The Invisible Giant

MR. LEAL:

Mr. Minister, ladies and gentlemen: We bid you a cordial welcome to this luncheon meeting of The Empire Club of Canada.

I suspect that everyone in this audience will have more than a nodding acquaintance with the subject under discussion today. I work for the insurance industry in the sense that a substantial part of my salary cheque is paid over to them for insurance in one form or another, but I am not paid to work for them. Always interested in first principles, I turned to the Shorter Oxford for a definition and there I read that insure means "to secure the payment of a sum of money in the event of loss or damage to property, or of the death or disablement of a person, in consideration of the payment of a premium and observance of certain conditions." Comes the tail, comes the sting!

I suppose most of us subscribe to the biblical admonition that one ought to be one's brother's keeper and embrace the entirely humane principle of loss distribution. The substantial hikes in my premiums lead me to believe that some of my brethren are pretty expensive to keep! I'm sure that our distinguished visitor and guest speaker today will discuss and justify these increases.

The observance of conditions referred to in the definition is a sobering reminder that money is to be paid on terms and that insurance is a contract of indemnity and not a lottery. I'm sure that Mr. Horsford will remind us that insurance companies pay on the basis of legal liability and have no obligation to function as charitable institutions. But the concern of the industry is to streamline the settlement of disputes with policyholders about claims and this is the basis of the timely experiment being conducted by Mr. Horsford's company in establishing ombudsmen or arbitration proceedings. He will be telling about this.

Our distinguished speaker was born and educated in England and joined the Royal in 1951. After holding a number of appointments in both the head office for the United Kingdom and the Royal Group's world-wide headquarters, he became Secretary of the Royal Group in 1970. In April 1972, he came to Canada as senior Deputy General Manager for Canada and in May 1974, he was appointed President and Chief Executive Officer, Royal Insurance, Canada.

He is a fellow of the Chartered Insurance Institute, a director and member of the Executive Committee of the Insurance Bureau of Canada, a director and member of the Executive Committee of the Insurers' Advisory Organization, and Vice-President of the Insurance Institute of Ontario.

I am privileged to introduce Alan A. Horsford, President and Chief Executive Officer, Royal Insurance, Canada, and to call upon him to address us.

MR. HORSFORD:

Mr. Chairman and members of the Empire Club: Thank you for the welcome that you have just extended to me.

I must say it is delightful for any guest speaker to know that he has pleased much of his audience before he even gets to his feet. It seems that I've managed this neat trick by deciding not to talk about either the activities of the Anti-Inflation Board or the strength of the -free-enterprise system vs. creeping government control. Both subjects are very important, of course, but there is a limit to how much can be absorbed about them. I understand that so far as guest speakers on these topics are concerned, you reached your limit some time ago.

I cannot resist, however, telling you of a quotation that I came across when preparing for this talk, because it might explain a great deal of what has happened since the beginning of the year. It is from another book by a friend of ours, Professor J. Kenneth Galbraith, in which he says: "Clear and unambiguous statement may not be the best medium for persuasion." It seems that some people have taken that lesson from him to heart.

In that very kind introduction, there was a reference to my being an executive. As you know, an executive has been defined as someone who talks to visitors whilst the staff get on with their work. Worse still, I am an economist by training, and we all know about that profession's lack of contact with reality. Professor Milton Freedman, an economist himself, once illustrated that fact with the following story. A chemist, a physicist and an economist were stranded on a desert island. They had nothing but canned food and no can opener. The chemist said that if they lit a fire he could calculate the degree of heat needed for the cans to burst open. The physicist said that if the chemist did that, he could calculate the trajectory of the food as it shot out of the can so that they would be able to stand in the right place to catch it. The economist said he couldn't understand what all the fuss was about. The answer was perfectly simple. Why not just assume that they had a can opener?

However, worst of all my qualities is that I clearly have the distinction of being a master of bad timing, as is demonstrated by my choosing to speak about "the invisible giant" in a week in which the Anti-Inflation Board announced that it was studying whether to make the general insurance business subject to the anti-inflation guidelines in view of the large volume of complaints from the public. On the other hand, perhaps the circumstances underline my choice of title, since it seems that the AntiInflation Board is unaware that the 26 leading general insurance groups are already subject to the legislation, and of the 117 Canadian companies which are required to give 30 days pre-notification of price increases, six are general insurance companies.

You mentioned, Mr. Chairman, that I might be referring in the course of what I have to say to my own company, but I am going to disappoint you in saying very little about the Royal Insurance Company. There are a number of businesses which, by their very nature and importance affect almost everyone, young and old. Food is one, of course; housing is another; the clothing industry another. But there is another business which pervades every aspect of Canadian society, and of course I refer to the general insurance business, or what we choose to call property and casualty insurance, to make the distinction between that and life insurance.

