The Omens for Motor Insurers are Not Good

Written by Paul Moorshead

At first sight UK motor insurers turned in another encouraging result during 2004, improving performance for the sixth year running and producing the best figures for ten years. Do not be deceived, however. Look a bit closer at the underlying trends and you will see a market heading for trouble.

Let’s first consider the raw figures. Premium income net of reinsurance rose by nearly 5% during 2004 to £8.9 billion. Loss ratios actually fell slightly to 74.0% and, with expenses constant, the market’s overall result came in at 101.3%. That’s an improvement on 2003 of 0.9%. Given the upward movement in equities, most motor insurers should have enjoyed steady if unspectacular profits.

As good as it gets
One more heave, you might think, and we could even see a positive underwriting result during 2005. Regrettably, any underwriter who believes in this scenario is in for a shock. The signs are that 2004 will be as good as it gets. Once again, the market has peaked too soon. Only the best will prosper.

As ever, the devil is in the detail, beginning with those loss ratio figures. The improvement came about entirely through a £327 million prior year release. In other words, insurers were able to use historic over-reserving to improve their results. Whilst an entirely legitimate use of funds, it makes the figures look better than they really were.

EMB had predicted this kind of development, but the size of the release during 2004 was much greater than we expected. In fact, it was the biggest in pure monetary terms and as a proportion of premiums in at least twenty years. As such, it is unlikely that a similar windfall will benefit insurers again during 2005.

Inevitably, individual insurers posted results above and below the average. Notable success was seen in the results of Zurich, Direct Line, National Farmers Union, Brit and Provident – all of whom booked operating ratios below 95%.

Care should be taken in looking at these figures. The results for Churchill and NIG look worse than they actually were because of one-off costs associated with restructuring. Both companies achieved quite encouraging underlying progress. The Co-operative may prop up the table of the largest 20 insurers in terms of results but, being a mutual, they probably have different financial drivers.

It is also worth observing that there are no clear winners in terms of the merits of being a direct insurer as opposed to using broker channels or in terms of size. Westminster was, for example, too small to make the league table, but produced the market’s second best operating ratio.

Rising burden of risk

Having looked at the loss and operating ratios, let’s now consider premium income. £8.9 billion may appear to represent a healthy increase, but that is entirely because companies took on additional risk. Premium per policy actually fell during 2004, with average earned premiums per policy dropping by between 1% and 7% depending on the class of business.

As a result, the class-by-class figures paint a gloomy picture. Gross loss ratios deteriorated during 2004 for Private Car Comprehensive, Private Car Non Comprehensive, Commercial Vehicles and Fleets. Only Motorcycles bucked the trend and showed an improvement in loss ratio.

Furthermore, the strength of reserves now held (as measured by paid to ultimate ratios) has only strengthened for Motorcycles, while weakening for Private Car Non Comprehensive and Commercial Vehicles, and remaining constant for Private Car Comprehensive and Fleet business. This suggests the loss ratio deterioration is real and not led by insurers "feathering their nests" in anticipation of leaner times ahead.

Claims vs premiums

The motor market has achieved underwriting profit just once in the past twenty years – in 1994. As this article has tried to illustrate, the only hope of repeating that solitary success in the next year or two would be through a sharp upward movement in premiums.

Motor claims inflation is running at approximately 5% year-on-year – made up of 6-8% inflation on injury claims and 2-4% on the rest. Over most of the last few years premiums have risen by slightly more than claims inflation, enabling the slow improvement from the totally unacceptable peak combined ratio of 122.6% of 1998.

Unfortunately, this improving trend in premiums is unlikely to continue. All the evidence suggests that motor rates have peaked and will, therefore, fall further behind claims. Even this pessimistic assessment ignores the likely impact of periodic payments, which came into force in November 2004.

Courts may now order insurers to compensate injured claimants on a regular basis – payments that can be reviewed at a later stage – instead of just giving them lump sums. It is EMB’s belief that this will add fuel to the fire of bodily injury claims inflation, but the limited number of awards to date makes judging the actual impact difficult at this stage.

Going forward, with premiums flat, we expect deterioration in the pure year loss ratio for 2005 to 81.0% with back year reserve release equal to 1.0% of premiums. We would expect the expense ratio to increase to 28.7% giving an operating ratio of 108.7%. The actual figures for 2003 and 2004, and our estimate for 2005 are provided below. You will see that there are likely to be worsening results virtually across the board.