With three-quarters of domestic non-life insurance companies in the UK rated within Standard & Poor's investment grade range - and the market's stable outlook affirmed in May 2002 - the industry is in a generally healthy state, says Standard & Poor's

THE STABLE outlook, determined as the result of a review of the UK's domestic personal and commercial lines insurance writers, excluding Lloyd's and UK domiciled reinsurers, is a testament to the market's resilience to difficult operating conditions. Nevertheless, despite the underlying stability of the market, it is apparent that there remain varying fortunes among the participants.

Although premium rates in the personal lines market have continued their ascent, they are slowing, while rates in the commercial lines market continue to rise steeply. In terms of premium rates and profitability, the personal lines sector might have already reached its high point in the insurance cycle.

Certainly 2001 was a better year than 2000 for the personal lines sector. However, it is an open question as to whether 2002 will see any further improvements. Although personal lines rate increases have not come to a complete standstill, the boom period might well be coming to an end

Social inflation
Offsetting the positive impact of the continuing, albeit slowing, rate increases, however, and asserting a downward force on the market and its stable results in 2001, is evidence that social inflation - the steep incline in court-awarded liability payments - has worsened liability policy loss ratios. The liability culture prevalent in the US for many years has firmly established itself in the UK and insurers are now struggling to cope with burgeoning personal injury costs.

At the same time, the UK's motor market, which in the past two years has seen a significant revival of its fortunes, with double-digit rate increases, is beginning to see its previously buoyant rate movements flatten.

Meanwhile, in line with international experience, a positive trend for the commercial lines market has arisen from the tragic terrorist attacks of 11 September last year. The scale of the loss provided a catalyst for commercial lines rates to rise exponentially on a global basis, particularly for large risks, promising stronger results for 2002. The expected boom has come at an opportune moment for the market, which has suffered from historically poor profitability over a sustained period.

Inevitably, insurers are expected to make efforts to sustain the high level of rate increases going forward to compensate for what had previously been a poorly-priced market. Although the rate increases in the commercial lines sector are significant, they are not considered extreme in view of the fact that the development has started from a very low base, with the market having reported losses year-on-year for the past eight years.

Future profitability for the market is by no means assured, however.

Whether the market can sustain the price increases remains to be seen, as commercial lines brokers remain a powerful force in the sector and have historically been able to keep rates low for their clients through tough negotiation.

Affecting the market as a whole, the severe fall in equity values in the UK will strain the sector's capital adequacy, which also remains vulnerable to potential future losses arising from severe weather. In Standard & Poor's opinion, the level of catastrophe reinsurance protection in the UK, especially in flood risk, remains inadequate. Despite many insurers cancelling protection in some high-risk areas, other less frequent but often higher-value flood risks remain on their books.

Meanwhile, the overall credit strength of the UK market, as embodied in participants' ratings, has long been buoyed by parental support, with almost half of investment-grade entities benefiting from some degree of group backing in addition to their own, stand-alone financial characteristics.

However, although parental support contributes to many companies' healthy financial strength ratings, it is only one of many contributory factors to the market's stable outlook. Of greater benefit to the UK insurance industry is its sophisticated customer risk profiling, conducive regulatory and accounting framework, successful distribution methods and liquid investments.

Risk profiling
The UK's risk profiling has long been ahead of continental Europe in terms of segmenting the personal lines market and pricing it according to individual risk. France and Germany have now developed similar systems, but the UK remains a leader in the field.

An even wider gap between the UK and other European markets has developed in terms of distribution, where the UK has successfully established direct distribution channels for personal lines risks while Continental markets continue to rely heavily on tied agents. As a consequence the UK personal lines writers can boast significantly lower expense ratios.

Nevertheless, despite their associated costs, tied agents have benefited many Continental markets, due to the loyalty of their customers; a facet lost to the UK insurance market. As in many mature markets, price sensitivity has become a key feature in the sector and few customers are now loyal to their insurers.

Further depressing the positive trends is that, despite maintaining a diversified mix of investments and a healthy level of liquidity, in comparison to other leading European markets UK companies invest more heavily in equities.

With lower investment returns in recent times, this has suppressed the profitability of the UK market, although not to an extent to materially affect its outlook.