This business, the providing of insurance protection, either for your home, automobile and cottage, or for your particular business activity, or more likely for both, touches every adult in Canada in one way or or another. We all have possessions we are anxious to protect. We all expose ourselves to potential liabilities in our daily activities, whether by driving an automobile into the city or simply by driving a hard bargain. We are surrounded by uncertainty. There are enough risks in our daily life to satisfy even the most daring. And yet, despite the pervasive nature of the services provided by the propertycasualty insurance business in Canada, it is a fact that it remains a largely invisible giant.

A famous English statesman once said that there is nothing as uncertain as a figure unless it is a fact. Nevertheless, I should like to give you some figures and facts to provide some dimensions and shape for the invisible giant.

If I were to ask the average Canadian to compare the size and annual income of the life insurance industry with the property-casualty insurance industry, he would probably judge that the life insurance industry was the larger undertaking of the two by a considerable margin. This is a perfectly understandable impression, for the life insurance business in Canada is dominated by highly successful Canadian companies. It has an enviable measure of financial strength and responsibility and has built for itself, worldwide, an image of solid reliability. However, it is a surprising fact that the annual sales volume of the propertycasualty insurance business is considerably greater than that of the life insurance industry.

In 1974, for example, life insurers' net sales (and I carefully avoid the use of the word premium) totalled $2.9 billion, whereas property-casualty insurers did more than $3.8 billion worth of business. This year, we fully expect that total to exceed the $5 billion mark. Of course, a good part of that addition will come from the changes that have occurred in British Columbia! Unlike the life insurance industry, much of this money is in and out of our hands in the same year. But I estimate that the flow of investable funds is now running at a rate of three-quarters of a billion dollars per year, whilst the total invested assets of the property-casualty business exceed $5 billion.

It is important, from the point of view of our policy holders, that these investments are made as efficiently as possible, but of course there is also a responsibility to maintain a reasonable relationship between the spread of investments across the country and the geographical source of the insurance funds. Most major companies, and indeed I believe the industry at large, pay special attention to this particular aspect as part of their social accountability.

Companies are not free to dispose of the funds as they wish. Instead, those funds have to be invested in accordance with the very clearly defined statutory provisions contained in the various Canadian insurance acts. There is a particular feature of the statutory provisions which has a wider significance for the financial community in Canada. That is the requirement that common stock must not exceed 25% of total assets on a book value basis. This inhibition on the flow of funds into common stocks has been the subject of industry representations to the federal authorities for some upward adjustment of that percentage. Mind you, we didn't press the case very strongly in 1974! But over the longer term, we still feel that a change is both desirable from our point of view and also beneficial for the Canadian economy.

General insurance is conducted through more than 300 federally and provincially licensed companies, although this total includes companies in common ownership. Even so, there are more than 175 competing enterprises providing a fragmented marketplace, not dominated as in some industries by a small number of very large units, and one in which the biggest company has only a slim 7% of the total market.

Companies are either direct writers such as Allstate and State Farm, or agency companies who sell entirely through independent professional agents and brokers, of whom there are some 15,000 licensed across Canada. In many cases, I have to confess, these agents and brokers are the insurance industry as far as their customers are concerned and the company itself is invisible.

Let me try to put another dimension to the industry, and that is the total number of people employed. I am afraid there is no single source for this information, and so with the help of some of my colleagues we have done some estimating. As a result we have concluded that taking all the various segments of the industry, i.e. companies, agents, brokers and adjusters, our business employs at least 100,000 people across Canada-, or 1% of the total work force. Obviously, that is no modest undertaking.

Having provided a bare-bones framework for the invisible giant, I should like in the remaining time to fill in just a few of its features. The first is that, unlike the life insurance business, the property-casualty insurance industry in Canada has not been dominated by Canadian companies. In fact, the historical development has been quite the reverse. A major part of the industry has been, and still is, foreign owned, operating until a few years ago at any rate what was essentially a branch-plant operation. As a result, there has been an almost total lack of opportunity for Canadians to take a significant financial interest in the industry. This is nowhere more clearly evidenced than in the absence of any general insurance company from the lists of leading companies that are constantly being compiled by the financial press.

However, the character and composition of the industry is undergoing a period of fairly rapid change just now. Many companies are converting from a branch to a Canadian domestic operation, with the elimination of branch activities. This is being done as a first step towards local financing, and in turn this should hopefully provide eventually for a greater share of Canadian ownership in the business.

In this the timing is good, because this evolutionary stage in the industry has come when the demands being made on it for greater and greater amounts of insurance protection have never been more insistent. Canada's economy is showing impressive growth. It is becoming increasingly sophisticated and diverse, and this is inevitably reflected in a large and growing appetite for all forms of insurance protection in both monetary and real terms.

