Bottom Looking Up

After an eventful 2011, evidence exists that the insurance industry is past the bottom of a lengthy soft commercial market pricing cycle. Steadily low or declining premiums, plentiful capacity and relatively generous terms have been the hallmark of commercial renewals over the past five years — a span that has included a global credit crisis, significant natural disasters and general economic malaise. Now, there are signs of change.

In a country-specific report released earlier this year, Marsh characterizes Canada as a “market in transition . . . where insurers are moving towards a more disciplined approach to underwriting, which is likely to start to drive rates up . . . Global and local events have started to erodethe positive underwriting results of the previous three-to-five years for Canadian insurers. As a result, many insurers are taking a bottom line approach to pricing, rather than simply looking at top-line premium income.”

Elaborating, David Mew, managing director and national placement leader for Marsh Canada says: “When we say the market is in transition in commercial lines, it means that it is no longer soft, particularly after a prolonged period of pricing decreases. So far, however, we are not seeing the 15-20% increases that would signal a hard market.”

Underlying conditions are pointing to movement in the marketplace, Mew notes. First, the loss ratios in some key commercial lines of business are deteriorating, most notably in property lines. After the Slave Lake fire, heavy flooding in regions across Canada, a tornado in Goderich, Ontario and a late fall windstorm in Alberta, the claims ratio in commercial property increased to 78.5% in the third quarter 2011, well up from the 67.4% posted for the same period the previous year.

“In commercial property, the loss ratio has been increasing steadily,” says Mike Lardis, senior vice president of commercial lines underwriting and pricing for Aviva Canada. “I think here, specifically, more insurers are looking to achieve rate adequacy.”

Deborah Moor, president of Lloyd’s Canada, says 2011 was a tough year for the insurance industry. A high level of global catastrophes led to industry-wide claims of around $107 billion. “The Canadian insurance market is not immune from those events, and we’ve also seen events closer to home such as the Slave Lake fires,” she says.“We are starting to see more stability in property lines as a result.”

Reinsurance renewal contracts for primary insurers, the majority of which were done in January, have also seen price increases, particularly for catastrophe treaties.

“Generally, reinsurance costs are up between 5% and 15%, depending on the line of insurance,” says Neil Morrison, president and CEO of Hub International HKMB/Ontario. “Some primary insurers will have trouble passing those costs onwards, but it will certainly put pressure on a firming rate landscape. Sometimes we don’t appreciate the fact that even though a typical insurer may spend 20% of premiums on reinsurance, and a 5% reinsurance price increase translates into just 1% on their premiums, that 100 basis points at the margin on $500 million or $1 billion of revenue is a big hit to the bottom line.” Global catastrophe losses and significant losses in Canada were factors in Canadian reinsurance renewals this year, resulting in some price increases and available capacity reductions by global reinsurers, adds Moor. “This should drive price firming in the catastrophe exposed commercial lines in the coming year.”

Conditions for a Hard Market

Given meager interest rates and investment income that is too flat to have much of an impact on any underwriting losses, Mew says at least three of the four conditions of a hardening market are present: increasing loss ratios in some lines, higher reinsurance pricing and limited investment income.The one missing factor is a key exception: lack of capacity. A competitive market shows that both foreign and domestic insurers still view the Canadian market as a good place to do business.

“In discussions with my colleagues, I don’t see any big signs of a turn or significant rate increases in property and casualty lines,” says Steve Pottle, director of risk management services for York University. “I think there is enough capacity in the Canadian marketplace, and plenty of competition. No one insurer wants to put its neck out there and be the first to make those large increases. If one company does do it, there are 30 or more waiting in the wings saying ‘Good luck with that.’”

Several sources say capacity and rate are highly dependent on specific lines of business and individual risk profiles.

“While globally we have seen insurance rates increasing in regions and lines of business that experienced catastrophes last year, this has not happened across the market as a whole,” notes Moor. “The same is true in Canada. Certain specialized areas such as sawmills, where major players have pulled out of the Canadian market, and energy business, where there have been large losses in Canada as well as elsewhere, have seen rates rising.”

