July 1, 2000 by Sean van Zyl, Editor
The 2000 Canadian Insurance Congress — which this year celebrated its tenth anniversary as Canada’s premier annual reinsurance/primary company CEO forum — drew together a strong cast of speakers from across the sectors of the North American property and casualty insurance industry. The underlying message presented to the senior management audience was the need to deal with a rapidly changing marketplace in terms of technology advancements, the declining growth of traditional markets, heightened consumer expectations, and what is rapidly becoming a less-than-friendly legal court environment.
Set against the stark and rugged beauty of British Columbia’s Whistler Mountain resort, this year’s Canadian Insurance Congress drew focus on the forces of change sweeping through North America’s financial services industries. In particular, speakers at the congress stressed the need for reinsurers and insurers to investigate new growth opportunities against a backdrop of contracting traditional markets.
In the opening presentation to the insurer CEO audience, Paul Kovacs, chief economist for the Insurance Bureau of Canada (IBC), stresses the need for Canadian insurers to address the current imbalance between poor premium growth and rising costs. And, he observes, although last year’s financial returns for the industry were unfettered by the prior year’s ice-storm claim hit, the numbers remain dismal. Most stressing, he adds, is that signs of a broad rate hardening in 1999 had lost steam by the final quarter of the year, according to the preliminary data for the first three months of this year. “Last year’s return on equity (ROE) of 6.5% and a combined ratio of 106% is simply not sustainable [to achieve long-term growth]. Despite coming off the ice-storm, we haven’t been able to recover the bottom-line.”
Most telling from the figures is an established downward shift in the industry’s premium growth rate relative to Canada’s gross domestic product (GDP), while the combined ratio has moved out of sync with the long-term trend movement of interest rates (see charts). Historically, insurers have softened their discipline on the underwriting ratio when interest rates have trended upward, thereby providing relief to the bottom-line through higher investment returns. The industry’s financial returns for the last two years suggests, however, that insurers have discarded this wisdom, allowing the combined ratio to continue tracking upward despite a downturn in interest rates. Kovacs is also less-than-optimistic of a sustainable strengthening of interest rates in coming years, suggesting an improvement in the industry’s financial performance will have to be brought about through more stringent underwriting and renewed focus on premium growth.
Although the industry’s financial performance remains disappointing, Kovacs is optimistic of improved pricing conditions this year. However, he cautions, premium growth is likely to be modest for the 2000 financial year with all indications pointing to a stubbornly high combined ratio. As a result, Kovacs does not expect the industry’s ROE for this year to rise much.
A similar scenario is unfolding in the reinsurance market, comments Sean Mooney, chief economist at Guy Carpenter & Co. Inc. (New York). Globally, reinsurers are in stress, he says, with the growth outlook for both the Canadian and U.S. markets likely to be of slow decline over the next ten years.
While the U.S. reinsurance market has seen some selective hardening of rates on renewal of business, this has not flowed into the Canadian market, Mooney observes. Canadian reinsurers reported a combined ratio of 105% last year, somewhat lower than that of their U.S. counterparts. As such, there has been less pressure in Canada to bring about rate increases and renewals for 2000 have largely remained flat, he notes.
With traditional areas of business unlikely to produce meaningful growth in coming years, particularly in light of intense competition from non-traditional entrants to the market, reinsurers have to refocus their business strategies and employ excess capital for expansion into new areas of risk and risk-product development, Mooney stresses. “Insuratization” is likely to become the next area of advancement in the reinsurance market, he adds, whereby insurance money will be directed into what are currently not seen to be “insur- ance risks”. Essentially, Mooney expects reinsurers will respond to the advancement of the investment banks into the traditional risk underwriting business by developing their own “alternative risk products”.
This view is supported by John Snyder, the executive vice president of rating agency A.M. Best Company. He expects the role of the reinsurer will evolve over the next ten years to become a “conduit” or intermediary in developing risk solutions between the insured markets and global financial institutions.
Jorgen Jensen, vice president at Employers Reinsurance Corporation (ERC), confirms that the international landscape of reinsurance is changing rapidly. In many instances, the change-process is being driven by external factors to the industry, he adds, with information technology advancements playing center stage. Jensen believes, however, that the insurance industry’s typical “reactionary attitude” to dealing with change could prove self-defeating. “Strategy development is critical, we’ve become too focused on action plans but don’t take the time to think out what we are really doing. We need to reduce the processes and maximize on human ingenuity, to ‘think outside of the box’ rather than ‘cubbyhole approaches’.”
The distribution revolution
Addressing the changes occurring at the distribution end of the business, Ted Belton, author of the Belton Report, notes that this has been the “hot button” of the industry throughout most of the 1990s.
What initially began as a legislative reform debate sponsored by the banks in a bid to gain access to selling insurance has subsequently become a much larger force of change which is being driven by heightened consumer expectations and the growth of direct writers through new technology delivery capabilities, he says. “What started out as a ‘distribution revolution’ [in the 1990s] is going to become a war. I predict that those who had problems coping with change in the 1990s are going to be overwhelmed in the years ahead.”
