The perfect storm: new regulations and an inflationary environment will cause an upswing of M&A and consolidation

By George Netherton, Partner, Head of Europe Insurance & Asset Management at Oliver Wyman

 

As Q2 results roll in, we’re beginning to see the impact of the perfect storm of challenges facing the UK personal lines insurance market. The effects of significant regulatory changes, heightened inflation, and macroeconomic uncertainty have so far largely been hidden by profits achieved during the pandemic; however, they are gradually being unmasked. The next two years will be tough, and we expect significant market shifts to result.

 

The challenges

The beginning of this year saw major regulatory changes brought in by the FCA. Welcome reforms aimed at creating a level playing field and ensuring good value for money for loyal customers, have nevertheless pushed up premiums for new customers and reduced profits in the back books of many insurers. Those with large retained profits in their back books have reduced flexibility in attracting new customers now, and we are seeing some overdue investment in innovation, particularly around electric cars.

As materials, labour, and energy prices rise, inflation challenges are not only being seen in insurers’ cost base and claims value chain, but are running far ahead of expectations. The motor insurance market, for example, has experienced significant levels of inflation in the first half of 2022, resulting from higher used car prices, higher third-party claims costs, longer repair times and inflation in the cost of car parts. As a result, profitability is dropping sharply.

Climate change is also hitting the market, with more extreme weather events, such as storms and heatwaves, becoming more frequent and expected to result in increased claims for flood damage, subsidence and even wildfire. In the first half of 2021, global insurers paid out the largest amount of claims in 10 years to cover the damage caused by natural disasters. Insurers are also facing costs for developing net zero and transition plans, as climate commitments are prioritised and scrutinised.

In addition, the cost of technology and data investment is becoming an increasing burden. Weaker businesses are struggling to justify big investment costs, yet are struggling for competitiveness without them.

 

The impact

Traditionally, insurance has been a stable business with balance sheet reserves reducing volatility and creating room for manoeuvre. This has meant that some in the market have in effect been ‘zombie business models’, not creating economic value for shareholders but still writing some new business, nursing a backbook and hoping for better next year. Insurers can give the impression of health long into their decline and several that were on their way-out pre-pandemic were able to rebuild their reserves to some extent as lockdowns created unexpected profits from motor portfolios. However, the tide is now going out and the recent market changes will make it very difficult for unprofitable outlets to survive. As the market settles into the new ‘rules of the game’, we expect to see some significant changes.

We predict the market will rationalise down to a smaller number of players, consisting of some rejuvenated major players and some low-cost digital attackers. Many Tier 2 and 3 insurers may withdraw from the market entirely, consolidate their exposures or merge to reduce their cost base. Marginal players will be faced with the choice of significant investment to reach market leadership or narrowing to focus on defendable niches.

At the same time, we predict diversity and scale to come back into fashion. The decade of 2010-20 was dominated by the success of largely monoline businesses writing largely one product (motor) through largely one channel (price comparison websites). But this concentration is now proving painful. Diversification brings resilience and breadth of opportunity, and the companies recently announcing successful Q2 results are those that have been able to secure varied portfolios. Personal speciality businesses, such as pet and travel, will benefit from this as they become attractive opportunities for major players seeking diversification in tricky core markets.

Tough market conditions are a natural part of the insurance cycle, but the combination of factors experienced over the last year has been extraordinary. The challenges run deep, and the impacts will continue to be seen for a long time to come. Insurers need to continue to adapt to protect their operations, promote customer retention, and prepare for the future.

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