Canadian Underwriter

Overcoming Challenges

June 1, 2006   by Canadian Underwriter

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How the cycle, catastrophes and broker challenges will guide the industry of today and tomorrow

Cycle management represents the foremost concern among many challenges highlighted by an industry leadership panel at the April 2006 CIP Symposium in Toronto.

Four of the six panel speakers listed cycle management as one of the three major challenges facing the insurance industry in 2006-07.

“Can it be flattened?” ING Canada chief operating officer Debbie Coull-Cicchini asked, referring to questions posed at a morning seminar. “Can it be restrained? Moderated?

“Cycles will continue. We know from recent past that exaggerated cycles can destroy value, remove choice and alienate us from our customers.”

Royal & SunAlliance president and CEO Rowan Saunders said he was “optimistic” the insurance industry would be able to avoid the same kind of alienation consumers felt after a hard market period during 2001-04.

“Historically, our industry has just not had the ability to manage this (cycles) appropriately, and we’ve gone from boom to bust,” Saunders said. “The most disappointing thing about that…is the credibility challenge we impose on the industry, not just with regulators but also with our consumers.”

Saunders noted current underwriting results are good and return on equities is strong. However, now that competition is back, he said he is forced to ask the question: “Do we return to some form of cash-flow underwriting and compete on price, or are we going to be more innovative in terms of customer service and product innovation?”

Saunders said he believed the current market cycle “will be different.”

Bruce Perry, senior vice president of PartnerRe Canada, shares Saunders’ optimism. He observed, for example, that the market appears to be stable despite the 2005 hurricanes and natural catastrophes. “We didn’t see the knee-jerk reaction around the world that we’ve seen following Hurricane Andrew and the World Trade Center,” he said. “If these catastrophes that struck Canada and the United States last year [had] happened in 2001 – which is Canada’s worst year of insurance on record – we’d still be in a hard market.”

However, Bill Star, chairman, president and CEO of Kingsway Financial Services Inc., is not so sure the industry has learned anything over the past several cycles. He said high interest rates increased investment income in the ’80s and ’90s, and this investment income masked the industry’s poor underwriting results during the same period.

“Now we’re seeing – after a long, prolonged soft market – a hard market from 2001-04,” Star said. However, the relatively short period of the 2001-04 hard market, Star continued, “concerns me as to whether we’ve learned anything at all We’re starting to see a bit of firming [between 2004-05], but not very much. Interest rates aren’t going to change very much, a slight increase, but that’s probably one of the biggest problems we’ll face is a return to poor underwriting results.”


Regardless of how much the industry has learned, the message from the panel discussing the insurance cycle at the symposium is that the cycle will continue, largely because of the external forces affecting rates and risks.

Andr Fredette, senior vice president and general manager for Caisse Centrale de Rassurance Canada, said the Canadian insurance industry reflects the global economy. As such, even if an event affects the market in another part of the world, fluctuations will be felt within Canada’s homeland operations.

The current state of the market, for example, reflects global market ‘hiccups,’ Fredette said. He explained that while the impact of the 2005 hurricane season had only a minor impact on the Canadian insurance market, some rate increases were felt. In fact, he said, “if the hurricanes had not occurred we would have had a softening market.”

Whether the Canadian industry experiences a large loss or no direct loss at all, events in the global market will continue to guide the cycle as far as capacity is concerned, Fredette said.

Part of the explanation, according to Philip Cook, CEO of Omega Insurance Holdings Inc., is that by nature the insurance industry is susceptible to external factors.

“We’re constantly affected by supply and demand,” Cook said. “Supply and demand is more than just the supply and demand of the insurance product: it relates to the general economy.” For example, Cook said, as construction booms, so too does the demand for coverages. In this way, economic cycles make a lot of difference to the overall insurance industry, he said.

“Unless you believe that the supply is exactly equal to the demand, I think we are going to continue to see cycles go up and down,” Fredette said.

Capacity fluctuation is another economic force affecting the cycle.

Specifically, Cook referred to fluctuations resulting over the past two years from both new capital and capital replacing losses, primarily from Bermuda. Such fluctuations have been in response to the increasing severity and frequency of catastrophic events.

