Insurance Times’ analysis of the 2018 Annual Reports reveals a continued reliance on reserve releases, but could changing strategies and market conditions spell an end for a reliance on prior-year performance?
The UK general insurance market is relying heavily on reserve releases from prior years as insurers struggle to find current-year underwriting profits.
Insurance Times’ analysis of the 2018 Annual Reports for three leading insurers, Admiral, Direct Line Group (DLG) and Esure, revealed a net underwriting loss of £272.0m for 2018 before reserve releases were taken into consideration.
Only Esure failed to release any profits from prior-year reserves, with the troubled insurer instead pumping in an additional £27.8m as it struggled with increasing claims costs and poor weather conditions.
DLG and Admiral, meanwhile, released almost £520m from prior-year reserves, which helped turn in underwriting profits from otherwise loss-making portfolios.
| Admiral | Direct Line Group | Esure | ||||||
|---|---|---|---|---|---|---|---|---|
| 2018 | 2017 | 2018 | 2017 | 2018 | 2017 | |||
| Operating Profit | £487.50 | £414.90 | £601.70 | £642.80 | £7.80 | £111.30 | ||
| Current year underwriting profit | (£58.50) | (£31.40) | (£149.30) | (£147.30) | (£64.20) | (£4.10) | ||
| Reserve releases (excl. Ogden rate change) | £169.90 | £175.90 | £349.60 | £435.40 | (£27.80) | £26.70 | ||
While these high levels of reserve releases have been a mainstay of the two insurers’ results in recent years, reduced risk margins above actuarial best estimates are set to apply the brakes to such favourable prior-year developments, and other profitable revenue streams will need to be sought out in order to offset this.
Admiral
Admiral would have fallen to an underwriting loss in 2018 had it not been for the favourable changes to the Ogden discount rate combined with other reserve movements that saw the insurer release a total of £235.9m from reserves over the course of the year.
This change in reserving levels accounts for almost half of all of Admiral’s profits for the year, and continues a trend of the insurer relying heavily on prior-year developments for its profitability, although this could be coming to an end.
The insurer insisted in its Annual Report for 2018 that it “continues to reserve conservatively, setting claims reserves in the financial statements well above actuarial best estimates to create a margin held to allow for unforeseen adverse development” but also admitted that those margins have decreased over the last 12 months.
“The margin held in reserves remains prudent and significant though is slightly lower than the comparative period-end, reflecting the reduction in Management’s assessment of uncertainty around the reserves,” the insurer stated in its Annual Report.
But with growth slowing in the insurer’s core UK motor book, and international growth seemingly hard to come by, reserve releases could start to dwindle.
Admiral chief financial officer Geraint Jones, however, insisted that the growth being seen in the UK was respectable given the insurer now has a 15% share of the market in the UK.
“In 2018, we grew UK motor nearly 10% in customers. When you are that size, it’s not a bad rate of growth at all,” he said. “We grew 10% in Spain, nearly 20% in Italy and more than one-third in France. The US was up over double digits.
“They are all growing quite nicely despite those challenging conditions.”
Jones added that the insurer was also targeting faster growth in the UK home insurance market.
“We have not really tried to cross-sell to our existing customers that hard until quite recently, with our multi-cover offering,” he said. “Our hope is that we will be able to grow that business much faster than motor is likely to grow over the coming years.”
But despite Jones’ assertions, the insurer’s reserve releases have already started to fall compared to previous years.
If you exclude the £66m released from reserves as a result of the favourable change in the Ogden discount, Admiral’s reserve releases for 2018 were £6m lower than in 2017 and represent the lowest amount since 2014, if you also exclude the negative effect the previous Ogden discount rate change had on reserves in 2016.
And Jones himself is being realistic in his expectations for reserve releases and admits levels will drop over the coming years, but will still be a significant source of profit for the insurer.
“It’s probably fair to say our reserve releases won’t stay to the level where they’ve been in the last couple of years,” he said. “Nonetheless, we would always take a cautious approach to reserves and so always expect reserve releases to be a meaningful, substantial part of our profitability.”
In addition to reserve releases, the insurer also benefited greatly from a range of other sources of profit in addition to its underwriting business, which included profit commissions from reinsurance partners of £93.2m, installment income of £10.7m (which includes a new loan business launched in 2017) and other income (including ancillary products) of £169.5m.
The insurer’s price comparison business also brought in profits of £8.8m for the year, up from £7.1m in 2017 and £2.7m in 2016.
Direct Line Group
DLG was the biggest benefactor of reserve releases of the three insurers included in this analysis, freeing up almost £350m of prior-year reserves, only £54.8m of which related to the change in the Ogden discount rate.
This is still significantly lower than the £435.4m released in 2017, however, and as with Admiral, analysts are worried that future reserve releases will be at a lower level than investors have come to expect from the insurer under former group chief executive Paul Geddes.
A report from investment bank Berenberg, published a little over two months after the announcement of Geddes’ departure highlighted some headwinds that his successor and former DLG chief financial officer Penny James will face, with declining reserve releases chief among them.
The report said that it expected reserve releases to “normalise towards 10% of net earned premiums”, and added that “offsetting this headwind with cost and commission savings would be an excellent achievement”.
But speaking to Insurance Times, Andy Broadfield, DLG director of investor relations, said the declining reserve releases is the result of a wider strategy at the insurer to retain less risk, which he said the insurer has been open about since breaking away from RBS.
“We have been quite public [about our reserve releases getting smaller], and the reason for that [decline in reserve releases] is because we are retaining less risk,” he explained. “When we were part of RBS Group we kept the first £10m of each motor bodily injury claim, and by 2014 that had scaled down to £1m, the same as Hastings and Esure.
