Standard and Poor's annual report on the UK motor insurance market reveals a deterioration in underwriting result. Lynn Rouse takes a look at the findings and asks whether insurers are likely to turn the decline around
Collective financial results from the UK motor insurance market deteriorated in 2004 compared to the previous year, with predictions that the overall combined ratio for 2005 will fall below the level necessary to generate an adequate rate of return on capital. This is the key finding from ratings agency Standard and Poor's annual analysis of the detailed market figures, based upon Financial Services Authority returns.
Despite the beneficial effects of reductions in claims frequency, in both private motor comprehensive and fleet markets, price cuts have occurred at a rate not justified by these savings, undermining the overall performance result.
As predicted by - or some may say prompted by - alarmist market mutterings about 'price wars', figures show that both motor markets have softened, pushing them yet further away from the seemingly unobtainable goal of underwriting profitability. "In many ways, as I said last year, there are signs of weakening," comments David Laxton, director of ratings services at S&P.
"The result has been a deterioration in fleet business, with noticeable premium cuts, as well as the first signs of reducing private comprehensive premiums. While this is against a background of lowering claims frequency, even where there have been reductions, this is not enough to justify the price cuts. This is the beginning of a slow erosion of the market's current profitability."
The headline figures reveal that the UK motor market's gross written premium shrank by nearly 2%, from £11.9bn in 2003 to £11.7bn in 2004.
To put this in perspective, this is the first time that GWP has decreased, year on year, since it fell by a similar percentage figure between 1995 and 1996. Although the financial year combined ratio stayed at 101% - one point adrift of break even point - the more indicative 'accident year' combined ratio moved out from 101% in 2003 to 103% in 2004.
Mr Laxton explains why the accident year figure is more important to analysts and stakeholders: "Financial year combined ratio is the reported headline figure but the accident, or current year, combined ratio excludes changes to reserves for prior years and relates to the current year's trading. Therefore, the accident year figure gives a view of profitability of the more recent years' premium levels. It is clear of the 'noise' of prior years."
While GWP shrank, it is worth mentioning that net written premium increased between 2003 and last year, from £8.6bn to £9.1bn. Again, Mr Laxton warns against using this figure as the definitive one: "We are increasingly wary of net numbers because several insurers are reinsuring into captives offshore. This distorts the numbers at net levels so we tend to focus on GWP."
Although anything higher than 100% in combined ratio technically indicates an underwriting loss, Mr Laxton explains that 103% is the figure to watch.
"At 103%, you can still get an adequate return on the capital needed for this business. At the moment, no one will be unduly concerned about profitability but they could be if premium rates and combined ratios were to deteriorate."
The key question, therefore, is will 2005 produce a better or worse underwriting result? Mr Laxton responds: "I expect another point or two of deterioration in the motor market's combined ratio next year."
Consequently, with the prospect of 105% being the all-important black and white figure this time next year, he adds that the market is: "Showing every sign of threatening that adequacy of return." However, he stresses that this comment is made with the "obvious caveat" that within the market itself company and group results vary quite considerably.
In terms of specific risk groups, the fleet sector, which comprises around 15% of the total market, has suffered the greatest negative change. Average premiums fell by more than 7% between 2003 and 2004. "The fleet market has seen its claims ratio deteriorate by six points from 71.8% in 2003 to 77.7% in 2004," continues Mr Laxton.
"Underlying that is the drop in average premium from £695 to £646. At the same time, claims have actually been relatively stable with the interesting thing being the fall in claims frequency. This has dropped from 26 per 100 four years ago to only 20 per 100 last year, while the average increase in claims costs during that same period has been about 11% per annum."
Mr Laxton points to the obvious consequence of all these factors combined: "It is safe to say that the results on fleet business have worsened significantly during the past two years, driven by a reduction in premiums. This market is the first one to show signs of weakening, with the gross claims ratio rising from 67% to 78% over the past two years. This is a market that is softening."
So what has been driving the more marked deterioration in fleet business?
"Presumably this is the area that has seen the greatest pressure on rates, which is, to some extent, inevitable. The sector's loss ratio has been really quite good in recent years but has got worse and whether companies will be able to hold the line is less clear. Obviously it is also a market where some buyers are more sophisticated, because it contains some large fleets. Consequently, it is understandable that more pressure has been brought to bear."
Private car comprehensive
Representing an almost 60% market share, private car comprehensive cover is by far the largest risk group in the UK motor market and has followed a similar - albeit less dramatic - trend to fleet. The average premium has fallen slightly from £378 in 2003 to £372. However, as Mr Laxton points out: "This is the first time since 1998 that the average premium has not risen."
Such statistical evidence would seem to suggest that insurers have not heeded his advice from last year, when he said: "It is not sufficient to hold pricing at its current level, as claims inflation is cracking on at a fair rate - insurers have got to be pushing prices up," (PM, 29 July 2004, p13).
