ICBC is giving it away.
After reporting net income of $390 million in 2004, the publicly-owned Insurance Corporation of British Columbia mailed rebate cheques totaling $100 million to provincial motorists in September. It was the third such repayment by ICBC in recent years, following the distribution of $47 million and $218.5 million in 'road safety dividends' in 1998 and 2000, respectively.
Despite those sizeable rebates, ICBC's balance sheet still shows retained earnings of $925 million. Clearly, the Crown corporation is a very profitable entity. Indeed, an analysis of ICBC's annual reports from 1985 to 2004 - when B.C. was governed by Social Credit, the New Democratic Party and the BC Liberals - shows that the company had net income in 15 of the past 20 years.
Yet, the Consumer's Association of Canada reported this summer that ICBC's insurance rates - that is, the average premiums paid by B.C. policy holders - are 45% below those for Ontario drivers and about 30% less than what Albertan motorists pay. In those two provinces, automobile insurance is provided by the private sector.
This seems a conundrum. On the one hand, ICBC has an enviable record of profitability and is sitting on a pile of cash totaling nearly one billion dollars. On the other, ICBC's rates are lower than those levied by private insurers. How can a publicly-owned company enjoy such manifest profitability while charging below-market premiums?
But perhaps a second question also should be asked. That is, is there a better use for the Crown corporation's ongoing profits, instead of being rebated to drivers who already enjoy lower-than-market premiums or left sitting on the balance sheet?
Put another way, could ICBC's profits be put to a better use for its shareholders, the 4.2 million people who call British Columbia home?
Buffett explains the insurance biz
Let's consult Warren Buffett, the folksy American investment guru known as the 'Oracle of Omaha.' According to Fortune magazine, Buffett's company, Berkshire Hathaway, last year was the United States' 12th largest corporation, with annual revenues pegged at $74.4 billion. Buffett clearly knows something about business.
And as he makes clear in an annual letter to his shareholders, "Our main business - though we have others of great importance - is insurance." Berkshire Hathaway has extensive insurance and re-insurance operations, including one entity not dissimilar to ICBC: GEICO, which targets drivers through extensive advertising and direct mail campaigns.
Buffett likes to explain that insurance is unlike nearly every other kind of commercial enterprise. That's because most businesses expend a considerable amount of cash before they generate revenues from the sale of their products or services.
Consider a shirt-maker, for example. The manufacturer must purchase raw materials (fabric, thread and buttons), pay wages and benefits to employees; rent or purchase premises where the employees will work, as well as tools and machinery; pay for utilities such as power, heat and light; package and ship the shirts to a retail outlet; and conduct an advertising or promotional campaign to create consumer demand. If it all works out, the shirts will find favour with the buying public and eventually the retailer will send a portion of the proceeds back to the manufacturer.
The entire process may take weeks, months or longer. And because there is a lag between outlay and income, the shirt-maker must finance operations either from savings or, more likely, by borrowing the necessary funds. And this adds yet another cost item to the manufacturing process: interest expense.
The above is true for nearly every kind of business. Interest must be paid on monies borrowed to cover the lag between outlays and income (or, foregone on re-invested profits).
But the process is reversed for insurance companies: income precedes their largest outlay. Initially, policy-holders make premium payments to an insurance company; it is only later, after a claim is approved, that the insurer will expend monies to cover the approved claims. Between the time when premiums are received and when claims are paid, the insurance company earns interest on the monies it holds.
Simply, most businesses pay interest expense on borrowed monies. Insurance companies, however, earn interest on premium revenues held - which Buffett calls 'float' - until they pay claims.
"Float is money we hold, but don't own," he explains. "In an insurance operation, float arises because premiums are received before losses are paid, an interval that sometimes extends over many years. During that time, the insurer invests the money."
Over the past two decades, ICBC has generated $38.5 billion in 'premium income' from B.C. motorists. On top of that, it realized another $6.5 billion in 'investment income,' which is the interest on float. Total revenue from both sources - premiums and interest - was about $45 billion.
Not all gravy
But there is a catch. "This pleasant activity," says Buffett of generating float to earn investment income, "typically carries with it a downside. The premiums that an insurer takes in usually do not cover the losses and expenses it eventually must pay. That leaves it running an 'underwriting loss,' which is the cost of float."
Simply, an insurance company incurs many costs in the course of conducting its business. These include advertising to build consumer demand, a sales force to sell its policies and analysts to approve or reject claims submitted by policy-holders. Plus, there are numerous administrative expenses. Taxes must be paid. And finally, the biggest expense of all, the payment of approved claims.
