FSA warns insurers of risks

The Financial Services Authority has warned insurers they must tighten their risk management, underwriting and reserves after releasing 7% of their reserves and making an overall underwriting loss of 1%.

It also warned aggregators were failing to treat customers fairly and pushing down premiums.

In its Risk Outlook for 2009 it said: “The use of aggregators within the personal lines market continues to increase and this may maintain pressure on premiums. For consumers, aggregators may make assumptions to generate quotes quickly, and there is a risk that if a consumer is not aware of such assumptions, they may find that they are unable to make a claim. Additionally, if information about policy excesses is not provided clearly, consumers may end up with less cover than they intended to buy and insurers may fail to treat their customers fairly.”

It said insurers:

• Must have effective risk management in underwriting and reserving, and review their business plans in light of recent and expected claims experience.
• Need to monitor their exposures to potential claims relating to market events.
• Carry out regular stress and scenario testing to ensure that they remain adequately capitalised.
• Evolve their risk management so that it is effective and fully integrated with capital management.

The FSA said insurers should maintain effective operational controls to address the risks of financial crime, which may be exacerbated by current market conditions.

Higher claims on protection products could arise in the economic downturn. Firms need to ensure that

• contract terms are interpreted fairly and legitimate claims are met in a timely manner.
• protection products sold to consumers are appropriate and that the consumer would be eligible for claims under their terms and conditions.

In its analysis of the sector the FSA said: “Underwriting results in recent years have been supported by reserve releases and investment returns. Market conditions make the need to underwrite for profit even more important. In addition, if there were a major catastrophe, insurers might need to recapitalise. However, the sector is currently more attractive to investors because it is less heavily exposed to the asset risks affecting other sectors. In the retail market, there is a mixed picture in changes in premium rates. Pressure on pricing could affect profitability leading to changes in coverage or terms and conditions, which may result in poor consumer outcomes. Some insurers may also be exposed to potential claims on certain liability lines related to the wider financial markets, although the size of these potential claims remains unknown.

“Prior to the inclusion of investment income, the UK Company market as a whole made a 1% underwriting loss during 2007.2 Sizeable prior-year reserve releases supported the underwriting results, and in many classes of business masked an increase in the loss ratio attributable to the most recent business. In aggregate, the industry released £2.2bn or 7% of net reserves, which follows significant reserve releases in both 2005 and 2006.

“In addition to prior-year reserve releases, 2007 also benefited from sizeable investment returns which will have supported profits. Although there have been recent rate increases in motor and certain lines of reinsurance, there is no evidence of consistent hardening across the board. Reserve releases to the same extent as seen over the last three years may not be sustainable in the longer term, particularly if premium rates do not increase.”