That said, the private comprehensive group has also enjoyed a reduction in claims frequency, although the fall from 17.2% in 2000 to 16.5% in 2004 is nowhere near as dramatic as the seven-point drop in the fleet sector.
"Clearly the reducing frequency of motor claims is a reflection of better risk control and the quality of newer cars," says Mr Laxton. "These factors are significant in the control of claims cost and frequency."
Perhaps it should come as no surprise that all the talk of pricing discipline has been more wishful thinking than hard action. After all, pressure on rates can be hard to resist if ignoring the general momentum equates to the loss of market share. However, Mr Laxton is quick to point out that there is substance in these claims of taking a disciplined approach to underwriting.
"By and large, underwriters have held their line - the premium reductions we have seen in private car comprehensive are not dramatic, so I suspect insurers have been able to hold their positions. However, some insurers have publicly spoken of their intentions to reduce writing and cut back in the face of rate pressure."
When it comes to individual company and group performance, the figures reveal some interesting statistics that beg certain questions.
In terms of overall groups, Zurich tops the chart with an accident year combined ratio of 95.9% (financial year figure 88.8%), followed by Fortis with 97.7% (FY 97.4%) and Royal and Sun Alliance producing 99.3% (FY 98.6%).
Taking the accident year figures for combined ratios for the top 10 individual companies - not groups - we can see these vary by a massive 41%. The best performer on this front, as may perhaps be expected, was Direct Line with 87.3%, while sister company Churchill props up the other end of the table with a significant 128.1%. Furthermore, NIG - the third Royal Bank of Scotland insurance company to make the top 10 - is not far behind with 120.4%. So what lies behind these results that together create a current year combined ratio of 105.9% for the RBS Group?
"Direct Line has always been ahead of the pack, being more effective generally at keeping its expense ratio lower," says Mr Laxton, pointing out that the less impressive Churchill and NIG results "arise from the expense ratio". Commenting that these two companies have only recently been absorbed into the group, he adds: "My view is that this overall RBS result is likely to be a one-off effect on the expense ratio with better figures coming next year. I can only assume that these combined ratios reflect the costs of the merger."
Three groups in the top 10 have combined ratios over 110% on an accident year basis: Co-operative Insurance Society, Axa and Halifax Bank of Scotland, with Axa the best of three at 112%. CIS is something of an anomaly, being the only mutual in the top 10 and, consequently, having different internal operating criteria to its rivals. Mr Laxton comments: "Axa appears to continue to have challenges and HBOS is still in its developmental stage."
Axa's financial year combined ratio, however, is much lower at 102.6% than its accident year one of 112.2%. So what does this discrepancy indicate?
"This suggests some release of reserves from earlier accident years, and that earlier losses may have been overstated."
Esure is, of course, the significant newcomer. "It is already one of those with the highest profiles in the top 10," adds Mr Laxton. Regarding the accident year combined ratio for the HBOS group, he points to the key underlying figure being the 35.1% expense ratio - the highest recorded by any of the top 10 groups.
"Esure is still in the initial stages of establishment so it has the scope to improve its profit through both growth and reducing its expense ratio," he says. "The figures show that its actual loss ratio is not out of line with the market but that it is carrying quite a heavy expense ratio - this is not untypical of companies in their early stages."
So does Mr Laxton think Esure will move higher up the table next year or that it will produce a better combined ratio? "This is a business that has grown pretty fast and I expect it to continue to attempt to do so - if only to get its expense ratio down to a level where the business is viable. So growth will be important to get the business balance right."
As for his overall predictions for 2005, Mr Laxton reiterates his earlier comments: "I believe we will see a continued slow softening of premium resulting in a further slight deterioration in the market's results. The market is a lot more concentrated than it was, interest rates remain low and insurers are still reluctant to invest in equities.
"So there has been a greater focus on underwriting results, bringing about a slower deterioration than those we have seen in the past. The motor market has always been cyclical - what we are seeing now is that same cyclicality but at a lower amplitude."
More concentrated the market certainly is, as S&P's own figures show.
Back in 1994, the top four motor companies, at that time, controlled only 34.4% of market share. A decade later, the four biggest players control 61.4% in 2004.
"People have been talking the market down for a long time and everything happens more slowly than the gossip suggests. The general level of discipline has been higher than it has been historically and insurers won't want it to run away too fast."
However, will the UK motor market ever be able to produce an underwriting profit again? This has not been achieved since 1994. "The market came so tantalisingly close and never actually made it - but it is really not necessary to break even on an underwriting basis to make a decent overall return." We can only wait until next year to see if the market manages to maintain or improve on that all-important 103% - or drop to Mr Laxton's prediction of 104% or 105%.
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