Two-tier market to develop, accounting firm predicts

Car crash

The UK motor insurance market will remain unprofitable in 2012 and 2013 despite making a big improvement in 2011, according to analysis by Ernst & Young (E&Y).

The accounting firm also predicts the formation of a two-tier motor insurance market, greater private equity involvement, and argues that Gibraltar’s days of outperforming the UK and Lloyd’s are numbered.

Still unprofitable

E&Y’s analysis shows that while rate increases significantly improved the industry’s net combined ratio to 105.5% in 2011 from 122.1%, the industry is still unprofitable and is likely to remain so “for the foreseeable future” as the market begins to soften.

Assuming a 4% reserve release in 2012 and 2013, the reported net combined ratio will remain steady around the 105% mark for the next two years at 104.8% and 106.1% respectively, E&Y predicted.

“While this is a marked improvement on 2010, the industry has yet to make an underwriting profit in eighteen years and it does beg the question of whether something fundamental needs to change,” said Catherine Barton, partner in Ernst & Young’s financial services actuarial team.

She added: “We had been hopeful that this was the year that the industry would turn a profit but rate increases in the second half of the year didn’t materialise.”

Two-tier market

E&Y said premium inflation was suppressed by new entrants and the fact that some insurers were able to return to profit when rates were harder.

Barton said: “We are now at risk of seeing a two-tier market develop where those insurers whose motor businesses have returned to profitability will start to compete more aggressively on price.”

She added that that the insurers who have not returned to profit “face a choice between increasing their premiums and returning to profitability but losing market share, or holding out and operating at a loss for a few more years in order to defend their volumes.”

Claims trends

While company accounts in 2011 painted a mixed picture of claims inflation, with bodily injury claims increasing for some and falling for others, E&Y predicted that claims inflation for 2012 will be 5.6%.

“The factors which point to claims costs increasing far outnumber those that may reduce claims costs in the near future,” said Barton. The potential drivers of increasing claims include new and expensive vehicle technology, a possible downward movement in the Ogden discount rate for calculating future losses, changes to the Judicial Studies Board guidelines and RSA’s recent High Court victory against Allianz and Provident on motor repair costs in subrogation cases.

Barton noted that the ban on referral fees, which could reduce claims, will not come into force until April 2013.

Private equity

E&Y also predicted that the shape of the market is set to change.

Barton said that as firms prepare for Solvency II, motor could be seen as an attractive way to diversify a portfolio and companies might accept the business line’s poor profitability as a trade-off for better capital ratios.  

However, she added: “In the next three years it looks like we could see up to 50% of the UK motor market changing hands and, if this level of transactional activity plays out, we expect private equity players might be keen to get into the market while profits are low and they think they can strike a good deal.

“This would definitely shake up the current model as private equity will need a much higher return on capital than the current levels and would create a very interesting dynamic in the market.”

Gibraltar supremacy challenged

Finally, E&Y argued that while Gibraltar-based motor insurers continued to outperform Lloyd’s and FSA-regulated firms, the gap was not as wide as last year.

“The disparity between the Gibraltar returns and the Lloyd’s and FSA results has narrowed considerably,” Barton said. “Gibraltar-based insurers currently require less capital to back their policies than insurers based in the UK but when Solvency II goes live that capital advantage will disappear.

“Most Gibraltar insurers are mono-line and therefore will not benefit from the diversification advantages their FSA and Lloyd’s competitors already have.”