March 30, 2022 by Alyssa DiSabatino
At 18%, the industry’s return on equity was sky-high for the first three quarters of 2021, but industry observers warn this could be cut in half in two years.
While these high profits have reduced solvency risk for most insurers, it’s not all sunshine and rainbows. Property and Casualty Insurance Compensation Corporation (PACICC’s) CEO tells the industry to heed caution.
“Every single time that insurers have reported such above-average profits, competitive forces have quickly acted to cut the industry’s return on equity in half—to an average of 7.4% —within two years,” President and CEO Alister Campbell writes in PACICC’s annual report.
Campbell notes P&C insurance profitability has been widely cyclical.
“In the past, such high levels of profitability have proven not to be sustainable,” PACICC’s board chairman Glenn Gibson writes. “Over the past 45 years, P&C insurers have reported return on equity of greater than 15% on 10 occasions.”
These years of high profitability generally appear in groups (1977 to 1978; 1983; 1986 to 1987; 2004 to 2006; and 2020 to 2021).
This year’s return on equity soars above the rest — the average return on equity in the P&C industry’s years of peak profitability was 16.8%.
Gibson notes that auto and commercial lines had a particularly strong underwriting performance in 2021 — a key reason for the industry’s profitable results. And PACICC’s members saw loss ratios at profitable levels in every major line of coverage.
However, he writes, “the increasing loss ratio for personal property (62.7% in 2021, up from 55.9% in 2020) and lower net investment income in 2021 (down 25.9% from 2020) give clear indication that this period of profitability is likely to be short-lived.”
Campbell writes the “good news” is these profits have resulted in improving capital test scores for most insurers.
PACICC reports the average Minimum Capital Test (MCT) figure in 2021 was 264.4% — an increase from 234.2% in 2020. The Branch Adequacy of Assets Test (BAAT) figure also increased from an average of 297.3% to 298.9%.
In terms of solvency, no Canadian insurers failed for the 18th consecutive year. This is not uncommon for the industry.
Gibson notes PACICC primarily sees the failure of smaller, regional insurers, but “the increased pace of consolidation means that the next failure is more likely to be that of a medium-sized or even larger insurer, which places new pressures on our current operating model.”
This led to PACICC’s seeking members’ feedback on the merits of purchasing reinsurance to ensure a more efficient and cost-effective response to future industry solvencies. Gibson says PACICC will be reviewing the results in June.