Insurance

United Kingdom

UK Personal Motor Insurance

Innovation and Opportunities in a Challenging Market
Special Report
Technology Innovation Benefits Industry: Fitch Ratings believes the motor insurance industry will benefit from innovation supported by the increased use of telematics (Figure 1) and big data. As the pressure on insurers technical profitability is set to continue driven by fierce competition and regulatory developments, these new tools have the potential to improve the profitability of motor insurers by addressing long-standing industry issues including increased claims costs and fraud. Telematics Small but Growing: While the telematics penetration rate is still low, regulatory changes could support the growth of the market. The eCall initiative will require all new vehicles in the EU to be fitted with telematics devices by 2015, giving insurers the opportunity to use the infrastructure for telematics policies. Additionally, recent deals between technology providers and insurers are likely to boost growth.
2010 2011 2012 2013

Figure 1

Number of Telematics Policies

United Kingdom
(000) 350 300 250 200 150 100 50 0 2009

Thousands

Source: British Insurance Brokers' Association

Figure 2

Winners and Losers: As the use of new technologies becomes mainstream in the industry, there will be winners and losers. Firms with agile operating structures and efficient decisionmaking processes will be better positioned to benefit. Insurers implementing telematics ahead of their peers will also be likely to benefit by better retention of lower risk drivers. Tackling Fraud: Telematics and big data could be effective tools against insurance fraud. Detailed road accident information recorded by telematics devices should help insurers to validate legitimate claims and assist in denying fraudulent ones. Additional industry datasharing projects are expected to deliver substantial fraud savings benefits to insurers. Improved Risk Selection: Fitch believes that telematics data could help insurers to develop improved pricing capabilities compared with traditional models, leading to better informed underwriting decisions and more predictable claims costs. Data on customers behavioural risk profiles could allow for further customer segmentation and opportunities to offer additional tailored products and target marketing. Support Customer Retention: New technologies can help insurers to improve their customer retention rates through increased efficiency of claims management. Higher customer satisfaction could lead to customer referrals and purchase of additional products. Customer retention rates have suffered from the growth in aggregators. Challenges Ahead: Significant investment may be needed to implement systems and models capable of handling big data. New technology also opens up a question of the asymmetry of data between customers and insurers and whether customers are being treated fairly. Telematics data-sharing can address this issue, but raises the possibility of anti-competitive behaviour that could attract regulatory scrutiny. Any insurer handling telematics data needs to be aware of current and forthcoming data protection laws. Business Model Challenged: Challenging motor market conditions have assisted the rise of Gibraltar-based insurers whose businesses are characterised by low-cost strategies, pricing flexibility and agile operating structures. These strategic advantages allow these companies to continue to increase their market share.

Personal Motor Combined Ratios 2008-2013e

Accident year basis
(%) Combined ratio 123%

130
120 114% 110

113% 103%

110% 107%

100
90 80

Source: SynThesys, 2013 Fitch estimate

Related Research
2014 Outlook: UK Non-Life Insurance (December 2013)

Analysts
Anna Bender +44 20 3530 1671 anna.bender@fitchratings.com Ekaterina Ishchenko +44 20 3530 1532 ekaterina.ishchenko@fitchratings.com Martyn Street +44 20 3530 1211 martyn.street@fitchratings.com

www.fitchratings.com

2013e

2009

2008

2010

2011

2012

1 May 2014

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Innovation: Opportunities and Challenges
Fitch expects the UK motor insurance industry to benefit from innovations enabled by the growing use of telematics and increased use of big data. Telematics refers to the devices fitted to cars that collect and transmit driving behaviour data to insurers so that insurers can set premiums accordingly. With insurers technical profitability under pressure through a combination of market competition and regulatory reforms, these new tools have the potential to improve underwriting profitability by curbing long-standing industry issues including claims inflation and fraud. Telematics technology is expected to deliver a number of benefits including assisting insurers in developing more accurate pricing models and superior underwriting capabilities. This should lead to more predictable claims costs and facilitate further customer segmentation and target marketing. Improved claims management is likely to result in higher customer satisfaction, leading to improved retention rates, customer referrals and purchases of additional products. A number of developments could potentially accelerate the expansion of telematics market. European Unions eCall initiative, aiming to provide fast assistance to drivers involved in an accident, will require car makers to fit vehicles with telematics devices. New requirements are expected to be implemented by 2015 and could give insurers an opportunity to use new infrastructure for telematics insurance. Recent deals between insurers and technology providers signalled a boost in telematics growth. Fitch considers that there will be winners and losers as the use of new technologies becomes a norm across the industry. Fitch views companies with more agile operating structures and efficient decision-making processes as being best placed to benefit from the data innovations, allowing them to better identify and retain lower risk drivers. The agency believes that significant investment in the infrastructure to support the use of big data may be required. Additionally, the industry will need to address data protection and datasharing concerns, which will require further regulatory guidance.

