December 1, 2001 by Sean van Zyl, Editor
With the Canadian property and casualty insurance industry likely to end this year with a return on equity of less than 2% — the lowest level on record — and as claim costs continue to outstrip premium growth, insurer CEOs are predicting a difficult year for 2002. Insurers are also concerned with the pending withdrawal of reinsurance cover for terrorism-related losses as from the beginning of next year, the result of which has created market uncertainty as company management attempt to identify their exposures and plot their business strategies. Insurers say there is one certainty to next year’s marketplace, prices across the commercial and personal lines of business will have to rise by more than the costs of underwriting if a major shakeup of the industry is to be avoided.
Canadian insurers brought home a meager 1.8% ROE for the first nine months of this year, the lowest level on record, according to the Insurance Bureau of Canada’s (IBC) chief economist Paul Kovacs. And, although the third quarter results of insurers point to a significant firming of prices that did lift the ROE to almost double that of the nine months, it can be safely assumed that the industry will not achieve more than a 2% return for the full year, he adds. Furthermore, the industry’s combined ratio for 2001 will likely be around 110%.
Much of the problem lies with runaway costs, mainly associated with auto healthcare claims that have risen in value significantly beyond what insurers have been able to charge for the risk, Kovacs observes. Notably, the latest third quarter financial returns of insurers show an 11% gain in net written premiums for the first nine months of this year while claims costs rose by 12%. Net earned premiums over the same period came in dismally lower with an 8.2% increase.
Most of the claim cost factors remain in play, Kovacs notes, which when coupled with the anticipated steep increase in reinsurance cover prices as from the beginning of January, insurers will not have much flexibility in managing their books of business. The good news is that premium rates have been rising across-the-board, which clearly points to a turn in the industry’s price cycle. “Recent [price] adjustments have been larger and come somewhat sooner than expected. This may become the hardest market since the liability crisis 17 years ago.”
Kovacs points out, however, that firming prices in 2002 will not necessarily provide the level of profitability the industry desperately needs to achieve. Pressure on the bottom-line will continue until the rising cost of claims is tamed, he adds. Furthermore, any gains made through premiums written in 2002 will only translate into earned premium growth in the following financial year. Another factor which will have a significant bearing on the performance of insurers next year is the investment side of the business. Although Kovacs believes that interest rates are currently at the low of the market cycle, and therefore should rise in coming months, there is unlikely to be much relief available to insurers through investment returns and realized gains. “2002 is not going to be a year for profit.”
So, how do management of companies see the 2002 marketplace shaping up? CU’s survey of insurer CEOs revealed a mixed range of views, although all consulted agree that immediate and significant pricing action has to be taken in light of the dramatic cost increases that have taken hold this past year. While most CEOs are optimistic that upward rate adjustments in the commercial and personal lines markets will stick in 2002, they believe action will also have to be taken in terms of product reform. And, although market capacity is likely to remain high, availability will be limited to properly priced risks. “The focus for 2002 will be the bottom-line,” is the consensus of CEOs.
“I think that 2001 will be the worst year in the industry’s history,” comments George Cooke, president of The Dominion of Canada General Insurance Co. Quebec is currently the “jewel in the industry’s crown” in terms of profitability, he notes, but it took the industry three years to achieve this correction. “The economy was booming then, unlike the present economic situation, and I think this will create a more grudging consumer reaction to price increases.”
As such, Cooke is less optimistic of a full financial recovery for the industry in 2002, with most companies staggering the level of rate increases expected over a longer period of time. “Insureds won’t accept the full pain overnight.”
Cooke also does not expect the industry’s ROE will improve much in 2002. Although he predicts earned premium growth of about 30% on commercial business and around a 10% gain on personal lines for next year, the industry’s bottom-line will remain weakened by cost pressures and investment market volatility. And, regardless of the September 11 events, he notes that reinsurance pricing had been rising substantially. “Insurers will find huge increases in reinsurance costs for next year, and some companies may not even find terms on some classes of business.”
ING Canada president Claude Dussault expects that the investment side of the business will be the weak link in the industry’s performance in 2002. The economic outlook for next year is not bright, he adds, and this is reflected in the investment markets. “This [investment income] is an important component of our [the industry] ROE.”
Dussault does, however, believe that rate adjustments will take hold in both the commercial and personal lines markets. “I think there is a realization among brokers that price increases have to be implemented. Many insurers have been communicating this message and explaining the reasons behind the increases.”
Gregg Hanson, president of The Wawanesa Mutual Insurance Co. concurs that investments play a significant role in the financial performance of the industry. “Let’s not fool ourselves, investment returns drive the business.” Although the investment environment will remain poor in the first months of 2002, Hanson believes that the equity markets will improve in the second half of the year.
That said, he agrees that a return to profitability will depend on strong price action in 2002. This mostly needs to be done in the Ontario and Maritime auto markets. “I think we will see significant price increases in these markets, although commercial pricing will also react strongly.” Overall, Hanson does see some improvement in the industry’s financial position next year, with the combined ratio likely to begin falling back from its current high of 110%. The insurance market’s direction and pricing is being primarily driven by reinsurance, he notes, and the reliance of individual companies in this respect will affect their financial performance.
Igal Mayer, president of CGU Group Canada Ltd. believes that it may take two to three years before insurers are able to implement adequate pricing to the markets. Claims costs sneaked up on insurers this year, he says, taking many by surprise. As a result, pricing adjustments were left too late. In this respect, he adds that in the year ahead action will have to be taken beyond price and include product reform. Claims costs in Ontario have become a critical issue, he notes, and immediate legislative reform has to be introduced.
