“If all the economists were laid end to end, they'd never reach a conclusion.”
—George Bernard Shaw
Let me contradict the great writer and offer some conclusions for the first half of 2012. Back in March at the annual Swiss Re breakfast, I suggested slower economic growth would likely mean slower premium growth. That happened. How much slower? Growth in direct written premiums slowed from 5.6% in the first six months of 2011, to 3.6% in the first half of this year.
Six months ago I also projected the prolonged period of record low interest rates and volatile financial markets would continue. That also proved to be the case: at the end of June 2012, average yields on 3- to 5-year Government of Canada bonds were 92 basis points lower and the TSX index was 1.8% down compared to the same period in 2011.
As one would expect, this has had a direct impact on the property and casualty industry’s return on investment, lowering it by almost half a percentage point to 3.5% — from 3.9% in the first half of last year.
The natural environment is the second trend that we at the Insurance Bureau of Canada (IBC) considered. Noted was the relationship between higher temperatures and the increased intensity, frequency and duration of precipitation; in other words more severe weather.
Global data shows the number of catastrophic weather events has been rising over the last 25 years, meaning more rainstorms, floods, droughts, wildfires and heat waves. These trends are also present in Canada — temperatures are rising and events that used to happen once every 40 years are now happening once every six years in some parts of the country, Environment Canada reports.
But for the first half of 2012, the industry experienced some benefits from climate change, with a very mild winter, record temperatures in the summer, and fewer costly weather events. In other words, we had abnormal weather — with record hot weather in Canada and the United States — as predicted, but without the adverse impact on claim costs that we had in the first six months of 2011.
The third major trend affecting the insurance industry is increased attention from regulators. IBC acknowledges the importance of prudent regulation to the success and stability of the property and casualty industry — in providing assurance to consumers, and in ensuring a level playing field.
However, we continue to be concerned about the impact of regulatory changes on the industry’s costs, and on the potential impact on the price of insurance to consumers. Canada’s p&c insurance companies are well-capitalized as stated on many occasions by the insurance industry’s solvency regulator. IBC agrees, and the figures bear this out — as does our industry’s history in meeting claims obligations.
Overall, the mid-year financial results show a decrease in the loss ratio to 62.4% from 68.4% reported in the first six months of 2011, as well as an increase in the industry’s capitalization with the capital ratio increasing from 237.5 to 241.8.
During the first six months of 2012, we were lucky with the weather, with only $260 million in Cat claims, considerably lower than the $1 billion reported at this time last year. The mild weather was a factor in the 5.6% drop in net claims.
However, insurers will continue to be challenged on the underwriting front as severe weather in the third quarter pushed insured Cat losses more than $700 million — these could put 2012 on par with the past few years (excluding the Slave Lake event). Additionally, the return on investment is continuing to decline, the result of the low interest rate environment.
LINE OF BUSINESS
Turning to performance by line of business, loss ratios fell for three of the four major insurance lines. In the first six months of 2012, personal and commercial property loss ratios benefited from decreases in direct incurred claims and higher earned premiums. However, as noted above, third-quarter results will likely be much weaker owing to the rising costs of natural catastrophes.
The Ontario auto market is performing better, but is not out of the woods yet. Auto results may have been better were it not for higher claims from the bodily injury segment of the market and the continuing impact of fraud.
After the financial crisis of 2008 and the slide in equity markets resulting from the Euro debt crisis in 2011, insurers increased bond holdings by 5.5 percentage points — from 72.7% in 2006 to 78.2% in 2011. The investment mix continued to be very conservative in the first half of 2012, with 76.1% in fixed-income securities, 12.1% in common and preferred shares, and almost a percentage point increase in the proportion held in short-term deposits.
When we look at industry investment performance, two points stand out:
• Investment income fell by $139 million — even though the total industry investment base rose by 2.3% in the first half of 2012 compared to the same period in 2011. That is significant, and demonstrates just how challenging the investment environment is.
• Second, in the past four years, the industry’s average return on investment of 4.1% is half of what it was in the prior 16 years.
Insurers also appear to be holding a higher proportion of their assets in cash. Following the 2008 crisis, companies had started to reduce cash; now they seem to be growing more cautious once again.
It is believed several factors foreshadow a prolonged period of investment uncertainty, among which are the slow pace of the U.S. recovery combined with uncertainty over the upcoming presidential election and related resolution of the fiscal cliff, the continuing Euro debt crisis and whether or not a break-up over the euro can be avoided, and decelerating growth in China and other major emerging economies which are further weakening global economic prospects.
Most forecasts for economic growth have been revised downward since the expectations held in early spring, reflecting fiscal tightening in many developed countries and growth deceleration in emerging markets.
At home, the road ahead will continue to pose challenges as Canadian households are holding a record amount of debt and as both federal and provincial governments are shifting focus to deficit reduction.
As headwinds swirl around the global recovery, insurers not only face underwriting challenges brought about by climate change and fraud, but also possibly weaker demand and a prolonged low interest rate environment. In addition, increased regulation will continue to shape our industry.