Insurer margins - Economic dip leads to uncertainty

For the past seven years, the UK insurance market has been going through a period of supreme confidence. There was a peak in spending and everyone wanted a piece of the market.

Insurers and broker consolidators alike were keen to spend. Insurance Australia Group, for instance, bought Hastings Direct, Equity Insurance Group and Barnett & Barnett between 2006 and the start of this year. However, poor results, the economic downturn and the lack of rate hardening have conspired to humble much of the insurance industry and, today, many such as IAG have now become very publicly unstuck.

To make matters worse for IAG, in the last week of July, Hastings was fined £735,000 by the FSA for failing to treat customers fairly in cancelling approximately 4,550 motor insurance policies that were sold too cheaply due to an internal systems error. The mistakes, made on separate occasions between July and September of last year, meant that some of the policies were £539 cheaper than they should have been on average.

Big changes

In this new climate, cost cutting is rife. In the last couple of months, Zurich has slashed 10% of its UK workforce, Axa has axed 120 jobs in Ireland and Norwich Union's latest round of layoffs will leave 1,800 people out of a job.

"Insurers are seeing progressively thinner margins," noted Phil Bird, director of non-motor and SME underwriting at Groupama. He remarked that it is not only insurers that will feel the pinch: "Many insurers are reassessing their rewards for brokers."

"Commissions have been rising now for several years," commented Chris Hanks, general manager commercial lines at Allianz: "As a result, the costs to market are now relatively bad value for the customer and need some correction. This will put the brake on commissions rising and I expect to see some limited movement downwards."

Risks are also being reassessed. At the beginning of July, RSA stopped offering professional indemnity insurance to sole-practitioners and two-partner firms, despite those practitioners comprising over 40% of the market. "Insurers are thinking more about how they are pricing risk," commented Bird, "Previously, they were prepared to lower premiums to chase volume but now, with poor profit results, there is a move towards more realistic pricing."

The credit crunch has taken a lot of the blame for the current problems in the insurance industry. According to the Office for National Statistics, the UK economy grew only 0.2% in the second quarter of this year, markedly slower that the 1.6% experienced this time last year. Investment incomes are likely to be hit and the crunch follows last year's poor results with reserve releases of £440m by Norwich Union and £600m worldwide by Zurich attempting to mask the problem.

Culpability

Nevertheless, Bird believes that the economy is not entirely to blame for the industry's problems: "Ratings have been soft for a couple of years now; the momentum has just been sped up by reduced security in investments."

Despite the problems, there is still plenty of good news. Hiscox's DNA of an Entrepreneur Survey, published in July, concluded that 52% of small business owners had no intention of limiting their expansion plans. While larger insurers are cutting costs, smaller businesses are bucking the trend. Also, Provident Insurance has revealed plans to double in size after securing a major deal with General Motors' UK operation; the insurer is reported to be seeking to grow its workforce by 25% over the coming months.

There may be more poor results to come as the extent of the low margins become clear but Bird is confident that insurance markets will recover: "We may well see more insurers dipping into their reserves but, as rates rise, the market is showing slow signs of recovery."

IAG in the UK

November 2006 - Acquired Hastings Direct.

January 2007 - Acquired Equity Insurance Group.

March 2008 - Acquired Barnett & Barnett.

May 2008 - Rejected QBE takeover bid and chief executive Michael Hawker resigns.

July 2008 - Announces restructure of UK operations with 300 jobs cut. Despite previous assertions that it would not sell off any of its UK business, IAG confirms that sales are likely of Hastings Direct, Advantage and Equity Insurance Brokers.