EUR 850.00 For Business Accounts Only

Morningstar | Don't Believe the Hype in U.K. Motor Insurance. See Updated Analyst Note from 04 Jun 2019

The U.K. motor insurance market is one of the most dynamic insurance markets in Europe. However, this isn’t always positive. We think the evolution of this market has led to greater price transparency, lower customer retention and persistency. All this has combined to result in a price pressured market consisting of, in our opinion, businesses that are generally quite low quality and lacking economic moats. We're raising our fair value estimate slightly for no-moat Direct Line and no-moat Admiral to GBP 2.7 and GBP 18.2 respectively, but both businesses are overvalued.

Generally, we think investors perceive these companies as relatively high quality, given their historically healthy returns on equity. But we also think they run quite opaque business models. Once you strip down the reinsurance relationships and compare the businesses with the entire U.K. motor market, we think these businesses are still subject to the underwriting cycle. And the market is not pricing a forecast downturn in the cycle, driven by capital and pricing.

We think there are three key indicators that show to us the U.K. motor insurance underwriting cycle is on the cusp of turning. A cycle is characterised by rising returns on equity that attracts competition, and capital, to the market. This resulting higher level of competition puts pressure on pricing and subsequently operators price less adequately to cover these risks. This results in falling returns on equity as lower pricing adequacy, in time, feeds through to net income. Competition and capital subsequently exit as returns fall and this leaves remaining businesses with room to start increasing prices again. And so the cycle is repeated.

In our special report "Don't Believe the Hype in U.K. Motor Insurance" we delve deeper into these indicators. For the first key indicator, we are already observing a turn in pricing in the U.K. market. According to the 's comprehensive car insurance price index, U.K. motor insurance has been tailing off since the end of 2017. We are yet to see this come through in underwriting results and we think it typically takes 12 to 24 months to show levels of profitability. The second key indicator is a market with elevated levels of capital. As competition has increased, the capital of the largest U.K. motor insurers has risen by nearly 40%. Lastly, we think U.K. motor underwriting data going back to 1985 clearly shows three cycles. These cycles generally last between eight and 12 years, and with the peak of the last soft cycle in 2010, we think the market is aligning for a correction.