Clapped out motor

The motor insurance market is caught in a downward spiral with few signs of recovery.

Harsh, maybe, but take a look at the figures. According to Standard and Poor's 2005 Motor Review, the net combined ratio for UK motor insurers in 2004 was 101%, in comparison to 101% in 2003 and 102% in 2002.

But when insurers strip away prior-year reserves they are left with a bleak picture - a combined ratio that leapt from 101% in 2003 to 103% in 2004.

In the private car comprehensive sector, which accounts for 60% of the total market, the average premium has fallen from £378 in 2003 to £372 in 2004.

In a fiercely competitive market insurers have become accustomed to trading in the red and using their reserves to make up for the shortfall. This has made underwriting for profit even more of a challenge.

"The best performers are still making money on motor, but many are already making a loss. We are doing well due to tighter control of underwriting, claims and expenses," explains Paul Chaplain, Fortis' underwriting director.

"There is a lot of competition for private motor insurance. This is a high-profile product that moves around the market relatively rapidly. Insurers need to recognise there is inflation, especially on third party claims. There is constant pressure from people who want to maximise third party and injury claims, where inflation is always much higher than retail price inflation."

The AA's benchmark Premium Insurance Index has revealed that the market saw premiums rising in the second quarter of 2005, after a period of falls, but more will need to be done if insurers want to make any money out of their motor books.

"One thing is certain: claims inflation has not gone away," Chaplain says. "Although claims frequency across the private car market dropped last year, insurers are not increasing prices enough to deal with inflation."

Andy Goldby, motor director at Groupama, says there has been a slight improvement in rates. "Over the last couple of months we have seen a stabilisation of premium rates and then a slight 1.3% increase, which was most noticeable in the higher risk segment of the market."

But the market still has a lot of catching up to do. "Our analysis of movements in the market rate for motor insurance, based on shop around price, tells us a similar story to the AA Index," says Goldby.

More exaggerated

"We have seen average premiums drop consistently since 2003 so that by June 2005 the market price was around 3% lower than in December 2003.

This was even more exaggerated in the lower risk segment of the market, for example older, more experienced drivers with high no-claims discounts, where rates were over 7% cheaper than December 2003," he adds.

Despite that, according to Deloitte, results for 2004 are expected to be better than in 2003 due to the high level of reserves being released into claims pots to boost performance. The results are also based on premiums written in 2003 at higher rates, which will further help to improve profits.

"But 2005 will be another matter," Goldby points out. "With claims inflation estimated to be running at between 3.5% and 5% per year, we can expect to see the market as a whole show profitability in 2005 around 7% worse than in 2004, unless it is able to release reserves from prior years to compensate for the poorer performance of recently written business."

If low premiums in a market driven by volume rather than profitable underwriting are to blame, Goldby says substantial changes to rates could "merely destabilise the market".

He suggests that the only way to prevent a downward spiral is for insurers to maintain their discipline and not chase volume before profitability or use prior year releases to subsidise new business rates.

Unsustainable situation

According to Gill Murphy, head of corporate affairs at Royal Bank of Scotland Insurance, the situation is unsustainable and insurers are likely to increase premiums this year.

"Market pricing is finely balanced at present. In 2004 the market experienced increasing pricing pressure with some insurers introducing modest increases and others cutting prices, with the overall result that prices generally were flat."

Murphy adds: "This is in spite of claims inflation, and personal injury claims in particular, increasing at the rate of 6%. This cannot be sustained.

We anticipate that premiums will rise this year as insurers strive to increase profits in the face of fierce competition and the rising costs of personal injury, litigation and compensation claims."

Fleet sector

The situation is even worse in the fleet motor sector - which accounts for 15% of the total motor market - with premiums pushed down by 7% in 2004. Kevin Edwards, head of commercial motor underwriting at Norwich Union, says this market is showing "worrying signs that will get much weaker".

"Rates are nowhere near where they should be to keep up with inflation, and we've recently seen even more rate reductions," he says. "Insurers need to stop looking backwards on previous years' performances and start looking forward to calculate the impact of current rates on profitability.

"My concern is that when they realise the inadequacy of their rates, they will have to implement some high price increase, which customers don't like. As an industry we don't have a good reputation for stability. At the moment we are at a crucial stage, and I'm concerned that we are about to do the things that have given us a bad reputation all over again," he adds.

Edwards explains that the claims ratio in the fleet market was 72% in 2003 and 78% in 2004. "I'm afraid 2005 is not going to give us any profit at all. With the rates we are charging in 2005 and the losses we will get in 2006, it is a certainty that we will have losses in 2006."

This scenario isn't new - the motor market has not made any underwriting profit since 1994. It only remains to be seen whether insurers will grab the bull by the horns and start putting premiums up, or whether they will bend once again to the 'price war' and put volume before profit.

S&P ON MOTOR'S SUPERFICIAL STABILITY

Standard & Poor's expects to see further weakening of results in the UK motor insurance market next year as the cycle turns. But this deterioration is not expected to be as severe as in previous cycles due to the current low interest rate environment and more active cycle management by insurers.

Over the past three years the market appears to have enjoyed an unusual level of stability, but looking beyond the surface suggests there are signs of softening in the sector.

"The UK motor industry over the past 20 years has been marked by a combined ratio that falls and rises in line with the familiar insurance cycle, but there has been a period of unprecedented stability in the past three years," says Standard & Poor's credit analyst David Laxton.

"However, despite this superficial stability there are, as highlighted last year, underlying indications that results are beginning to slip." The results of the two largest motor sectors make the factors behind these changes clearer. Fleet business is the second largest risk group within UK motor, accounting for 15% of motor business in terms of gross motor premiums written, and is leading the softening in the market.

Its gross loss ratio has deteriorated in each of the past two years, to 78% in 2004 and 72% in 2003, compared with 67% in 2002. This deterioration has been driven by falling premiums - down 7% in 2004 to £646 from £695 in 2003 - while claims costs have remained fairly static.

Private car comprehensive is the largest risk group, representing 60% of gross motor premiums. Its gross loss ratio has also deteriorated slightly over the past two years, to 77.1% in 2004 and 76.5% in 2003, from 74.6% in 2002.

Premium earned per policy fell by £6 to £372 in 2004 from £378 in 2003; this is the first year since 1998 that premium per policy did not increase, indicating the return of price cutting in this sector. Claim costs per policy have fallen slightly (£287 in 2004, down from £289 in 2003), reflecting increased security on modern cars and improving risk management by insurers.

"These factors point to the weakening phase of the cycle, although the low interest rate environment, combined with more active cycle management on the part of insurers, means that we expect the scale of the deterioration to be less than in previous cycles," said Laxton.