Motor Insurance Market Developments

UK motor underwriters are expected to suffer from fierce competition and subdued investment returns through 2014 and into 2015, conditions that have already prevailed for a number of years. In 2013, underwriting performance in the UK personal motor sector deteriorated after the beneficial prior-year reserve releases were excluded (Figure 3). This is thought to be a consequence of the industry reducing premium rates, perhaps too much, during 2013 and the beginning of 2014, in response to regulatory reforms passed to tackle increased claims costs.
Figure 3

Personal Motor 2003-2013e

Accident year combined ratio 130%
123% 123% 122% 122%
120% 110%

Calendar year combined ratio

113%

114%

113%

109%

107%

105%

105%

104%

103%

103%

104%

90% 80% 70%

100%

2003

101%

2004

101%

2005

2006

2007

2008

2009

2010

103%

2011

2012

2013e

Source: SynThesys, 2013 Fitch estimate

Related Criteria
Insurance Rating Methodology (November 2013)

UK Personal Motor Insurance May 2014

103%

100%

107%

110%

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Aggregators Intensify Price Competition
Market competition intensified with the growth of price comparison websites, which has pressured pricing and eroded profit margins. Fitch estimates that aggregators accounted for over one-third of all motor sales and around 60% of new business in 2012 (Figure 4). Writing profitable business through aggregators has previously proved challenging for many UK-based insurers, with underwriting questionnaires typically being less comprehensive than telephone based interviews. Customers purchasing policies through web-based distribution channels are also highly price sensitive, placing less value on the quality of policy terms and conditions. This has had a detrimental impact on policyholder retention rates as customers are encouraged to shop around for a better deal at renewal, creating the need for insurers to increasingly focus on customer satisfaction to counteract the growing market share of aggregators.

Figure 4

Direct Distribution Channels - Personal Motor New Business

Inner ring: 2006 Outer ring: 2012
Aggregator Telephone Online nonaggregator

Gibraltar-Based Insurers Add Further Pricing Pressure

Further competition for UK motor insurers has come from Gibraltar-based insurance companies. Fitch considers that these emerging companies will continue to gain market share by exploiting strategic advantages including greater pricing flexibility and a lower cost base compared with traditional insurers. Gibraltar-based insurers primarily distribute their products through cost-efficient integrated broker structures or price comparison websites. They are generally considered to have leaner operational structures and faster decision-making processes, allowing them to monitor and adjust pricing more rapidly than traditional insurers. Gibraltar-based insurance companies share of the UK motor market reached 16% in 2012, achieving a combined ratio of 96% in 2011 versus 106% for UK-based motor insurers. Established traditional insurers are expected to respond by increasing their own focus on innovation and cost efficiency. Currently, Gibraltar-based motor insurers are required to hold less capital against their policies than UK-based insurers providing them with a further competitive advantage. This benefit is likely to disappear once Solvency II comes into force in 2016.

Source: Fitch estimates

Regulation Tackling Claims Inflation

Fitch expects regulatory reforms passed in 2013 to continue to dampen the frequency of lowercost bodily injury claims, as they address the so-called compensation culture that was assisted by legislation passed in the late 1990s. The reforms are in part seeking to reverse the significant rise in motor premiums that has occurred since 2011. These increases were necessary to return the industry to profitability following a sharp rise in the cost of bodily injury claims in 2009 and 2010. The regulatory reforms include the Legal Aid, Sentencing and Punishment of Offenders Act (LASPO), which has outlawed referral fees in personal injury cases and removed recoverability of success fees and After the Event (ATE) insurance premiums from insurers. These two factors combined with difficult macroeconomic conditions, were the key drivers of a rise in whiplash claims in the UK. Regulation introduced during the 1990s, included no win, no fee conditional fee agreements (CFAs), which grew in popularity following the abolition of legal aid for the majority of personal injury claims. Successful CFA-related claims led to the claimant becoming liable for the legal costs as well as the success fee, so to protect themselves from incurring significant costs, claimants could also take out an ATE legal expense insurance. This allowed these costs to be recovered from the defending insurer. While initially this mechanism did not have a significant impact on the number of claims, it eventually fuelled loss costs for bodily injury claims, reaching a peak in 2009 with a combined ratio of 122%.

