Canadian Underwriter

Primary Insurer Strategies 2004: Towing The Bottom-Line

December 1, 2003   by Sean van Zyl, Editor

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Although the upward rate adjustments applied by insurers over the past two years of the hard market are beginning to translate to the financial bottom-line with the property and casualty insurance industry expected to end 2003 with a return on equity of about 10%, there remains a great deal of uncertainty surrounding the auto product. With auto accounting for over 50% of total premiums written in Canada, the future of this product is also very much the future of the private p&c insurance industry. And, on the eve of a new year, insurers wait anxiously for direction from nearly every provincial government that operates on a private auto insurance system to whether there is indeed a “future”.

While the sharp pricing actions taken by insurers this year and in 2002 across all lines of business were critical in order to stem mounting underwriting losses, these corrective measures also drew unwelcome media and political attention on the auto side. The result has been what many insurer CEOs describe as a “lack of faith crisis” in terms of a growing negative public perception of the insurance industry as auto rates continue to soar in response to the ongoing rise in claims costs.

The insurance industry has lobbied the provincial governments for several years to bring about auto product reform to quell the surge in underwriting losses, primarily through minor bodily injury claims. However, the counter-action of the provincial governments over recent months has been to “freeze” auto insurance rates with one province having thus far introduced a “rate rollback”. A number of insurers have subsequently indicated that they will not be writing new auto business in this province. Faced with such adversity, and against an ominous backdrop of government-run auto insurance possibly being adopted by several of the provinces, insurers have yet to see cost-saving benefits from the various provincial reform packages that have thus far been tabled.

Notably, while the overall Canadian p&c insurance industry is expected to produce a reasonable profit for 2003 – at least in comparison with the dismal returns of the immediate prior years – most insurers writing auto will end this year with a combined ratio of over 100%. Essentially, insurers are being forced to subsidize auto rates through other lines of business in order to satisfy political demands. With much of the Canadian p&c insurance market reliant on foreign capital, and therefore an expectation of a investment return comparable with that of other global markets, the current unrealistic demands being made on auto by the provincial regulators cannot be sustained, the CEOs say.

The CEOs also point to a dramatic rise in catastrophe losses this year, with nearly all of the events having occurred in the third quarter. And, as many observe, perhaps the biggest “catastrophe” is the losses arising from the Facility Association (FA). The FA, which serves as the “market of last resort” for auto risks which insurers are not willing to take onto their books (the FA is funded by its members being the insurance industry), is expected to end 2003 with a combined ratio of around 170% with a loss of almost half a billion dollars. This cost will come out of insurers’ pockets in addition to their own auto losses. So, while the industry appears to be on the “right track” toward achieving sustainable profitability, the future viability of the industry very much depends on the “political factor” affecting auto, the CEOs observe. As such, CU asked some of the leading industry players to provide their personal perspective and “strategic approach” to how they plan to deal with the marketplace in 2004.

Igal Mayer, president of Aviva Canada Inc.

2003 was a year of contradictions for insurers in Canada. While the industry’s financial fortunes began to improve, the viability of the private sector delivery of auto insurance, our largest line of business, came into question. Throughout the year, we were on the receiving end of intense and often unfair public scrutiny, while at the same time asked to accept unrealistic, even punitive, legislative change – all while we were struggling to restore profitability. This took place in a year peppered with crisis – wildfires, blackouts and hurricanes – as we proved our worth time and time again, by helping our policyholders return their lives to normal.

Our single biggest challenge in 2004 is restoring our credibility. I believe we will accomplish this by continuing to work with provincial governments to reform automobile products to quickly deliver what really matters to consumers: lower, affordable premiums. In the longer term, credibility can only be restored by taking the “mystique” out of our business, through education and engaging the public in discussions to find the balance between affordability of insurance for the many, and the needs of the few who are injured in accidents.

At Aviva, we have an exciting year ahead of us as we build on the progress we have made through new solutions, systems and processes launched in 2003. We will leverage the investments we have made in the fundamentals, to continue to make it easier for our brokers to work with us.

We will also actively do our part to counter negative perceptions of our industry in order to foster an environment of positive change to the benefit of insurers, regulators, brokers, staff, shareholders, and most importantly – our policyholders. I am proud to say I work for the insurance industry, a sector that is a major driver of our economic engine in Canada and one which also does a great deal of good for society – we help people in times when they need help the most. Now is the time to come together, as an industry, with a shared interest in successfully winning back our reputation, one Canadian at a time.

Janice Tomlinson, president of Chubb Insurance Co. of Canada

One year of profit improvement is not enough. Coming off an ROE of 2% for 2002, the industry cannot afford to let down its guard in terms of maintaining underwriting discipline. But, I believe that the marketplace will reflect signs of pricing stability in 2004, particularly on commercial property business.

