Walking through Wonderland

Quarterly figures over the past three years confirm what is visible to all who have followed the (re)insurer’s latest 2008 Q2 results: insurance companies’ loss ratios are starting to become a problem.

This is true in all lines of business. For federally-regulated insurers, both licensed in Canada and abroad, loss ratios have been on a steady incline for the past three years.

For federally-licensed Canadian (re)insurers, personal property loss ratios increased from 56.25% in 2006 Q2 to 73.67% in 2008 Q2. In commercial property lines for these same Canadian (re)insurers, the loss ratio jumped from 49.70% in 2006 Q2 to 77.58% in 2008 Q2. As for auto insurance lines, it’s the same story: for Canadian (re)insurers, the loss ratio went from 68.52% in 2006 Q2 to 81.58% in 2008 Q2.

The figures for foreign-based, federally-regulated insurers are different, but the direction of the loss ratios — i. e. up — is exactly the same.

So with loss ratios on the way up, shouldn’t pricing come up accordingly?

Not when the industry has double the capacity it needs to underwrite risks in Canada. MSA Research notes the Canadian insurance market has more than Cdn$11 billion in capacity available to underwrite business in Canada. Considering that Canada’s biggest claims event ever — the 1998 Ice Storm in eastern Ontario and Quebec, resulting in around 800,000 claims — cost Canadian (re)insurers a total of Cdn$1.6 billion, you can appreciate that it will take quite the calamitous disaster to make a dent in that kind of overcapacity.

And so, with this huge cushion at the industry’s disposal, anecdotal tales of illogical behaviour abound. Loss ratios are going up in commercial lines and the credit crisis threatens to result in increased litigation against directors and officers of financial corporations? No problem, lower D&O rates further. For that matter, offer cut-rate discounts of anywhere up to 50%. After all, loss ratios in commercial lines were lower than 50% only two short years ago. (Forget about the fact that they are almost 80% now.)

Lest anyone think this is all about (re)insurers’ behaviours, guess again. The regulator’s behaviour in the sagging auto insurance market is equally puzzling. For example, auto insurance caps designed to control insurers’ expenses are under attack in the courts. One cap, in Canada’s second-biggest private auto market, has already fallen. The regulators’ response? Alberta approved a marginal rate increase of only 5%, even though insurers and actuaries say the loss of a cap will more likely escalate (re)insurers costs by 20-30%. Yes, the regulators protect policyholders’ wallets in the short term. But aren’t they also supposed to be protecting the consumers’ long-term interests?

Some insurers might tell you that, relative to the industry’s darkest moment ever, in 2001, the industry is in comparatively good shape. That’s true, if the nightmare scenario is your standard of comparison.

But at this point, the industry’s relative financial health, buoyed by a surfeit of available capacity, is obscuring the puzzling market behaviours that ultimately stand to erode the industry’s credibility when it comes to boasting good underwriting discipline. And regulators are not helping by approving only marginal rate increases in an effort to protect the policyholders’ pocketbooks in the short term.

It’s time for regulators and (re)insurers to plan a strategy for educating the consumers as to the need for increasing rates. The industry’s future financial health — and the consumers’ pocketbooks over the long term — depends on it.

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At this point, the industry’s relative financial health is obscuring puzzling rate behaviours that might ultimately erode the industry’s credibility.

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With loss ratios on the way up, shouldn’t pricing come up accordingly?