This situation, Cook said, is frightening to the investor. The amount of capacity raised through private investment and raised capital affects the financial strength and status of the industry as a whole, which affects premiums and rates and thus guides the overall cycle, he noted.

These oscillating insurance cycles can tarnish the reputation of the industry, not only in terms of waning investor interest but also in a lack of consumer confidence. “It (cycle fluctuation) affects broker credibility, regulator rate-making processes and investor continuity,” Cook said.

Despite this uncertainty, Standard & Poor’s analyst Donald Chu said the agency’s outlook on Canada’s property and casualty insurance market is stable. “We (S&P’s) believe the industry will remain competitive and cyclical,” Chu said.

Chu’s forecast for the industry is positive, but he reiterates that cycles are inherent to the insurance industry. “They (insurers) have no idea how much the product will cost at the time they sell it,” he said.


Market consolidation and anecdotal reports of availability issues in specialty lines of insurance will challenge brokers in regaining a measure of trust from consumers, according to speakers on the broker panel.

Senior brokers warned capacity issues would likely arise if insurers consolidate and/or increase their ties with brokerage firms. If this market consolidation in the insurance industry occurs, the interests of brokers and consumers will be compromised, the brokers warned.

“[Consolidation] is only going to become a larger issue,” Aon Reed Stenhouse chairman and CEO Doug Swartout said. “Because if you [listen to ING Canada president] Claude Dusseault, he’s a great guy, but he wants to be 35% of the market. And if he wants 25-35% of the market, you’re going to have [Aviva Canada president] Igal [Mayer] wanting 25-35% of the market. It’s going to go down the line. [Royal & SunAlliance president] Rowan [Saunders] is going to want that….

“Pretty soon, if everybody wants 25% of the market, you’ve only got four insurers. Then it starts to get difficult to place certain risks because we don’t have enough market.” Swartout cautioned his audience that he was exaggerating to prove a point. He went on to note that Canada has at least 300 insurers.

Still, he said, “it’s great to say that we’d like a boutique to write this business, but I hate to tell you, folks, [Canada has] only US$40 billion of insurance premium. California’s got more than US$40 billion in insurance premium. We’re not going to be able to do a lot of things.”

The threat of closer financial ties between brokers and insurers is one reason why clear and precise rules on disclosure are necessary, according to BFL Canada president and CEO Barry Lorenzetti. “Depending on how much the brokerage firms’ revenues sources are squeezed, [
brokers] will look to insurers for more support,” Lorenzetti noted. “However, for brokers to be getting more support from insurers is a delicate issue, which raises certain questions…

“Is increasing ties between brokers and insurers conducive to restoring trust in brokers on the part of the consumers? Would you wish your doctor to prescribe medication to you based on the fact that the pharmaceutical company that produces the medication makes his life easier by supporting him or assisting in any way?”

Insurance Brokers Association of Ontario CEO Robert Carter downplayed the threat of consolidation in the immediate future, observing that there are more buyers than sellers in the current marketplace. Nevertheless, he noted, there is already “a reduced market in specialty areas, which is a concern.”

Carter said insurers should be improving their communications with brokers, negotiating policy terms according to what consumers need. Instead, inexperienced underwriters are writing cookie-cutter policies that risk nothing and are, according to Carter, of limited benefit to the consumer.

Fred De Francesco of Fairview Insurance Brokers Inc. said more boutique insurers are required. He encouraged underwriters to use appropriate pricing as a means to offer potentially risky niche products.

“We’re in the insurance business,” De Francesco said. “All exposures are insurable at the right price. I can insure a dynamite factory that I know is going to blow up on Saturday and make money. If I know that the maximum probable loss on the risk is going to be $20 million, I’ll have premiums of $35 million.”


The unprecedented wave of natural catastrophe losses in 2005 could have swallowed the insurance market whole in its mighty undertow, but a symposium panel agreed the global industry entered the storm season with enough breath to sustain itself through the aftermath.

