Welcome to the January 2009 edition of the Insurance Market Update in which we focus upon issues in the general insurance industry. In this issue, as a follow up to the summary of our motor market survey in an earlier edition, we focus on the state of the household insurance market.
Catherine Barton, Richard Lywood and James Rakow draw on information from our survey on the household insurance market and examine how 2008 fared in the aftermath of the huge flood losses in 2007 and ask whether 2009 will be the start of a strong run or whether it is just the calm before the storm as economic uncertainty presents challenging times ahead for insurers. For further information on the Deloitte Quarterly Household Report, please contact James Rakow. Your comments and suggestions for future themes or topics are, as always, welcome.
Kevin Elliott
Editor
UK Home Insurance – A Wakeup Call For Industry
The huge flood losses in 2007 reversed the run of profitability and stability seen in the household insurance market over the previous few years, but how has 2008 fared in the aftermath? And how will the market react to the impending recession in the UK?
After The Deluge
The insurance industry needed a year of recovery following the floods of 2007, a year in which the net operating ratio shattered the calm run of between 93% and 101% since 2003 with a jump to 120% as a result of claims from the summer flooding. This was driven by a leap in the claims ratio from 53% to 78%, while the expense ratio rose only slightly from 40% to 42%, due in part to increased claims handling costs (note: these ratios are based on data from FSA returns).
Wise After The Event?
What lessons have been learned? It is clear that the risk of widespread flooding and other weather events is a reality that both the insurance sector and government need to act upon.
In 2008, the 'statement of principles' originally agreed by the government and ABI, which was due to end in 2009, was extended until 2013. The agreement means that insurers will continue to offer flood cover to the 517,000 existing homes in high flood risk areas, provided that the Environment Agency ensures that adequate defences are planned and installed within the next five years.
Additionally, the ABI has called for this spending to be brought forward as increased public spending could assist in stimulating the economy. The ABI reports that there has also been overwhelming support for a recognised standard or kitemark to show that new homes are built to flood resistant standards, allowing homeowners to make a more informed decision when buying a house, and the analysis of flood risk far less expensive for insurers.
When implemented, these measures could have a great impact on the household insurance market. Many climate change indicators suggest that flooding is set to increase in the UK, and defences and regulation will make the risk much easier for both insurers and homeowners to deal with.
According to the ABI, customer satisfaction with the response of insurance companies following the 2007 floods was good, with ratings above those of the government and the Environment Agency. Measures taken included finding temporary accommodation, fitting kitchens on upper floors for customers who did not want to leave their flooded homes, and one company even purchased over 400 caravans to be used as temporary accommodation.
2008 – A Return To Normality?
While 2008 saw some significant weather events, losses have returned to more usual levels. This sets the stage for a return to profitability in the market and Deloitte forecasts the net operating ratio in 2008 to be 99%. Since the household market is catastrophe-driven, we believe that a market level operating ratio of around 95% in years with catastrophe-free claim levels may enable insurers to remain profitable overall once years of extreme weather events are taken into account. So this forecast does not represent a perfect return to health for the market, but is undoubtedly a step in the right direction.
While nothing happened to match the losses of the floods in 2007, there were significant weather events in 2008, most noticeably windstorms Johanna and Kirsten, arriving a day apart, which drove losses of around £150 million in the first quarter. There were also a number of near misses, including windstorm Emma, which caused an estimated €750 million – €1300 million of losses across Europe, mostly in Germany and Austria.
February also saw the largest earthquake in the UK for 25 years, as Lincolnshire was hit by an earthquake of magnitude 5.2, causing £10 million – £15 million damage. A British Geological Survey estimated that this scale of seismic activity only occurs around once every 20 years.
The floods of 2007 and these near misses in 2008 demonstrate how susceptible the industry is to large weather related losses. As shown in figure 1, operating ratios have hit peaks of up to 125% in the past, and in the absence of catastrophe, under-pricing can produce a loss-making series of underwriting results, for example as seen between 1997 and 2002.