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Figure 5

AA British Premium Index Market Average Trend

Motor comprehensive cover
450
400 350 300 250 200 150 100 1Q07

3Q07

1Q08

3Q08

1Q09

3Q09

1Q10

3Q10

1Q11

3Q11

1Q12

3Q12

1Q13

3Q13

1Q14

Source: AA

The expectation of future lower claims costs, together with the fierce competition, has led to a significant fall in premiums in 2012-2013 as shown in Figure 5. Some companies might have overestimated potential claims costs reduction, which could lead to some price corrections to counterbalance the overshoot.

Regulatory Developments Focused on Promoting Competition

The new regulatory focus on competition is a challenge for insurers but also brings opportunities for growth and new product development. Fitch believes that the outcome of a number of on-going reviews by the Financial Conduct Authority (FCA) and the Competition Commission (CC), aimed at improving the transparency of add-ons sales, could add further pressure to the technical profitability of motor insurers. Add-on products can be an important driver of technical earnings and hence, profit contributor for motor insurers. But an FCA review of general insurance add-on products published in March 2014 concluded that the profitability of add-ons lacked transparency, making it difficult to demonstrate value to the customer. The review also found that an insurers point of sale advantage could undermine competition between alternative add-on offerings within the market, potentially restricting customer choice. Proposals to address the issues include banning preticked boxes, ensuring that customers actively choose add-on products, improving the way add-ons are offered through aggregators and requiring insurers to publish loss ratios to highlight low-value products. At the end of 2013, the CC published its provisional findings on the private motor insurance sector and identified a number of issues that are partly responsible for the high costs of insurance premiums for the policyholder. The provisional findings centred on the claims settlement process, which is considered too complex and increases the costs of replacement cars and repairs. The final report is expected to be published in September 2014.

Emerging Trends: Telematics and Big Data

Fitch views the growing use of telematics technology and increased use of big data as positive for the UK personal motor insurance market. In the near future, the effective development of these tools has the potential to reduce claims fraud, while over a longer period, they can improve pricing capabilities as the industry successfully integrates collected data into pricing models. Together with improved customer retentions, these technologies are expected to result in improved profitability for motor insurers. Telematics refers to the use of mobile applications and black box devices that capture and transmit driving behaviour data to insurers in almost real time. Recorded information includes driving time, speed, distance driven, number of journeys and specific driving behaviour such as

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braking, cornering and acceleration. Telematics is also capable of recording details surrounding an accident, which can be used to validate legitimate claims and assist in the detection of fraudulent representations, as the occurrence and level of severity of an accident can be verified almost instantly. G-forces recorded by telematics devices could help to determine if a whiplash claim is genuine and whether the injury suffered is consistent with the speed of the vehicle at the time of accident. Whiplash claims accounted for over 60% of all motor claims in the UK in 2012-2013 contributing 20% towards the average motor premium. Big data is a term used to describe increasingly large and complex data sets (such as those recorded by telematics devices) that require innovative data processing tools to manipulate the volume of recorded information and extract meaningful information. An increasing number of insurance companies use big data as part of their decision-making process.

Supporting Claims Fraud Prevention

Fitch views telematics technology as having the strong potential to reduce fraudulent claims by capturing additional information about a road accident. According to the ABI, detected fraud figures reached a record high of GBP614m in 2012, accounting for over 7% of the motor claims costs and 56% of the total detected general insurance fraud in the UK. The figure of undetected fraud is believed to exceed GBP1.2bn. Fitch estimates that a reduction of undetected motor fraud by 50% would improve the personal motor combined ratio by 7pp from 107% to 100%, while a reduction of 80% of undetected fraudulent motor claims would improve the combined ratio by 11.5pp (Figure 6).
Figure 6

Estimated Impact of Fraud Reduction on Combined Ratio

Accident year basis
(%) 110 107

105
100 100

95
95 90 85 Assuming current levels of 50% of fraud eliminated undetected fraud Source: Fitch, SynThesys, ABI 80% of fraud eliminated 100% of fraud eliminated 92

Data-Sharing Initiatives to Reduce Misrepresentation Fraud

Fitch expects insurers to benefit from a number of industry data-sharing initiatives that have been or will be implemented, to tackle insurance misrepresentation fraud that takes place at the point of sale. These initiatives are expected to deliver substantial savings for insurers and potentially lead to underwriting profitability of business underwritten through aggregators. My Licence project set to go live in 2014 and Insurance Fraud Register launched in 2012 are the two key elements in tackling motor insurance fraud through the use of databases containing information about driving convictions, penalty points and details of all known insurance fraudsters and fraudulent claims made.

