By Jeff Sanford
Toronto, Ontario — February 2, 2016 — This past week Aviva Canada announced it would buy up the assets of RBC’s general insurance arm. The deal was a relatively small one for the insurance industry, with about $582 million changing hands to seal the deal. Around 575 RBC Insurance employees will become part of Aviva Canada’s operation. A 15-year distribution deal that will see Aviva products sold to RBC Insurance customers was also part of the transaction.
The move was unsurprising to many who follow the insurance sector closely. Several years ago RBC made some noise about plans to lobby the government to allow it to sell insurance out of its bank branches. “Syngeries” would be achieved according to RBC executives. RBC even set up insurance offices right next to bank branches in some communities. But the regulatory shift never happened. With radically and weirdly low interest rates making it ever tougher to eke out a profit, it made sense for RBC to offer up the book of business to another company. The deal between Aviva and RBC went ahead. But what does this deal say about some of the wider trends and issues in the insurance industry?
In a recent report, credit rating agency A.M. Best noted that consolidation through exactly the type of deal struck between RBC and Aviva could be expected as a series of market issues put pressure on Canadian P&C issuers to become more efficient and bulk on assets. What are the market issues insurers are dealing with? One of the biggest trends hanging over the insurance industry right now are the extremely low interest rates that have surprised almost everyone.
Today interest rates are effectively zero. This fact has great impact on the insurance industry. Last year the Organisation for Economic Co-operation and Development (OECD) released a report warning that “the current low interest rate environment poses a significant risk for the long-term financial viability of pension funds and insurance companies.” As the report states, over time as bonds become due, high-yielding bonds are replaced by low-yielding bonds in the portfolios of insurance companies. The longer rates stay low, the lower the return to insurance companies.
The OECD Business and Finance Outlook warned that one of the main concerns of regulators is that insurance companies might become involved in a “search for yield.” That is, in order to generate the necessary returns and keep the promises made to policyholders when interest rate were higher, insurance companies will be tempted to invest in riskier ventures. According to the OECD report, “If interest rates remain low into the future, funds and insurers may find their assets insufficient to meet their promises, unless they adjust their pension or payment promises … [insurers] may need to offer lower guaranteed returns on new contracts to reduce liabilities and, in extreme cases, renegotiate current terms.”
Bankruptcies among insurers are very rare. Union of Canada Life Insurance was wound up in 2012 after 148 years of business. That was the first failure of an insurance company since the early 1990s when three companies failed: Les Coopérants, Sovereign Life and Confederation Life. In each of these cases, low interest rates were said to have played a part. So no wonder some of Canada’s largest insurance companies have been taking measures to handle the low interest rates.
When it comes to the property and casualty (P&C) market, Canadian insurers have, so far, managed the new low rate environment. In a report released this past fall, A.M. Best suggested, “Canada’s Profits Endure Despite Lower Interest Rates, Regulatory Changes and Consolidation.” The report notes that “despite challenging market conditions, characterized by slowing economic growth and further interest rate declines,” the company was maintaining its stable ratings outlooks on Canadian P&C insurers. Although the companies were dealing with a large amount of “uncertainty” in several lines of business, to their credit, the Canadian P&C companies have managed to grow their businesses through this period of volatility. According to A.M. Best, the Canadian P& C market remains “resilient.”
Companies in the sector have stayed ahead of trouble by investing in new underwriting technology and enhanced risk management practices. Risk-adjusted capitalization levels have been maintained, trouble averted. All in, according to A.M. Best, “The Canadian P&C market, along with the many individual companies participating in the market, has demonstrated resiliency in addressing ongoing headwinds … it is A.M. Best’s expectation that this industry will continue to respond appropriately to these ongoing and emerging challenges.”
One method for managing the heavy weather will be the ongoing trend toward demutualization. The long-awaited final regulations outlining the process of demutualization for Canadian P&C insurers were released this past July. The new financial structure will help. Also in favour of the P&C insurers has been a lack of catastrophic events. There have been some big snow storms, intense rain and hail incidences but nothing massively catastrophic, and that has helped.
Another issue for auto insurers in Ontario has been the Auto Insurance Cost and Rate Reduction Strategy, which was the controversial promise made by the current Liberal government to reduce auto insurance rates by 15 percent. According to the A.M. Best report this caused a significant contraction in personal accident premiums and “exerted significant pressure on the industry’s automobile loss ratio in Ontario.”
The market for auto insurance was expected to “remain challenging” for insurers. The report goes on to say that the organization responsible for overseeing the insurance sector, the Financial Services Commission of Ontario (FSCO), “appears to be taking a reasonable approach to rate reductions, given the upward trajectory in auto loss ratios.” That is, FSCO has understood the challenge insurance companies face in such a low rate world. The 15 percent reduction in auto premiums has not come to pass in Ontario. The Liberal government has had to step away from that promise. Rates have come down by about 6.5 percent instead. But as the challenges remain, it is no surprise that P&C insurers continue to seek out ways to maintain the stability.
Another key method P&C insurers have utilized to manage the heavy weather has been consolidation. By buying up smaller companies, more business is spread across a smaller corporate infrastructure. This reduces costs. An active market remains for consolidation in the Canadian P&C sector. An A.M. Best report on consolidation in the Canadian P&C sector suggests the “active M&A market for Canadian P&C insurers shows no sign of slowing … Ongoing performance pressures in Canada’s property and casualty market, combined with the need for scale and long-term strategic positioning continue to drive consolidation in the sector,” according to the report.
In 2014, Canada’s top 10 P&C writers 66.2 percent of the market’s direct premiums, compared with 56 percent in 2007. Long story short, the big guys are getting bigger and taking up more market share. At that time, A.M. Best said that as the industry moves into the third quarter of 2015, it “anxiously awaits the next merger that is likely around the corner. While time will tell when the next big deal goes from a mere discussion to a full blown announcement, there are a myriad of factors that could lead to continued activity over the near- to mid-term.” It seems that next deal showed up last week when Aviva absorbed the RBC assets.