Figure 1. Motor And Property Performance In Recessions
Maintaining Profitability
As shown in figure 2, premium rates were on a downward trend prior to the floods of 2007, which promptly halted in August 2007 when the effect of the floods became apparent and insurers saw the need to increase rates.
These premium rate indices are published in the Deloitte Quarterly Household Report (note that these reflect new business rates only). Our index measures the average 'most competitive' premium for a basket of risks. This means that while it only takes one or two insurers offering low prices to move the index down, a concerted effort from a number of players is required to move the index up.
In mid 2008, premium rates increased sharply. This was most likely a reaction to the worsening economic climate, and the forecast of tough times ahead for the insurance industry. But with little premium inflation since August 2008, one has to ask – are insurers raising premiums enough to prevent another underwriting loss?
Figure 2. Deloitte Quarterly Household Report – Premiums Rate Inflation Index
2009 – Wise Before The Event?
It is easy to look back and be wise after the event, but is the market wise to events in the immediate future? The impending recession and current economic climate bring with them a number of knock-on effects that could affect profitability and insurers must remain on their toes to avoid being caught out.
The channel shift to internet-based aggregators may accelerate as consumers become more price-aware. This will result in a more competitive market, as insurers seek to maintain market share. However, they will need to take care that they are not punished by the 'winner's curse' of providing the lowest quote, and consequently selling a large quantity of policies at a trading loss for the insurer. The increased presence of aggregators will also act as a dampener on premium levels which would otherwise rise quickly.
Past data suggests a strong correlation between instances of fire claims in commercial property and so-called moral hazard claims. As the economy deteriorates into 2009 we may see an increase in fraud and exaggerated claims, the prevention of which may drive expense ratios back up following their gradual decline over recent years.
A study undertaken by the ABI has revealed that those with a household income of less than £10,000 are 2.6 times more likely to have committed insurance fraud than average, and that home contents policies are by far the most likely to have fraudulent claims made on them.
Past recessions have coincided with a worsening in the operating ratio of the market, though the effects of severe weather losses make this a difficult relationship to quantify.
However, a recession is not all bad news. Insurers may benefit from an expected fall in the costs of repairing damaged properties, due to the decline of the construction industry. Historically, recessions have not led to a fall in spending on household insurance. Rather, the proportion of households who chose to buy contents insurance actually increased during previous recessions, suggesting that insurance is valued more in times of economic uncertainty.
Another feature of the current economic environment is the unprecedented low interest rate. Previous recessions have been coupled with higher rates (in excess of 10%), allowing insurers to bolster poor underwriting results with good investment returns. These high investment returns will not be available to insurers as we head into 2009 with the base rate the lowest it has ever been, giving even greater reason for caution when setting premium levels. This will be felt even more by motor insurers due to the longer tail nature of liability claims.
While the floods of summer 2007 halted the decline in premium rates, the worsening of economic conditions towards the end of 2008 has seen premium rates rise again as insurers act to guard against recessionary effects and the fall in interest rates. We believe that in spite of the increased competitiveness in the market, net earned premium inflation will continue to rise: to 4.4% in 2008 and 4.9% in 2009 in a "business as usual" market.
Besides recessionary effects, future profitability remains as ever at the mercy of large weather losses. Already this winter, insurers have seen an increase in claims relating to burst water pipes, caused by the extremely cold conditions at the beginning of the year.
Conclusion
2008 saw a return to profitability thanks to a mild year of claims following the huge losses of 2007. While the response of the industry to the floods has been highly rated by customers, insurers must remain poised and cautious as we head into the uncertainty of recession.
Our forecast of a return to profitability for the upcoming financial year has been based on a "business as usual" scenario, not taking the effects of the recession into account. The recession adds an increased element of unpredictability to the market, which will increase the overall uncertainty of these forecasts.
Whilst premiums have been increasing it is not clear how long this will last. If the market is to remain profitable, we must see continued growth in premium rates in order for insurers to avoid a run of poor net underwriting results.
Following a year of recovery, we look ahead and wonder if it will turn out to be the beginning of a strong run, or if we have just enjoyed the calm before the storm as economic uncertainty presents challenging times ahead for the household insurance market.
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.
