Underwriting performance HERE, and SOUTH

Canada’s domestic property and casualty insurers have relied heavily on investment income to make up for their lackluster underwriting results. In addition, the companies’ underwriting performance is marked by higher expense ratios than those of their U.S. peers.

Underwriting ratios for insurers have averaged 104.1 for the past five years. In 1998, the average underwriting ratio was 105.1. The companies have relied on investment income to generate after-tax ratios of return that have averaged 11.14%, with a rate of return for 1998 of 9.0%. During the same period, reserves to surplus have gone from 183% in 1994 to 149% for year-end 1998. This clearly reflects a tightening of the domestic industry’s underwriting liquidity and use of revenue from investing activities. From an underwriting leverage perspective, the property and casualty industry has maintained a very conservative premium written to surplus ratio, with a ratio of 1.89 to 1 for 1998.

U.S./Canadian comparison

A comparison with the U.S. property and casualty industry is enlightening in this regard. In both countries, insurers have benefited from the extended bull market in stocks, which has bolstered earnings and surplus. While much has been made of U.S. insurers’ reliance on stock market gains, the fact is that 77% of the industry’s investment portfolios are in fixed-income securities. Common and preferred stocks account for about 23% of U.S. companies’ total investment portfolios, with stocks more aggressively held by larger companies.

Analysis of the data from A.M. Best Canada Ltd.’s “WinTRAC P&C ’99” database shows that the Canadian industry, in total, had 22.4 % of its investments in equities (preferred plus common). For Canadian companies only, a larger proportion of equity holdings were in preferred stocks. When foreign-owned companies are excluded, the overall percentage for equity holdings rose to 27.9%. We also noted that, for 12 companies, equity holdings represented more than 50% of the investment portfolios (see chart, next page).

In the U.S., the property/casualty industry has been a net seller of common and preferred stocks in recent years. Effectively, the industry’s growth in stockholdings has been the result of valuation gains. Most insurers’ investment returns are under pressure because they limit their positions in common stock and because of declining fixed-income investment yields. Considerable stock sales over the past several years reflect investment managers actively selling and buying common shares to remain within investment guidelines, as well as the desire to lock in gains and increase earnings and profitability measures. This indicates the recognition by U.S. companies of the importance of risk and investment management.

The overall investment strategies for companies in the two countries are different for a variety of reasons. The tax-exempt status of dividend income from common stock and specified preferred stock holdings for Canadian companies is a major difference, as all dividend income in the U.S. is taxed. In addition, realized and unrealized gains in Canada are subject to tax, with unrealized gains taxed on a mark-to-market tax basis.

The role of investment income (including realized capital gains) in supporting U.S. and Canadian insurers’ earnings is illustrated in the accompanying chart. For U.S. companies, net income and investment income have moved steadily upward in tandem, while underwriting losses — excluding an unusually profitable 1997 — have remained generally flat.

Canada’s net income also has generally risen in recent years in the face of uniformly poor underwriting results. However, as the chart shows, net income in Canada has risen slowly while investment income climbed at a more pronounced rate — except in 1998, when both measures declined. At the same time, growth in net premiums written has been static, at about 0.2%.

This reliance on investment income, rather than underwriting performance, may need to be addressed by the Canadian industry in the event of a sudden and sustained stock market downturn. In addition, depending upon catastrophic reinsurance protection purchased, operating results could become even more depressed if a string of natural catastrophes were to occur. A.M. Best notes, however, that investment strategies employing tax consideration would focus investment in more secure equities.

Underwriting — combined

ratio differences

An analysis of Canadian companies’ underwriting performance reflects pure loss ratios that are consistently lower than those of the U.S. industry, with an expense component that is consistently higher.

Over the past five years, the Canadian industry’s loss ratio has been approximately five points below the U.S. industry’s, while the expense ratio has been approximately five points higher. Several factors account for the Canadian industry’s higher expense ratio. The market, in general, is composed of two major components, with personal lines comprising 72% of the market and the remainder consisting of commercial-account and other activity. The increased expense costs relate to higher acquisition costs for both activities in the Canadian market. In particular, the bulk of personal lines activity is written through brokers, while the acquisition costs for commercial business is higher than in the U.S. market.

Some price firming expected

In the near term, A.M. Best Co. expects that downward pricing pressure will abate, with some price strengthening in selected geographic regions and product lines. In Quebec, for example, some price hardening in personal auto — a sector that accounts for approximately 40% of the Canadian property/casualty industry — already is becoming evident. These trends, combined with the conservative underwriting leverage, mitigates concerns over the industry’s reliance on investment income. However, it is anticipated the industry will continue to have a higher proportion of investments in equities as a matter of investment strategy that would be in keeping with investment returns not subject to tax. In the long term, A.M. Best expects that automation and consolidation at the agency and company levels will contribute to expense reductions and improved underwriting results.

TOP 10 P&C INSURERS IN TERMS OF PERCENTAGE OF EQUITY HOLDINGS: