Rates are slowly rising but insurers are still facing challenges when it comes to profit margins, not least from the economic environment. Catherine Thomas explains how pricing may be key for the future.
Despite evidence of rate rises across most business lines the profit margins for the top 100 UK insurers are set to remain under pressure throughout the rest of 2009 and 2010.
Challenging economic conditions are likely to lead to an increase in loss frequency due to higher levels of theft and arson, as well as a rise in the number of fraudulent claims.
In addition, the commercial sector is expected to see many more liability claims as insolvencies expose the failings of directors and other professionals.
Perhaps more significantly, the ability of insurers to support reported results with prior-year reserve releases is expected to reduce, and the potential for large weather-related losses in the last few months of 2009 and in 2010 cannot be discounted.
In 2008, the UK insurance industry once again relied upon reserve releases to produce an underwriting profit, although the effect of prior year performance on results was less marked than in 2007. The overall accident year loss ratio was high, albeit lower than in 2007, due to the absence of large flood losses.
Overall, the top 100 UK insurers reported an improvement in underwriting performance (measured by underwriting result percentage of net premium written). However, the performance of individual market participants varied significantly and was largely dependent on the level of each company's prior-year reserve releases and whether these were sufficient to offset accident year losses. Half of the top 20 insurers reported an underwriting loss, and the performance of eight companies in the top 20 deteriorated from the level reported in 2007.
In each of the past four years, annual results have been buoyed by releases from reserves, principally for business written during hard market conditions between 2003 and 2005. However, outstanding claims for these years are reducing, and the cushion built into reserves for business written between 2006 and 2008" when market conditions were weakening" is expected to be lower.
Consequently, AM Best believes insurers are unlikely to be able to subsidise weak accident year returns with excess prior-year profits much beyond 2009. So if the industry is to remain profitable, accident year underwriting performance must improve.
Insurers are beginning to respond to this need and rates began to rise in 2008, particularly for personal motor and flood affected risks. In the first half of 2009, rate increases spread to other lines of business.
However, the UK insurance market remains highly competitive, and insurers are finding it difficult to push through material improvements in pricing without sacrificing their market share. Additionally, in the weaker economic environment, customers are seeking to cut spending, with some reducing their level of cover. Together these factors may prevent insurers achieving price increases at a sufficient level to support future profitable results.
As would be expected, there was a sharp reduction in the gross ultimate loss ratio for the property sector in 2008. Weather experience was benign, in contrast to 2007 when the class was heavily affected by losses from the June and July floods.
After the 2007 floods, a number of large property insurers announced their intention to raise rates, and pricing did improve in 2008. However, increases were lower than initially anticipated, with movements for commercial business less marked than those for household insurance. On the whole, insurers struggled to achieve significant increases in a market where participants have performed well in most years and capacity is plentiful.
Although pricing is expected to continue to improve throughout 2009 and into 2010, there is some concern that increases will fail to keep pace with deteriorating loss experience. A prolonged downturn is likely to lead to an increase in the level of claims relating to theft and arson. At the same time, higher numbers of fraudulent claims can be expected.
Of course, the most significant driver of overall performance in both years will be the frequency and severity of weather-related events. Managing and accurately pricing flood risk remains a key challenge for property insurers, and the use of flood models in the UK is increasing.
In addition, the industry continues to work with the UK government to ensure that flood insurance remains widely available. In April this year, the government published its draft flood and water management bill which, if enforced, should lead to flood risks being managed in a more efficient and organised manner. However, there is still some concern among insurers regarding the level of public spending on flood defences, and uncertainty surrounds the government's long-term funding strategy, which is yet to be published.
Motor remains competitive
Accident year results for motor business remained weak in 2008, although the upward trend in the gross ultimate loss ratio stalled. Once again, reserve releases supported calendar year results, masking the true impact on performance of inadequate rates and claims inflation.
Although AM Best believes there is still a sufficient margin in reserves to bolster results in 2009, it is also likely that reserve surpluses are diminishing. At the same time, rising costs, particularly for personal injury claims and legal expenses, are putting pressure on profit margins, and the need to increase rates to support performance is becoming more urgent. There is evidence that the sector is taking action to improve results, and in the first half of 2009, personal lines insurers built on the single digit rate increases achieved in 2008.
However, competition is strong and, while there is evidence of underwriting discipline at renewal, pricing for new business remains aggressive. The highly commoditised nature of personal motor insurance makes it particularly vulnerable to price-based competition, and the proliferation of price-comparison websites has made it much easier for buyers to shop around. So as disposable income shrinks, the tendency of policyholders to switch providers to save money is likely to increase.
Pricing remains weak in the commercial sector, with rate movements lagging behind those for personal motor. Problems in the wider economy are putting pressure on businesses, and some are reducing the size of their fleets, and consequently insurance spend. With ample capacity in the market, it is difficult for insurers to achieve material rate increases.
Liability to remain in profit
The performance of the UK liability market exceeded expectations in 2008 as the ultimate loss ratio stabilised and prior years continued to develop favourably. In 2009, the sector is expected to remain profitable. Rates are beginning to increase, albeit slowly, and further reserve releases are likely.
Beyond 2009, the picture is less positive. It is unlikely that substantial releases can be sustained in the medium term. In addition, the determination of adequate pricing and reserving is especially challenging for liability business, and the uncertain economic outlook makes it even more difficult to predict claims trends.
In particular, the professional indemnity, and directors' and officers' sectors are likely to be affected by the economic downturn. Higher numbers of insolvencies tend to lead to an increase in litigation as interested parties seek to recoup losses they believe have arisen from poor advice or negligence.
Despite this, AM Best does not expect a significant upsurge in the frequency and magnitude of claims paid due to the UK's restrictive 'opt-in' approach to class actions and the difficulties likely to be experienced in establishing which party is at fault. Weak investment results are putting additional pressure on the market to achieve rate increases in excess of claims inflation. In the past, liability insurers have been able to produce profits despite underwriting losses as the relatively long-tail nature of the business written enables them to benefit from investment income over a longer period. However, low interest rates and volatile equity markets mean insurers can no longer rely on investment earnings to shore up results.
Overall, the calendar year performance of the top 100 UK insurers improved in 2008, principally due to further reserve releases and the absence of large weather-related losses. In 2009, the potential for an increase in the magnitude and frequency of claims, reducing reserve releases and low investment income are expected to put downward pressure on profit margins. Although some insurers are taking action to improve pricing, they are struggling to achieve material rate increases and maintain market share.
With market conditions set to remain difficult for some time due to intense competition and economic pressures, UK insurers may have to choose between profit and volume.
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