However, other areas of commercial business, including liability (with a third quarter loss ratio of 64.5%), small and medium sized accounts and professional liability remain highly competitive in pricing, with abundant capacity.

“Directors and officers liability and professional liability is still very competitive,” Mew says. “You have 45 to 50 insurance companies chasing this business in Canada. “

This heightened competition and robust capacity may delay the transition to a firmer commercial market in Canada, according to some sources.

“A few large multinational insurers believe their combined loss ratios to be in the mid 90s and they are taking that as license to attempt to build market share — including in Canada,” observes Morrison. “Concurrently, new capacity is entering the Canadian market. Lloyd’s syndicates and Bermuda operations aresetting up shop here and looking for premium. Meanwhile, domestic Canadian insurers are not inclined to let the additional and new foreign capacity eat their lunch; they are predictably being competitive in order to keep what they have.”

Many insurance companies writing domestic risks have worked hard to build up a good book of business and they don’t want to walk away from it, Mew adds. “The acquisition costs of getting new business are much higher than the retention costs, and I think that is where we are right now,” he says. “There is a lot of waiting right now in a transition market.”

For Lardis, this competition plays out particularly in the small to medium sized market for “straightforward” risks. “We are looking at a new operating model for straightforward risks that involves a service centre-type approach,” he says. “Clearly in commercial lines, some risks are more complex. But if the account is relatively simple, we are focusing on getting a rate out very fast to brokers.With this business, I think we can be more aggressive for the right kinds of risks.”

Insurance Buyers

A long soft market and consistent pricing has benefited many insurance buyers, Pottle says, but risk managers still have to contend with some obstacles.

“One area of frustration for risk managers is the feeling that the ‘incumbent shouldn’t be encumbered’ by less aggressive rate offerings on renewal,” notes Pottle, chair of the RIMS Canada communications and external affairs committee. “Why would insurers and brokers be aggressive on new accounts and not do the same with retained business? Why don’t they treat old clients like new clients?”

Complacency, a byproduct of relative
ly easy past renewals, is another potential issue for risk managers and commercial insurance buyers. “One concern from an internal perspective is that we are becoming accustomed to insurance costs as flat or decreasing,” Pottle says. “That is the way it’s been for the past at least five or six years. Some in the organization may think insurance rates will always be fixed or declining, but we don’t know where premiums are going down the road.We have to build in some planning for that.”

The likelihood of double-digit insurance rate increases is slim, according to several sources. “For us, this is not a situation where we will simply take a rate increase across the board,” says Lardis.

“I think you will get selective hardening of a few percentage points in 2012 and then likely increases in the 3% to 5% range in 2013, with more pressure on commercial property. However, we are not looking at sudden 10% to 15 % price changes.”

Barring a major catastrophe or a sharp withdrawal in capacity, any rate changes should be gradual and orderly, according to Morrison. “The real but hopefully remote risk is a sudden withdrawal of that foreign capital/capacity, which would result in unwanted upwards price volatility and ensuing political heartburn for the industry,” he says.

Lardis says an exclusive focus on rate changes may obscure what insurers are trying to accomplish through a more targeted approach to underwriting individual risks. “This goes beyond rate to underwriting, data and analytics,” he says. “Insurers are taking a much more granular view of individual risks. If we feel we can use data and analytics better, we will go after certain risks. If not, we are willing to walk away. In property, I think we are getting some areas of reduced capacity, where insurers are willing to exit on certain risks.”

In other words, insurers are showing a much greater commitment to underwriting discipline and risk appetite. How that discipline plays out in a stillcompetitive commercial marketplace will determine where rates are heading for the rest of this year and into 2013. “It will be interesting to see in the second and third quarters of this year if the underwriting and rate discipline will stick,” Mew concludes. “I think right now in this market, brokers have to work harder to get the best deal for their clients. But that is in the nature of this business.”