However, for the industry, the biggest challenge lies in auto. Deteriorating results on auto have emerged from nearly every province. The future direction taken by the regulators regarding auto product reform will have significant implications for many companies. The public and political attention that has been drawn to the pricing of auto insurance will also likely result in increased regulation of the industry during 2004. I also think that company solvency will remain high on the agenda of the regulators.

As Chubb is not a major auto writer, our main concern is the increasing risk exposure emerging through corporate governance and the impact this will have on directors’ and officers’ (D&O) covers. Terms and pricing in this segment of the market will remain relatively tight through 2004. Our strategy at Chubb has always been to be a niche player in the marketplace. We will maintain this approach going forward, focusing on the market segments we have developed over a long period of time.

Ernst Notz, president of The Citadel Assurance

It is certainly not business as usual for The Citadel or any other p&c insurer in today’s market. External forces have created a shift in the business model under which we all operate. They are contributing to our industry’s inability to generate an acceptable ROE. Interest rates remain low and the investment markets are weak, hence poor investment income. These external factors will play a significant role in determining how well we perform in the coming year.

Looking forward to 2004, I see rising reinsurance costs and increased scrutiny of the security of reinsurers. In commercial lines we can expect facultative reinsurance costs to be high and capacity hard to come by in 2004. In personal lines rising claims costs and fraud will continue to be significant factors. The FA business will remain a thorn in our side. In auto, we are bracing for a wave of refor
ms as the governments finally respond to the crisis in auto insurance and start to implement what we hope will be appropriate solutions. While we are waiting to see the outcome we all must work to educate consumers about our role as the delivery system of the government prescribed auto insurance product, not its creators. The insurance industry must do more to explain this to the public.

There is a lot of misinformation being spread about the benefits of the various public insurance systems. We need to get the message across to politicians and consumers that greater benefits mean higher prices and fewer benefits mean lower prices. This fundamental principal is forgotten when rates for public insurance systems are being compared to private insurance.

Looking at the big picture, the hard market will continue in 2004, however, not to the extent that we experienced in 2003. We will see some consolidation throughout 2004 since the big players have done their housekeeping and should be ready for some new ventures. I am optimistic that we will see improved results for most companies to the end of 2003 and on into 2004.

Charles Lawrence, president of CNA Canada

Before looking at 2004, let us reflect on 2003’s performance. Most insurers will report improved financial results primarily due to the much needed price increases of the past few years. Many insurers are claiming individual product loss ratios are now where they need to be and therefore we have “arrived”.

The potential consequences of our success are: “let’s start talking about a “soft market”, “let’s renew policies ‘as is'”, or better yet, “let’s reduce premiums below expiring terms.” It appears we may have already started to forego our commitment to “underwriting profit”. But, where does our comfort come from? Has investment income suddenly returned to the market because of higher interest rates? No. Have insurers’ ROEs suddenly reached acceptable levels? No. Have all prior year development concerns disappeared? No. Have claims trends and inflationary factors returned to zero? No. Have reinsurers decided to renew treaties as is? Doubtful. Has capacity completely returned to the market? No. Are shareholders happy? No. Would you invest your money in this business? Not yet.

The industry has taken criticism from insureds, and rightly so, for high double-digit rate increases. A sudden reversal in pricing will not translate into improved insurer/broker/client relations. A failure to commit to underwriting profit in 2004 will ultimately lead to another hard market with 20% plus rate increases. Are we once again prepared to explain this to insureds?

The real issue is not what we see for 2004, but how do we want the year to develop. If rate increases have gotten our loss ratios where they need to be this should not result in “as is” pricing, and it certainly does not mean reduced premium from expiring terms. We must continue to focus on claims trends and the increase in the cost of business. The forecast for 2004 looks promising in the absence of any major catastrophe events. This forecast does not mean double-digit ROE for many companies, and the rating agencies will not quickly reverse their analysis of the industry as one year does not make a turnaround.

In 2004 we will be determining the profitability of 2005, 2006 and 2007. A failure to cover increased costs through an effective pricing strategy will produce failure in the coming years.

Bill Star, president of Kingsway General Insurance Co.

The insurance industry, especially in Canada, is still facing many challenges going into 2004. Private passenger auto is the greatest problem due to the amount of political interference. Fraud continues to play an important role since most insurers take the way of least resistance and pay losses instead of fighting or challenging questionable claims.

