Bankruptcies in the insurance industry: Preparedness remains crucial

Just because there haven't been any insurer bankruptcies in Canada since 2004 doesn't mean they won't happen again. When they do occur, insolvency typically affects at least three insurers in the same territory over a few years. The industry must remain vigilant and prepared, particularly in light of climate risks. 

The Property and Casualty Insurance Compensation Corporation (PACICC) has recently published When, Where and How Often Insurers Fail: Introducing the Global Failed Insurer Catalogue, the latest edition of its investigation series titled Why Insurers Fail. The study is authored by Grant Kelly and Zhe (Judy) Peng. 

PACICC, the compensation organization that intervenes in case of an insurer's bankruptcy, plays a role similar to Assuris in the life insurance sector. The organization published its latest studies on insolvency cases in the insurance industry in early summer 2022. 

Since its founding in 1989, as noted in its most recent annual report, there have been 13 insurer bankruptcies, but none have occurred since 2004. 

The authors point out that as bankruptcies become less frequent, it might be tempting to conclude that such events are a thing of the past. However, PACICC's compilation shows that 547 insurers worldwide have gone bankrupt since 2000, both in property and casualty insurance and life insurance. These bankruptcies occurred in 55 different jurisdictions, with the United States alone accounting for 263 during that period. 

Internationally, about 24 insurance companies go bankrupt each year, with 17 in property and casualty, six in life insurance, and one operating in both markets. Since 2005, the average has dropped to 20 bankruptcies per year, according to the report. 

In the period from 2000 to 2002, PACICC's compilation reports 369 bankruptcies among property and casualty insurers worldwide, with a peak of 37 insolvencies reached in 2001. From 2003 to 2022, the average number of bankruptcies each year in this group dropped to less than 14, with half of these events occurring in the United States. 

Two to three years 

The study shows that when the first bankruptcy occurs in a given jurisdiction, it has a contagion effect on the industry. PACICC's compilation reveals that there is often a cluster of at least three insurers that become insolvent over a period of two or three years. Afterward, the market stabilizes. This is what happened in Canada with the six bankruptcies that occurred between 2000 and 2003. 

There are no specific indicators for a country or a business strategy that can predict bankruptcy, the authors add. However, known factors are common in all cases: poor risk selection, inadequate pricing, insufficient reserves, company governance, and regulatory framework shortcomings. 

A newer factor has emerged: the impact of natural disasters. "Climate risk appears to be increasing solvency risk," the authors summarize in the study's executive summary. 

The report cites examples where an insurer's bankruptcy resulted from the primary or secondary risk associated with a major natural disaster. Catastrophic risk was responsible for about 30% of property and casualty insurer bankruptcies in 2021 and 2022, and this trend is on the rise. 

PACICC notably cites eight examples where U.S. insurers became insolvent in 2021 and 2022 due to hurricanes Laura, Delta, Zeta, and Ida, as well as the ice storm that hit Texas. 

The regulatory framework is not intended to prevent all insolvencies but to minimize their impact in such cases. "There is no reward in the insurance marketplace without some risk," the study states. The competition generated by the arrival of new players and the exit of less profitable insurers is, on the contrary, an indicator of the industry's good health. 

In a study conducted in 2017, PACICC counted 161 property and casualty insurers that ceased operations in Canada between 1995 and 2015. Only six left the market due to involuntary circumstances, including insolvency. 

"Bridge insurer" 

In 2021, PACICC indicated that the insurer compensation fund needed to be strengthened, as the systemic risk resulting from the bankruptcy of a major insurer was associated with a figure: $35 billion. 

This tipping point would be easily reached in the event of a major earthquake in a densely populated region. In the latest edition of its Solvency Matters bulletin, PACICC notes that most, if not all, developed countries exposed to significant earthquake risk have put some form of government safety net in place. "The absence of such protection is a major shortcoming in Canada’s public policy framework," according to PACICC. 

The organization notes that "despite 10 long years of advocacy on this file," the government seems to be putting all its efforts into the flood issue, which is "more politically urgent," and that a short-term solution to the systemic risk associated with a major earthquake is likely to be found. 

The type of failure that is most likely to require PACICC's intervention is changing. "The increased pace of industry consolidation means that the next failure is more likely to be that of a mediumsized (or larger) insurer, perhaps triggered by ever-increasing natural catastrophes fueled by climate change," the organization said. 

PACICC's resolution powers have a gap: the absence of a "bridge insurer" mechanism. Such a mechanism exists in the banking sector and also at Assuris, PACICC's counterpart in the life insurance sector. As a result, PACICC is working with the Office of the Superintendent of Financial Institutions (OSFI) on this issue. Monthly meetings are planned throughout this fall to establish a "bridge insurer". 

Inflation 

Furthermore, PACICC's evaluation of compensation limits is ongoing. In the fall of 2022, Eckler was commissioned to collect and analyze approximately 750,000 individual compensation files. 

In April 2023, the board noted that the initial report submitted by Eckler had shown that inflation had led to some erosion of compensation limits in the three years since the previous evaluation. 

Insurers were surveyed about the 2023 review of coverage, compensation limits by province, and the appeals process for claims for exceptional difficulties. The feedback collected will allow PACICC's management to prepare the solutions that will be submitted to the board at its meeting on November 16. 

Before coming into effect, any changes to coverage and compensation limits must obtain regulatory approval. This 90-day review will take place from December 2023 to February 2024. PACICC members will also need to endorse the change at their annual general meeting in April 2024.