Profitable times: What now for UK insurers?

After years of struggling with underwriting losses, the UK insurance market is now reaping the rewards of a hardening rate environment. But what should insurers do with these profits?

The UK insurance market has turned a corner – or to be more precise, it turned a corner a couple of years ago. The graph below shows how the non-life insurance sector has performed from a pure underwriting basis based on returns collected by the Bank of England (BoE). Loss activity in the 2021-2023 years have been lower than in previous years alongside a hardening rate environment, which means that, for the first time in recent history, the industry as a whole is making underwriting profit.

The story from a Lloyd’s perspective is even rosier with 2023 reporting a combined ratio of 84% and 2024H1 showing even stronger performance. There are some pockets of the market which are still running poorly but otherwise on average, things are looking good.

That’s great, isn’t it? After all, one of the ways insurers can provide peace of mind would be for them to exist to pay the claims several years later. That relies on the insurer being profitable.

Having not seen profit in a while, do insurers have the muscle memory to understand what they need to do with it? Here are some ideas.

Reinvesting profits: streamlining operations for sustainable growth

Pre-Covid was the era of efficiency as insurers sought to reduce their expense ratio, which they have done successfully. Expense ratios have dropped by 4% points from 2017 to 2023. This fervour has been accelerated in recent years with the (re)-introduction of artificial intelligence. Efficiencies can be small scale (i.e. marginal) or wholesale. Either way, there is a need to recognise that creating efficiency requires investment of either time and/or money. It is often a fallacy to believe there is enough capacity within an existing business as usual (BAU) team to be able to support large scale changes within an organisation, the irony being that previous efficiency drives have likely driven BAU teams to an efficient size. 

It is worth thinking about how insurers can continue to drive efficiency through the organisation but with more of an investment lens on to make sure the projects are adequately resourced and supported. Profitability also means there are less distractions within the business, freeing up further time to focus on these initiatives. More importantly, this would be the moment for insurers to unwind any temporary 'sticky tape' solutions to create a good foundation for future innovation. 

Preparing for the future: expanding market share amid upcoming competition

The classical theory of underwriting cycles tell us that the next phase in the cycle is for rates to begin to soften as more entrants enter the market. It would be a good idea to consider how an insurer would want to react to that impending competition. They could take a defensive position and continue to shore up their existing operations and service levels to fend off new entrants. However, the market can be price sensitive. The alternative would be to play offence and expand into existing or new markets.

These things will take time and the first few years may not be quite as profitable but manageable with profits elsewhere in the business. However, a strong, well thought out business case can help mitigate some of these risks in search of future profit – or at least diversifying profit when the market softens. Data and analytical capability has come a long way since the start of my career such that it is now common for companies to quantify the impact of their strategies in order to put forward a robust business case.

Maximising shareholder value: optimising capital and equity

Making profits is only one side of the equation. Shareholders do want a return on equity and insurance stocks have to compete with other industry sectors to attract investment. In addition to improving profitability, insurers do need to think about the amount of capital and equity they are holding. Figures from the Bank of England show capital cover has been rising in recent years, probably driven by increased profitability, suggesting that capital use may be becoming less efficient.

It would be easy enough to return the capital through buybacks, but it would be more interesting to understand if the capital could be optimised further to obtain additional investment return within the insurer’s risk appetite or to invest in growth or new lines of business. 

Insurers could decide on a combination of changing the investment strategy and/or a change in the reinsurance programme. It can take time to work out the optimal positions to take on both. However, the return on such an exercise could be quite rewarding, enabling insurers to pursue other longer-term strategies.

Navigating profitability with Consumer Duty in mind

Insurers operating in the consumer or small and medium enterprise space have been coming under regulatory scrutiny in the last few years in relation to conduct risk. A headline of higher profits is unlikely to reduce the attention. However, it is worth insurers understanding the source of their profits and whether that is in breach of conduct rules.

That is not to say that making profits is bad – from the graph above it is evident that the industry experiences profits and losses and the two need to even out for a business to be commercially viable. Further, insurers do need to exist to pay claims in the future so financial strength is important. However, the regulator has been clear that profitability cannot be derived from unfair practices.

While it would not be unreasonable for insurers to celebrate the hard work that has gone into turning market fortunes around, this is by no means the moment for insurers to rest on their laurels. Profitability allows insurers some leeway to invest in their future. How they choose to do so will depend on their business priorities and risk appetite. We can help in all of these areas and more.