Taking into account the huge loss burden, Swiss Reinsurance Company Canada president and CEO Jean-Jacques Henchoz said the year-end results were “quite remarkable.” The third quarter combined ratio was just below 100%. But with the burden of losses inflicted by Hurricanes Katrina, Wilma and Rita, Henchoz noted, the combined ratio rose to 102-103%. The return on equity (ROE), which would have come in at 10.1%, declined to 8% by year-end as a result of the historic storm losses, he noted.

“The key word this year is resilience,” Henchoz said. “The numbers show underlying earnings were very sound and … good underwriting from the industry.”

At the heart of this industry-wide resilience, according to Henchoz, is the fact that the overall burden was well-dsitributed. Losses resulting from Katrina, Wilma and Rita were spread out as follows: 45% U.S. coverage, with about 37% (one-third) of this covered by primary lines and about 8% by U.S. reinsurance. The reinsurance industry, he added, absorbed about 50% of the 2005 hurricane losses – about 26% of which was covered by Bermuda reinsurance.

“The key message here is that while the loss numbers were huge, there was good spread in terms of geographical coverage and good risk diversification,” he said.

Nonetheless, Henchoz maintained that increasing frequency and severity of natural cats is challenging many different industry players – including adjusters.

In order to facilitate the magnitude of claims arising from mega-cat events like Katrina, insurers need immediate access to a multitude of property adjusters, according to Gary Kaplan, the chief underwriting officer and executive vice president of Zurich North America Commercial. The problem, Kaplan said, is the huge number of adjusters required to respond to such mega-catastrophes cannot be carried on a permanent basis, since events of such magnitude are rare and unpredictable.

In addition, an increasing frequency of mega-cats complicates the adjuster’s world: traditional and expected costs required to pay out the claims no longer apply. “Conventional pricing goes out the door, as pressure increases on supply and demand for labour,” Crawford Canada executive general adjuster Lorne Montgomery said.

Convention also disappears for ratings agencies and modeling firms that are faced with increasingly abnormal and capricious climate conditions. Today such agencies accept a trend toward higher frequency, severity and prices. The next step is adapting models and ratings to reflect these unfamiliar mutations.

“Modeling firms are a mess, trying to recalibrate their tools and reviewing their assumptions,” Henchoz said. He added this will lead to expectations of higher frequency, severity and pricing.

Henchoz said current methods and standards for predicting weather severity and frequency are invalid; so too is the ability to rate how inconsistent and erratic storms affect a company’s bottom line.

“They key fact is that ratings agencies now recognize that natural catastrophes are the Number 1 threat to the insurance industry’s financial strength,” Henchoz said. This, he continued, is leading to increased capital requirements to achieve good ratings.

The industry has responded to this new standard by raising “a lot of new, fresh capital, primarily from Bermuda.”

“This new capital was vested not only to take advantage of the hardening of the market but also to cope with increasing requirements from the ratings agencies,” Henchoz explained. “Some players, to keep their ratings, had to raise new capital.”

The market is in a growth phase and this trend will continue, according to Henchoz, as a result of increases in both exposures and the concentration of population in high-risk areas.

Therefore, the question insurers face is how to secure their bottom line against catastrophe risk.

Henchoz predicts cat bonds will be well-represented in the future of securitization. Since 1996, the interest in cat bonds has been about US$23 billion worldwide capacity, Henchoz noted. He said this represents about 3% to 4% of the worldwide reinsurance volume.

“The numbers are still small, but I believe very strongly that given the interest of financial investors, and also the ability of specialists to model the loss burden to securitize some of the exposure, that this trend will grow; cat bonds will be a significant part of growth in the cat market,” Henchoz explained.

The interest is already peaking according to Kaplan.

Due to concern of modeling inadequacies and inconsistencies, Zurich bought cat bonds to increase cat capacity. The benefits of the bonds were tested immediately, when the 2005 Atlantic storm season caused the company to cash out a US$200-million bond during the first year it was purchased.

Kaplan says Zurich will pursue further cat bond purchases. He added, however, that while cat bonds have proven themselves worthy of purchase, they require much more work than traditional reinsurance. Still, he said, purchasing the bonds is worth the additional trouble.

“We’re going to have to do that (purchase cat bonds) and find different ways to line up capital against exposures because there’s not enough reinsurance to cover all the cat exposures,” Kaplan said.

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