It is quite obvious that the industry's financial resources must match the rapid development of this country's economy, if we are to achieve proper recognition as a responsible and significant segment of the financial community. And yet we face some problems.

First, is the current severity of the solvency requirements of the federal authorities for the protection of Canadian policy holders. These require general insurance companies to maintain a significant margin of recognized assets over clearly defined liabilities. It is difficult to make accurate comparisons, between one jurisdiction and another, but to give you a perspective, companies in the United Kingdom have to maintain free resources, that is resources over and above the liabilities as they are measured, equivalent to 10% of their premium income. In the European Common Market the margin is 16% of premium income, whereas currently in Canada it is between 20 and 25% of premiums. This provides enormous financial security for Canadian policy holders, but whereas the margin in the United Kingdom is now recognized to be too low and is being changed, there is ample evidence to justify some relief in the other direction in Canada.

I am pleased to say that there is an acknowledgment of the situation by the federal authorities and it is likely that legislative changes will be made before long.

At this point I should perhaps underline the importance of what I have just been saying because it does mean that, contrary to what some politicians say, the money that people pay in premiums to the general insurance industry stays in Canada and is used in Canada. It is not drained away to some other part of the world.

Whatever change is made in the solvency requirements, it is still necessary for the industry to generate an increasing total of free resources if it is to respond in a constructive way to the increasing demands of our growing economy.

There are only three sources for such funds: retained profits, appreciation of investment portfolios, and the raising of fresh capital. The last one is of limited value until the organizational changes to which I referred just before have been developed to a greater extent.

Investment appreciation is, after the experiences of 1974, less reliable than we thought, which leaves us with retained profits. As you know, the industry has just come through a cyclical down-swing which we hope bottomed out in 1974 when, for the first time for many years, the industry had an over-all operating loss. We believe that there has been a limited recovery in 1975 but it is too early yet to have industry aggregates to confirm this. Nevertheless, the importance of adequate retained profits cannot be over-emphasized if the industry is to have the financial resources to meet the demands which are going to be placed on it as the Canadian economy grows.

Another feature of the industry is that it has two distinct streams of income: one from underwriting activities and the other from investment earnings on the funds generated. In the past, in my opinion, we made a mistake as an industry in not disclosing investment income which the public came to believe was a crock of gold. All that is past now. Full details are published regularly in the quarterly bulletin of Statistics Canada on financial institutions. They are even accompanied there with a pretty chart devoted to the subject. There is one benefit from this disclosure. At least we can now provide an honest answer to the question, "If you are losing so much money on your underwriting, why do you stay in business?" The answer is simply that what we lose on underwriting is more than made up by what we earn by way of investment income, or has been except for that disastrous year 1974.

A particular complication for the industry is that whereas financial solvency is a federal responsibility, pricing and availability of market are primarily a provincial concern, and the possibilities for conflict are self-evident.

Pricing for general insurance is an extremely interesting feature, since the industry is one of a unique group where the price has to be established before the cost of the raw materials is known. It is virtually on its own in the sense that it has such a limited ability to influence the cost of the materials, by which I mean such items as new automobiles, spare parts for automobiles, hourly labour costs for garage repairs, building and redecoration costs, court awards and medical expenses.

We could, of course, try to band together to control hourly wage rates for repair work, but it is likely that we would quickly be faced with charges of discrimination and offences against federal combines legislation. We could, of course, try talking to judges about court awards, but talking to judges does not seem to be very popular at the present time.

The length of exposure to a fixed price under a typical general insurance contract is also unusually long, and this is often not appreciated. Let me give you an example with reference to the increase in prices that has occurred recently. In this province automobile insurance prices were last adjusted in July, 1975. The work on the measurement of the increases needed at that time was completed in April of that year. Those prices hold good for all contracts issued or renewed until June 30, 1976, and a contract (insurance policy) issued on that day runs for a further twelve months until June, 1977. That is not the end of the story. You would be surprised at the length of time after the termination of a contract period in which we continue to have losses reported to us. A further twelve months for automobile insurance would not be unusual. This takes us to June, 1978 on prices established in April, 1975.

It will be clear to you from this that our business is peculiarly vulnerable to the acceleration in the rate of inflation. This is a large part of the explanation of the difficulties we have been experiencing since 1973, when the inflation rate jumped from 6% to 9% to 12%. Whatever it is running at now, it is still double digit. It also explains why, as an industry, we give our wholehearted support to the general objectives of the federal authorities in seeking to contain the impact of inflation.

Clearly, our pricing activities involve a large element of judgment, and whilst we can try to estimate with reasonable accuracy the likely total dollar value of losses that will have to be paid, whether it be for automobile insurance or home owners insurance, we cannot identify the individual policy holders who will be faced with a loss. This is the simple answer to those who inquire why the price of their insurance increased, although they have had no claims. We can only mitigate the impact of increases on them. We cannot insulate them altogether, if there has been a general increase in the total expected payment of losses.

