UK auto insurers losing race between pricing & inflation; profits at risk

UK auto claims inflation moved from headlines to bottom lines as insurance policy rates have failed to keep pace and listed insurers responded with cuts to forecasts, a reduced share buyback and even new reserve building.

“It is clear that claims inflation is accelerating at a pace that UK motor insurers cannot keep up with,” analysts at the Jeffries equity brokerage said in response to the first of recent profit warnings from LSE-listed P&C insurers.

“Even with prices rising, we expect margins to deteriorate significantly,” Jeffries analysts wrote. “We believe the market is a long way off pricing adequacy.”

The most affected insurers could reach for increased reinsurance coverage to bolster solvency and thus protect investor confidence in dividend payments, analysts at Deutsche Bank speculated.

“Results will be impacted by normalising claims frequency, higher claims inflation and stubbornly weak pricing which has continued to fall short of expectations,” analysts at Bank of America said in announcing a slash to its sector earnings forecasts. “This will make for a painful combination for 2022 and very likely drag into 2023.”

Comments followed word July 14 that auto claims inflation had forced mid-cap LSE-listed auto insurer Sabre not only to press policy prices, but to add reserves as well. Against the short-tail nature of the bulk of Sabre business, new reserves came as a serious warning. The net loss ratio rose 26.7 percentage points on severity and the combined ratio veered to within inches of the 100% mark.

Sabre had blamed its H1 profit warning chiefly on inflation factors, speaking to a 12% claims inflation rate in H1, measurably above forecasts and readings issued only one quarter prior. Those numbers likewise pushed beyond the upside of market forecasts.

Markets knew an industry-wide story when they saw one.  Not only did Sabre lose a quick 36% on its way to 44% in losses since announcement, shares of LSE-listed peers Direct Line and Admiral were down at a double digit pace on very short notice and are down 19% and 25% since the announcement.

Those investors were right. Direct Line followed July 18 with a profit warning of its own, equally built on inflation problems that likely drove the H1 motor loss ratio to neighbourhood 86%. Direct Line’s CEO blamed inflation for a pending rise in the combined ratio to 96-98% for 2022, well above the group’s 93-95% mid-term goal which had been confirmed as recently as the Q1 trading update May 4. Expenses will be cut and a buy-back program trimmed. Reserves, for now, can hold the line.

And that is only for the LSE-listed insurers sufficiently with the type of focus on personal lines leaving no room to avoid profit warnings. Privately-held insurers can enjoy the privilege of silence. Larger rivals can blend inflation-hit lines into a broader and more diversified picture.

Analysts at the Berenberg brokerage, who had been daring investors to buy recent dips in share pricing, had worked early to put a positive face on the Sabre profit warning.  Sabre’s pain, Berenberg argued, “is partly driven by company-specific issues” including “overly optimistic” consensus forecasts and a “patchy” reserving history. Direct Line might yet protect itself via its in-house repair network. And if rival Admiral could go the week without issuing a matching profit warning, the worst might have passed.

“The UK motor insurance market is not broken,” Berenberg analysts declared. “We do not believe [inflation] is an unmanageable risk.”

By time of the Direct Line profit warning four days later, Berenberg was admitting a rather systemic failure of pricing to keep pace with runaway inflation. They now cited a “weak pricing” cycle, exacerbated, they claimed, the a new regulatory pricing regime in place for 2022. “The only way out for motor insurers is to react with material price increases,” Berenberg analyst Thomas Bateman wrote to walk back the recommendation to investors.

The gap between claims cost inflation and a “stubbornly weak pricing cycle” might be a 50% year on year decline in earnings for the field of UK auto insurers, analysts at Bank of America warned.

“Our expectations are low for the UK motor insurers,” Bank of America said in a report still ahead of the warning by Direct Line. “We expect profits to be down around 50% YoY and expect dividends to be 15-34% lower.”

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