However, rates for property and commercial auto have remained firm and should still have moderate increases. That said, there is downward pressure by most provincial governments in Canada to reduce rates on private passenger auto even though most companies have combined ratios in excess of 100%. With investment returns at an all time low, a combined ratio of 95% must be attained in order to give shareholders a reasonable return.

During 2002 and 2003 we have seen numerous failures in the industry. Mergers and acquisitions have played an important role in a changing marketplace in the U.S. In this respect, we can expect to see changes in Canada as foreign companies become unhappy with unreasonable regulations that prevent them from receiving an adequate return on their investments.

Automobile insurance will be the main topic on the agenda during 2004. Of the provinces where insurers compete for business, Quebec is the only province that does not have a problem. Regulators in all other jurisdictions are not willing to effectively deal with the product. They must face the fact that premiums will continue to go up unless they make changes to reduce benefits and the associated claims costs. They must set limits upon court awards and eliminate no fault benefits that lead to fraudulent claims. The industry must accept some of the blame for not taking a strong stand on claims and for giving in to the whims of politicians.

The FA will also have to change in that servicing carriers must be held accountable for the serious deterioration in the results. We may see a return to an assigned risk plan which would then make each insurer responsible for the results of risks assigned to them. This could be tempered with a pool for losses in excess of one million dollars. A change must be made particularly in Ontario since the existing system in not acceptable. Overall, it will be a challenging year, the result being “the survival of the fittest”.

Nicholas Smith, attorney in fact in Canada for Lloyd’s Underwriters

For insurers, recent years have been ones of searching: to rediscover the virtues of underwriting discipline, risk selection and rate adequacy. We have also been searching for an explanation to the maelstrom of criticism that has hit us from the popular prints and politicians, and too often, searching our pockets to find the wherewithal to deal with atrocious business results.

It is to be hoped that these years of finding have produced a recipe for a sustained period of solid financial performance, as well as finding the route to work with governments and others to solve some of the structural problems afflicting us. And, in this respect, we can hope that 2004 will be the year when we see that they have been.

All in the industry – and I mean brokers and policyholders as well as insurers – need a period of calm and certainty. As the actions taken by insurers over the last two years are now bearing fruit in improving performance, 2004 should see a more stable environment in terms of pricing and conditions. Although, there will remain “pockets” of the market where capacity will be tight. Notably, “stability” does not betoken a softening, let alone a soft market. Hopefully, the hard lessons that have been taught recently may have succeeded in changing the prevailing mindset in the industry from boom-bust/soft-hard to stability = profit.

A calmer environment may well be one in which insurers’ voices can be heard better, for there is clearly a need to explain our products and the factors involved – i.e., regulatory, judicial, reinsurance and so forth, which ultimately drive pricing. And, next year’s environment should certainly be one through which insurers should seek to repair some of their frayed links with brokers.

Making predictions about a market of some 70 businesses is always difficult, but I am pretty confident in stating that Lloyd’s underwriters will not be rushing to insure auto in the Maritimes, or Canada generally, in 2004. In 2003, the market had its highest ever level of capacity, and predictions are that profits will be in line with 2002’s (pro-forma annually accounted) record. Capacity for 2004 is expected to be similar as for this year as the “franchise board’ is concerned not to have the mark
et over-supplied with capital. Lloyd’s Canadian business has undergone a great transformation since the millennium with a shift away from personal lines and a reduction in the number of brokers holding delegated authority contracts. I expect 2004 to be more stable, and there to be some modest growth in premium volumes. OSFI’s solvency requirements – internationally uncompetitive generally, but particularly punitive for Lloyd’s – will continue to act as a brake to further expansion for a market that operates as a global business.

Rowan Saunders, president of Royal & SunAlliance Canada

The industry will finish 2003 with an underwriting result of slightly above 100%, producing a return on equity (ROE) of slightly better than 10%. This will be the best underwriting result the industry has had since the late 1970s and there is already concern that prices may begin to soften. Yet, by comparison, both the banking and life sectors are producing ROE’s of around 15%. Historically, the p&c insurance industry is subject to severe pricing cycles and inadequate long-term profitably. We need to break out of this cycle and consistently deliver a reasonable level of profitability – both to generate and retain sufficient capital for the industry and to avoid the market dislocations which such severe pricing cycles create.

How can we make this happen? In the short-term, it will require the support of provincial governments to develop a stable auto product on which the industry can make a reasonable return. Over the longer term, it will take discipline on the part of the industry to maintain adequate pricing levels. With over 200 companies competing for about $30 billion in premiums, this will be a challenge. By contrast, the banking and life sectors are each dominated by three to five leading companies. The p&c insurance sector needs further consolidation and the emergence of 3-5 market leaders.

