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© Copyright 2000 Rogers Media. The following article first appeared in the May 2000 edition of
BENEFITS CANADA magazine.
24th Annual Special Report on Group Insurance: Now what?
Canada's group insurance business made great strides in 1999. Whether you see demutualization and
consolidation as steps forward or backward depends on your perspective.
By Kevin Press
The consolidation trend has become synonymous with BENEFITS CANADA's Annual Special Report on Group
Insurance since the mid-1990s. Reporting on merger talks between Great-West Life Assurance Co. and
Confederation Life Insurance Co. back in 1994, then-editor Paul Williams wrote: "Conventional wisdom has it
that the Canadian group insurance industry is about to undergo a period of rationalization. Beset by
shrinking margins, a stagnant market, rising claims, faced with mind-chilling investments in technology
while looking over its shoulder at potential competition from banks and third-party administrators, the
story line for the industry is that only a few strong insurers will survive."
That prediction has played out in breathtaking fashion. Consolidation has been held up as a significant
trend in every group insurance report since. Providers have joined forces in the hopes of finding new
efficiencies in their service of plan sponsors.
Unfortunately, the business remains mired in too much unprofitability. Dave Johnston, senior
vice-president, group sales and marketing at Great-West Life Assurance Co. in Winnipeg says that providers
suffered from years of over-supply. "During that period, prices were quoted at levels that were not
substantiated by the actual business," he says. "In an over-supplied market, the search for market share
becomes quite predatory and quite aggressive. That's what happened in the mid-1990s--it led companies to
become unprofitable."
There is change ahead. The 24th Annual BENEFITS CANADA Special Report on Group Insurance finds an industry
refocusing its attention on profitability. Demutualization--the transformation of mutual insurance
companies to publicly held stock companies--puts these firms in an unforgiving spotlight. Stockholders
demand profitability, from every business the company is in. That will put new pressure on demutualized
companies' group insurance divisions, and by extension, on the entire industry.
"In the old days, companies could take renewals they did not expect to make a profit on, just to keep the
business," says Nick Heymann, manager of group life and health marketing at Canada Life in Toronto. "Now
[providers] are asking 'is this company worth keeping? Are we going to make money?' There's going to be a
far sharper focus on expenses."
Johnston says group insurance providers are finding a better balance. "An industry has to be profitable to
exist. I don't think of it as a negative for customers . . . Overall, you might be looking at 2% of premium
as the difference between being profitable or unprofitable. So the impact is not huge. Prescription drug
increases have way more of an impact."
Last year saw several key demutualization announcements. By year-end Sun Life of Canada, Manulife
Financial, Mutual Life of Canada (now Clarica Life Insurance Company), Canada Life, Industrial-Alliance
Life Insurance Company and Great-West Life (which was already a stock company), had all either demutualized
or were in the process of finalizing their transformation.
These organizations represent $15.1 billion. That is 64.8% of the total group insurance industry measured
on Dec. 31, 1999. Except for Industrial-Alliance, this list comprises Canada's five largest group insurance
providers.
These firms are going through demutualization for a reason. Selling shares raises capital, which will mean
expansion for some.
"A lot of them are looking in other countries," says Heymann. "We're looking in Brazil. In fact, we have
operations now in Brazil. A lot of companies are looking in India, the Far East and South America."
On the other hand, some firms may find themselves part of other's expansion plans. There are providers that
have a takeover premium built into their share prices.
It is unlikely that we've seen the end of consolidation in the domestic group insurance business. Two
scenarios are possible. One of the large providers could buy up more market share. Or another Canadian
institution (the banks are always part of this kind of crystal ball gazing) will make a move.
Cathy Honor, vice-president, group retirement services at Sun Life of Canada in Toronto, says the second
possibility could have a pronounced impact on her part of the business. "Various banks have tried, but
really haven't been able to take much, if any, share away from the insurance companies," she says. "We
still have about 80% share of the pension market. If Fidelity or Royal Bank, or any of them, bought [an
insurance company] you could see a new type of competition."
