Industry fragmentation may dampen enthusiasm - Industry giants call for large rate hikes

By Stéphane Desjardins | August 20 2001 07:50PM

Canadian P&C insurance heavyweights are unanimously calling for rate hikes of between 10% and 20%. But fragmentation of the market among many insurers is potentially cooling this enthusiasm and prompting the giants to decry the lack of leadership in Canada.

“We should not be surprised with the inadequate profitability of insurers, which has been a problem for years,” says Yves Brouillette, chairman and CEO of ING Canada. There are several causes for this situation, but the main one is a lack of leadership and rigour among many insurers. As a result, some of these insurers’ results are extremely dismal. Especially if you compare them to life insurers, banks and mutual fund companies.”

Mr. Brouillette made these comments in May at a round table on this topic at the Canadian Insurance Congress, held at Mont Tremblant, in Quebec. His sentiments were echoed immediately. Conference goers Robert Gunn, President for the Americas of Royal & Sun Alliance, George Cooke, Chairman and CEO of Dominion of Canada, Mark Webb, then President and CEO of CGU, and John Phelan, President of Munich Re of Canada, unanimously agreed, then added fuel to the fire.

Spurred by the intensity of the discontent, The Insurance Journal approached the CEOs of industry frontrunners. Along the way, we noted that this unanimity is not as prevalent in the field.

“Last year, the return on shareholder’s equity in the P&C insurance industry was 6%,” comments Mr. Brouillette. “Excluding capital gains, this return presently stands at 4%; it is low. And this year, there will be no capital gains but capital losses. I am convinced that this paltry performance stems from a lack of rigour among several Canadian insurers.”

Mr. Cooke admits that the only ones to blame for this embarrassing situation are insurers. “Four years ago, the people on top could see that the price was too low. This situation was compensated by 35 percent stock market returns and large amounts of unrealized returns. This has allowed companies to go and hide. Over the same four year period, there has been a reduction of reserving, making the returns look better than they should be. … Companies have been fighting for market share at the expense of sound underwriting.”

To those who suggest an average rate increase of between 5% and 10%, Mr. Phelan replies that this rise is an absolute minimum. “To counter premium inflation alone, it would take more than 5%. And that’s before you tackle the profitability problem. I would go so far as to say that 10% would do little to improve insurers’ results.” Mr. Phelan does not want to pinpoint a percentage, but he is discouraged by the lack of discipline among insurers. “It’s true, the industry is terribly fragmented. The largest player has 10% of the market. That is why it is not surprising that no one could play a leadership role.”

Several industry players mentioned European rate hikes in auto insurance, which often reached 45% in Great Britain and France and up to 50% in Italy.

“The time is more than ripe to rethink prices in our industry,” Mr. Gunn says, but the market forces do not respond easily to a general rise in prices, owing to this notorious fragmentation. On the other hand, he continues, he sees companies holding back to see what the others are doing. “We have been moving more aggressively than the others and they follow us. We take it in the chin!”

Barry Gilway, President of Zurich of Canada, stated that the average rate hike needed to turn this situation around is between 10% and 20%. “Actuaries even recommend 35%!” But he does not feel that the largest insurers need to lead the way. “The market dynamics ensure that each player sets its rates according to its target returns for shareholders. The reason that we are not making money is simply because some players have neglected profitability in a bid to conquer market share. We have no one to blame but ourselves. End of the story.”

Mr. Gilway added that the Canadian P&C insurance market is worth $20 billion, broken down as follows: $7 billion in business insurance, $11 billion in personal lines (car and home), $1 billion in large business risk and the balance in the hands of government. “I have noted, like my colleagues, that far too many players are sharing a market that is actually quite small. In comparison, the American market is 12 times the size of the Canadian market. This does not prevent the Canadian market from being very generous to consumers.“


Ted Belton is an actuary and long-time observer of the Canadian market. His Belton Report has been tracking market trends since 1975. Mr. Belton commented that he has witnessed four or five cycles since he has begun compiling statistics. Regarding rates, the industry has gone through a series of hard and soft cycles.

A competitive market in which profit margins tend to decrease characterizes a soft cycle. A drop in competitive pressure that bolsters returns on shareholders’ equity characterizes a hard cycle.

“However, with the current market fragmentation and generally satisfactory returns of previous years, I do not foresee a major correction in terms of rates. And believe me, cycles never change because of the actions of a leader. Several insurers would have to act at the same time. Often, the ones who initiate this type of movement are not the key players.”

Mr. Belton recalled a meeting of the Insurance Advisory Organisation, (of which he is a former president) attended by several insurance company presidents. One of them had announced a significant increase in rates and the others had wished him good luck. “The following month, the man came back saying that there were two ways to lose your shirt in this industry: by your loss ratio or your expense ratio. In fact, insurers may be announcing increases in the next few months, but they’ll go about it quietly. Except in automobile insurance, in Ontario and the Maritimes, where it will be steeper. And again, insurers will be prudent.”

The Zurich Canada president confided that he might not be one of the leaders his colleagues are actively seeking to raise the bar.