These costs - operating expenses plus claims payments - usually exceed premium revenue. The result, as Buffett says, is an 'underwriting loss.' And the only way to make up this shortfall and generate a profit is with 'investment income' - which is the interest earned on the float.
ICBC's profits come from interest on 'float'. It breaks down this way:
As mentioned earlier, ICBC's premium income over the past two decades totaled $38.5 billion. But the company also incurred approximately $11 billion in operating costs and paid another $33 billion in approved claims.
Total expenses were $44 billion or $5.5 billion more than the $38.5 billion in premium income. This resulted in what Buffett describes as typical for insurance companies: an 'underwriting loss.'
But when ICBC's investment income of $6.5 billion is added to the picture, the $5.5 billion deficiency is transformed into a profit of about $1 billion. (The cumulative total of profits, minus losses, over the past two decades was $943 million, and as mentioned earlier, retained earnings are $925 million.)
Lower costs, lower premiums
ICBC seems pretty typical of most insurance companies. But what about those low premiums paid by B.C. drivers? The answer is that ICBC has lower costs than private firms.
Since it enjoys a monopoly on 'basic' automobile insurance in B.C., the Crown corporation does not need to expend large sums on advertising to attract customers. And because it is owned by the B.C. government, ICBC pays neither federal nor provincial taxes (with the exception of insurance-premium taxes to Victoria).
With lower operating costs than private insurers, ICBC therefore has a lower 'operating loss,' and so can charge lower premiums. ICBC's low rates and profitability benefit countless British Columbians.
The average B.C. motorist, according to the Consumers' Association's study, pays $1,324 for insurance annually. That's $390 less than what Albertans pay and a whopping $1,059 less than Ontario drivers. B.C. businesses benefit in two ways: first, their employees' wage and salary demands are dampened by lower-than-market auto-insurance costs; and second, their own fleet insurance and transportation costs are lower than those faced by competitors in other provinces.
The provincial government also benefits from ICBC's profitability. First, because Victoria has adopted generally accepted accounting principles (GAAP), which includes Crown corporations in the province's bottom line, ICBC's retained-earnings reduce B.C.'s total debt. Second, the Crown corporation's annual operating profits help to boost provincial revenues, thereby contributing to a 'balanced' or surplus budget. And third, ICBC collects more than $400 million annually in fines and revenue for the province and operates 'Road Safety programs,' at no cost to Victoria! (The $100 million-plus annual cost of these activities is paid by ICBC.)
Still, ICBC has many critics. The Consumers' Association of Canada claims that the Crown corporation's already-low premiums ought to be slashed even further. But not only would that jeopardize the company's financial health, it would put more motorists on the road as driving costs were reduced. The provincial government would have a less-profitable Crown corporation and face rising road construction and maintenance costs.
Private insurers continually bemoan ICBC's basic auto-insurance monopoly, saying they cannot compete with a publicly-owned entity. Yet, it must be remembered that a free market is one where consumers can walk away without purchasing a good or service if they do not like the offered price. That option does not exist with automobile insurance because the government, by law, requires motorists to buy coverage before getting behind the wheel.
This legal requirement distorts the insurance market at least as much as the presence of a publicly-owned corporation. As well, it would be perverse for a government to require its citizens to purchase something without ensuring that it was available at the lowest-possible price.
Could ICBC be more than it is?
Perhaps there is a different way to view ICBC. Forget about reducing rates even further. Quit sending rebates to policy-holders. Ignore demands to privatize the Crown corporation.
Instead, why not utilize ICBC's ongoing profits for all British Columbians?
The reason Warren Buffett is so well known is that he took steady, if unspectacular, profits from Berkshire Hathaways's insurance operations and built sizeable equity positions in companies including American Express, Coca-Cola, Gillette, H&R Block, Moody's, The Washington Post Company and Wells Fargo, among several others.
He also owns outright numerous smaller companies in such disparate fields as shoe-manufacturing, furniture-retailing, building products, jewelry, energy, flight simulators, jet-leasing and candy, plus such well-known consumer brands as Dairy Queen and Fruit of the Loom, and much, much more.
Is it time that British Columbians quit complaining about ICBC and instead thought about its commercial potential?
Put another way, what would Warren Buffett do if he owned ICBC? He'd invest.
With ICBC being a public insurance company, the question, therefore, falls to you, me and the rest of British Columbians. Where should we be investing all those hundreds of millions of dollars in revenue for the long-term betterment of British Columbians?
Political analyst Will McMartin writes a regular column for The Tyee.
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