Driving on the edge

The private motor market is in a precarious position.

The tortuous path that motor insurers need to traverse is profitability. Over the past years, the market as a whole has been clawing its way back to profit, but there are worrying indications that this recovery could come to an end. The market is on the verge of plunging into a soft cycle.

Insurers are waiting anxiously to see which way rates will go, acutely aware that the market's fate may lie in each others' hands.

Signs of a decline in rates were starting to show last year. A survey by Budget Insurance Services found in the third quarter of 2003 motor premiums dropped by a quarter of a percentage point.

The FSA was also beginning to take note of the prevailing market conditions. Speaking at the Institute of Economic Affairs' annual conference, David Strachan, director of the FSA's insurance firms division, warned insurers of a "growing body of evidence" to suggest that the premium cycle was beginning to turn.

Latest figures from car insurance search site Confused.com found that the private motor market was continuing to soften in the fourth quarter of 2003, following a decline of almost 1% in the third quarter.

And according to the AA's British Premium Index, rating increases had slowed in the final quarter of 2003, increasing by only 0.25% compared to an increase of 1% in the previous quarter.

Insurers agree that 2003 saw a decline in rates. Allianz Cornhill personal motor manager Neil Walker says: "At the end of 2003, our rates were 1%-2% lower than at the same point in 2002."

The market is now anxious that this trend does not continue and that some increases can be achieved. Equity Red Star underwriter Ray White says: "It is a question of where the market will go from here. I hope that it won't soften and that we will get some small increases."

A return to a soft cycle would be damaging to profitability. While profits have been improving in the past years, the industry has still to pass the break-even point.

According to Standard & Poor's UK Motor Review 2003, the combined ratio of the market as a whole (private and commercial) was 102.2% in 2002 - still above the important 100% mark, but showing a steady improvement on the 1998 result of 123.7%.

A softening of rates could stall this gradual recovery, pushing the market back into the depths of unprofitability.

The delicate position of the private motor market can be seen from a comparison of claims costs to premiums. The average private car comprehensive premium increased by only 1.8% in 2002, yet the average cost of claims in the sector increased by 4%. Claims inflation is now estimated to be around 5%. Downward pressure on rates would only serve to widen the gap between premium income and claims costs.

The future path of rates is uncertain. Zurich head of motor underwriting Dave Swann says the market is on a knife-edge. "We expect rates to remain fairly flat in the near future. But we will have to wait and see if that is the case."

There is certainly no desire among insurers to cut rates, and they are making efforts to obtain increases where possible. Allianz Cornhill, for instance, raised its rates with a 0.75% across-the-board increase last month, and will be looking to get further increases where possible.

But it remains to be seen whether insurers will be able to achieve the rate hikes that they desire. There are great pressures in the market to reduce rates. Insurers point to competition from bancassurers and supermarkets, who have been aggressively building their books of business through price competition.

"The biggest driver of softening premiums has been the supermarkets," says White. "Now Asda has entered the fray."

The fear is that the rest of the market will be unable to resist these deflationary pressures out of a need to compete and maintain their own premium volumes.

But Groupama marketing and communications director Jamie Marchant says that the commoditised nature of the motor market will make it very difficult for the industry to avoid reducing its rates.

Consumers buy on price, so if insurers want to maintain the scale of their books of business they will have to follow suit, he argues. The alternative is to stand firm and underwrite for profit.

"It is the industry's own fault that it is in this position. It has commoditised the market, and it is coming back to bite it," says Marchant.

The industry will require a strong nerve if it is to hold firm and write for profit. Will it be able to do this?

Walker says: "The way that the market has behaved in the past would suggest a move to unprofitability going forward. It would only take a couple of the big players to try and build market share to drag the market down. As others lose volume they may be tempted to follow suit."

Certainly, the shadow cast by history is a very large one indeed. The market has only been profitable twice in the last 18 years, showing a distinct lack of control on the part of insurers.

But Walker insists that Allianz Cornhill will stand firm, maintain rates and live with falling business volumes in order to maintain profitability. He is also optimistic that other insurers will also behave sensibly. "Everyone is much more aware of their responsibilities."

Whether his optimism is misplaced remains to be seen. Yet holding firm and sacrificing volume for the sake of profitability is not without its dangers. "The worse case scenario is that insurers won't have enough volume to maintain their infrastructure," says Walker. "But this is a long way off at the moment."

Falling rates could also see insurers withdraw from the market. This is a step that Equity Red Star would be prepared to take. White says: "We have a diverse book of business of which private motor is one part. If rates come down to certain levels where it is not economical to compete we will pull out."

But there are indications that, despite talk of writing for profit and not volume, insurers are guilty of encouraging the softening market. The latest premium survey by Confused.com found that the direct writers and brokers were responsible for the majority of premium reductions. In contrast, the supermarkets were responsible for the majority of price rises.

Could it be that when it comes to profitability, insurers will end up shooting themselves in the foot?