Exposed to the elements

The insurance sector faces a shake-out, says Andrew Verity

IF INSURANCE is a product for worriers, the last four years seem to have turned the insurance market into something of a worrier's paradise.

The cost of insuring against any kind of worry - from a car crash to a fire at home; from hurricane damage to legal liability - has plummeted since the early 1990s. In most classes of insurance, companies have never competed so hard for customers' premiums.

In October 1994 premiums for buildings insurance cost an average of pounds 141.96 a year. Four years later, after a 15 per cent rise in retail prices, that premium has fallen to pounds 126.20.

So competitive is the market, some insurers are prepared to offer giant discounts in an effort to knock out competitors. Companies such as Liverpool Victoria will offer buildings and household insurance for as little as pounds 83.62 a year. That compares with a premium of pounds 407.29 from Eagle Star.

Similarly, buildings insurance will cost as little as pounds 70.72 with Churchill, whereas its competitors' premiums are as high as pounds 290.07. On average, buildings and contents insurance costs 10 per cent less than it did four years ago.

The low premiums are good news for consumers. For insurers, though, the only news is bad. For the past two years insurance companies have fought so hard for a share of the retail market that they have been prepared to lose money simply to keep new business coming in. The fight for market share reached its climax last year when the insurance industry lost pounds 1.4bn on motor insurance .

The picture is similar in commercial insurance, where companies are finding it increasingly difficult to maintain their margins on normally healthy product lines such as commercial liability insurance.

So why has competition in the insurance industry become quite so vicious? The standard explanation is that insurance is a cyclical industry and that it has now reached the depths of the latest cycle.

The cycle began in the late 1980s, when the insurance market became crowded with players seeking to capitalise on the housing boom and the rising number of new car owners. As prices dropped, many smaller companies dropped out and the remaining players began to raise their premiums.

In the early 1990s it became apparent that new entrants such as Direct Line could make healthy profits, and seize market share by using new sales techniques.

In commercial insurance too, it became apparent that markets such as Lloyd's of London had become highly profitable. As new entrants attempted to undercut established players in the mid-1990s, premiums again began to tumble.

Many of the new entrants found they were able to slash their rates further because of booming equity markets. The returns generated by their investments were used to cross-subsidise the rates offered to customers. Such was the rush to join the market that there is now a huge over-capacity in insurance.

Rachel Hadley, of AA Insurance, says: "The gloomy people in this industry would say that there is no money to be made in insurance. It is all made on investment. If the markets are on a down-cycle then, in effect, some may have a choice between taking a loss and exiting the market."

Peter Mynors, insurance partner at PriceWaterhouseCoopers, says: "The problem is too much capital and too many companies. Insurers are saying: 'We've got this capital, we don't want to give it back to our shareholders, so will use it to get business.' If they stood back and priced themselves out of the market, they would have too little premium income, too many staff, and the business would begin to look rather sick."

Multinationals, seeing that insurance companies in many cases have weaker balance sheets than their own, have also begun withdrawing business from the traditional providers such as Royal&SunAlliance and CGU. Instead, they are taking on their own risks and setting up insurers themselves.

Insurers believe it is not only the insurance cycle that has depressed profits: there is also a deeper trend. Sophisticated computer systems and a wealth of information on consumer habits has allowed many insurers to underwrite with much greater accuracy.

Liverpool Victoria claims it is this that allows it to undercut its rivals. "The difference is in the way we rate the risk. For building and contents insurance we can analyse the risks not just down to an area but down to a row of 12 houses in one postcode. We can assess vulnerability to theft, geographical hazards such as subsidence or floods, and the likelihood of crime."

Insurers nurse the hope that the cycle will turn again. Some, such as CGU and GRE, have raised rates on products such as motor insurance by 8 per cent over the last year. CGU has already suffered some loss of market share.

But the scope for raising rates in other product lines may be limited. Stephen Bird, an insurance analyst with Merrill Lynch, paints a particularly gloomy picture of the big motor insurers. "Action is being taken but we are not confident that any of the [top companies] will make an overall insurance profit within the next three years. Conditions look like they will remain tough."

Consolidation has already taken place on a grand scale with the mergers of Royal Insurance and SunAlliance, Zurich and British American Financial Services, and Commercial Union and General Accident. But with 300 companies still active in general insurance, industry observers feel that further consolidation is a safe bet.