“In auto, for example, many insurers have adjusted their rates upward about 15%. Some are on the second rise in one year to let them reach this mark. As far as we are concerned, we are far from this position. Our average increase is about 8% to 9%.” Mr. Gilway claims to be the victim of a paradox: today Zurich is not aggressive enough precisely because it was too aggressive… early on. “In February 2000, we were one of the first large insurers to institute a significant rise, namely 2.9%. What happened was our business literally went elsewhere, overnight! Brokers started shopping around for their customers. They did their homework. But it hurt us. That being said, we introduced a new hike, from 8% to 9% in mid July.”

Why is the Canadian industry so fragmented? “Because the entry barriers are less imposing than in life insurance,” John Phelan explained. “Anyone can launch a provincially-chartered P&C insurer with capital of as little as $5 million or $10 million. However, the situation is better in Quebec than in the rest of Canada. In la Belle Province, you have two or three players, Desjardins, ING Groupe Commerce and AXA Assurance, who dominate the market. There is more discipline in Quebec.”

Does less competition cost consumers? After all, the greater the supply, the greater the advantage to the consumer. “When competition is too intense, the prices invariably end up reflecting economic reality,” Mr. Phelan added. “In real life, nobody wants cut-throat rate hikes. Neither consumers nor insurers.”

Mr. Brouillette agrees. He questioned whether the industry is serving consumers better with premiums that fluctuate substantially, and concluded that all companies prefer to operate according to a budget. That way they can establish the changes in its premiums over several years. Presently, this is far from the case: companies have seen their premiums fluctuate by 50%.

At any rate, the main insurers assert that they have all moved “in the right direction.” But it will take more, Mr. Gunn noted. “Fourth quarter 2000 was a bloodbath. Despite an upturn in first quarter 2001, I don’t think it’s enough. If insurers made difficult decisions in Quebec, they will have no choice but to do the same in the rest of the country by the end of the year. And the bulk of the work must be done in Ontario, which is actually the largest Canadian market. At Royal & SunAlliance, we have introduced two rate increases (10% and 12%) in auto this year, with the second being scheduled for the fall. For bad drivers, it will rise from 25% to 30%. The regulatory authorities have already approved this increase.” “It took us four years to get into this trouble,” Mr. Cooke pointed out. “And you can’t fix a four year problem in twelve months. I agree with 35% increases in some commercial lines. We have tried to prepare ourselves for the downside, have controlled growth, and now we are having better results than the industry, whose average combined ratio was 114% in the first quarter of 2001. Ours was 107.4%. It’s not so bad compared with the others, but it’s still a poor performance from the shareholders’ standpoint. Yet it took us three years of concerted effort to reach this point. In 1998, the ratio was 118%. In 1999, it slipped to 107%. In 2000, it will be 108%. Without Quebec, it would have been 111.9%. It is clear the insurers did what it took in Quebec.”

Another troubling aspect of management that has a direct impact on insurers’ results: the ivory tower effect. More than one insurer tends to manage the entire Canadian market from their Toronto headquarters. “Some managers integrate the Maritimes into their Ontario balance sheet! It’s completely absurd,” Mr. Cooke noted. “We began segmenting the country a long time ago. Several insurers followed, but much later. It is reflected today in their financial results.”

Mr. Brouillette is another believer that the solution does not lie uniquely in rate hikes. Appropriate subscription is crucial when it comes to cleaning up insurers’ balance sheets. “At our company, we have invested massively in technology to refine our underwriting techniques. Today we are reaping the rewards.”

For his part, Mr. Gilway says that the winners will be those with the lowest expense ratios. “In the case of Zurich, our cost is 33% in the first quarter. We will pare it to 28% in two years thanks to our Internet platform.

In fact, the key to successful cost control is integrating systems as much as possible, while decentralizing decision-making.”

Mr. Gilway cited the example of Zurich’s data processing centre, which is centralized in Chicago for North America. This centre handles business evaluated at $15 billion US. “I have a sister company, Farmers, which posts sales of $12 billion US. My sales stand at $500 million CAN in P&C. The Farmers electronic platform is quite capable of absorbing this business. As a result, our data processing costs, which are $55 million today, will decrease to $42 million in 2001 and $36 million in 2002. These are substantial gains, all the more when you consider that Canadian P&C margins will not be very sizeable in the next few years.”

Mr. Gilway says he is a firm believer in technological standardization and economies of scale to solve leadership problems instead of company consolidation. “The two largest insurers have the same number of technological platforms as they do markets. I won’t name them,” he said with a chuckle, “but that’s not the way to realize savings.”  He said he does not see a tidal wave of consolidation sweeping through Canada. “Why buy a company that is barely profitable or reporting a loss and aggravate your own results? To gain market share?”

Mr. Gilway is banking instead on Zurich’s internal growth, which he forecasts at 20% for the year. In contrast, Mr. Brouillette predicts that consolidation will continue. He is watching for opportunities. Mr. Cooke calls himself a buyer even if, for the time being, “There is nothing up for sale.” He says that consolidation will gain a second wind worldwide, a trend which will have domestic repercussions. Unless small insurers put up the “for sale” signs. Mr. Gunn is definitely seeking opportunities. “It is true that we have [$235 million] to undertake acquisitions, following the sale of our life portfolio to Maritime Life. But good opportunities are few and far between and we are not talking with anyone for now. But our intentions are no secret.”