In this rather sketchy commentary on our pricing practices, I believe we can also find an explanation in large measure for the number of complaints which the Anti-Inflation Board is receiving about price increases for automobile and residential insurance, because as you know after food prices the largest number of complaints is being made about these two services. In most instances, the change which is being complained about was introduced well before the federal government's announcement last October, but the annual cycle of insurance renewal which began before that date is still underway, and I referred to the increases introduced in this province in July, 1975 and which will not have worked their way through the full body of policy holders until June 30, 1976.

The situation is compounded, of course, in the residential property insurance area because our practice until recently was to issue contracts for three years, and it is therefore perhaps understandable that someone who last bought their insurance in 1973 is surprised by the premium being asked in 1976. Again, a part of the additional cost is no more than a reflection of the much higher property values which now prevail.

Provincial involvement in our business provides another example of our invisibility or apparent invisibility. I hope that my distinguished fellow head table guests from the government of Ontario will forgive this example. Douglas Carruthers was appointed by the Ontario government to carry out a study of the insurance industry, both life and property-casualty. He recently completed his work, and has put forward his recommendations in the form of a revised model for our business.

This model contains many significant and far-reaching proposals. It is therefore a matter of surprise and concern to executives in the property-casualty industry that as far as we are aware Mr. Carruthers had no contact whatsoever, either with our trade association, the Insurance Bureau of Canada, or with any of the major companies in the market in the course of the several years he spent on his research. There may well be an adequate explanation for this approach, but I must confess I find it extremely difficult to fathom.

As I have been talking, I may have conveyed to you the impression of a rigidly controlled industry whose solvency is exhaustively checked, whose pricing is monitored, whose investments are specifically channeled by government. While I think there is an element of truth in that, I do not wish to give you the impression that because of this competition is either stifled or low key. Nothing could be less correct. The property-casualty insurance business is without a doubt one of the most intensely competitive market arenas anywhere. This competition provides adequate safeguards for the consumer to ensure that any very profitable upswing in the underwriting cycle is extremely limited in duration.

An extraordinary feature of the invisible giant is the amazing durability of some of the popular misconceptions about it. For example, a widespread misconception is that acts of God are not covered by insurance. This is manifestly not true, since many so-called acts of God can be protected against by insurance--lightning, hail storms, tornadoes, earthquakes and hurricanes are some.

Recent events in New Brunswick provide a practical illustration, for the hurricane-speed winds which hit that province at the beginning of February caused severe damage. Preliminary estimates indicate that insurance companies will likely be paying more than $10 million in loss settlements. In one respect, however, this unfortunate event underlines my title, because when it occurred the companies principally involved in that market rushed extra staff to the spot, placed advertisements in the local newspapers drawing attention to the procedure for reporting losses, and everything possible was done to accomplish speedy and equitable financial recompense for that act of God.

A similar event in the United States or in the United Kingdom would have been reported in both the newspapers and on television, with an accompanying reference to the insurance position and the likely loss payments that would arise and which the industry would have to meet. In Canada, however, whilst the story was on the front page of the newspapers across the country and on television, the prompt response of the property insurance companies was totally ignored.

Returning for a moment to the general subject of paying losses, which is the business we are in, it is strange indeed that I can think of no other business which is so regularly accused of not wanting to do the job for which it was created. In our case, I am afraid, we were hung with this albatross a long time ago, and like the Ancient Mariner we find it hard to get rid of.

For interest's sake I obtained from our statisticians the information that insurance companies in Canada pay out $100,000 in automobile losses every hour of every day of every week throughout the year. That figure speaks for itself.

I would like to make a further point, and this relates to something which your chairman said in his introduction. It is a point which frequently seems to escape our critics. It is simply this. The money we use to pay losses is supplied by all our policy holders including those, and there -are many, who have never had a claim. In effect, we hold the money in trust. This places a heavy responsibility on insurance companies to see that whilst losses are handled equitably and quickly, at the same time the funds are not subject to abuse by being handled, or dealt with, or paid out irresponsibly.

At any earlier stage of my remarks I commented on the rapid development of the Canadian economy, with its increasing diversity and sophistication. The potential for further growth is enormous. What is equally certain is that the demands on the general insurance industry will grow at the same pace. The challenge we face today, then, is to show the same growth in sophistication, the same growth in diversity, so that we can play our proper role in the financial community of this country. I believe we can and will respond to that challenge.

Our distinguished speaker and guest was thanked on behalf of the audience by Mr. R. Bredin Stapells, Q.C., a Past President of The Empire Club of Canada.