Increased claims for injury are affecting UK reinsurers, and new court-imposed periodical payment orders are proving expensive. Some talk of leaving the UK market, but is there also a chance of growth?
Motor insurers in the UK are hurting. Profitability is, in the words of a briefing note by actuarial consultant EMB, “under siege”. Remarkably, that is a bit of an understatement: a typical motor insurer can easily find itself with a severely loss-making combined ratio of 120%, meaning it is paying out £1.20 for every £1 it receives in premiums.
Third-party bodily injury claims have soared since the credit crunch struck in 2007, suggesting that a large chunk of the increase can be put down to what has become virtually an industry in its own right: the estimated £1.9bn annual fraud against the general insurance market. Bodily injury claims per vehicle for claims of under £100,000 increased 10% in 2009, with the average compensation payment hitting £3,512 in 2008 and still rising.
The relatively small size of these claims means that they do not hit the reinsurance market, which provides back-up for the biggest, most severe personal injury claims of £2m or more. There is less evidence that claims of this size are increasing as they can take up to two decades to settle; many compensation battles that started since the onset of the financial crisis are still in the courts.
It stands to reason, though, that the pattern of increased small claims will be mirrored by rises in the larger market, and the reinsurance majors have at least recognised the risks. Reinsurers could even be forced to leave the UK market should they decide that the risk management needed to protect themselves against the surge in claims is too great.
For example, yet more capital will have to be placed on their balance sheets and the reinsurer might well believe that this could be put to work more profitably elsewhere.
EMB consultant Naeem Ali echoes this warning: “Reinsurers will have to have bigger reserve margins and there is uncertainty surrounding the periodical payment orders [PPO]. They can cost a lot more than paying a lump sum. This has the potential to be a big issue.”
PPOs – payments in the form of annuities made over a number of years to meet a claimant’s changing circumstances – have become increasingly common across all types of compensation, from insurance to divorce settlements, over the past five years. In April 2005, the courts were given powers to award compensation in the form of PPOs rather than a lump sum, regardless of the views of the parties involved.
Many judges have concluded that a lump sum might resolve the matter quickly, but that it is too difficult to assess the amount needed to meet the injured claimant’s future needs. A PPO means that a payment can be made according to whether, for example, the claimant’s health improves or deteriorates, and is therefore viewed as a more accurate form of compensation.
The Court of Appeal’s January 2008 judgment on the Thompstone v Tameside & Glossop Acute Services NHS Trusts case was key, as it found a way of inflation-proofing future payments by using a different measure to the Retail Price Index. The alternative measure is typically 2% higher, meaning that even if future healthcare costs rise above the rate of inflation, they can be easily covered. Since this judgment – and because judges increasingly believe that lump sums do not guarantee financial security many years hence – PPO awards have risen significantly.
This means, then, that the risk is passed from claimant to insurer: an injured party had to eke out an admittedly large amount of money for the rest of their lives, now the companies have to administer a complicated regular payment system that increases at a rate higher than inflation. While this can occasionally end up cheaper for the insurer, as care can turn out to be cheaper than might have been anticipated when paying a lump sum, on average it is more than 40% more expensive.
Cost of care
The cost to the reinsurer is even greater, which is why more capital reserves will have to be pumped on to the balance sheet. Ali suggests that it will take evidence of 10-20 years of paying the claims to know whether such prudence was necessary, showing why reinsurers are unnerved by the lack of certainty surrounding PPOs and the huge increase in injury claims.
Munich Re’s senior executive manager for the UK and Ireland, Manfred Aldag, says he is “not surprised by the recently observed claims inflation”, pointing out that the business is closely monitoring changes in their number, severity and payout pattern.
A recent Munich Re report, the does-what-it-says-on-the-tin ‘Severe personal injury claims in Europe relating to motor insurance’, points out why Aldag expected the increase. “A problem … is the explosion in the cost of care. As judges and experts have become much more aware of the care needs of victims with brain or spinal cord injuries over the years, so the extent of care granted has greatly increased,” it says. “Professional round-the-clock care is now the compensation norm. Prices are likely to rise further in coming years as demographic changes [mainly an increase in the number of elderly people] exert more pressure on demand in the care market.”
Aldag admits that the changes to the market – though the price of care is also more than 50% of the total cost in Germany and France – have meant that Munich Re has reduced its presence in the UK motor reinsurance market.
But Aldag argues that the industry will inevitably find ways of cutting costs in response to the pressure on its margins, which could create opportunities for growth. “The most recent claims inflation and the decreased investment income should trigger an increased market discipline and hence support such a development [expanding Munich Re’s motor reinsurance business in the UK].”
All these claims mean that rates inevitably increase, which could be one attraction to Munich Re once the market has settled slightly.
According to breakdown specialist AA, car insurance premiums went up by 11% in the second quarter of this year, with the hike in fraud a major cause. Lloyd’s of London underwriter Novae has recently set up a small motor reinsurance unit of no more than five people and a book of £1m-£2m ($1.58m-$3.17m) to test whether there is money to be made. “In a [broader] market, where rates are so difficult to get hold of, we saw motor reinsurance as somewhere we could exploit an opportunity,” Novae chief executive Matthew Fosh explains.
Swiss Re monitors the market through what it has coined the “bodily injury claims landscape”. It has been found that much of the UK’s claims inflation is typical across Europe, with common problems including low interest rates.
But the PPO is the great exception that is hurting the UK market. Head of the casualty centre in Swiss Re’s product underwriting division, David Bassi, says: “Both effects [PPO and the Thompstone case] significantly impacted the cost of severe bodily injury claims … We expect that this effect will intensify and may last for several years. This specific development is unique to the UK when compared to other European countries and consequently severe bodily injury claims in the UK are experiencing higher claims inflation.”
Not blaming motor
The main motor market outside of the UK is Germany. Michael Huttner, analyst at bank J.P. Morgan, points out that Germany has had enough problems for at least one of the big players to reduce its exposure to the market, though hints that the overall picture is not as murky as the UK.
“A year ago, Swiss Re effectively pulled out [of German motor reinsurance]. We’ve seen the latest [financial] results of the primary and reinsurers and none was too good, but reinsurers did not blame German motor as a main cause of that,” Huttner says.
He points to Hannover Re as one player that is still operating in the German motor reinsurance market, but says that this is “mainly because of risk selection”. Hannover Re’s major client is HUK-Coburg, the huge motor insurance mutual that has one-tenth of the German market. Effectively a co-operative, risk is spread among its members meaning that Hannover has a strong client that it can work with to ensure profit margins remain strong through the tough times.
Indeed, motor reinsurance is a relatively strong part of Hannover’s book, the world’s fourth-biggest reinsurer expecting to lose €89m ($113m) on the BP Deepwater Horizon oil spill off the Gulf of Mexico. Hannover Re executives also believe that the price war in Germany ’s €20bn motor market has finally reached an end, so is expecting some uplift from its cover over the next few years.
The UK market, then, appears to be the most difficult, with reinsurers unlikely to have the data that they so badly crave in order to make a proper judgment of changing risks in motor for at least another 10 years. Should another legal bombshell hit the UK market, however – which is possible with a new government – all that evidence will be worth nought, and reinsurers will be no more comfortable at their exposure to this tightening market. GR