“By retaining less risk we have to hold lower levels of capital [and there is less scope for reserve releases as a result of that].”
Broadfield said the change in the insurer’s risk retention strategy is a result of the differences between operating as an independent business compared with operating within a group structure.
“When we were part of RBS Group, which is a larger financial services organisation, holding £10m – which is similar to what Aviva does within its UK motor portfolio – makes more sense as you can withstand the volatility as you have a more diverse capital base,” he said. “But as a standalone listed company, on a return-on-capital basis, it is much more efficient for us to use reinsurers’ balance sheets for that risk.”
But with lower reserve releases offering less help with DLG’s underwriting profitability compared with previous years, the Berenberg report highlights concerns that the insurer will not be able to find underwriting improvements from elsewhere.
The report states: “As excess reserve releases gradually normalise, this will act as a margin headwind. Investment income is also reducing, as higher-yielding bonds roll off and average invested assets are lower, following significant excess capital returns and reduced retention levels in more recent underwriting years.”
Like other insurers, DLG also draws profit from its investment returns and other income streams, but its much larger books of business compared to Admiral and Esure means that these are much more significant in the context of its profitability, particularly with the insurer making a current-year underwriting loss.
DLG reported instalment income of £119.9m for 2018, slightly up on 2017’s £116.4m, while instalment income fell to £154.6m (2017: £175.4m) as a result of the declining bond market. Other income, meanwhile, grew to £72.1m (2017: £62.9m).
Esure
Esure has gone through some difficult times in 2018, with adverse claims development hitting reserves as it slumped to an all year underwriting loss of £92.0m, down from a £22.6m profit for 2017.
The troubled insurer had to pump £27.8m into reserves last year, adding to the woes already loss-making current-year underwriting loss of £64.2m. This compares to reserve releases of £26.7m for 2017.
Chairman Sir Peter Wood attributed the insurer’s underwriting struggles to “competitive market dynamics (lower premiums and elevated claims inflation in Motor) combined with the Group’s own claims experience” as well as increasing claims costs as a result of the “exceptional weather events seen across the UK”.
Motor was the biggest problem for the insurer, with an all-year underwriting loss of £74.5m (2017: £24.9m profit) as the loss ratio climbed to 88.5%, 4.4 percentage points of which came from reserve strengthening, particularly for small and medium sized bodily injury claims.
The insurer’s home insurance book, which makes up a much smaller percentage of its business, saw the loss ratio climb to 82.1% (2017: 65.6%), resulting in an all-year underwriting loss of £17.5m (2017: £2.3m).
Esure’s poor underwriting performance meant the insurer was only just above its solvency capital requirement with own funds of £356.7m and a solvency coverage ratio of 108%, much lower than the 156% reported for 2017, and dangerously close to the 100% mark where regulatory intervention may occur.
In February 2019, Berenberg analyst Iain Pearce said: ”We view this very much as a company-specific issue. As we discussed in multiple notes, we believed esure’s growth and footprint expansion was fraught with risk, especially given its minimal reserving buffers.
“We do not believe that any of the companies in our coverage have acted in such an ill-disciplined manner. As such, we would not expect the companies in our coverage to face similar issues.”
Esure had long-been targeting aggressive growth targets, something that analysts had been warning the market about since April 2017, and it seems this chasing volume at the expense of focused underwriting has come back to haunt the insurer.
Since then, a reinsurance arrangement has been put in place by new owners Bain Capital, which bought the insurer in August 2018, resulting in an improved solvency coverage ratio of 149% as of the end of March 2019.
The loss transfer portfolio agreement sees a reinsurer assume the group’s existing open and future claims liabilities through the transfer of the group’s net claims liabilities at 31 March 2019. The arrangement also includes adverse development cover, preventing net claims liabilities deteriorating beyond a pre-agreed point.
Away from this poor underwriting performance, profits from other income streams have climbed to £87.6m (2017: £75.7m) as the insurer benefited from almost £14m worth of revenue from brokerage and commission income, as well as £9.7m from fees generated from the appointment of firms used during the claims process and from car hire suppliers.
Esure has also seen a drop off in investment income as falling bond yields saw investment returns of £12.2m in 2018, down from £13m for the previous 12 months, and with the bond market continuing to offer low returns, new chief executive David McMillan could see this as an area where the insurer could take on more risks to help boost its capital base.
| Admiral | Direct Line Group | Esure | ||||||
|---|---|---|---|---|---|---|---|---|
| 2018 | 2017 | 2018 | 2017 | 2018 | 2017 | |||
| Operating Profit | £487.5 | £414.9 | £601.7 | £642.8 | £7.8 | £111.3 | ||
| Current year underwriting profit | (£58.5) | (£31.4) | (£149.3) | (£147.3) | (£64.2) | (£4.1) | ||
| Reserve releases (excl. Ogden rate change) | £169.9 | £175.9 | £349.6 | £435.4 | (£27.8) | £26.7 | ||
| Ogden rate change | £66.0 | £0.0 | £54.8 | £0.0 | N/a | N/a | ||
| Profit commission | £93.2 | £67.0 | N/a | N/a | N/a | N/a | ||
| Investment income | £36.7 | £41.7 | £154.6 | £175.4 | £12.2 | £13.0 | ||
| Instalment income | £10.7 | £1.2 | £119.9 | £116.4 | N/a | N/a | ||
| Other income | £169.5 | £160.5 | £72.1 | £62.9 | £87.6 | £75.7 | ||
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