Risk Selection Change: From Static Factors to Behavioural Model

Fitch believes that firms using telematic-derived data could develop enhanced pricing models and better informed underwriting decisions, leading to more predictable claims costs and improved profitability. This is in contrast to traditional pricing models that are based on static factors or proxies linked to historical claims experience, which have a looser connection with
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actual driving behaviour considered to be a more accurate indicator of risk. New underwriting capabilities will require faster decision-making processes within organisations to capture fully the benefits of innovation. The use of telematics data has the potential to change the way insurers conduct business. More detailed customer risk profile information would facilitate further customer segmentation in the insurers portfolio, which could allow them to implement targeted marketing and tailor new products to address specific niche markets. Good drivers would be more likely to renew their policies because of a price discount provided by the telematics driving record allowing insurers to capture and retain low-risk drivers. However, such technological change does not come without its challenges. Significant investment would be needed to build and implement systems and models capable of incorporating telematics data or find ways to integrate the increased amount of data into traditional pricing models.

Better Customer Experience to Improve Retention Rates

Fitch believes that with help of new technologies, insurers could improve their customer retention rates that have been under significant pressure from the growing aggregator business. Customer retention rate increases are likely to lead to a notable improvement in combined ratios as new customer acquisitions cost insurers as much as five times more than the retention of an existing policyholder. Acquisition costs in the motor sector accounted for as much as 50% of overall expenses. The claims management process has been identified as a key factor influencing customer satisfaction and hence retention rates. Telematics solutions improve the accuracy and speed of reception of accident information and could thus make the claims handling and settling process more efficient. Some parts of the claims management process, such as the first notification of loss could be completely replaced by telematics based solutions as the information on the accident would be transmitted to the insurer in real time. Swift claims management is likely to result in higher customer satisfaction and positive customer experiences, which could lead to opportunities for cross-selling, customer referrals and purchase of additional products. Add-ons products, such as motor legal expenses, breakdown cover, a courtesy car, have been an important source of income for the loss-making motor insurers. The evidence suggest that policyholders who already use telematics improve their driving patterns, leading to fewer accidents and lower claims costs.

Telematics Data Sharing and Competition Law Interplay

While telematics opens up opportunities for insurers to compete on pricing based on superior underwriting capabilities, the technology raises new questions about the asymmetry of information between the policyholder and the insurer. Customers would have limited capabilities to determine whether the premium charged according to their driving behaviour and insurance pricing model is consistent with the premium charged to other customers with similar risk profiles. This is an important aspect to assure that the customers are treated fairly by insurers. At present, the asymmetry of information is partially compensated for by price comparison websites and the use of similar factor-based models. The development of a wider industry telematics database can ensure consistency in determining premiums across the industry, however there is a lack of consensus in the industry about what form this initiative should take. Most of the routes leave open the possibility of the development of anti-competitive behaviours. Any data-sharing initiatives are likely to come under major scrutiny from the competition regulators. Fitch believes that further regulatory guidance might be required on data sharing and data standardisation.

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Any insurer handling telematics data needs to be aware of the current and forthcoming data protection laws as the telematics data is subject to the Data Protection Act 1998. The EU General Data Protection reform expected to be implemented by 2015 is likely to reinforce the right to be forgotten rule, which allows the removal of data from a companys system based on individual request, and introduces the data portability rule, which gives an individual the right to obtain a copy of his/her data from one company and to transmit it to another.

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Appendix 1:
Figure 7

Rated UK Non-Life Insurers

Issuer Amlin AG Amlin plc Allianz Insurance Plc Brit Insurance Holdings BV Chubb Insurance Company of Europe SE Hiscox Insurance Company Limited Hiscox Plc Hastings Insurance Group (Finance) plc Lloyds of London Society of Lloyds (The) Markel International Insurance Company Limited RSA Insurance Group plc Royal & Sun Alliance Insurance Plc Sterling Insurance Co Ltd Sunderland Marine Mutual Insurance Company Ltd
Source: Fitch

IFS Rating A+

Long-Term IDR A

Rating Outlook Stable Stable Stable Stable Stable Stable Stable Stable Positive Positive Stable Negative Negative Stable Positive

AA BBB+ AA A+ A B+(EXP) A+ A A A BBB+ A BBB+ A

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UK Personal Motor Insurance May 2014