011 ROE has been adjusted to reflect merger and acquisition activity during the year.)

The industry-wide numbers mask wide diversity in individual company performance. Measured by the ROE, about 49% of companies had better results last year, while 51% had weaker results.

The chart Consolidated Results (Please see Figure 3) compares 2011 to 2010 results.

On the horizon

The Canadian P&C industry remains highly competitive with more than 220 companies offering insurance products to Canadians.

Although consolidation in the industry now appears to be gaining momentum, the market share of the Top 10 insurers is about 64%. This compares with the life insurance sector, where three companies occupy 65% of the market, and banking, where the Top 5 banks represent 85% of the market share.

A perennial issue for the industry is Ontario auto, which remains a challenge despite some recent improvements. Between 1995 and 2010, the average loss ratio for Ontario auto was 82%. The market has been as hard on consumers as it has on insurers. In the five years beginning 2007, average premiums rose nearly 21% to $1,582, which is more than 47% higher than in the province with the next highest premiums.

Further in the future

While ROE remains below levels of the past, there are reasons for optimism. The last three years have seen slow but steady improvements in underwriting performance, ROE and capital.

Looking two to three years out, most forecasters expect economic growth in North America to improve. Eventually interest rates will rise. The skills that firms have developed over the past few years in managing in a low-interest rate environment and improving underwriting should stand them in good stead in the years ahead.