Off down the rocky road again?

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Standard and Poor's analysis of the UK motor sector in 2003 has found signs of softening in rates so clear that insurers may find them impossible to ignore. Has the cycle turned already? Lynn Rouse investigates

While 'price war' may be too extreme a term to confer on the current state of the UK motor insurance market, there are certainly individual battles being waged on price for market share. This is the chief finding of ratings agency Standard and Poor's annual analysis of the UK motor insurance industry's financial results published today.

In short, the recovery of underwriting profitability in the UK motor market has suffered a blow in 2003, with a stalling in the improvement of underlying profits and claims costs running ahead of premium increases. While several of the larger companies are trying hard to maintain pricing discipline, others are not playing ball. And S&P credit analyst David Laxton warns that the market is fast reaching the point where difficult commercial decisions will have to be made: enter the fight or lose market share.

Turn in the cycle

"Despite apparent improvements in the underwriting profitability of the UK motor insurance market in 2003, rate increases were not sufficient for it to maintain the underlying results seen in 2002," says Mr Laxton. "The results threaten a turn in the market cycle at a time when its current level of profitability can only be considered adequate."

During 2003, gross premiums written by UK motor underwriters grew by 3% to £11.9bn, excluding business written through Lloyd's. This growth is noticeably smaller than the 8.4% increase seen between 2001 and 2002, when GWP increased from £10.66bn to £11.55bn.

The results for comprehensive insurance on private cars - the largest class of business - saw the first deterioration in the gross claims ratio for five years, rising by two percentage points. This was despite an increase in the average premium earned per car to £378 from £368. However, the average claims cost increased by 6% from £1608 to £1710 and this was only partially offset by a very slight fall in accident frequency.

The 2003 results for fleet motor, the second largest class, were distinctly worse. Gross loss ratio has deteriorated five percentage points from 67% to 72%. Premium per vehicle remained virtually unchanged, at £695 compared with £692 in 2002, but average claims costs increased by a significant 16% to £2261 from £1956. A worse deterioration was only prevented, according to S&P, by a two-percentage-point reduction in claims frequency to 22%.

It is noticeable this year that some of the top 10 players are "way off the pace" in terms of combined ratio, according to Mr Laxton. This is the key indicator of underwriting profitability - and, in 2003, the net combined ratio for UK companies writing motor business did strengthen slightly from 102% to 101%. However, the more important figure of current-year combined ratio shows a movement in the opposite direction. This latter figure, which excludes adjustments to prior years' reserves, weakened in 2003 from 100% - break-even point - to 101%. Furthermore, taking the headline figures, the individual combined ratios for the top 10 players vary by an incredible 31 percentage points. Allianz Cornhill was the best performer in 2003 with a headline ratio of 90%, while the highest combined ratio comes from Axa with 121%.

Of the top three players, one combined ratio has also noticeably weakened - that of the enlarged Royal Bank of Scotland group, which acquired the additional brands of Churchill and NIG last year. And Co-operative Insurance Society, with a current-year combined ratio of 121% and a headline net figure of 114%, also stands out. As a mutual, however, CIS would be unhappy with direct comparisons being made on this ratio alone, as it operates against different internal criteria. To some extent, therefore, it "marches to its own tune", as Mr Laxton says - although CIS's new head of of general insurance, Andy Watson, has admitted that the figure needs to improve (PM, 27 May, p14). However, the argument about mutuality cannot be put forward by Axa. With a current-year combined ratio of 111% and net combined ratio of 121%, Axa's results stand out as a significant discrepancy. Unlike the four players that rank above it in terms of gross premium written - as well as the five smaller players below it - Axa's sum of claims also outstrips its GWP.

Last year, Mr Laxton reported that the UK motor market had come "tantalisingly close to break-even point" (PM, 28 August 2003, p8). But signs of a turn in the underwriting cycle were already apparent. In fact, he asked: "Does this mean the market will once again descend quickly into a loss-making position, as it did after 1994 - the last year the market declared an underwriting profit?"

One year on, Mr Laxton does not believe this fear has become a reality - primarily because of the change in the market's shape and dynamics since that period. "The market is much more concentrated than it was then, therefore it is easier to maintain discipline," he explains. "This factor is coupled with lower interest rates, meaning that companies' tolerance for a combined ratio over 100 is much lower now. These two factors should act as a restraining influence and a lot of companies are committed to trying to hold the line.

"That 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."

He is, to some extent, quietly optimistic that any market deterioration will not be as pronounced as in past downturns. "I hope and believe that the rapid descent into losses won't repeat itself - but there is still very real pressure on underwriting profits."

