In 2017, the combined underwriting results of the largest 100 UK non-life insurers improved but remained in the red. How well did insurers perform under pressure from strong competition and unfavourable claims trends?
The profit margins of UK non-life insurers remain under pressure in 2018 due to the effects of strong competition and unfavourable claims trends. In the property sector, premium rates are falling, in spite of rising claims costs. Meanwhile, the rate improvements achieved for motor business last year have proved unsustainable. This year, results will also be affected by losses from storms Eleanor and Emma in the first quarter of the year, and the frequency and severity of further weather-related events will be a key driver of final performance.
On a positive note, insurers have welcomed changes to the personal injury compensation system set out in the Civil Liability Bill. The Bill, which entered the House of Commons on 28 June 2018, reforms how the personal injury discount rate is set and includes measures designed to reduce the number and cost of whiplash claims. However, it has still to receive Royal Assent and the associated reforms are unlikely to be implemented this year.
Key measures outlined in the Bill include a tariff of compensation for whiplash claims, a ban on seeking or offering to settle whiplash claims without appropriate medical evidence and an increase in the small claims track limit for road traffic accident-related personal injury claims to £5000 and for all other claims to £2000.
In addition, the Bill will change the way the personal injury discount rate is set. In order to better reflect actual claimant investment behaviour, the rate will be determined with reference to expected rates of return on a “low risk” diversified portfolio of investments rather than “very low risk” investments as is assumed in the current rate. It is expected that the rate will be reviewed shortly after the legislation comes into force and, thereafter, at least every five years.
Proposed changes to the discount rate setting process follow the reduction in the rate announced by the government in February 2017 from 2.5% to minus 0.75%. Many insurers had been incorporating a lower rate into their reserving assumptions, but the industry was surprised by the drop into negative territory. The change had the greatest impact on companies underwriting UK motor business, but other liability classes exposed to bodily injury claims were also affected.
Once implemented, measures in the Civil Liability Bill should improve claims experience in the UK. However, in such a competitive market, AM Best expects any savings to be quickly passed to insureds in the form of premium reductions. In addition, the claims environment is likely to remain challenging, due to persistent issues with fraud, higher repair costs and a growing compensation culture.
Investments are again expected to provide only marginal support to overall earnings this year, as low interest rates persist. In general, UK insurers pursue defensive investment strategies, with a focus on capital preservation. In search of higher returns, some continue to modestly increase their allocation to equities and lower rated corporate bonds, but low-risk assets, such as cash deposits and high-quality fixed-income securities, still dominate portfolios.
Economic and political uncertainty following the referendum vote to leave the European Union continues to dampen growth prospects in the UK. Real gross domestic product growth in 2017 was positive but subdued at 1.8%. Economic growth forecasts vary widely, depending on the manner and terms by which the UK exits the EU. However, medium-term economic growth is expected to be between 1% and 2%.
The ability to continue to conduct cross-border business throughout the EU after Brexit is a pressing concern for Lloyd’s, the London market and other UK-based commercial insurers. However, for the retail non-life sector, a loss of passporting rights is unlikely to be a material issue as most underwrite principally domestic business. Nevertheless, all UK insurers will be affected by any Brexit-related economic fallout, which could have negative implications for investment income and claims inflation, as well as premium volumes due to a reduction in demand for insurance.
Performance of the non-life insurers
The 100 largest UK-regulated insurers, ranked by non-life gross written premium, reported a combined underwriting loss in 2017, due in part to an increase in weather-related losses. However, the combined deficit was lower than in the previous year, when earnings were hit by material losses related to the reduction in the personal injury discount rate. Although the government announced the rate cut in February 2017, most affected insurers took the associated one-off reserve hit in their 2016 results.
The performance of individual market participants varied considerably and was largely dependent on the type of business underwritten. In general, the earnings of companies with London market operations deteriorated, due to catastrophe losses in North America. In contrast, the technical results of insurers with material exposure to the UK motor sector improved.
In 2017, AIG regained its position as the leading UK company by non-life GWP, supported by growth in personal insurance and financial lines. Aviva Insurance remained in second place and Royal & Sun Alliance rose to third place, with intragroup reinsurance driving a 23% increase in GWP. The previous year’s leading company, Aviva International, fell to sixth place. In 2016, Aviva International, a reinsurance vehicle for the Aviva plc group, rose dramatically up the ranking, due to a number of significant intragroup transactions.
UK insurers published their solvency capital requirements relative to eligible own funds under the Solvency II regime for the second time at year-end 2017. Overall, the industry is well capitalised but there are significant differences in solvency ratios across the market. Drivers of the variance include the nature of business written, the capital strategies of insurance groups in respect of their subsidiaries and recent performance.
