Ogden hit prompts Fitch to set UK non-life company insurance market on negative outlook

Fitch Ratings has revised its sector outlook for the UK non-life company insurance market to negative from stable after a harsh drop in the personal injury Ogden discount rate.

Competition in the sector is already intense and Fitch expects that following the change in the Ogden discount rate insurers’ margins will come under further significant pressure in 2017.

The Ministry of Justice announced on Feb. 27 that the Ogden discount rate used to calculate the compensation in large motor and liability bodily injury claims would be cut to -0.75 percent from 2.5 percent, effective from March 20. The move is supposed to reflect the lower real risk-free returns available on the UK index-linked government securities.

Following the cut to the Ogden discount rate, insurers have suffered a one-off hit to earnings as they have been required to increase reserve estimates to account for the significantly higher costs of large bodily injury claims. For example, Direct Line reported a 38 percent and Admiral reported a 27 percent reduction in profit before tax for 2016 as a result of the Ogden discount rate cut.

Fitch believes that many insurers will have used up a significant proportion of their reserve buffers to absorb the impact of the lower Ogden discount rate. Given the sector's historical reliance on reserve releases to support technical results, this will lead to a further drag on profitability as reserve releases are likely to be lower going forward.

Fitch expects motor insurance premiums to rise significantly to reflect the substantially higher costs of bodily injury claims settlements. But due to intense competition in the sector, it could be difficult for insurers to pass on in full the increased costs to policyholders. Furthermore, Fitch expects increasing premium rates to lead to greater use of price comparison websites as more consumers shop around for cheaper coverage. In 2016, almost 70 percent of new business motor insurance sales were made through aggregators and this is likely to increase further, adding more pressure on already very thin profit margins.

The agency expects higher lump sum claims settlements to also drive substantial price increases for reinsurance cover. This could put a significant strain on companies that rely heavily on reinsurance as part of their business model. Smaller companies that would opt for lower retention limits are likely to be most affected as reinsurance pricing for those layers will increase significantly. Fitch believes that this could lead to consolidation in the sector as smaller players struggle with the increased cost of reinsurance, depleted reserves and pressured profitability as a result of intense competition.

A further increase in the insurance premium tax (IPT) to 12 percent from 10 percent is due to come into force on June 1, 2017, which adds further pressure to insurers' profitability as it will be hard for the industry to keep passing on higher costs to policyholders.

Despite these negative fundamentals, the rating outlook for Fitch's universe of rated insurers within the UK non-life sector remains stable. This reflects strong capital adequacy, product diversification, conservative reserving policies and solid earnings of rated issuers. Given the strong credit fundamentals of Fitch's rated universe, we do not expect the Ogden discount rate change to result in negative rating actions for individual issuers.