Belton believes the “bank threat” in insurance distribution has become a non-issue due to the successful political lobbying efforts of the independent brokerage community. “Even if the banks were to gain some legislative freedom, they are not likely to dominate the market due the changes [within the industry] already underway,” he comments. Rather, the real forces of change facing traditional players in the market is being driven from within, he adds, with the proliferation of direct writer call centers. “These [call centers] are mostly owned by traditional players and not new entrants.”
Belton expects distribution will continue to be a major competitive factor in the years ahead. In that respect, he sees companies embracing multi-distribution strategies as being the most successful. The broad acceptance by the public of the Internet as a comparative information source is a prime example of the shift in power from the intermediary to the end consumer. And, he adds, the changes occurring in this respect are not limited to insurance or financial services, consumerism is having an impact across all industries. As such, Belton refers to the recently announced pilot project by Ford Motor Company to sell vehicles in Canada directly to the consumer over the Internet as well as through their dealer network. “Insurers need to get over their concern that multi-distribution is betrayal of the broker market. This process of change should be called “reintermediation” rather than “disintermediation” — it’s about offering the consumer options.”
Red tape reform
“Flexibility and transparency” are the cornerstones of the anticipated federal package on financial services reform expected to be tabled before the close of the cur
rent parliamentary session, says Julie Dickson, assistant superintendent at the Office of the Superintendent of Financial Institutions (OSFI).
The new rulings include streamlining of financial institutional ownership and capital investment guidelines, she adds. However, most importantly to the insurance sector, the proposed legislation has shifted a considerable degree of decision responsibility to OSFI from the Ministry of Finance. The result will be greatly enhanced responsiveness to industry approvals submitted to OSFI, she comments, including decisions regarding provincial and foreign acquisitional interests. “The Federal Minister [of Finance] has given OSFI more power to make decisions, a very important decision in streamlining the regulatory process…OSFI is finally becoming a fully financial services integrated body.”
Integrated financial services and regulatory reform were key to the message given by Dina Palozzi, superintendent of the Financial Services Commission of Ontario (FSCO). She refers to the recent announcement that FSCO and the Securities Commission of Ontario will be merged as one body serving the province’s financial services sectors. There is no question that the traditional pillars of the financial sectors are coming down, she surmises, and both provincial and national regulators have to be prepared to move with the times. “Innovation has become key to success, regulators have to adjust to this reality.”
Palozzi says FSCO’s proposed financial services reform package, set to go ahead for approval later this year, is based on models developed in the U.K. and Australia. “They observed that regulation should be based not on sectors but according to market conduct.”
Other than her role at FSCO, Palozzi is also a key figure within the Canadian Council of Insurance Regulators (CCIR) and the National Joint Forum of Regulators (NJFR), of which both bodies have been working to streamline provincial regulation, she notes. So far, 15 of 20 provincial and territorial regulators have signed an agreement to work toward a basic set of consumer protection standards whilst lifting licensing restrictions on financial intermediaries, she says. “There really is a single industry out there, and the federal government has insight into this.”
Although there is a strong case for provincial harmonization of financial services regulation, concedes Bob Hobart, superintendent of Financial Institutions of British Columbia (FIBC), some issues are too specific province-by-province according to consumer needs. For instance, he argues, B.C.’s auto market (which is dominated by the state monopoly held by the Insurance Corporation of B.C. (ICBC)) is very different from that practiced in Ontario or Alberta. “I disagree that a single regulator of market conduct regulation is the right approach. I believe this is better served by a local agency…auto insurance is a good example of how each province treats the business differently.”
If insurers do not already have enough of a headache dealing with rising claim costs and sluggish premium growth, the claims management field is likely to become an even hotter potato as punitive court awards against the insurance industry continue to escalate, warns Lee Samis, senior partner at law firm Samis, Blouin, Dunn, Toronto.
Samis expects punitive damage and class action suits against insurers will continue to rise in numbers and value in the years ahead. Two key factors are likely to play a role in this respect, he says, the first being a changing Canadian public attitude to compensation and how the courts are reacting to popular opinion, and secondly, the migration of good legal talent away from institutions to the plaintiff bench. In the first instance, Samis believes Canadians are adjusting their views more toward that of the U.S., which to a large extent is being promoted by lawyers pursuing contingency fees. In the latter case, Samis says insurers are partly at fault in not retaining quality legal talent which has seen a migration of senior and very experienced council to the opposition. “Movement of the talent from one side of the field to the other…this is definitely something to be concerned with.”
Samis also drew attention to the careless use of documentation and emails, many of which have found their way into the court as part of the plaintiff’s defense. In a fictional context, he refers to the popular movie, “The Rainmaker”, and in real life, the State Farm aftermarket auto parts case, as classic examples where internal company paperwork has been used against insurance companies. “The State Farm case is a typical example of lack of control over document security.”
Samis suggests two positive courses of action insurers can take to combat the growing threat of punitive litigation. Firstly, he points out that the courts only ever see insurers in a bad light, namely when they are contesting payment of a claim — “this is something we should try do something about”. And, he notes, the industry as a whole should look at working in cooperation with other industries in a joint initiative to compile legal research to “correct these legal imbalances”.
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