A change of tactics

Malcolm Smith, Commercial manager, Groupma Insurance

There is no need for a pocket calculator to work out the implications behind a class of business that can produce a £4m claim following a fall from scaffolding, on a policy where premiums are often no more than £100 per capita. Nor the long-tail consequence of claims - such as for industrial disease or illness - that only come to light after several decades have passed.

While employers' liability remains good value for money for customers, it continues to be an extremely challenging line of business for the market.

The seeds of the current situation in EL were sown in the late 1990s, when soft market conditions led to several years of rate reductions, at a time when claims costs and frequency were rising. The subsequent poor results triggered a significant correction in rates and caused the commercial market to harden quite severely in the period between 2001 and 2003, with prices rising dramatically, capacity being reduced and, in some instances, withdrawn altogether.

During this period, both the traditional and the fringe markets turned their back on some high risk trades and business with a poor claims record, creating real problems for some firms in obtaining statutory EL cover. The problem for UK businesses was two-fold, significant rate increases but, for some types of company, difficulty in finding insurance cover at any price.

Real concerns

Ultimately, the Association of British Insurers stepped in to help address some of the real concerns being expressed - with trade associations bringing the situation into the national media and ultimately drawing the unwanted eye of the main political parties - much to the detriment of the reputation of the insurance industry. This is perhaps not surprising when rates typically increased by over 50% and moved far higher for more hazardous risks.

As time has passed, these concerns have gradually been overtaken by evolving market conditions. It became more competitive, more insurers returned and insurers' results began to turn round. By 2005 many of the problems highlighted in the media had pretty much receded altogether from public attention and scrutiny.

However, nothing stays still for long and things now seem to be deteriorating again. EL is a volatile class of business. In the latest Groupama-sponsored Professional Broking Sentiment Survey, 48% of brokers said EL was 'quite concerning'. It appears that just over half of the respondents are not quite so concerned but perhaps that just highlights the softer market conditions that we have all become accustomed to over the past couple of years. However, it is also clear that a high proportion of intermediaries and their clients have been badly scarred by the experiences at the beginning of the decade and that these problems still live long in the memory.

So, where are we now? Since 2004, Groupama's experience is that average EL rating strength has been reduced by around 15%, as the premium increases of 2001 to 2003 have been slowly eroded. Higher risk liability business that was spurned a few years ago is now being written freely by some insurers, and at very competitive premiums. This includes the involvement of insurers that have no current Standard and Poor's rating, let alone an "A" rating that most would consider critical when placing long-tail business. In short, there now appears to be growing evidence that the market may once again be sliding towards crisis and back into loss after an all-too-brief spell of profitability.

A new volatility

It is not necessary to search too far to find the reasons. Claims cost inflation - the estimation is that this is in excess of 7.5% per year. This relates mainly to legal costs, increases in awards, and periodical payments on large claims, the latter being a relatively new development that has introduced a new volatility that insurers now have to manage.

Furthermore, in 2007 the liability classes seem to be seeing greater rate reductions than on property business. Market competition has really hit home and it is certainly not getting any better - if anything, things are getting worse.

EL is long-tail business and underwriters do not get a picture of the results of what is underwritten for three or four years. However, accounts cannot be truly closed off for far longer. On the business Groupama is seeing this year, and going forward into next year, the rating trends suggest that the market is getting close to being at marginal profitability once again. Practically all the increases achieved in the early years of the millennium have now all but been eroded through rate reductions and claims cost inflation.

Another issue relates to long-tail disease claims going back over many decades. Asbestos-related diseases like mesothelioma are a particular problem, and the market is currently awaiting legal decisions on related illnesses such as pleural plaques. Last year, Groupama received first notification of a number of new disease claims relating to employment in the 1960s and 1970s and it was certainly not alone. These claims need to be reserved from current income as the old years of account have long since closed. This is yet another ongoing cost affecting much of the traditional market.

Of course, because there was no market experience, these illnesses were never priced in to the original premiums paid and, as we look to the future, the industry is faced with a host of potentially similar challenges.

Passive smoking and stress are just two examples of claims that have so far made little impact but, if the courts do move in favour of extensive settlements for this type of injury and illness, underwriters face a very uncertain future.

Against this background, there is much support for the Association of British Insurers' initiative to move long-tail occupation and disease claims funding into a separate pool. Insurers would like to see disease claims taken out of EL and separately funded because it is almost impossible to price.

A state-supported pool that insurance companies manage on behalf of employers, somewhat akin to the terrorism pool, could be a good solution but at the moment this is only conceptual and a lot more lobbying will be required to effect change.

The rate at which premiums have been eroded almost to the margin was mentioned earlier.

Have rates already gone below the threshold of economical viability? Well, that depends where you operate and there continues to be substantial differences between the lower end of the market and the much more volatile market for larger risks and higher risk trades. Insurers and brokers never seem to be quite as competitive for a £3000 combined policy as they might be for a £100,000 portfolio.

However, there are new players on the block and this, coupled with better results on liability business over the last couple of years, has been pushing the market back down the route of cutting rates. We may not yet be at the bottom but the market is right on the margin and premium rates need to start rising soon if we are to avoid the problems of the past.

Frankly, the current downward pressure on rating is simply not sustainable. And, if premiums continue to fall the market will almost certainly be writing business at unprofitable levels again.

Rising interest rates are not a panacea either, because claims cost inflation is running significantly ahead of insurers' investment returns. So, although investment income usually makes the difference between profit and loss, the effect of time with 7.5% inflation on claims costs more than negates any potential benefits.

To make matters worse, underwriters now need to absorb NHS service charges too. Groupama has calculated that these will increase claims costs by between 5% and 6% on EL, so it seems pretty obvious that rates should be moving up just to account for this new cost. However, current competition is such that the market does not look sufficiently strong to be able to support this which is a real worry.

Uncertain future

In summary, the very substantial rate increases the market carried four to five years ago have been largely subsumed by rising costs and rate reductions and, sadly, the future scenario is decidedly gloomy.

As we look forward into 2007 and 2008 the costs we already know about - continuing rise in claims costs, rate reductions, and the NHS hospital charges - need to be managed. However, these are just the challenges that we can see. Who knows what other factors lie hidden from us at this moment in time? The market really needs prices to rise - and soon.