It’s been a tricky time for the UK motor insurance sector. As economies came out of the pandemic and people returned to the road, the level of claims started to tick higher. Add in rampant inflation that pushed the costs to service claims up, this was a recipe for unprofitable business.
Higher premiums were the obvious answer. But with most people buying annual policies, it still takes time for price hikes to feed through to operating performance.
Year-over-year change in motor vehicle insurance cost
Source: Office for National Statistics – CPI Index Motor vehicle insurance (August 2023).
The good news is that the benefits of some mammoth price hikes are now starting to show. At the same time, we’re hearing costs are stabilising, which is more positive than it has been over the past couple of years.
Here’s a look at the three largest players in the UK market.
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Admiral
Admiral is one of our preferred plays in this sector, and recent first-half performance looks much better than we’ve seen for a while. Challenges remain, but actions are starting to feed into results.
UK motor insurance isn’t their only line of business, but it’s the core division – a tricky place to operate in recent times, given the rising cost of servicing claims.
However, with average premiums up over a quarter over the first half, the benefits are starting to take effect as customers roll over to contracts at higher rates. The benefits are higher revenue through premiums and improved profitability – especially as costs ease at the same time.
While improving market conditions are a bit of a rising tide lifting all boats, there are some Admiral-specific reasons we think it’s well placed.
One of the key decisions an insurer makes is which risks to take on, and they can control this without having to turn customers away by reinsuring (essentially shifting the insurance risk to a third party).
Admiral’s been picky in which policies to keep, with a history of passing on around 70% of the business it attracts – broadly double the industry average.
There are two advantages.
On one hand, this has let Admiral keep the riskier policies it’s targeting, while still attracting strong customer flows and taking a cut of the profit its reinsurance partners make.
The other is the treasure trove of data it’s able to collect by onboarding a whole range of customers.
The data is vital, and Admiral’s invested heavily in its analytic capabilities ahead of competitors. Choosing profitable insurance is all down to picking the right price and level of risk – both of which benefit from better data insight. That combination of more data and unique analysis is a key competitive advantage in our eyes.
It’s not all rosy though. International markets have been a struggle, especially in the US. Management remains open to options, and we wouldn’t rule out a sale of the asset altogether if things don’t improve.
All things considered, we like the way Admiral’s been managed over a tough period and markets seem to agree with a premium valuation. Still, as the market improves, we think Admiral’s well placed to continue outperforming in the sector, although nothing is guaranteed.
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Direct Line
It’s safe to say Direct Line has been struggling with the more difficult environment. Motor is the largest segment, though operations also span home, rescue, and other products.
Focusing on motor, many of the mentioned challenges mean the division hasn’t been profitable. Given its size, that’s pulled the entire business into the red.
But recent results did bring a glimmer of hope. Price hikes are starting to take effect, with new business levels that look like they’ll be profitable.
Further actions are underway, from improved fraud prevention, better use of discounts and opening another repair centre to give more control over the claims process. It won’t happen overnight, but the outlook is starting to improve.
The other cloud hanging overhead has been solvency. There’s not been an immediate concern, but capital levels have been toward the lower end of the target range. There are plans to ship off the commercial insurance broker business, NIG.
We see two benefits to this deal. The first is a better focus on personal-line and small business insurance. But, arguably more important in the near term, would be the capital injection. Assuming the deal goes through, this would restore capital to more comfortable levels.
Similar to Admiral, Direct Line is also investing in better tools to help assess and select the right risk. It’s not ahead of the pack, and there’s work to be done. But combined with a shift away from the use of intermediaries, we think this should let the group take on more profitable business.
The forward yield at 8.5% needs to be mentioned. At half-year results, the business didn’t pay an interim dividend because of weak capital levels.
Two conditions need to be met to get payments flowing. The first is a restoration of strong capital levels (covered if the NIG deal completes). The second is improved Motor performance over the second half. We think both look likely, but remember that neither is guaranteed.
For investors willing to stomach some added risk, the low valuation compared to peers means rerating is possible should conditions play out favourably. Don’t expect an easy ride though, short-term challenges are likely to persist.
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Aviva
Aviva is by far the most diversified business of the three. Despite being one of the largest UK motor insurance companies, that business is far from the main driver of performance.
UK & Ireland life insurance generates a little under half of its profit, the rest comes from a range of general insurance lines (including motor) in the UK & Ireland, and Canada.
Performance from general insurance across all geographies is improving as claims return to more normal levels. Just like the other major players, a focus on pricing has impacted volumes. But this looks necessary to help stem some of the headwinds caused by higher claims costs and frequency.
Looking to Aviva’s other areas, the bulk annuity market is getting a lot of attention.
Management expects volumes to remain strong over the medium term, which should provide an inflow of business for players like Aviva. It’s remaining picky about what to take on, but CEO Charlotte Jones has hinted that it could allocate more resource should the right opportunities arise.
The UK health insurance market is another hot area.
As the NHS comes under increasing pressure, it’s pushing more people into private healthcare. Aviva has plans to increase the number of products to offer a more well-rounded service. It’s a move we think makes sense.
The balance sheet looks strong, and investors are being rewarded from the ongoing transformation. So far the group’s trimmed down and increased its focus on core markets.
Aviva completed a £300m buyback over the first half, and management have hinted that cash generation could support further returns in coming years. Couple that with an 8.3% forward dividend yield, and it’s compelling. Of course, nothing is guaranteed.
We like the current direction, but the sector is a little out of favour. Whether Aviva can successfully transition from transformation into growth remains a question mark.
One of HL's Independent Non-Executive Directors is also a Non-Executive Director at Aviva plc.
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This article is original Hargreaves Lansdown content, published by Hargreaves Lansdown. It was correct as at the date of publication, and our views may have changed since then. Unless otherwise stated, estimates, including prospective yields, are a consensus of analyst forecasts provided by Refinitiv. These estimates aren’t a reliable indicator of future performance. Yields are variable and not guaranteed. Investments rise and fall in value so investors could make a loss.
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