GROWTH IN 1999
In the meantime, Canada's group insurance market continues to grow. The total industry increased 11.2% to
$23.3 billion (see "The Big Picture," page 41). That compares with 10.6% growth in 1998, and a 10% increase
in 1997.
Heymann attributes the gains to general economic conditions. "Jobs are being created," he says. "Companies
are bringing on more people. Another reason is the increase in health costs. Thirdly, more and more small
businesses are getting covered because more are being created. A lot of small businesses are getting more
profitable, and therefore they're offering benefits."
The group health market broke the $7 billion mark in 1999. That business is up to $7.1 billion--a 10.8%
increase over the previous year (see "Top Group Health Providers," page 44).
Canada's group life business rose 5.2% to $1.7 billion (see "Top Group Life Providers," page 48).
Administrative services only (ASO) deposits are up 10.1% to $5.8 billion (see "Top Administrative Services
Only Providers," page 48).
The only business that saw a slowdown in growth last year was pensions. But that is not to say the numbers
are weak--the country's 16 providers report 11.6% total growth for the year ended Dec. 31, 1999 (see
"Pension Providers," page 49). That's down from 16.1% growth in 1998.
The growth is made up of an 11.3% increase in pension assets under management (up to $64.3 billion), and a
13.8% jump in pension contributions ($8.7 billion in 1999).
THE COST OF DRUGS
Measured by product group, the highest year-over-year increase was for drugs. Drug premiums rose 27.9% to
$342 million during the year (see "By Product," page 44).
"Some of that is due to the off-loading of government plans," says Heymann. "We're picking up more . . .
Some of it, we end up swallowing. Some of it we pass on at renewal. The problem is that renewals come a
year later, or six months later. So we have to eat the costs for those months. And then it's hard to give a
renewal that includes all the costs.
"No insurance companies are making money on health and dental. We're all losing," he says. "We need to come
together as an industry and see how we can get lower costs for drugs, and handle the way government is
off-loading its expenses."
Michael Best, senior vice-president, group insurance at Clarica in Waterloo, Ont. says three trends are
putting pressure on providers and plan sponsors alike: "We've got the combination of increasing
costs--particularly in some of the pharmaceutical parts of the business--increasing usage as the population
ages and a downshift from government."
Extended health represents the biggest piece of the business again this year, with $2.3 billion. It's also
a close second in terms of percentage growth--with an increase of 26.4%.
NEXT STEPS
In recent discussions surrounding the group insurance market, there has emerged a pessimism among some plan
sponsors about where the group insurance industry is heading. Providers though, like Nick Heymann, say that
in the long run, no one benefits from a group insurance industry that is not profitable.
"If companies continue to lose money, they'll just stop offering insurance," says Heymann. "Also, as
insurance companies focus on reducing expenses, everyone benefits. If plans are cheaper to run, they can
offer cheaper rates."
Best agrees that things will get better. "There are two big forces in the marketplace right now," he says.
"There is the unavoidable pressure on insurers to operate their group business more profitably than in the
past. But there is an equal pressure on employers to keep their benefits costs under control in the face of
rising health costs, which is the largest part of group insurance costs in Canada. These conflicting
pressures are going to result in a market which is much more innovative than we've seen in recent years.
Insurers and employers will work together, even more than they have in the past, so that both can meet
their objectives.
"I think the market is going to be more challenging for intermediaries as well," he says. "Those that can
add real value by understanding how to match the needs of employers with the capabilities of insurers will
do well. Those who make their living by price shopping will do badly. The days of churning group insurance
business to get lower prices--which has been a major force in the business in the past--are over."
Are Heymann and Best being overly optimistic? We will see. Clearly, technological advances will help group
insurance providers realize new efficiencies. "You'll see the whole concept of electronic administration,
employee self-service, that type of thing, continuing," says Johnston. "There are definitely areas where
the unit costs are going down. What happened in the industry was that the pricing went down much faster
than the unit cost did. So the pricing is coming up a bit. But the cost of running programs per unit will
continue to go down because of technology."
