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CHARLOTTETOWN, Prince Edward Island-If the weather cooperates, Canadian insurers may well have a prosperous 1997, despite falling interest income, an economist predicts.

"There are a lot of strengths in our industry," said Paul J. Kovacs, chief economist at the Insurance Bureau of Canada in Toronto. "I think this will feel like a pretty good year. I'm fairly upbeat about where we are and where we are going to go."

Mr. Kovacs, who spoke at a session at the Canadian Insurance Conference on Prince Edward Island last month, said that if insurers escape large catastrophe losses like those rung up last year, they should end 1997 in good financial condition.

Canadian property/casualty insurers in 1996 were hammered by unusually high catastrophe losses of more than $500 million Canadian ($366.5 million), whereas the industry historically has paid out about $100 million Canadian ($72.7 million) annually in such losses.

"I don't think we should expect $500 million in catastrophic losses" this year, Mr. Kovacs said. "But the trend of around $100 million is probably now low, and we're on our way to higher numbers."

Catastrophes aside, the Canadian insurance industry is seeing improved performance, he said. "The fundamentals of the industry are very, very sound. Except for the bad weather, the basic numbers for our industry are simply the best we've seen in 20 years."

Canadian insurers recorded a net profit of $1.74 billion Canadian ($1.28 billion) last year, a 21.6% rise from $1.43 billion Canadian ($1.05 billion) in 1995. Return on equity reached 13%, up from 11.7% the year before.

The industry posted a combined ratio in 1996 of 104%, not ideal, Mr. Kovacs acknowledged, but a slight improvement from 104.7% in 1995.

Mr. Kovacs expects the industry's combined ratio will decline in 1997, and the "improvement will be most evident in the personal property side because the catastrophic losses won't be what they were before."

First quarter 1997 figures indicate that insurers' loss ratio fell to 73.1% from 76.8% in 1996. The expense ratio climbed to 32.5% from 30.7%.

Insurers are concerned about rate adequacy in the commercial property insurance market in Canada, Mr. Kovacs noted. In contrast, "personal property is a very profitable piece of business right now."

The personal lines market in Canada is profitable partly because insurers have latched onto telemarketing, according to another panelist at the session.

"Direct response is taking the property/casualty industry by storm," said Edward F. Belton, director of research at RBC Underwriting Management Services Inc. in Toronto.

He forecasts telephone sales of personal lines coverages will account for as much as 20% of the market by the end of this year and could amount to 30% or more by 2000.

Mr. Kovacs pointed out that property/casualty insurers in Canada are turning their focus to profitable underwriting in the face of falling interest rates that are leading to lower investment income.

IBC figures show property/casualty companies' investment income totaled $638 million Canadian ($460.8 million) in the first quarter of this year, compared with $755 million Canadian ($555.5 million) in the same period in 1996.

Along with that drop came a decline in net income to $265 million Canadian ($191.4 million) in the latest quarter, down from $331 million Canadian ($243.5 million) in 1996.

Investment gains are going to be harder won in coming months, he said, predicting interest rates will edge up-but only slightly. "I'm looking for interest rates to move by half a percentage point.*.*.I think it's going to stay very hard to make the strong investment returns that the industry got used to in the '70s and '80s."

Panelists in another session agreed that double-digit investment returns that insurers have realized in recent years may be gone for a while. They suggested insurers consider broadening their portfolios to boost investment yields.

"Too many (property/casualty) companies invest only in bonds," said Warren Laing, chairman of Yield Management Group Inc. in Toronto. Adding a mix of equities can reduce portfolio risk and increase returns, he suggested.

"This is pretty basic," Mr. Laing said. "Yet it's quite surprising how many companies don't do it."

"Bond returns this year will be on the disappointing side," said Cameron Laird, vp of bond investment at Zurich Canada Investment Management Ltd. in Toronto. Returns on Canadian government bonds have been trending downward in recent years, he pointed out.

Mr. Laird agreed that insurers need to adjust their asset mix in order to overcome sluggish returns on bond-heavy portfolios.

"The two best substitutes for bonds, we believe, in terms of earning high investment yields, are preferred shares and high-yielding common shares," he said.

Preferred shares carry a preferential tax treatment on dividends, and high-yielding common shares "can often rival preferred shares in terms of the yield they are providing," Mr. Laird said. The holdings should be considered a substitute for bond holdings "in this period of low interest rates," he added.

Donald G. Smith, president of Canadian Insurance Consultants Inc. in Toronto, moderated the session on the outlook for the Canadian market.

Daniel P. Towle, vp at General Re-New England Asset Management Inc. in Farmington, Conn., moderated the session on investing.

Richard Rooney, senior vp at Burgundy Asset Management Ltd. in Toronto, also spoke at the investment session.