Capital’s Pendulum

Although Canada’s property and casualty industry remains well-capitalized, skyrocketing personal accident loss ratios in the auto product and increasing property losses still pose a challenge for insurers.

On Sept. 10, A.M. Best Company held its 2009 Insurance Market Briefing — Canada in Toronto. During a series of panel discussions, the rating agency laid out hurdles that it says the industry still needs to overcome, despite reassurances from many experts that the economy is nearing the end of a deep recession.

PROPERTY AND CASUALTY PANEL

Overall, Canada’s property and casualty market is stable, despite underwriting and investment losses, said Joseph Burtone, assistant vice president at AM Best.

The industry’s BCAR (Best’s Capital Adequacy Ratio) was 221.8 at the end of 2007, and this figure dropped to 200 by the end of 2008. “But this is still well in excess of the minimum 175 required for an A++ rating,” Burtone observed. “This tells us that despite the drop in capital, there is still an excess in the system.”

The industry has less net income, he said, noting that by June 2009, the net income was 28% lower than the net income of June 2008.

He put the statistics into context, noting that the years leading up to the financial crisis were banner years. But still, he said, “we knew previous years of profitability were unsustainable.”

Injury loss ratios are one of the main drivers of the losses, the panel suggested. In fact, it’s quite likely Canada’s personal accident loss and LAE (loss adjustment expense) ratio will reach 120% by the end of 2009, said Charles Huber, senior financial analyst with AM Best Company.

The combined ratio (COR) for Canada’s property and casualty industry in the calendar year 2008 was 101%, Huber noted. For the accident year 2008, it was 105.7%.

“The reduction down for the calendar year to 101% was because of a Cdn$3-billion reserve release from prior accident years,” he said. “This would equate to 110% or more on the combined ratio for the accident year if those reserves had not been released from prior accident years.”

Increasing loss ratios, particularly in Ontario auto, are driving the CORs, he continued.

The loss and LAE ratio was 70.8% for the entire industry in 2008. In the first half of 2009, it was 69.9% he said.

In auto, on the other hand, the loss and LAE ratio stood at 116% at the end of 2008.Through the first half of 2009, that ratio increased to 118.7%.

“This is not just Ontario, it is across the country,” Huber qualified. “But in Ontario, it is probably higher.”

Huber said he anticipated the loss and LAE ratio to go up by another point or two, so that the ratio would hit 120% by the end of the year.

“We are greatly hoping that a permanent stabilizing solution comes down the pipe because this may affect companies’ ratings,” he said.

As of press time, the Ontario Minister of Finance had not yet released a much-awaited response to a series of recommendations for auto reform released earlier this year by the Ontario insurance regulator, the Financial Services Commission of Ontario (FSCO).

Overall, “we believe that the market is stable,” Burtone said. “In prior years, companies kept a lot of capital in the operating units and now we’re at a crossroads in the industry.” Nevertheless, he said, “we believe that at this point, [even] with the challenges the industry faces, the capital should be able to withstand any of these challenges and the industry should maintain a stable outlook.”

The rating agency expects return rates to decline, but also expects them to remain profitable, he continued.

“Underwriting will continue to be challenged with volatility in the auto sector,” Burtone said. “There is uncertainty around the regulations in Ontario, there are legal challenges to the minor injury caps [in other parts of the country], and it seems that commercial pricing hasn’t really broken that price floor yet, but it has to happen at some point.

“When you’re running a loss ratio around 70% and expenses are taking up around 30%, in order to remain profitable, someone will have to pull that first gun out of the holster at some point.”

REINSURANCE MARKET REVIEW

When it comes to capitalization of the Canadian reinsurance market, the “pendulum is really swinging,” said Robert DeRose, vice president of AM Best Company’s U.S. reinsurance and Bermuda market segment.

At the beginning of 2009, Canada’s reinsurance market was very focused on capitalization preservation, DeRose told delegates at the A.M. Best market briefing.

“The capital markets were dried up,” he said. “People were really concerned about financial flexibility. That’s easing somewhat.”

Companies have really started to build capitalization from their earnings and from the low catastrophe losses they’ve incurred, he added. “Now they are focussing on ways to deploy it.”

But managers of reinsurance operations need to be wary of releasing loss reserves to soften deteriorating accident year results, DeRose cautioned.

“The big culprit is inflation,” he said. “You need to make sure that you’re pricing [for] factors that might be five years off,” he said. “If you are using reserve releases to offset pricing, by the time that you hit five years off, there may be problems… We’re keeping a close eye on it.”