Game Changers: Environment and Economy

The growing frequency and severity of catastrophic weather events resulting from climate change has had a major impact on the Canadian insurance industry. The industry is also currently facing a variety of pressures from the global economic environment. From my view, economic and environmental forces are pushing insurers to an inflection point from which the industry will either adapt and grow, or risk a steep decline in profitability. To adapt, it’s important to have an in-depth understanding of how these factors are affecting our businesses and what we can do from an operational standpoint to lessen this impact and increase profitability.

Economically, Canada is faring pretty well relative to the rest of the world, having emerged from the 2008-2009 recession somewhat unscathed with a strong credit rating and currency appreciation against its peers. However, this does not mean that we are immune to global developments, with recent forecasts predicting miniscule GDP growth and a long-term, low-interest rate environment. Additionally, regulators are proposing new and more stringent capital regimes, requiring insurers to hold more financial resources to protect solvency.

These factors place the p&c industry under a great deal of pressure given our ability to generate a profit and sustain a reasonable return on equity is reliant on two sources of income: underwriting profit and investment income.  A soft market has resulted in the industry running at an underwriting loss with a combined operating ratio above 100 per cent, and low interest rates have forced fixed income yields to levels lower than those seen in the last recession.

With the recovery of interest rates largely out of our control, there is now a great need to focus on the underwriting result. However, compounding this challenge is the increasing severity and frequency of catastrophic weather events. Weather and catastrophe management are at the forefront of our minds as the industry has been hit with significant claims activity from intense weather including earthquakes, flooding, hurricanes, hailstorms and snowstorms in recent years.

Consider this: 2010 was the 33rd consecutive year of above average global temperatures. The correlation between greenhouse gases and greater severity of heavy rain and flooding has increased. There were 167 natural catastrophic events including the New Zealand and Chile earthquakes, European winter storm and Australian floods, in 2010.

Severe weather patterns have continued into 2011, with major catastrophic events around the world. Approximately 26,000 people lost their lives in catastrophes in the first six months of 2011, most of them in Japan. With more than $70 billion in insured catastrophic losses in the same timeframe, 2011 already ranks as the second most expensive year according to Swiss Re’s sigma statistical records. This figure was only surpassed in 2005 when total catastrophe claims amounted to $120 billion, with hurricanes Katrina, Wilma and Rita causing claims of more than $90 billion. With an increased population moving into coastal regions, the potential for significantly higher claims activity is even further amplified.

If there’s one takeaway from all these statistics, it is: Expect intense weather events to escalate and become ever more frequent.

Shaping our response to catastrophic weather events by enhancing our weather modeling has been a key element to our continued progress. Modeling is one way insurers try to predict catastrophic outcomes by applying demographic, geographic and weather-related data to their underlying portfolios. There are, however, limits to what these models can predict. For example, they can only predict damage based on known hazards, such as wind speed and ground movement, and not the resulting ‘secondary loss agents’ that may arise, such as the tsunami following the Japan earthquake, levy failure in Louisiana after Hurricane Katrina, or post-catastrophe inflation due to supply issues. It’s important to remember that modeling is only a tool – a deep understanding of the underlying portfolios is still needed in order to anticipate complications arising from secondary loss agents and the effects of aggregation.

We also take the time to learn from previous catastrophic events, the most recent of which was the 2010 Chilean earthquake, an 8.8 magnitude disaster resulting in a gross loss of £1.4 billion for RSA. As a result, we’ve been able to apply this learning to our preparation for weather-related catastrophes in Canada.

Our key takeaways from Chile were many:

• Preparation is key: With the resulting structural damage and power outages following the earthquake, our people on the ground needed to know how to react, as normal modes of communication were not viable. Within four hours of the earthquake our claims handlers were starting to survey the damage; within 48 hours our Concepcion office leased a suitable command center, and within four days, systems were back up and running;
• Catastrophes are complicated and flexibility is key. RSA flew in 30 of the company’s best claims people from around the world to assist local employees. A specialized catastrophe team was mobilized in order to manage the process of servicing the 32,000 claims received (equivalent to 10 years worth of claims), in addition to the support functions of finance, HR and IT divisions. Essentially, an entire business unit needed to be mobilized in a short period of time in order to deal with the complexities arising out of a major disaster, while ensuring that this was done in a cost effective manner;
• Consider whether third party claims adjuster and vendor contracts will still work in the extreme. With an earthquake of this magnitude, many vendors were unable to fulfill contracts given damage to their own operations, while those that could were needed for periods of time in excess of their contract period;
• Be aware that contract wording and clauses will be tested; 5) Be ready for fraud;
• Understand and manage accumulation;
• Insureds should not underestimate the potential for business interruption losses, as recuperating from a major catastrophe can take much longer than the indemnity period.

The gap between strong and weak industry players will continue to increase if companies do not adapt to these economic and weather related challenges alike. This divergence in performance may speed up the consolidation of the p&c industry, resulting in a less fragmented market where highly adaptable players with strong strategic direction, solid balance sheets and increased underwriting and claims efficiency will prevail.

Rowan Saunders is the president and CEO of RSA Canada