Price adequacy is key to reducing insolvency

Two-thirds of Canadian insurers became insolvent over the past 30 years, according to research released by the Property and Casualty Insurance Compensation Corporation (PACICC).

The latest study in PACICC’s “Why insurers fail” research series, titled: Inadequately pricing the promise of insurance, suggests that the failure of these insurers was due to inadequate pricing.

PACICC is Canada’s national guarantee fund providing financial protection for policyholders in the event that a member P&C insurance company becomes insolvent. Since its establishment in 1988, PACICC has paid out $105 million (CDN) to or on behalf of approximately 10,000 policyholders.

The recent research highlights the necessity for industry members to “correctly price insurance products—so that premiums charged today provide sufficient resources to fund claims liabilities when they fully materialize in the future,” explained PACICC president and CEO Paul Kovacs.

According to lead author and PACICC chief economist, Darrell Leadbetter, there were some clear indications of insurer behaviour that exasperated struggling agencies, including temporarily offering aggressive pricing to attract customers or entering unfamiliar markets.

“Stricter forms of rate regulation in Canada and the United States can disrupt the link between the cost of resolving claims and pricing decisions that can increase the risk of insolvency because an insurer may be forced to draw down its capital to support claims,” explained Leadbetter.

Additional observations on solvency risk from PACICC’s research include:

• Inadequate pricing is the leading cause of failure among Canadian property and casualty insurance companies over the past 30 years;
• Insolvent insurers that sold rate-regulated products were, on average, four times more expensive to liquidate than other insolvent insurers;
• In many cases management undertook strategies that could be described as “gambling for survival” just prior to failure;
• Inadequate information and reporting were found in 71% of insurance failures linked to inadequate pricing;
• Managerial experience is an important determinant in the survival capacity of new insurers, as 70% of failed insurers were less than 10 years old;
• Companies writing in new lines of business, outside their area of expertise, are at greater risk of failure.

Originally published in Canadian Insurance Business Magazine in April 2009