UK: Insurance Market Update: The Deloitte View for Non-Life Insurers – November 2010

Last Updated: 30 November 2010
Article by Deloitte Financial Services Group

Most Read Contributor in UK, August 2017

Welcome to the November edition of the Insurance Market Update in which we focus upon issues in the motor insurance industry. In this issue, James Rakow and Ian Clark review the state of the motor insurance market, in particular, commenting upon the underwriting results and the drivers impacting those results.

The motor insurance industry is facing challenging times in which pressure is coming from an increasing cost of claims despite commensurate premium increases. The current downturn has many parallels with previous low points in the cycle: increased price competition; under pricing; and pressure on claims costs from personal injury claims. However, the speed at which the market has declined in one year, together with very low investment returns and declining support of releases from prior year claims reserves, is very different.

However, not all is doom and gloom within the industry. Intermediaries are using stripped down insurance products to succeed on price comparison websites and then selling higher margin products, consequently making money. It would appear that some insurers are now understanding better the full value chain for motor insurance and where profits are being made, and adapting their strategic direction accordingly.

Ultimately, motor insurance is a compulsory product and it will be the consumer who will suffer by way of significantly increased pricing if the value chain breaks down.

As always, we look forward to receiving your feedback. Your views, comments and suggestions for future themes or topics are most welcome.

Kevin Elliott


All Good Things Must Come to an End

The last ten years has seen an unprecedented run of headline underwriting results close to the break-even net operating ratio of 100%. After an eight year run from 2001 to 2008 when the net operating ratio maintained cruise control between 100% and 105%, the ratio suffered its largest ever year-on-year deterioration, increasing by 15 percentage points to 120% in 2009.

However as Figure 1 shows, the UK motor insurance market has seen performance as poor as this before:

  • during the last recession in the early 1990s there were high levels of car theft claims costs and insurers were under pricing their motor product; and
  • in 1998, the market was faced with increased price competition from new direct channels set up by insurers combined with a step change in the cost of settling large bodily injury claims following the landmark House of Lords judgment on the Ogden discount rate.

The current downturn in fortunes for motor insurers has many parallels with these two previous low points in the cycle: recession; increased price competition; under pricing; and pressure on claims costs from personal injury claims. Once again, the Ogden discount rate debate has also been reopened.

That said however, what sets this downturn apart is the speed at which the market has declined – moving from the top to the bottom of the cycle in one year – together with the absence of any significant support for insurers' results from investment returns or prior year reserve releases. In the early 1990s the Bank of England base rate was nearly 15% and it was above 5% in the late 1990s. This compares with the lowest base rate the UK has seen for many years.

So how did the market move 15 percentage points in one year? Quite simply premium inflation did not match claims inflation in 2009, this accounted for half the movement. The remainder of the movement resulted from the reduction in the support from the prior year reserves (see Figure 2).

The Only Way Is Up?

The question everyone should be asking is "are we at the bottom of the cycle?" With a net operating ratio of 120%, insurers and their capital providers surely hope so.

At a risk free rate of return, insurers would be doing well if they were able to earn an investment return equating to 5% of net earned premium. If this low level of return currently available was reflected across the market then in 2009 many UK motor insurers, even after taking into account investment returns, were losing the equivalent of the old Solvency I level of capital requirement.

Pedalling Very Fast

On the premium side, the momentum is in the right direction for insurers, but not for consumers. Our own premium rate index (Figure 3) shows new business premium quotes increasing at the fastest pace since the index began in 2002. With customers facing big increases on renewal, their natural course of action is to shop around for a cheaper provider. Insurers' biggest challenge is therefore to achieve increases in premium rates while at the same time retaining the customer. On the claims side, rising claim costs, particularly personal injury claims, pull in the other direction. Motor insurers are pedalling very fast in the hope that in 2010 and beyond premium inflation will outstrip claim inflation. Only if they continue to increase premiums well into 2011 will we see the market return to profitability in the near term.

Choppy Waters

This market has demonstrated that, with strong premium rate increases, it can move from the bottom of the cycle to the top of the cycle in two years (see Figure 1 on previous page). Perhaps with a fair wind this can be achieved again? A significant concern for insurers is that instead of a fair wind they encounter further choppy waters: shocks to claims costs – leading to the need to strengthen prior year reserves, bad weather – leading to higher claim frequency, or one or two major players deciding to ease off on premium increases.

Such continued turbulence in the market could mean that 2009 was not, as many have assumed, the bottom of the cycle (Figure 4) but the herald of more bad news.

When insurers announce their 2010 results early next year we will get the first clear indication of whether the industry has been pedalling very fast just to stand still or whether it is on its way to better times again.

But Who Makes Money Out of Motor Insurance?

A stable motor insurance industry that delivers sustainable pricing service to customers requires that all elements of the motor insurance value chain make a profit. That is not to say that all elements of the value chain will be making a profit at all points in the underwriting cycle. Currently, the UK motor market which comprised of approximately £14 billion of gross written premium in 2009 is generating a loss of in excess of £1.6 billion for motor insurers. Clearly, motor insurers are losing money, but what about elsewhere in the value chain?

Many of the recent insurer announcements have focused on the escalation of the cost of bodily injury claims and the under reserving of prior years' claims that has emerged as a result.

This has largely focused on the role of the claims management companies where referral fees continue to increase and where revenues continue to grow. One of the largest claims management companies which recently reported its results showed on average a 22% growth rate in turnover and a 27% growth rate in profits over the past five years, with its profit margin now close to one third of its income. This demonstrates that money can be made in the claims value chain but possibly to the detriment of insurers.

It is difficult to see significant near term change in the bodily injury position for insurers, as changes resulting from Lord Jackson's review and the Ministry of Justice reforms are as yet far from certain – we can therefore expect bodily injury to continue to be a challenge for underwriters.

The other area of the claims value chain that has attracted much attention has been credit hire referrals. As far as the insurers are concerned this is now less of a problem as the impact of the credit crunch and the resultant recession has put pressure on the credit hire company business models and reduced their influence on the value chain.

It is perhaps on the premium side of the value chain where the industry has changed most. Who would have foreseen five years ago a position where a broker takes a net rated product from an insurer and then sells that product below its technical price to the retail customer, immediately generating a loss. That is now exactly the position that the industry frequently finds itself in with motor insurance sold through price comparison websites and this has led to strategic decisions being made which historically the industry would have been at a loss to understand.

The motor insurance broker today seeks to build up as big a motor policyholder base as is possible by selling stripped down low benefit products followed by an up sell strategy of ancillary products, premium finance and other forms of cross sale activity where the margins for the broker are significantly higher. The results of this can clearly be seen in the profits of the major personal lines intermediaries which can be described as robustly healthy.

What is clear from all of this is that there are elements of the motor value chain, be it in claims or premiums, that are inherently profitable, although motor insurers are today losing money.

We are now seeing healthy price rises in most areas of motor insurance but these need to be sustained if the value chain is to be fixed and this is by no means certain in a highly price transparent motor market. Some capacity has left the market as a result of disappointing losses. It would appear that some insurers have begun to understand that underwriting is not a silo activity and there is a need to better understand the full value chain for motor insurance and where profits are being made and adapt their strategic direction accordingly.

In order to fix problems motor insurers will need to change, be vigilant and also talk with one voice. Ultimately motor insurance is a compulsory product and it will be the consumer who will suffer by way of significantly increased pricing, if the value chain breaks down.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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