To keep serving customers, insurers can no longer simply rely on cutting costs and releasing reserves to stave off rate increases, argues Chris Hanks

I HAVE SPENT the past few weeks reading various briefings and articles and listening with interest to views over whether the market is hardening, whether our customers can afford to pay the increases we are seeking, whether they are reducing their insurance cover and how we need to react to the current severe financial climate.

Our challenge has been not only convincing customers that rate increases are necessary, at a time when most policyholders have one eye firmly on reducing costs, but also convincing ourselves that this adjustment is vital for our long-term health.

There is no doubt that rates have been moving up in personal lines for some time, although the strength of the aggregator proposition has meant that real price rises to consumers have been mitigated. In the commercial lines market, price increases have been much more difficult to achieve and very inconsistent. Some of the green shoots we saw last year in commercial rate increases have not grown into the trees we had hoped for, although some insurers are clearly doing better than others.

The strong position taken by a few in trying to lead the market up was always going to be moderated when the balance between what they really need for their business, their customers’ requirements and distribution support was fully understood. I do not regard a change in that stance as a position of weakness, but maybe that’s how it would be viewed if the original message appeared to be so strong, unequivocal and intolerant of negotiation. The reality for all of us is that we trade in a market, and you can’t sit outside the market unless you intend to be eventually ignored.

However, the other reality is that claims inflation continues to rise and the recession is bringing with it some changes in frequency and more fraud. Disasters really do happen with no warning, just as we saw earlier this month in the case of the lost Air France jet. If there is another run of summer flash floods, insurers will not be able to meet claims out of their existing margins.

To continue to provide better service and security of protection, to take risks and to pay claims, insurers need to reflect that in their prices. No amount of cost-cutting can make up for the price rises that are necessary to cover claims costs. If these necessary increases continue to be avoided, then insurers are only putting off the evil day when the eventual price rises will be much bigger and will be accompanied by reductions in capacity and failure to write risks.

While the insurance cycle is a world-wide phenomenon, the UK market is distinguished by high costs of distribution, which have risen alarmingly over the past few years and remain disturbingly high despite some limited reductions.

When I look at the Allianz world picture, the UK stands out quite alarmingly. That is just as relevant to the cost of buying clicks on the internet as it is to broker commissions or managing agents’ fees. This cannot be put down to the old Europe model of tied agents because the UK also compares unfavourably to a number of other broker markets.

Full distribution costs have not been factored into many of the current insurance premiums. While some of these costs have been covered in productivity savings or by work transfers, the rest has effectively come out of insurers’ margins.

There is no doubt that insurers have funded this partly by releasing reserves built up in earlier years. Despite warnings that reserves were drying up, there seem to have been more releases to support insurer’s 2008 results. However, if you’re not putting excess profits into that pot for a rainy day, there will come a time when you can’t draw out. That day is probably already here for a number of insurers.

In addition, we need to invest more in our people to build up the professionalism and capability to trade in a more disciplined and regulated industry, and the unwelcome reduction in investment returns due to the financial crisis. These factors will add costs to our products in both the short and the long term.

That’s why, despite the pressures from our clients and the difficulties they face, despite the stuttering start to the hardening market we have seen and despite the variety of views about whether this about to take off or not, the hardening of rates in the market is both an inevitability and immediate necessity.

It is true that those who have run better businesses can withstand the heat longer, but that’s no way to run a profession. You cannot stop the competitive forces of the market making it difficult to achieve your individual aims, but the alternative to taking action is to slide into unprofitability or even worse.

I do not think that most of the current crop of senior executives in the mainstream insurance companies are going to let that happen. IT