Saying ‘Hello’ to the Hard Market

As we transition into the New Year, we observe that these are indeed transitional times for Canada’s property and casualty insurance industry.

Right now, the industry’s story appears very much to be a grey zone between two market cycles.

Insurance company CEOs have noted at various conferences throughout the latter part of 2008 that by all rights we should be transitioning into a harder market during these tough economic times.

In doing so, they point to several interrelated industry statistics concerning profit margins, investment returns and claims/loss ratios.

On the profit margin side, as predicted by many over the past few years, the effects of the soft market have taken their toll on the company balance sheets. As a whole, the industry saw its 2008 Q3 profits sink from Cdn$3.6 billion to Cdn$2.3 billion when compared to the same period last year, according to data from MSA Research.

MSA Research data also shows there was an 82.9% drop in underwriting income during the first nine months of 2008, when compared to the same period last year.

As to be expected given the contracting economy, the industry’s investment income also took a hit. During the first nine months of this year, Canadian insurers saw their investment income decline by 14.6%, MSA Research data shows. This trend is confirmed in data posted by Canada’s solvency regulator, the Office of the Superintendent of Financial Institutions (OSFI). Federally regulated insurers reported a Cdn$400-million loss in net investment income over the first nine months of 2008 Q3.

The precipitous drop in profits, underwriting income and investment returns are all happening at the same time claims costs are increasing. As indicated in this month’s cover story, loss ratios are up across all lines — property, auto and commercial.

The situation is dire in auto lines. Particularly in Ontario, many auto insurers are reaching the point — if they haven’t reached the point already — where they are taking a bath in red ink (which you don’t want to do during an economic recession).

So, to recap: insurers’ profits and premium income are dwindling because of decreased rates common to soft market cycles, investment income is drying up and claims are more frequent and expensive.

So when your income doesn’t match your expenses, what do you do? You raise rates.

Indeed, all signs are pointing toward a hardening market in 2009-11. And yet, anecdotal evidence remains that the soft market is lingering. This could just be an interregnum period between the two market cycles; if so, this is the moment they refer to in baseball as the “payoff pitch.” This is the moment when insurers prove to consumers that they have learned from previous market cycles.

For a consumer, rate increases are never desirable. They are, nevertheless, justifiable as long as they are clearly explained and imposed judiciously and incrementally. It stands to reason that a 5% increase this year and in 2010 will be a lot easier to explain to consumers than keeping the status quo for two years and then hammering the public with a 30% increase in 2011.

The industry says it has learned its lesson from the painful transition period between the hard and soft markets in the early part of this millennium. The time to apply that lesson is now, during the transition from the soft to hard markets in 2009-2011.

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In my December 2008 editorial, I made a suggestion that OSFI’s Part XIII amendments were “essentially” about reserving. This was a misleading simplification on my part and I apologize to OSFI if this observation may have led anyone astray. To my critics, I recognize the Part XIII issue is far more complex than portrayed in my December editorial. By necessity, strict word count limits breed generalization, although that’s not to excuse my imprecise use of language. It didn’t help that I botched the title of the “Office of the Superintendent of Financial Institutions” and a typo appeared in the pull quote. These errors are mine and I apologize for them.

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By all rights, we should be transitioning into a harder market during these tough economic times.