AM Best Commentary: Future forecast

Regulatory changes, competitive market conditions, an uncertain economic environment and low investment returns are all taking their toll on UK general insurers. Although firms have enjoyed a respite from large climate-associated losses in the country in the first eight months of 2013, potential weather-related claims remain a challenge.

Insurers’ overall performance continues to be impacted by low investment returns and restrained consumer spending. In 2012, gross domestic product rose by just 0.2% and economic growth is forecasted to remain modest in 2013 at 0.9%.

The market remained highly competitive in 2013. Private motor and household premium rates decreased in 2012 and in the first eight months of 2013, placing pressure on accident-year earnings. Prior-year reserve releases are expected to continue to have a positive impact on overall 2013 calendar-year performance but are anticipated to diminish, and strengthening is likely to be required on some lines. The uncertain economic environment makes reserving a challenge, increasing the risk that a change in claims trends or claims inflation will erode reserving margins.

Performance for the property insurance sector in 2013 remains subject to uncertainty from weather-related losses for the remainder of the year. While adverse weather claims in 2012 were substantial, they did not materially impact results. However, large-scale flooding, in particular, has the potential to push the market into an underwriting loss, given the narrow margins.

Overall, the 100 largest UK-regulated insurers, ranked according to general insurance gross written premiums and including some international business, posted underwriting results in 2012 roughly in line with 2011. Both years saw significant improvements compared with 2010, when cold weather losses impacted property results and motor business required reserve strengthening.

In 2012, UK weather-related claims reached £1.19bn – the highest annual figure since the £3bn in losses for the 2007 summer flooding. The Association of British Insurers described 2012 as the wettest recorded year in England and Wales and the second wettest in the UK. However, the 2012 floods did not have a material impact on overall underwriting results.

Catastrophe claims
Insurers with London market operations experienced large claims in 2012, including Superstorm Sandy and the grounding of the cruise ship Costa Concordia. However, while these were material, compared with 2011, these insurers benefitted from a more benign period for natural catastrophe losses. Claims in 2012 did not significantly exceed insurers’ catastrophe budgets, unlike in 2011, when natural catastrophes included the Christchurch earthquake in New Zealand, the earthquake and tsunami in Japan, and the flooding in Thailand.

In 2011, property accounted for 27% of GI premiums, while motor represented 34% and liability stood at 12%. Of these three main GI segments, property is the only line of business to have made underwriting profits on a calendar‑year basis in any year between 2008 and 2012. Property has made an underwriting profit in four of the past five years with the exception of 2010, when the winter freeze impacted results and the combined ratio deteriorated to 101.7%.

The frequency and severity of weather-related claims, particularly related to flooding, is the main driver of performance in the UK property sector. In June 2013, the Department for Environment, Food & Rural Affairs and the ABI reached a new agreement to replace the Statement of Principles, which had been in place since 2000. Under the SoP, UK property insurers agreed to provide flood coverage for high-risk homes, provided the government invested in adequate flood defence programmes.

The new agreement will cap household flood insurance premiums for flood-prone areas, linking them to council tax bands, and will be funded by an industry-backed levy. All UK household insurers will pay into the pool, creating a fund that can be used to pay claims for those in high-risk homes.

An agreement to create the Flood Re scheme is a positive development and Defra has pledged a six-year, long-term commitment to provide £370m of capital investment in flood defences. However, many details still need to be agreed before the proposals for Flood Re receive legal backing through the Water Bill.

Competitive market
In the first half of 2013, premiums for home insurance have been declining owing to a competitive market. The decrease in household building and contents premium rates in 2013 is not surprising given the property sector’s continued good performance and the lack of material impact from 2012’s weather-related claims.

In comparison to the property sector, motor has returned overall underwriting losses on a calendar-year basis every year between 2008 and 2012. Performance was particularly poor in 2009 and 2010, when the combined ratio reached 119.5% and 118.8%, respectively, although in 2012, the combined ratio was at a more manageable 106.6%. Motor insurance is generally written by larger, diverse companies that have opportunities to cross-sell other personal lines helping limit the impact of motor underwriting losses.

UK motor insurers recorded another underwriting loss in 2012 on a calendar-year and accident-year basis. The net accident-year loss ratio deteriorated to 86.2%, compared with 84% in 2011, but this was offset by reserve releases, while 2011
saw a very small reserve strengthening. However, the calendar-year combined ratio for 2012 still deteriorated, reflecting an increase in the expense ratio.
The motor sector achieved substantial rate increases after heavy losses in 2009 and 2010, but these have not been maintained, despite the motor sector continuing to return underwriting losses. Given the competitive nature of the market, rates began to fall again in 2012, with further declines experienced so far in 2013.




Gender directive
Rates have been affected by a European Court of Justice ruling that banned European Union member states from allowing the use of gender as a criteria for financial services pricing from December 2012. The introduction of gender‑neutral pricing has caused insurers to adjust their pricing models, increasing the uncertainty around underwriting results for 2013 and 2014 as pricing strategies will take time to perfect.

Challenges for UK motor insurers include the continued use of periodical payment orders to settle high-value personal injury claims – such as brain or spine damage– through an initial lump-sum award together with regular payments to cover ongoing medical costs. Unlike whole lump-sum settlements, PPOs expose insurers and reinsurers to risks such as inflation and longevity, resulting in different requirements for investments, reserving and capital management than for traditional motor business.

In 2012, the UK liability sector experienced another year of underwriting losses, in line with the previous four years. A relatively modest prior-year improvement of 3.4% only just pushed the combined ratio below 110%. The prior-year reserve release for liability was markedly lower than the 9.2% and 7.1% levels of 2011 and 2010, respectively.

Reserve movements vary widely by year for this segment of the GI market. Determining adequate pricing and reserving for this long‑tail line is made difficult by the extended period between a policy being underwritten and a claim being paid. Competitive market conditions in recent years have increased the risk of underpricing and under-reserving, as well as the risk that terms and conditions have been weakened.

The difficult economic conditions experienced since 2008 have added to the uncertainty surrounding pricing and reserving levels, making it harder to predict claims trends as well as future levels of claims inflation.

The liability segment returned combined ratios between 104.7% and 109.3% from 2008 to 2012. As this is a long-tail line, investment income will help offset some of this segment’s underwriting losses.

However, the current environment of low investment returns diminishes the positive impact of investment income on the overall profitability of liability insurance. This makes adequate pricing for this long-tail line of business even more important. However, underwriting returns have remained poor despite depressed investment returns since 2008. At some point, low investment returns must place upward pressure on pricing.

Regulatory burden
The UK insurance sector faces a period of regulatory change. The Financial Services Authority was abolished in April, and the Bank of England is now responsible for the prudential regulation and supervision of banks and insurers through the Prudential Regulation Authority.

The Financial Conduct Authority has taken over the consumer protection work formerly carried out by the FSA. Insurers are most concerned by the potential burdens of cost and time that dual-regulation can bring.

UK insurers continue to encounter uncertainty surrounding the implementation of Solvency II. The proposed regulatory and capital regime, which aims to bring a harmonised, principles-based approach to insurance regulation within the EU, was officially due to come into force on January 2014, but is now expected to be introduced on January 2016 at the earliest.

Challenging market conditions, including intense competition, continue to put pressure on accident-year earnings in 2013. Reserve releases are expected to contribute positively to performance in 2013.

However, current economic conditions increase the uncertainty surrounding the existence of reserve margins being built into the more recent years, and whether such releases can continue in the future. Investment income is expected to remain low, restricting overall returns for the insurance market. 

Mathilde Jakobsen, senior financial analyst and Yvette Essen, director, industry research - Europe and emerging markets