Overall, the insurance industry's performance has been more stable than AM Best predicted last year but, as Miles Trotter explains, the market's prospects for 2007 and 2008 are negative as loss ratios edge up
The data in this year's AM Best Top 100 UK Insurers reveals that there has been a modest decline in performance of insurance companies in 2005. Overall, performance has been more stable than AM Best anticipated a year ago, with worldwide catastrophe experience and possibly the discipline of the Individual Capital Adequacy Standards regime supporting the market.
In the future, AM Best believes softening market conditions for most classes will have a more marked impact on performance. Six of the top 10 insurers reported improved underwriting results in 2005, as did 14 of the top 20. However, underwriting performance deteriorated last year for six members of the top 20.
AM Best's analysis shows a decline in performance in all the main sectors of the market. While this decline was from a highly profitable level and did not threaten the profitability of the non-life sector in 2005, AM Best nevertheless anticipates that the trend will continue in 2006 and that poor results from many non-life companies are likely in 2007 and 2008.
For property, the 2005 accident year gross loss ratio remained low at 53%, albeit 10 percentage points higher than the 2004 year loss ratio. Both 2003 and 2004 were exceptional years for property, and the 2005 ultimate loss ratio compares favourably with all the other years since 1996. Nevertheless, AM Best believes the significant increase of 10 percentage points is a clear signal of more competitive market conditions ahead.
Although international companies are under some pressure from high catastrophe losses in 2004 and 2005, for the most part this has not had a significant knock-on effect in the UK market. The property reinsurance market for UK accounts has been stable at best, with no perceptible impact from events elsewhere in the world.
AM Best has no major long-term concerns about the UK property market, which has been a consistent strong performer for insurers. However, in the absence of a market-changing event such as a major European windstorm, the direction of ultimate loss ratios in the medium-term can only be upwards.
There was further weakening in the motor market, with the 2005 GLR increasing to 81% from 77%. This is the third year in succession that motor loss ratios have deteriorated. Although there is an established weakening pattern, the development in the cycle to date has been somewhat flatter, in that step changes in loss ratios each year have not been severe.
AM Best believes it is too early to draw conclusions as to whether there has been a long-term change in the pattern of the cycle, although it is possible that investor pressure and the rigorous analysis necessary for Individual Capital Assessments are having a beneficial impact.
AM Best also believes the 73% loss ratio achieved by the market at its peak in 2002 is inconsistent with an aggregate underwriting profit across the underwriting cycle. However, motor has other attractions for insurers - loss development is reasonably transparent, while motor income provides substantial funds to invest and strong cashflow for liquidity. The class also gives insurers access to a large pool of customers, providing valuable opportunities for cross-selling more profitable products as well as helping to build a company's profile.
Indications from the motor market are that price-based competition is strong. There is more sophisticated competition based on alternative products, and an example of this is the emergence of 'pay as you drive' protection. Some insurers have also promoted service-based business retention strategies. However, AM Best believes that there is no clear evidence that the long-term tendency of buyers to focus on price - in personal and commercial motor - has materially changed.
In the long term, there is justification for lowering motor insurance costs for policyholders because of the transition to direct and online purchasing, particularly for personal lines, which will lower expenses. Ultimately, this will enable motor insurers to write business profitably at higher loss ratios. However, with the market's current structure, this will provide little relief for the commercial sector, which continues to be reliant on commission-based broker distribution channels.
Broadly, AM Best believes that a more rigorous attempt to maintain market discipline than in previous cycles is unlikely and that a return to significant underwriting losses is a strong possibility.
As AM Best anticipated last year, there was an increase in the GLR for liability lines in 2005, up to 68% from 60% for 2004, reflecting a more competitive market. This is the first year that the liability sector GLR has increased since 2000.
The 2005 loss ratio is already supportive of performance, only a little better than break-even, and there are likely to be further increases in the medium term. Underwriting losses from liability lines would appear to be inevitable.
The long-tail nature of liability lines means investment income is a more significant factor in performance. Nevertheless, AM Best believes that, taking into account the reserving risk associated with the liability lines, the future prospects for the sector are negative.
Reserving is always the most intractable issue with long-tail lines, adding complications to performance interpretation and pricing. Examining development in accident year paid and incurred loss ratios across accounting years for UK liability business reveals that reserve deterioration in liability was a problem for the years 1998 to 2001. Early indications are more favourable from 2002 onwards but AM Best believes inherent unpredictability continues to make it difficult to arrive at any conclusion on current reserve adequacy.
A competitive market is well-established for all the major liability lines of business. AM Best believes a desire to achieve volume, rather than a commitment solely to profit generation, has reappeared in many parts of the market.
Competition is particularly marked for small to medium-sized enterprises, a target sector for several insurers in recent years. Historically, the sector has been less exposed to competition but the addition of several new entrants has changed this. In specialist liability lines, such as professional liability, competition for business has become fierce.
In conclusion, although the performance of the non-life insurance market in 2005 in isolation is not a cause for concern, the trends point towards considerably less favourable performance in this sector in 2006 and 2007.
- Miles Trotter is assistant general manager, analytics at AM Best.
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