Profitability in a downward spin

The private motor market is set to plunge further into the red next year unless rates increase dramatically, Deloitte has warned.

In its annual assessment of private motor insurers, the professional services firm predicts that motor insurers will, for the eleventh year running, fail to make a profit in 2005. It also warns that 2006 will prove to be an even worse year for the market with profitability tumbling further.

Deloitte estimates that the motor market's combined operating ratio (COR) for 2005 will be 104%, three points down on 2004. And in 2006, it predicts that the COR will fall further to 108%.

The last time the UK private motor market made a profit was 1994. It also made a profit in 1993. These were the only two years since 1984 that the market has made a return on underwriting (see graphs).

Catherine Barton, partner in the insurance practice at Deloitte, says the problem insurers face is that rates are failing to increase in line with rising claims costs.

"We are seeing upward movement [in rates] from some insurers, but earned premiums are not going up enough to match claims inflation," she says.

For 2005, Deloitte predicts net earned premium will drop by 1.1% despite claims inflation of 2%. In 2006, net earned premiums are expected to rise by 0.7%, but Barton says this will be insufficient to match a predicted claims inflation of 5.8% (see box 1).

Barton says: "The market's performance will depend on the rate inflation put through in the next few month. Claims inflation is not as much as two years ago, although there are some issues on the cards such as periodical payments which could have an effect. But claims inflation is continuing and premium inflation is not catching up with it."

According to Deloitte's calculations, rates would need to immediately increase by 10% if the market's profitability is to stay the same in 2006 as it is expected to be in 2005, ie if the COR is to stay flat at 104%.

Given that premium inflation in 2006 is expected to be only 0.7%, this would be quite a leap and would require a strong nerve from any insurer who wished to take the lead.

Some motor insurers are attempting to introduce premium increases. Analysis by Deloitte's found that in the third quarter of 2005, average new business premiums increased by nearly 1% if one insurer, Swiftcover, was excluded.

But including Swiftcover, average new business premiums fell by just under 5%. This, says Barton, is an example of the pressure that internet-only insurers could bring to bear on the market, potentially hindering its return to profit if other insurers attempt to compete on price.

She said: "The quarterly report shows that insurers are putting through some increases, but unless [sufficient increases] come through quickly they will not have much impact."

The extent to which insurers release reserves will also have an effect on the market's performance, says Deloitte.

In recent years, the market has seen varying levels of reserve release, which have been used to boost profitability. 2003 and 2004 both saw net reserve releases, with 2004 being particularly significant.

Both years had a COR of 101%, but Barton says: "Without the reserve release 2004 would have been a worse year [in terms of profitability] than 2003."

In making its predictions for the profitability of 2005 and 2006, Deloitte assumes a net reserve release of 3% in each year. If these levels are not reached then the profitability of these years could be even worse, says Barton. IT