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HKMB International HEAD OFFICE: T: 416-597-0008 |
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Spring 2005 | |
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In this Issue: |
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2005 Forecast
In an economy that is growing at a rate of only 2 percent, most insurance companies are looking to increase their gross writings by 10 to 15 percent. Simple rules of supply and demand would suggest that this increased capacity chasing a slow growing book of business should put downward pressure on prices. Some rates have, in fact, already come down. Further reductions may materialize in the third and fourth quarters. Renewal rates for a typical commercial account that is profitable to an insurer could reduce by up to 10% in the first half of 2005. By the second half of 2005, many insurers will be forced into a reality check: if, as predicted, the economy continues its lackluster growth, insurers may find they have written significantly less premium than called for in their business plans, potentially causing them to reduce rates further to get closer to plan. Consequently, greater reductions are possible for those accounts renewing later in the year, especially “short tail” property insurance. We caution that this forecast is a broad-brushed description of what HKMB is currently experiencing in the marketplace and what should happen in the near term. Individual clients may experience different results. Some of the factors that will affect the pricing of individual risk include:
Finally, rates may be affected by the fact that insurers are depending less and less on reinsurance in the day-to-day activity of their business. Some insurers are operating with a reinsurance to premium ratio of as little as 2%, with most of the major carriers at about 20%. Because of these relatively low ratios and the expectation that the reinsurance “pie” will continue to shrink in Canada, reinsurers will have less control over the pricing of an account. Accordingly, the reinsurance marketplace will either have to be content with less business or sharpen their pens and reduce reinsurance rates.
Property and Casualty Insurers 2004 ProfitsProperty and Casualty insurers in Canada, generally speaking, had a very profitable year in 2004. Aggregated industry profits for the year are expected to be in the neighbourhood of $4.5 billion, generating a return on equity of approximately 20%. Not surprisingly, numbers like these have the public questioning whether premiums are too high – but not so quick! The insurance industry is a cyclical business and profits year to year vary considerably. No one year -- even one as extraordinary as 2004 -- is indicative of excessive premiums. The cycle we are currently in started in 1997 and, including the banner year 2004, produced an anemic average R.O.E. of only 8.6%. The previous cycle, 1987 to 1996, produced a rate of return of only 10.6%; prior to that, 1984 to 1986 saw only 9.9%; and, the period 1978 to 1983 only 11.2%. Over the entire 27 years, the industry average R.O.E. was just 10%. This is a decent return but by no means excessive or indicative of usurious premiums. (Of course, individual insurers may have performed better or worse than these averages during the same periods.) Consider the following returns compared to the insurance industry’s R.O.E. of 6.9% over the 5 years ending December 2004:
Weak profits in the insurance industry should not be a positive signal to consumers. Individuals and corporations transfer risk to the insurance industry. A healthy balance sheet is essential to ensure the industry can effectively accept the risk. Events in recent years have battered the industry with catastrophic losses. The strong returns in 2004 are necessary to rehabilitate sharply weakened industry balance sheets.
The Contingent Commission IssueOver the past several months, the results of the investigation by Eliot Spitzer, Attorney General for the State of New York, has turned attention to the manner in which insurance brokers are compensated by insurers. By now we all know that a number of large, U.S. based, global brokerage firms are alleged to have committed acts of wrongdoing that included bid rigging, price fixing and collusion with certain insurance companies. In some cases, the allegations have been proven and certain executives had pled guilty to criminal charges.
There is no question that practices such as bid rigging are unacceptable in any business. However, contingent commissions, or as they are more correctly referred to “incentive commissions”, have a long and honourable history and exist in many industries. Many manufacturers, for instance, incent their retail partners by paying commissions based on certain sales criteria. Other industry examples would include automobile manufacturers, travel agents, tire retailers and food outlets. In the insurance industry, contingent commissions are payments made by insurers to brokerages on an annual basis above and beyond commissions paid on individual transactions. They are intended to reward brokerages for such things as retaining business, increasing the size of their book of business, and reducing claims ratios with a particular insurer. Contingent commissions allow brokers to invest in claims, loss control and other resources to help clients manage their risks better. Eliot Spitzer has raised a very important set of issues and, while regulators have always been aware and accepting of contingent commissions in the insurance industry, governments in many jurisdictions both within and outside the United States have been quick to impose stricter regulations. In Ontario’s case, the Registered Insurance Brokers Act 2005 has been revised to require brokers here to disclose to clients those insurers with which they have incentive commission agreements. We believe that the surest way to guard against apparent or actual conflicts of interest is through complete disclosure of all compensation arrangements between insurers and brokers. If you have any concerns about these matters, please contact us. We would be happy to discuss them with you.
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Finally, after a 3 year hard market, there may be some good news for insurance buyers in 2005 with current signs pointing to some rate and premium relief across virtually the entire market. Of course, individual circumstances will dictate what each buyer experiences in 2005. 
At the heart of Spitzer’s probe was the suspicion that the brokers under investigation were directing business to certain insurers through illegal practices such as bid rigging in order to inflate so-called contingent commissions, while giving secondary consideration to the best interests of insurance buyers. (It should be noted, that in Canada there has never been even a suggested case of bid rigging involving Property and Casualty insurance.) As Spitzer’s allegations unfolded, contingent commissions themselves were portrayed as a highly problematic and questionable practice because they were not generally disclosed to buyers, creating the potential for conflicts of interest.