At Royal & SunAlliance, we intend to maintain pricing discipline in the face of any market softening. In the current investment environment, we believe that companies need to achieve consistent underwriting profits to ensure a reasonable ROE and we will price to this objective. We are building stronger relationships with a smaller number of more strategic brokers. We are also moving forward with a number of technology initiatives, notably “WebBusiness” that will add value to our broker partners and enhance our operating platform. We are continuing to refine our underwriting risk selection and claims processing. Our results in 2003 reflect a dramatic improvement from 2002, and we expect continued improvement in 2004.

Peter Parkin, chief operating officer of The Sovereign General Insurance Co.

I look to 2004 with mixed feelings, as I think most insurance professionals would probably admit to. On the one hand, we have an industry that has improved its underwriting position quite dramatically as compared with the ravaged position it was left in from years of insane price-cutting and capital losses. On the other hand, the staff employed by the industry is angry and demoralized by the assaults it is taking on virtually every front.

The news media and radio talk-show hosts choose to ignore the wonderful work the industry does in rebuilding lives. Instead of discussions about the insurance industry’s response to the B.C. wildfires, the B.C. floods and Hurricane Juan – all devastating and life-altering events – the public is barraged with high insurance rate propaganda. I look ahead to 2004 wondering when the public we serve will begin to figure out that if the business was profitable, rates would stabilize and even come down. That is how business and the economy works. What company in their right mind would deliberately price a profitable business segment so high as to lose that segment? If a business segment is profitable, why would a company stop writing new business and even pull out of territories? Those actions should tell people something.

Insurers around the world have suffered from capital depletion and the absence of new capital. Underwriting profit should, of course, always be seen as essential, but insurers tend to forget this in their quest for marketshare. However, with the industry in the state it is currently in, I expect “underwriting profit” will be the trendy slogan for some time to come.

Without new “willing capital”, there are very few ways left for insurers to finance their growth. I forecast that rate increases in commercial lines will continue, but at a more moderate pace. Restricted ROEs in the auto line by certain governments will force insurers to look to achieve more reasonable ROEs in the non-regulated lines. Of course, in their efforts to impose “politically acceptable” ceilings on auto ROEs, we have not seen governments offer to put a floor on losses – even though insurers will be forced to play by their rules, their rates, and trust that the courts will not erode minor injury definitions.

In 2004, federally-chartered insurers will continue to be perplexed by the conundrum of being stuck between a rock and a hard place. On the one hand, being regulated by the Office of the Superintendent of Financial Institutions (OSFI), a government body that is responsible for and truly cares about the health and solvency of the industry’s players, whilst on the other hand, having to put financial health at risk due to the grandstanding demands of provincial regulators who only seem to care about votes. Perhaps the two levels of government should talk to each other? If we did not know better, we would think this was right out of Monty Python.

Gregg Hanson, president of The Wawanesa Mutual Insurance Co.

As we began 2003 the industry knew we were into a hard market, but I do not think anyone really foresaw the significant consumer backlash and government reaction to the rate increases that were introduced. With return on equity below 2% in 2002, clearly insurance companies had to take action. However, no one could argue that we handled this process very well.

We need governments to work with us to change the auto products, but it is clearly an uphill battle. Governments find us to be a convenient “whipping boy” on which to blame their problems. We all want a stable marketplace, but if we (companies, brokers and government) do not work collaboratively, this simply cannot be achieved. In this respect, I believe we are having some success in Ontario and New Brunswick, although auto loss ratios in Ontario are still too high.

The rate freeze and rollbacks in Nova Scotia are very aggressive, so it remains to be seen how cooperative the government will be when companies file new rates beginning in July 2004. Alberta is still very much the “wild card”. The problems are just not as acute in Alberta, but while the industry has proposed several versions of solutions to solve the problems, the government has not been listening. We very much hope that “cooler heads” will prevail in 2004, and we will be able to manage that situation to a successful conclusion.

After relatively low catastrophic activity for our industry over the past few years, 2003 changed that trend. Most of it occurred within a three month period. A large hailstorm in the prairies, the Kelowna fires, the impact of Hurricane Juan on the east coast and water damage losses in Vancouver, all remind us that we must respond quickly and fairly to our customers’ needs in these events to confirm that we are truly providing “peace of mind”. Meanwhile, Facility results have been a catastrophe in itself.

As we look forward to 2004 we must gain back the confidence of the governments to work with us rather than against us. And, we need to win back the favor of the public with the help of brokers in providing better information on what drives the cost of insurance. If claims costs can be controlled, so too can the pricing. In the end we all want the same thing – a stable, well functioning, competitive marketplace that operates with the best interest of the customer in mind.