By S&P's estimation, based on the current level of interest rates, UK motor insurers can incur a combined ratio of 103% and still make a decent return on capital. In the last two years, the market as a whole has actually made that return, but may be "hard pressed to achieve this in 2004". Mr Laxton warns that there is "very little room for manoeuvre and a deterioration of more than a couple of points would place the market as a whole on the wrong side of the line".

Also, although Mr Laxton believes that consolidation and interest rates offer some protection against market decline, other factors indicate that a strong recovery may be harder to achieve in the current climate. "In the late 1990s, motor insurers were able to push up prices quite quickly, but this clearly has not been the case over the last couple of years," he notes.

Discipline being tested

The simple fact is that the underwriting discipline being maintained by some players is being placed under significant threat by other companies who are aggressively pricing policies and fuelling competition. "There is a consciousness in the market that the pressure is building and insurers are approaching the point where they will have to make some difficult commercial decisions," warns Mr Laxton.

But how important is the overall market's performance in reality? Surely if those that are pricing aggressively are incurring significantly worse combined ratios, they will be the ones forced to change their behaviour - not those maintaining discipline?

Not so, explains Mr Laxton. The specific characteristics of motor insurance make the market forces operate in the reverse direction. When it comes down to the fundamental economics of insurance, 'search cost' is the key concept. And buying motor insurance has an increasingly low search cost. The lower the search cost, the more people will shop around: "if the search cost is zero, a buyer will always go with the cheapest," says Mr Laxton. "Therefore, one company's actions can have a huge impact on the whole market."

For example, a company like Esure - although not yet in the top 10 - can influence pricing market-wide. "If newcomers get enough publicity, they will take business if the bigger boys are trying to maintain price discipline. There will be a point at which the larger players have to make a decision or lose market share."

This pressure to succumb to competitive pricing surely becomes much greater the larger the players are that adopt this type of strategy.

For example, looking at the results from 2003, the enlarged RBS group's current-year combined ratio - having bought Churchill last year - is noticeably poorer than either of its two closest rivals. While Aviva's current-year combined ratio stands at 96% and RSA's at 97%, that of RBS is distinctly higher at 102%. Could the results of Direct Line - traditionally the biggest and most profitable motor insurance entity under the RBS banner, producing a net combined ratio of 74% in 2002 - have been adversely affected by the incorporation of less operationally streamlined brands? Not according to Mr Laxton. He categorically states that "it is not the acquisition of Churchill or NIG that is worsening this figure. It is certainly not being distorted by the addition of new brands."

This assertion is backed up by S&P figures from last year, which reveal Churchill's and NIG's respective net combined ratios to be 95.5% and 92.1%. The conclusion can be drawn, therefore, that the RBS group as a whole is already venturing down the competitive pricing route. And with the group's combined GWP making it the largest player, this strategy is likely to up the pressure on Aviva and RSA significantly.

In terms of financial strength, Aviva's UK general insurance arm Norwich Union remains at the head of the pack with a AA- rating, while Zurich, Axa and Allianz Cornhill all receive an A+. And judging by the current-year combined ratio, Aviva is also the most profitable group, very closely followed by RSA - although the latter is considerably smaller in terms of premiums written.

Motor policies written by Lloyd's syndicates decreased significantly between 2002 and 2003, with gross premiums dropping from £1.5bn to £1.1bn. This compares to £11.9bn GWP in the companies market - up from £11.55bn in 2002.

How profitable is the Lloyd's motor insurance market compared to the companies sector? "It is very difficult to draw comparisons and it is difficult to obtain figures calculated on the same basis," explains Mr Laxton. "Generally, Lloyd's regards its motor business as profitable - but it would be very misleading to try and draw any direct comparisons." However, the drop in premiums does seem to correlate with recent movements to Gibraltar and the company market of former Lloyd's players such as Highway, Zenith and Admiral.

Next year

Bearing in mind the 2003 results, what predictions can be made for 2004?

"I think 2004 bears a real risk of worsening against 2003. But the catastrophic falls of the 1990s will not repeat themselves," says Mr Laxton. "Rate rises will be smaller with further claims inflation most likely, resulting in a small deterioration in profitability. Companies should just about hold the line for another year - though that depends on how competitive pressures develop over time."

This is hardly a resoundingly positive endorsement of the UK motor insurance market's prospects of profitability. We can only wait and see whether - or how quickly - the disciplined players reach the point where they sense too much market share is at risk of being lost - and feel compelled to join the war on prices.


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