How inflation’s helping some Canadian P&C companies
Inflation, and more specifically efforts by Canada’s central bank and its peers worldwide to curb its impacts, has given something of a boost to property and casualty (P&C) insurers’ balance sheets.
Specifically, higher interest rates have expanded fixed income investment opportunities for insurers and increased potential yields, said a recent commentary from DBRS Morningstar. That report looked at four Canadian publicly traded P&C insurance companies: Intact Financial Corp., Fairfax Financial Holdings, Definity Financial Corp. and Trisura Group Ltd.
It noted all four “benefitted from consistent premium rate increases, less-volatile financial markets, and higher interest rates.” That’s led to steady top-line growth and positive underwriting and investment income.
“The companies have taken steps to capture yield in the current higher interest rate environment by investing in fixed-income assets,” DBRS Morningstar added. “Overall investment income was good, driven in part by higher reinvestment yields and dividend income with Fairfax reporting significant improvement over the prior year compared with the other companies.”
And those interest-rate gains appear poised to continue. Economists at major Canadian banks and investment houses project the Bank of Canada isn’t done raising benchmark lending rates in an effort to cool inflation. Comments from the U.S. Federal Reserve and other global central banks also suggest rate hikes outside of Canada will continue.
Labour worries
One key central bank concern is that rising wages for workers (which are necessary to help struggling individuals and families pay for basic needs) will also act to perpetuate inflation.
Even before the pandemic, labour shortages pushed up wages for jobs on the lower rungs of the economy. And those wage hikes were in some cases fuelled by the ‘great resignation’ trend during the pandemic that left some employers frantic to fill openings.
“The concern now is that strong wage growth will persist to the point that it becomes counter-productive — that is, where it begins to push the price of goods and services above actual purchasing power,” said an RBC Proof Point commentary earlier this year.
“Should soaring wages fuel greater spending, they could at best slow the pace at which inflation eases and at worst, reignite it.”
At the same time, RBC’s report noted wage growth had yet to catch up with inflation.
Likewise, in its July report, the Bank of Canada said that while the labour market had shown signs of easing, the unemployment rate remained historically low. “And wage growth has been between 4% and 5%,” it said, “higher than is consistent with price stability.”
In that context, recent efforts by unionized workers in Canada to procure contractual wage hikes suggest the Bank of Canada isn’t done raising borrowing rates.
The insurers-eye view
That could benefit P&C companies over the longer run.
Unlike life insurers, which can apply actuarial metrics to gauge claims patterns, P&C insurers must respond to Nat Cats and other events that require claims payment at a moment’s notice.
So, while life insurers have the luxury of putting some excess capital into the equity markets, P&C companies generally stick to fixed-return investments. And the value of those investments is keyed to prevailing interest rates at the time they’re taken out.
Starting in early 2022, the shift from a lower- to higher-rate environment did create some short-term challenges, financial officers at insurance firms told CU. But the shift also created opportunities for insurers to collect better long-term returns as lower-yield bond investments were redeemed and replaced by those providing higher returns.
In addition to conventional bonds, those new opportunities included investments by P&C companies in preferred shares, limited recourse capital notes, and floating-rate or variable-rate debt.
DBRS Morningstar’s report noticed a continuation of that trend.
“Given the significantly higher market yields, we expect natural turnover from maturities of fixed-income investments to continue to contribute to growing recurring interest income generated from the fixed-income investment portfolios of the companies,” it said.
Inflation’s downside for Canada’s P&C insurers has come in the form of higher payouts for what had once been garden-variety claims – spurred by sharp rises in parts and labour costs for car repairs and home restorations.
DBRS Morningstar’s report summed it up this way: “We expect premium rates to continue increasing in the short-to-medium term especially for property insurance as claims are being pressured by inflation, higher reinsurance costs and elevated catastrophic insured losses.”
Feature image courtesy of iStock.com/DNY59
