Stalled?

The UK has the most cut-throat and possibly the most deregulated motor insurance market in the world. The latest FSA returns show that in 2001 the industry continued to recover from three years of unacceptable losses, but it remains a tough way to make money. There have to be serious concerns about the ability of premiums to keep pace with claims in the medium term.

With motor rates going up on average by 15%, the market's combined ratio improved during 2001 from 114% to just over 104%. This improved performance can be explained by the overall loss ratio, down from 87% to 76% - exactly as EMB predicted last year. The expenses ratio remained unchanged at 28%. Underwriting losses, which exclude investment income, came down to £300m from £1bn in 2000 and from the record £1.8bn the industry lost in 1998.

These results reflect well on the motor market's ability to respond to softening rates. Underwriters have been far quicker to respond to adverse conditions than, for example, their liability colleagues. If it had been a good year for equities, most insurers would have returned to healthy profit levels on their motor accounts.

It was, of course, not a good year to rely on investments to make up for underwriting deficits. Different insurers have radically different investment strategies, but some of those that relied on equities are on record as having made substantial negative returns.

But the big picture statistics tell only part of the story. As always, there is a large gap between the most and least successful. The best performers out of the largest 20 insurers include, for the third year running, Fortis and Direct Line. Both made profits, as did Groupama, Cornhill and Norwich Union.

There is no single formula for success in motor insurance; the most profitable companies include both broker-based and direct response insurers. Lack of size is clearly no barrier either, with companies such as Privilege, Legal and General, Avon, and Ecclesiastical running small, profitable motor accounts. This year's star performer was Westminster Motor, which turned in the best combined ratio of all, 88%, with a motor premium income of just £17m.

While a number of insurers underperformed, only two of the top 20 insurers produced results that were significantly worse than average. Eagle Star made an underwriting loss of 33%, driven by a back-year reserve strengthening of 24%. This exercise was distorted by a sizeable reduction in current year earned premiums due to the transfer of business to its parent company, Zurich. And CIS reported a 23% underwriting loss. It is only fair to point out that as a mutual insurer with a large capital base its strategic objectives might be different from those of other insurers.

One of the most encouraging features of 2001 was the further strengthening of reserves among motor insurers. This has been in evidence now for several years, and was much needed in view of previous under-reserving, as well as the steep long-term rise in bodily injury claims.

One way to gauge the strength of reserves held by the market is to measure the ratio of paid claims to date against ultimate claims held (see table right). A low ratio is a sign of better reserving, and last year it fell from 51.3% to 48.4% for private car comprehensive claims and from 26.4% to 22.4% for non-comprehensive.

For the immediate future, we predict rising premium levels will push motor underwriters into the black in 2002 for the first time in seven years. EMB is forecasting loss ratios of around 72% for 2002, producing a 1% underwriting profit.

But this could well be as good as it gets. The market is showing signs of ending the large premium increases seen, and required, during the past three years. It is our belief that premium growth for 2003 is likely to be inflationary at best.

To put this another way, premiums can be expected to rise slower than claims, especially those related to bodily injury. The first two UK Bodily Injury Awards Studies, published in 1997 and 1999, reported claims escalation of around 12%-13% per year. The second report found personal injury costs had accounted for around 36% of the market's premium income in 1997, as part of a long-term rising trend. There is every reason to suspect the escalation rate has remained in double figures ever since. The third awards study currently underway will verify whether this is still the case.

In the past 15 months, inflationary pressures have continued. Increased NHS charges, a lower Ogden discount rate - currently at 2.5% - the impact of conditional fee arrangements, the possibility of increased periodic payments and further increases in the cost of medical treatment will push insurers' costs up faster than the general rate of inflation.

Of particular concern is the increased litigiousness in UK society.

If the modest underwriting profit that we predict for this year is to prove durable, premium rates will have to move into a higher gear, and there is little sign of that happening. Profitability will remain an elusive target for all but the best and most innovative motor insurers, be they broker, direct, mutual or composite. Most insurers will be forced to depend on investment income to achieve acceptable returns.

A prospect to deaden the heart of any insurance company finance officer.