Mayer points out that the financial performance of insurers next year will largely depend on their regional exposure and types of business. Notably, companies with large books in Quebec will likely fair better than those with heavy exposures in Atlantic Canada and Ontario’s auto market.
Royal & SunAlliance Insurance Co. of Canada president Larry Simmons sees identifying “loss costs” as being one of the more challenging tests facing insurers in 2002. “We will all try to get adequate pricing, but the uncertainty is not knowing what our ‘loss cost inflation’ will be.” That said, he confirms that pricing is going to be the industry’s focus in the year ahead, with commercial risks drawing the most attention. Personal lines rate adjustments will be less dramatic, he predicts, “bu
t it [personal lines] won’t escape the reinsurance burden entirely. It [personal lines] will still have to compete for capital.”
“A ROE of 2% is simply not acceptable,” observes Chubb Insurance Co. of Canada president Janice Tomlinson. She too expects that commercial lines will face the brunt of rate increases for next year. However, Tomlinson is skeptical to whether the industry will be able to achieve rate adequacy in a single year. “I think that we will be looking at two years of a hardening marketplace.”
Tomlinson believes that the deteriorating market conditions over the past year could see some insurers exiting certain lines of business in 2002, and “realigning their portfolios”, as head-office pressures begin to bear down on profitability. “It is going to be a challenging year.”
Barry Gilway, president of Zurich Canada expects the commercial market will provide better results in 2002. Zurich recently entered into an asset swap deal with ING whereby Zurich sold off its personal lines book of business. The company is now concentrating on large commercial and cross-border risks. As such, Gilway says that the large commercial risk segment of the market has already produced meaningful price corrections, with rates rising by 15%-25% over the past six months. He believes this momentum will continue through 2002 with further gains of 15%-25%.
A significant factor that will come into play next year is restrictions of coverage and limited capacity, Gilway says. However, he does not think that the Canadian commercial market will be as heavily impacted by rate adjustments as in the U.S.. “Canada is closing the gap with the U.S. market. However, I don’t think that rates here should reflect adjustments in the U.S., as the underwriting exposure is different.”
Ernst Notz, president of The Citadel Assurance notes, “we all know that the industry is in a bit of a hole, and now we’re going to have to pay higher reinsurance costs”. Notz refers to the September 11 terrorist attacks and the expected cost impact this will likely have on the industry through reinsurance. However, he adds, all of the adverse market conditions currently plaguing the industry were in effect prior to the terrorist attacks. Specifically, it had been known for some time that action would have to be taken in the Ontario and Atlantic Canada auto markets. He expects that a “big chunk” of the needed pricing action will occur in 2002, but that the industry will need more than one year of hardening markets. He predicts that the firming price cycle may well boost insurers back into double digit ROE territory by the end of 2002, but returns will still be modest relative to shareholder expectations. “I hope we will get the ROE to about 10% next year, but it is unlikely to reach 15%. Shareholders won’t be happy with less than 10%.”
The terror factor
The prospect of reinsurance protection against terrorism losses falling away from the market next year has created a substantial amount of uncertainty in terms of insurer business strategizing, says Simmons. This is just one side of the face of the terror risk issue, he adds, the other being identifying the potential for losses and pricing such risks.
The impact of the terrorist attacks in the U.S. has been a major driver behind the strong hardening of the reinsurance market globally, and Canada will not escape from rising prices, he notes. In this respect, Simmons believes that the Canadian government should play a role in stabilizing the insurance marketplace by providing a form of reinsurance capacity. The alternative is for insurers to withhold terrorism cover if reinsurance is not available.
“Terrorism exclusions cannot become the norm,” comments Cooke. In addition to the fact that insurers would not be serving their policyholders’ needs by not offering terrorism cover, exclusions on terrorism losses will not work in practice, he notes. For instance, he refers to the “fire following” component of policies, which is a regulated requirement of coverage. “Which means that we couldn’t exclude most of it [terrorism losses] even if we wanted to.”
Cooke confirms that reinsurance prices will be significantly higher for 2002, but the real issue is going to be the availability of capacity. Much of this problem relates to terrorism exposures, but he believes, the simplest solution lies in reinsurers evaluating the risk of terrorism in Canada in its own right. “We do not have the population and asset density as in the U.S. or U.K., the terrorism risk in Canada is not as great.”
Mayer also believes that the market could face an over-reaction due to the terrorism risk factor. It would be a mistake to push rate increases through with the September 11 attacks as an excuse. The primary and reinsurance markets were in poor shape before September 11, he notes, and rate adjustments should be seen in that light. However, this does not mean that terrorism does not present a threat to the Canadian market, he adds, which is why government involvement has become critical to ensure against disruption of the economy.
Reshaping the industry
“If you look at the top 50 insurers in Canada, I think there are a couple that don’t have the appetite to remain,” comments Hanson. Whether or not the market witnesses any consolidation, in terms of merger and acquisition activity or some players pulling out of certain lines of business will largely depend on financial performance in the coming year, he adds. However, from an overall perspective, Hanson does not see the amount of capital in the Canadian market diminishing.
Simmons concurs with this view, noting that restructuring is most likely going to be a combination of business alliances (such as the Zurich/ING deal) as well as withdrawals from some market segments. “I think that such decisions will be more strategic decision making with a focus on the bottom-line than trying to achieve scale.”
Dussault also does not believe that many companies would consider withdrawing entirely from the Canadian market. With the price cycle having turned for the better, most insurers will be holding on for the recovery. However, this does not mean the end of mergers and acquisitions, industry consolidation has been underway for a long time, he notes, and this trend will likely continue. Should any deals go ahead in 2002, Dussault believes that the emphasis will be based on performance and not size of the companies.
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