Profits for Canadian p&c insurance companies endure despite challenging market conditions: A.M. Best

Canada’s property and casualty insurance market – faced with challenging market dynamics and unforeseen headwinds like the steep decline in global oil prices – remains resilient, prompting A.M. Best to maintain a stable rating outlook for the industry as a whole.

Canada’s p&c market has benefited “from solid risk-adjusted capitalization, profitable operating performance, continued investments in underwriting technology and enhanced Enterprise Risk Management (ERM) practices,” A.M. Best notes in its most recent Canadian review and preview for the p&c and life insurance sectors, released Monday. The outlook in 2014 was stable as well.

“Strong levels of risk-adjusted capital and favourable earnings continue to reflect the overall favourable position and stability of the Canadian P/C marketplace,” the report states. As such, it was not unexpected that most A.M. Best rating actions were affirmations in 2014, namely 82% compared to 83% in 2013 and 82% in 2012.

Overall, the p&c industry remained profitable in 2014, with pre-tax operating income of $4.8 billion, up from $1.9 billion in 2013. “Net income of $4.3 billion in 2014 was more in line with the favourable results generated in 2011 and 2012, rather than 2013. Financial ratios, including a return on equity of 10.6% and a return on revenue of 12.1%, were also some of the best seen in the last five years, further strengthening the industry’s capital base.”

The industry’s combined ratio in 2014 closed at 98.5%, an improvement over the previous year, while there was a small improvement in the claims ratio “offset by a modest uptick in the underwriting expense ratio. This is to be expected as companies continue to make investments in technology to upgrade policy administration and claims systems and to leverage ‘big data’,” the report states. [Click image to enlarge]

By segment, total auto net premiums written (NPW) grew just 0.5%, significantly less than the 2.2% increase in 2013, in response to reforms implemented under Ontario’s Automobile Insurance Rate Stabilization Act, which took effect in the summer of 2013. “The loss ratio trend in accident benefits continues to remain a concern, as negative premium actions may not be sustainable and may expose the P/C industry to significant capital risk,” A.M. Best cautions.

With regard to property, “absent a major catastrophe, property results also reflected the industry’s diligence toward underwriting initiatives such as implementing plans to achieve rate adequacy, sub-limits and raising deductibles.”

The p&c industry reported premium growth in both personal property and commercial property lines. “Overall, total property NPW expanded by a healthy 7.7% in 2014, more than double the 3.6% increase seen in 2013, and slightly above the 7.4% recorded in 2012,” A.M. Best notes.

“The Canadian P/C market, along with the many individual companies participating in the market, has demonstrated resiliency in addressing ongoing headwinds and it is A.M. Best’s expectation that this industry will continue to respond appropriately to these ongoing and emerging challenges.”

These unforeseen headwinds include the following:

• a steep decline in global oil prices has negatively impacted the Canadian oil producers, causing significant reductions in planned investment spending in the energy industry;
• reduced global demand for key commodity exports;
• currency depreciation, while making exports more competitive, has increased the cost of imports; and
• slower-than-anticipated first-half growth in the non-resource sectors.

“In previous years, the oil and gas sector has been a significant driver of the Canadian economy, greatly outpacing the growth of other Canadian industries,” notes the report. “The recent reduction in prices and global demand for energy and commodities has led to reduced investment spending and increased worker layoffs, which, in turn, have increased the pressure on the broader economy.” [Click image to enlarge]

In a bid to stimulate demand, the Bank of Canada has twice cut the lending rate in 2015, the last 0.75% to 0.50%. But the cut “has shifted Canadian investment yields lower in recent months, putting downward pressure on the yield curve,” A.M. Best cautions.

“While the Canadian economy is facing some headwinds, the most recent June figures have indicated that there has been a slight expansion in mining, quarrying, oil and gas, wholesale trade, finance, insurance and entertainment,” the report states. “The slight rebound in the energy sector, however, could be short-lived and remains dependent on global supply and demand factors.”

“The Canadian P/C industry continues to respond positively to ongoing uncertainty in several lines of business, while simultaneously faced with market pressures that continue to drive consolidation,” A.M. Best notes.

A hallmark of Canada’s p&c insurance industry over the past several years, mergers and acquisitions activity has been “driven by competitive market pressures, a desire for scale and access to additional distribution channels, as well as a need to strategically align resources,” A.M. Best reports.

As a result, the report notes, M&As “have significantly impacted the shift in market share from 2007 to 2014 for the top 10 groups/companies, and it remains high on the list of industry trends.” [Click image to enlarge]

Citing the ACE Ltd/Chubb Corporation merger deal, A.M. Best notes that each company maintains successful commercial casualty Canadian operations. “Chubb Insurance of Canada, however, is almost twice the size of ACE INA Insurance from an equity perspective, with five and a half times the net premiums written. The Canadian operations are expected to be consolidated as part of the overall global merger; however, the ultimate impact on the commercial market remains to be seen.”

Aside from Intact Group, which now controls almost 16% of the Canadian p&c market, the report states, “there are generally razor-thin levels of direct premiums written that separate ultimate share percentages among this uppermost group of competitors.”

Overall, the expectation is that the M&A trend will “be further bolstered” by July’s release of the final regulations outlining the Canadian p&c insurer demutualization process, the rating agency reports.

Other key issues facing the Canadian p&c industry include the following:

• Demutualization – While Economical has been the most vocal supporter of the demutualization process, several smaller local mutuals may still need to evaluate whether or not the financial costs associated with demutualizing are practical and can provide any specific benefit. A.M. Best “does not expect demutualization to change the intricacies of the overall P/C market. It will certainly, though, impact a select few companies and may contribute to the consolidation trend.”
• Ontario Auto – The government-mandated 15% average reduction in personal automobile rates by August 2015 has caused a significant contraction in personal accident premiums and has exerted significant pressure on the industry’s auto loss ratio in Ontario. “While this market is expected to remain challenging for insurers, there have been some encouraging develops as of late,” including passage of several provisions targeting auto insurance and what appears to a reasonable approach to rate reductions, given the upward trajectory in auto loss ratios, by the Financial Services Commission of Ontario.
• Cyber Risk – “Most insurers that currently underwrite cyber security insurance policies have very specific coverages with an extensive list of exclusions. Growth potential in this market is expected to increase in the next few years,” the report notes. “From an A.M. Best perspective, data security is a key element of a robust ERM process, as much as is a management succession plan, a reserving methodology or a credit risk monitoring process.”
• Own Risk Solvency Assessment – The first round of ORSA filings have now been filed with Canadian federal regulators. “While company filings vary in length and detail, it appears that some of these filings are falling short in effectiveness. In general, while companies have documented risk profiles and appetites, they have failed to connect material risks and understanding of these risks, to the financial impact on future capital needs.”
• International Capital Standards – The global view of capital and the proposals of the Switzerland-based International Association of Insurance Supervisors to implement international capital standards remain challenging. “For P/C insurers that are part of a larger global entity, this may add a layer of complexity to the insurance group standards already in place in Canada.”

Some companies may face rating pressure in terms of changes to their outlooks or ratings, A.M. Best explains. That said, “these actions will be based primarily on individual company operations and will be a function of the interplay of risk-adjusted capitalization, operating performance and business profile, as opposed to overall market conditions,” the report adds.

While A.M. Best expects the Canadian p&c industry will continue to respond appropriately to ongoing and emerging challenges, “those companies that do not have the preparedness and/or resources to tackle these challenges head-on will likely face adverse strategic and operational risk, along with possible future rating pressure.”