For some UK insurers, the need to strengthen bodily injury reserves in 2016 depleted capital and pushed their solvency ratios to a weak level. However, at year-end 2017, solvency ratios had largely recovered, in some cases due to capital injections. For the combined 100 largest companies, the ratio of eligible own funds to SCR was higher at year-end 2017 than at year-end 2016.
The accident-year loss ratio for the UK property sector deteriorated by six points in 2017 due to a combination of lower prices and higher claims costs. Weather-related losses were up on the previous year and the cost of claims from escape of water, largely due to burst water pipes, remained high.
In spite of claims inflation, rates are under pressure due to strong competition and the availability of relatively cheap reinsurance. Competition is largely price-driven, particularly in the household sector, where barriers to entry are low due to a bias towards telephone and internet sales and the increased use of price-comparison websites. For small commercial risks, e-trading is becoming widespread and price-based competition in this market is increasing.
In 2018, results will be affected by storm losses in the first quarter of the year. The frequency and severity of weather-related events, and flood risk in particular, is the main driver of performance in the sector. Consequently, prospective performance is likely to be volatile. Although property insurers have benefited from generally benign weather experience over the past five years, back in 2007, severe flooding pushed the COR up to 117%.
Maintaining the availability of affordable insurance for flood-prone properties has been a key challenge for the industry. To this end, Flood Re was launched in April 2016, a not-for-profit reinsurance scheme supported by a levy on all policyholders. The absence of large flood losses in its first two years of operation has allowed the scheme to build up its financial resources, and at 31 March eligible own funds under Solvency II stood at £214m, compared to £100m in 2017.
The motor sector performed relatively well in 2017, with a healthy improvement in pricing supporting a 13-point fall in the accident-year loss ratio. On a calendar-year basis, the improvement over the previous year was even greater.
The competitive motor sector has a weak performance record due to inadequate pricing and poor claims experience. In particular, the cost of third-party bodily injury claims has contributed to persistent underwriting losses and volatile reserve movements. Most recently, the sector saw material reserve strengthening following the decision by the government to reduce the personal injury discount rate to minus 0.75%. Most insurers reflected the reserve charge in their 2016 results, pushing the year’s earnings deeply into deficit.
In 2017, the prospect of higher claims costs for personal injury claims pushed insurers to increase prices, with positive implications for underwriting earnings. However, in the first half of 2018, rates have fallen, as insurers start to pass on potential cost benefits of planned reforms to the discount rate and whiplash compensation outlined in the Civil Liability Bill. Given the reforms are unlikely to be implemented this year, these preemptive actions by motor insurers may be overly optimistic.
Over the past five years, earnings in the liability sector have been affected by weak premium rates and an increasingly litigious claims environment. The number of claims for industrial disease, particularly noise-induced hearing loss, remains elevated, but appears to be falling following a steep rise between 2011 and 2014.
On an accident-year basis, the liability sector has consistently reported combined ratios in excess of 100%. However, due to the long-tail nature of this business, reserve movements tend to make a material contribution to overall results. In 2016, and to a lesser extent 2017, calendar-year results were affected by reserve strengthening associated with the reduction in the personal injury discount rate.
In recent years, a number of insurers have chosen to dispose of their latent UK liability reserves, including Aviva, QBE, Axa and RSA. Deals have been driven by the introduction of Solvency II and more prevalent use of capital models, which have increased focus on the most efficient use of capital. In general, insurers are looking to redeploy capital from the run-off of long-tail reserves to potentially more value-added activities, such as writing new business.
In 2017, the combined underwriting results of the largest 100 UK non-life insurers improved but remained in the red. The level of reserve strengthening associated with the change to the personal injury discount rate was significantly lower, but weather-related losses were higher than in the previous year. In spite of two consecutive years of technical losses, risk-adjusted capitalisation for most companies remains at a robust level.
Competition in the UK non-life market remains intense and underwriting earnings are under pressure. Rate increases achieved last year for motor business have begun to reverse as insurers anticipate cost benefits of measures outlined in the Civil Liability Bill. The planned changes to the personal injury compensation system should be positive for claims experience. However, AM Best notes that there is considerable uncertainty as to when the reforms will be implemented and, when they are, what their impact will be on the frequency and severity of bodily injury claims.
In spite of performance pressures, UK non-life insurers are generally well capitalised. As at year-end 2017, the 100 biggest insurers’ combined SCR ratio stood at over 160%, although ratios vary considerably. This positions the industry well to withstand persistent headwinds and, in spite of strong competition, uncertainty related to legislative changes and the potential impact of Brexit, AM Best expects the UK non-life market to maintain a good level of capital adequacy.
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