*** ***
Profitability Now
Demutualization means stronger fiscal management nfor insurers, and higher costs for plan sponsors.
Among the clear ramifications of insurance carrier demutualization on Canadian plan sponsors is the
emergence of a more intense focus on profitability and fiscal management. Plan sponsors will bear the costs
of the benefits and services they want provided to their plan members.
Historically, private Canadian insurers focused on business volume and market share when measuring success.
Occasionally, this meant some plans actually operated below cost because of their prestige marketing roles.
After years of consolidation, insurers must develop and deploy effective pricing strategies that generate
the expected returns from each business and market segment. This is particularly urgent in light of the
increased financial scrutiny anticipated as the large mutual companies enter the public arena.
Benefit plan sponsors will see the biggest difference in the industry's revised approach to pricing. Rather
than expense and profit charges being determined from broad averages based on premium volumes, plan
sponsors can expect charges to be linked to the level of service and the amount of capital required to
support the risks that the insurer assumes.
Those plan sponsors that transfer more risk to the insurer will need to pay higher cost of capital charges
to reflect their increased use of insurer capital. More importantly, insurers will likely exit those market
segments that do not generate profitable returns in order to employ their capital elsewhere.
OPTIONS
Plan sponsors can influence the cost of capital charge by adjusting the amount of risk actually transferred
to the insurer. Under an experience rated (refund accounting) insured arrangement, this can be accomplished
by providing a capital offset in the form of a rate margin, a claims fluctuation reserve or a guarantee to
cover any insured deficits on termination of the contract. Alternatively, when it makes sense, the plan
sponsor could eliminate the cost of capital charge by retaining the benefit risk of the plan and engaging
the insurer in an administrative services only contract.
Plan sponsors will increasingly need to make economic decisions, balancing the amount of risk transfer with
its associated impact on the plan's net cost.
*** ***
What's Next?
Canada's group insurance is not what it used to be. Your move.
By Dean Connor
Look for your medical premiums to double over the next three or four years. If you have any doubts about
this, look at the introduction of 4,000 new drugs over the next five years. Look at the impact of your
aging workforce and bulging retiree population on medical costs. Look at what happens when insurers close
the gap between today's profitability levels and their target levels.
Look for a proliferation of new providers at the small end of the market. It's inevitable. When the market
reshapes into a dumbbell distribution, with a few jumbo players at one end and few players in the middle,
there's plenty of fertile soil at the small end for new niche players to emerge. Look for new players in
wellness, disability management, firms delivering benefits through the Internet, and look for the pharmacy
benefit managers to play a larger role.
Look for some breakthroughs in technology-enhanced service offerings, especially Web applications. Look for
a significant enhancement in claims payment, with worksite automated teller machines that receive your
claim, adjudicate it and deposit the funds directly to your bank account. On this score, I personally think
the not-for-profit insurers--like the Blue Crosses--will be challenged. Unless they band together into one
great big not-for-profit, they just won't have the scale and capital to make the necessary technology bets.
What should employers be doing at this time? Here are four suggestions:
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Simplify what you do. Get rid of the things that will be targets for extra insurer fees, like
multidivision accounting and complicated grandfathering rules. Ask your employees and your unions for
cooperation in cleaning up the plan. Drop the reports you get from the insurer that nobody reads.
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Look at reducing the role of the insurer by self-insuring post-retirement life insurance benefits, and
perhaps even self-insuring long-term disability.
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Think about whether or not it makes sense to shift your plan design to more of a defined contribution
approach, with a core layer of catastrophic protection for the truly big ticket claims that can torpedo
an employee's financial security. This will reduce your exposure to cost increases.
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Stay focused on managing the 85%-plus of your benefits costs that are pure claims.
Dean Connor is a principal with William M. Mercer Limited in Toronto. He offered this advice at a seminar
in March.
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