Spotlight: Commercial motor - Crunch time

The UK’s commercial motor insurance market marginally improved its profitability last year. The sector posted a combined operating ratio (COR) of 107% compared with 109% in 2010, a recent report by Deloitte revealed.

Once, such a small improvement would have barely raised an eyebrow in an industry used to making up for underwriting losses via the investment side of the business. Besides, the commercial motor market has traditionally been more profitable than personal lines - and has attracted less attention as a result.

But these are not normal times either for commercial motor or the wider insurance industry.

In such an unforgiving investment environment, a COR of 107% is no longer acceptable. Plus, for the first since 2006, the personal lines motor market performed better than the commercial side. Its COR of 106% last year represented a remarkable 18 percentage point improvement from 124% in 2010. Commercial motor lines improved by just two percentage points in the same period.

“For commercial lines to perform worse is a pretty rare occurrence,” says Allianz UK head of commercial motor Roger Ball. “Fleet has traditionally been more profitable than the retail side. But whereas retail saw some big rate hikes in 2010, the same did not happen in fleet. Now you are seeing the consequences of that.”

Exception to the rule

In its results, Allianz UK does not split out the performance of its commercial motor from the rest of its commercial book. The combined ratio of this overall book, however, was 94% last year and Ball suggests its commercial motor segment is not far off this.

If this is true, Allianz is an exception to the rule. Other players have endured some well-documented troubles on their commercial motor books. Aviva has had to strengthen its reserves, blaming van, taxi and scheme accounts for a 15 percentage point deterioration of its combined ratio between 2010 and 2011 to 113%.

Deloitte insurance partner James Rakow, who was involved in producing the report, agrees last year’s result for commercial motor was unusual but gives reasons.

“Commercial and personal lines are now at pretty similar levels,” he says. “Yes, this is unusual compared with recent years. But it has not always been the case. In the 1990s, for example, commercial fleet was very unprofitable.”

Harder to raise rates

Rakow notes that it can be much tougher to quickly move rates in commercial. “Unlike personal lines, where you can quickly increase rates, a large chunk of commercial business is made of large fleet contracts. These require negotiation with clients and can be harder to change.”

He also notes that within the industry-wide COR of 107% there are some insurers working with profitable books; in contrast, others are struggling badly. The difference he highlights is quality of management.

“You have to then look at insurers on a case-by-case basis, but the consistent theme we would highlight is the quality of management and their attention to the details of the drivers of profit and loss,” he says. “It is not just about seeking top-line growth but also careful risk selection, good claims management and controlling costs.”

One player performing well in commercial motor is Markerstudy. Group underwriting director Gary Humphreys attributes its success to being a niche player with a short decision-making process, allowing it to capitalise on opportunities.

“This enables us to be fleet of foot and opportunistic, which we see as a key advantage,” he says. But he too believes rate hikes are now needed in the sector.

“The commercial loss ratio falling behind personal motor should be of concern to the market. Commercial motor appears to be slower to react to the challenges motor faces, and pricing needs to reflect this.

“I expect commercial lines to improve and pricing to harden, but market discipline needs to be rigid. Too often a ‘growth’ strategy destabilises pricing and undermines attempts to improve the bottom line. Rates need to, and will, increase but there will be some that are swimming against the tide.”

LV= Broker commercial lines director Mike Crane also agrees that improvements in pricing are needed. LV= is a relatively new entrant into commercial motor. It moved organically into the sector in 2006 but established a more solid footing when it acquired Highway Insurance in October 2009.

A competitive market

Crane said LV= commercial motor business is now broadly divided into three categories: fleet, which includes trucks; the motor trade, which includes garages and car dealerships; and taxis. Each, he says, is performing differently.

“Commercial has lagged behind personal in terms of rate increases,” he says. “Some lines are OK but many are not, and the challenge now is to change that. It is a very competitive market. There are plenty of players and capacity, and this keeps rates lower than they should be.”

Crane says the aim of his business is to achieve a combined ratio of below 100%. “The landscape has shifted in terms of the investment environment, and underwriting has to reflect that. The pressure is on across all classes of business to make a profit.”

Rising claims costs

Profits are also under pressure from claims. Although frequency of claims has marginally improved of late, this could change if the economy improves. Meanwhile, the overall cost of claims is rising.

Insurers are enjoying several specific benefits in terms of the frequency of claims. The economic downturn has meant there has been a moderate decrease in the use of commercial vehicles.

Relatively mild winters have meant fewer accidents caused by adverse weather, while the high cost of fuel has dampened vehicle usage. “This is a short-term benefit, however,” Ball says. “As the economy improves, this dynamic will reverse.”

And the cost of claims is going in the opposite direction. A recent report by the Institute and Faculty of Actuaries collated and analysed data for UK third-party motor claims and periodic payment orders of UK bodily injury claims.

It revealed a 18% rise in the proportion of accidents involving bodily injury in the UK between 2010 and 2011 - the biggest increase ever identified. This, the report estimates, costs the insurance industry an extra £400m. The report mainly blames unprecedented activity by claims management companies.

As such, Ball believes rates must increase in commercial lines now - and at a rate above claims inflation, which is between 5% and 7%. “In this environment, I just cannot see how the industry can operate on a combined ratio of 107%,” he says.

“Within that, there must be players really struggling. That raises fundamental questions about some of the business models out there. I would think getting under 100% would be critical to most companies now.”

Avoid standing still

Ball also notes that growth in the size of this market can be deceiving. If rate hikes simply match claims inflation, the sector appears to show growth when in fact it is standing still. He estimates that the sector is in fact 3%-4% smaller now because of the recession.

Rate hikes are certainly possible. Commercial motor is not as price sensitive as personal motor with more sophisticated buyers appreciating quality service, claims handling and risk management services.

But it seems a differential will increasingly emerge between the sectors under the umbrella commercial motor. While value-added functions might work when speaking to large fleet managers, this dynamic might not be true on white van or taxi.

Deloitte’s Rakow predicts a disparity will emerge. The areas closest to personal lines will increasingly go online and become price sensitive, he says. The larger accounts will become more lucrative but insurers will have to offer more services.

The growing use of telematics in this sector will also help improve profitability, Rakow adds. “Those that can invest in this and understand the clients will win through.”