January 12, 2016 by Angela Stelmakowich, Editor
“Capital tends to follow opportunity,” and while Canada is currently viewed as a region affording opportunity, the property and casualty insurance industry here could experience significant pressure if investors start regarding other areas as greener pastures, Philip Cook, CEO of Omega Insurance Holdings Inc., suggested Tuesday during a presentation in downtown Toronto.
“It’s very positive that in 2015, we had an underwriting profit as well as investment return, because it means that the investment community will probably stay with the p&c industry even if more opportunities come up somewhere else,” Cook said during his 11th installment of Industry Trends & Predictions: 2016, an annual event presented by the Insurance Institute of Canada.
Although too early into 2016 to have definitive results, he told a packed house at the National Club that by using 2015 Q3 figures and overlaying the changes that usually take place in Q4, “it looks as though, at this point, the industry actually will produce an underwriting profit for 2015.” The projection is that the domestic companies will have a combined ratio of about 97%, foreign companies will have a combined ratio of about 92% and, together, “that will come to something close to 96%, which means a 4-point underwriting profit,” said Cook, who is also a consultant to several p&c insurance groups in Canada and the United States.
Despite the results, insurance-linked securities (ILS) and cat bonds can have an effect on how attractive Canada is as a destination for capital. “We’ve got to be realistic. If really significant opportunities come up in another country or in another area, then that capital will tend to follow those opportunities and that will put significant pressure on the Canadian insurance industry,” Cook said.
Those pressures could be “from the perspective of raising more capital or from the perspective of head offices of companies wanting to take back the capital they have here,” he explained. “We know we have a lot of surplus capital in Canada. So it’s certainly something to watch.”
One need only consider what has happened with China, he suggested. Last year, a huge amount of capital – not necessarily in insurance – was headed in China’s direction because of the opportunity and the government’s ability to control exchange rates. Recently, that has completely reversed.
“There’s now a flight of capital out of China and Chinese capital moving to the U.S. and other countries,” Cook told attendees. “Capital that had gone into China over the last two years are bailing out now because they realized that the Chinese government can’t stop the slide of their currency,” he said.
How might Canada’s p&c insurance industry remain attractive? “A good first step is actually creating an underwriting profit,” Cook told Canadian Underwriter in an interview. “That means that when investors look at things, they’re comparing us to the regular returns that they can make, plus an underwriting return. So that’s a good step in the right direction,” he explained.
“It probably means the capital will stay where it is for a while, but my bigger concern is still that if some other area develops, where the returns are more attractive, that capital will gravitate to that,” Cook said.
An example would be an insurance company in Canada that is a branch of a foreign company. If the foreign company has an opportunity to write something elsewhere, “they look around to see where their capital is sitting not doing anything, and repatriate it from their branches in Canada,” he told CU.
“The regulatory changes that we’re seeing are requiring more and more capital to support the business,” Cook told attendees. As such, “there’s an attrition of capital on that side and a need for more capital on the other side. In a sense, we’re quite fortunate that there aren’t other places in the world where that capital can generate more return,” he commented.
What is really “sucking up the additional capital is the whole ILS market,” Cook pointed out. This is already having an effect on the traditional reinsurance market, he said, suggesting that insurance may soon be next.
“It’s been interesting over the last 12 months to see that the cat bond market hasn’t expanded as much in 2015 as it did in 2014. What has happened is the operators of those cat bond funds have started to look at more conventional reinsurance as an opportunity to employ their funds,” Cook reported.
“Certainly, Bermuda is very, very concerned about the number of organizations that are now edging their way into more traditional reinsurance activity. And it’s probably only a matter of time before those same groups decide to look at insurance, direct insurance, as opposed to just reinsurance,” he suggested.
“The fact of the matter is a lot of that surplus capital sitting there will find its way into the reinsurance business, and possibly directly into the insurance business, over the next while,” Cook predicted. “That is a short-term prediction that will continue to happen in 2016 and it doesn’t bode well for any significant change in rates because those new entities entering that space will be entering in a very competitive nature,” he explained.
Funds, mainly pension and hedge funds, are “putting huge amounts of money in there, hoping they don’t have a catastrophic loss,” Cook said in an interview. “Funds that have invested as much as they can and getting returns as high as they can, they’re looking for more. So adding a reinsurance operation or insurance ingredient that gives them a return in addition to their investment return is attractive. But it’s also very volatile because if it starts to go the other way, they’ll go just as quickly,” he added.
“We’re nowhere close to a swing in the cycle; we’re still at the bottom. It’s still a very, very soft cycle,” Cook told attendees. What is particularly interesting, though, is that insurance companies have “started to figure out how to make money in the soft cycle as evidenced by the results for last year.”
Of course, that situation brings with it both positives and negatives. “The plus is that we have found a way to make money in a soft market; the negative is that it’s not going to suddenly turn the market to get back to significant profitability, which we may need to attract capital in the future.”