? What Happened To The Hard Market

2009 may well be remembered as the year the commercial soft market stood still.

During the last quarter of 2008, the full fury of imploding stock markets affected Canada’s property and casualty market, causing the net investment income of Canada’s federally regulated insurers to plunge from just over Cdn$4 billion in 2007 to Cdn$2.7 billion, the result linked to the U.S. credit market meltdown. Those losses continued in 2009 Q1, with the industry reporting to MSA Research investment gains of Cdn$401.67 million, down 39% from investment gains of Cdn$661.7 million in 2008 Q1.

Given a projected loss in premiums written as companies tightened their economic belts and attempted to do “more with less” in their insurance portfolios, and given no sign of substantial rate increases in insurance segments showing higher and higher loss ratios — auto and homeowners, for example — several industry observers felt a hardening market in commercial lines in Canada would be imminent.

Only it didn’t happen.

“So where is the hard market?” as MSA Research asks in its MSA/Baron Outlook 2009 Q1 report.

Many theories abound, but the role Canada’s regulatory system played in “softening” the blow of the global credit crunch north of the 49th parallel is frequently cited as a factor in creating a stable financial environment — one in which a soft commercial market might thrive.

As a general rule, Michael Boire of HKMB/Hub International observes, Canada’s insurance market has been stable, despite the market turmoil elsewhere. “The Canadian market has always been pretty profitable compared to other economies throughout the world,” he says. “We still seem to be less hit than other economies, so it’s not a bad place to continue to do business.”

Such stability is attributable in part to the “bang-up job” Canadian regulators have done in making sure insurance companies have adequate assets to meet policyholders’ needs, says Justin MacGregor, executive vice president of Martin Merry and Reid. Ltd. “I know there have been attempts to have the regulators relax their stringency, but I think the proof of the pudding is in the eating,” MacGregor says. “Largely in the whole rest of the world, insurance companies were watching their investment portfolios being savaged by the markets. The insurance companies have taken some pretty hefty write-downs in Canada as well, but not to the point where it’s made them gasp in desperation because their risk portfolios have been completely decimated. I think that regulation has helped maintain a stable market.”

The stable market has in turn attracted new market entrants, including W.R. Berkley Corporation, a big insurance player in the United States market, and Axis Canada Inc., which was authorized to write business in Canada in 2008.

“Canada has always been somewhat like Australia,” observes Michael McLachlan, president of Berkley Underwriting Managers Canada Ltd. “It has a very competitive environment, because it’s an attractive place to do business.”

For Berkley, the move to Canada follows a global strategy to have operations in every major insurance hub in the world, McLachlan says. For others, Canada was an attractive place to park their capital when U.S. rating agencies expressed concern about exposures south of the border.

“A few years ago, a lot of these U.S. companies — or originally they were Bermuda companies, and then they got licensed onshore in the States — were forced to move capital out of the U.S. because of the rating agencies saying to them, ‘You need to reduce your exposure to catastrophe.’ So they looked around the world and said, ‘Okay, so where can we set something up that isn’t cat-exposed; that there is still respect for the letter of the law; that has potential for profitability; and they speak the same language, mostly, as we do? Hey, what about Canada? Good place.”

Berkley and others are bringing substantial capital to bear in a market that is already extremely competitive and overcapitalized.

MSA Research and other commercial brokers say that although Canadian commercial lines insurers have shown some rate discipline — some brokers cited examples in which insurers walked away from some cut-rate business — competition for business is nonetheless fierce. “AIG is fighting to hold onto volumes,” MSA Research’s 2009 Q1 report notes. “The London market (Lloyd’s) is continuing to be aggressive and multi-line writers are seeking refuge from their personal lines woes in commercial.”

(Both Lloyd’s and Arch could not be reached for comment as of press time. AIG declined comment.)

“Insurers are trying to come back with as-is renewals and, at the end of the day, a new company that wants to write the business will take it away from them,” says Boire, president elect of the Toronto Insurance Conference (TIC), an association of Canadian commercial brokers. “And they’re all hungry.”

Indeed, MSA notes that at the end of 2008, there was almost Cdn$8 billion of excess capital in the Canadian property and casualty sector. “This excess $8 billion can support [Cdn]$16 billion of NPW [net premiums written] or more,” the Q1-2009 MSA Baron/Outlook Report notes. “This is enough to write another replica of Canada, excluding Ontario.”

Everyone talks about a hardening market in Canada being likely sometime down the road as part of a “traditional market cycle,” and many say such a hard market is needed. But if it isn’t going to happen as the result of a financial crisis — and indeed, the 2009 Q2 results of many Canadian insurers are showing signs of a rebound from the dire days of 2008 Q4 — then what will trigger it?

“The one thing that’s different in Canada than in the United States is automobile,” observes McLachlan. “So if the big players start to lose money in automobile — and that will depend on the [reaction] of the Government of Ontario — well then they tend to kind of draw back. And they say, ‘Okay, maybe we shouldn’t be writing some of this commercial lines business that we’ve been dabbling in for the past few years,’ and then that market hardens up as a result of it.”

But even here, insurance regulation has contributed to a relative degree of commercial market stability. MacGregor notes that although regulators generally don’t want to raise consumers’ auto insurance rates, Ontario’s insurance industry regulator, the Financial Services Commission of Ontario (FSCO), has responded to an epidemic of increasing loss ratios in the auto product. In 2009 Q1, for example, FSCO approved an average rate increase of 5.86%, with the CAA Insurance Company (Ontario) receiving the largest rate increase of 12.1%.This may not be anywhere close to the 14-16% most insurers need to stave off their losses, MacGregor notes, but it has had an indirect impact on commercial rates, keeping the commercial market soft.

“When we go into the up and down cycles of the hard and soft markets, quite often they’re actually not [driven] by commercial lines losses, they’re treated by personal lines losses,” MacGregor says. “Auto is one of the largest [personal lines] segments of insurance in the country. So if auto insurance is losing money… they’ve got to find a way to make money. And if auto rates are regulated, and insurance companies are only going to be allowed 2% or 3% rate increases when actually they’re losing 14-16%, what do they do? They are going to have to put up rates in the other areas [i. e. commercial lines] to counterbalance that. And since those other areas form a smaller proportion of the overall market price, they have to act even more dramatically [in commercial lines] to counteract the inadequate reaction in segments that caused the problem — the automobile segment.”

But given FSCO’s approval of rate increases more in the order of 5-7%, there is less pressure on insurance companies to make up the difference by increasing their commercial lines rates, MacGregor says.

Both MacGregor and MSA note that reinsurance rates have started to increase, but th
is in itself is not enough to cause the primary markets to do the same. So it will be awhile yet before commercial rates start to harden, observers note. Barring major catastrophe losses in what has been a quiet hurricane season thus far, McLachlan says, the soft market in Canadian commercial lines is expected to continue for at least another 12 months.

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Insurers are trying to come back with as-is renewals and, at the end of the day, a new company that wants to write the business will take it away from them.