Standard & Poor’s Ratings Services has changed its Canadian property and casualty insurance industry outlook to stable from negative, citing the improved operating environment and relatively favorable earnings prospects for 2004.

The Canadian P&C sector recorded a dramatic improvement in its operating performance in 2003 with the industry generating an ROE of 11.3% and a combined ratio of 98.7%. That compares with 2002 when the sector generated an ROE of only 1.7%, which is the worst result on record.

S&P says that the key reasons for the improved results were an increase in premiums, which rose by about 20% during the year; reduced claims experience; and improved investment income. The strong industry financial performance occurred despite the wildfires in British Columbia, Hurricane Juan that hit Halifax, a number of Prairie summer storms, a low interest rate environment, and a significant loss for the Facility Association (a mandatory nonprofit pool that makes insurance available to any driver who is unable to obtain insurance coverage in the regular market, which reported a loss of $550 million).

“Historically, the Canadian P&C sector has experienced a fair degree of variability in its operating earnings as claims experience can never be predicted with certainty, and catastrophic events are random,” S&P notes. As well, premiums remain subject to regulatory intervention and the business cycle and the forces of supply and demand remain significant.

The agency said the industry has been in a downward spiral since 1997, the last it saw double-digit ROEs due to a string of events that include the ice storms in Quebec, spiraling accidental benefit and bodily injury claims in the personal auto line, and reduced investment returns due to declining interest rates and volatile equity markets.

Although the earnings prospects for 2004 remain favorable, there are a number of variables that could dampen the industry’s financial performance in the future, S&P said. Following the rapid increase in auto insurance rates various provincial governments implemented premium rollbacks or rate freezes in 2003-2004 in exchange for cost savings that would be passed on to the industry in the form of legislated reforms. The effect of a reduced premium will be greater in 2005 as these reductions are fully rolled through the existing auto book, S&P predicts.

The other threat to earnings is possible price competition in the more profitable commercial lines.

However, S&P also noted that there is considerable uncertainty about the industry’s long-term profitability. “Earnings and underwriting profitability will continue to be volatile. The commodity nature of many insurance products, combined with the intense competition landscape, has made it difficult for any company to produce any sustainable competitive advantage.”