The company’s UK general insurance strategy will be under scrutiny this year

Aviva’s results for 2008 reveal the challenging position it faces in knocking its UK general insurance business into shape. It reported UK general insurance operating profit of £566m, an increase of about 50% on its restated 2007 UK operating profit of £368m.

But the performance must be put in the context of the flood-related losses in 2007, which cost the insurance industry billions and had an £475m impact on Aviva’s operating result. In 2006, the UK business delivered record profit of £1.075bn, nearly double the 2008 performance.

Prior-year reserve releases also mask the underlying performance: £285m was released in 2008, £430m in 2007 and £435m in 2006.

Strip out the impact of adverse weather and the prior-year reserve releases, coupled with the long-term investment performance, and a picture emerges of declining underwriting performance over the past three years:

• 2008: a £222m underwriting loss

• 2007: a £176m underwriting loss

• 2006: a £130m underwriting loss.

The reason for this decline appears to be a mix of tough market conditions and rising distribution and claims costs (the UK general insurance claims ratio has risen to 62% in 2008, from 58.7% in 2006).

These factors are not lost on Aviva’s management. Over the past two years, the insurer has taken action with a series of rating increases across its book of business and changes to its risk selection. It has walked away from unprofitable business and cut its costs – redesigning its operations functions, for example, and cutting some brokers’ commissions. There has also been a shift in focus away from (expensive) consolidator-produced business to the small and medium-sized broker channel.

These actions resulted in £265m of cost savings last year and a reduction in the expense ratio to 12.1% from 13.9% in 2007. But it is taking time for this action to filter through to profitability.

Aviva admits that its rating increases are struggling to outpace claims inflation in commercial lines, while rate rises in personal lines have been “marginally better” than headline claims inflation. However, an increase in claims farming, personal injury claims and credit hire costs has hit the profitability of its personal lines book, which has operated at a combined operating ratio of more than 100% for the past three years. Igal Mayer, Aviva UK’s general insurance chief executive, admits this is not good enough.

The question is when the various strategies employed by the Aviva management will bear fruit, and whether they will be enough. The insurer insists these efforts will lead to a “real improvement” in profitability this year. Indeed, it suggests that it will achieve a pure combined operating ratio of 98% without the benefit of prior-year reserve releases.

It is clear that this year’s performance will test the management’s strategy. If the underlying performance does not begin to show a significant improvement then perhaps a different course of action will need to be taken.

Key points

• The underlying performance of Aviva's UK general insurance business has declined over the past three years

• The business has been hit by tough market conditions and high costs

• Action has been taken to improve profitability through rate increases and cost-cutting, but these have yet to be
fully effective

• The performance in 2009 will be a crucial test of this strategy's success