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Liability insurance markets could work better

PN 70/03     3 June 2003

The UK liability insurance markets could work better an OFT fact-finding study has found.

Download a summary of the key findings in pdf format (288 kb). A more detailed report will follow shortly.

The five-month OFT fact-finding study was undertaken in the light of concerns over sharp and often sudden increases in premiums, reported reductions in underwriting capacity and increases in the excesses borne by policyholders.

Evidence from the study suggests that in 2002 average premiums for employers' liability insurance rose by 50 per cent, public and product liability by 30 to 40 per cent and professional indemnity by 30 to 60 per cent. This follows a six-year period during which liability insurance premiums fell in real terms by about 14 per cent.

The study found no evidence of a widespread lack of availability of liability insurance cover. However, there appear to be problems obtaining cover for asbestos-related risk and for professional indemnity insurance for independent financial advisers.

The report notes a number of changes which could be made to improve the current situation. Some of these are already in progress. These include:

• lengthened renewal periods – many businesses expressed concern about the limited time they were given to renew their policy or shop around for alternative cover (typically one or two weeks). The Association of British Insurers (ABI) and British Insurance Brokers Association (BIBA) are working on a minimum period of notice of renewal terms which the OFT believes should be at least 21 days
• initiatives to improve information and risk management – for example, the ABI is working with trade associations to see whether good health and safety practices by businesses can be rewarded. It is also considering providing `best practice' guidance for liability insurance customers (particularly for employers' liability insurance) in the same way that the industry has set standards for customers on issues such as protection against fire and theft
• increasing the use of rehabilitation – this should help to reduce costs by increasing a claimant's chance of securing employment
• improved data collection – to allow claims to be better forecast and to show the differential impact between different classes of risk.

Possible explanations given to us for premium rises fell into two main categories:

• cost increases: including an expansion of liability, 'loss shocks' such as those arising from the World Trade Centre, increases in legal costs and damages awards for personal injury, and reductions in the investment returns insurers set against underwriting losses
• changes to the competitive environment: including major insurer insolvencies and reductions in capacity. The OFT received no evidence of collusive agreements.

While changes to costs clearly have had an upward impact on premiums, they cannot alone account for the large increases experienced over the last year. Changes in the competitive environment such as major insolvencies and a reduction in capacity - leading to short-term upward pressure on premiums - appear to be contributory factors.

The OFT will continue to keep liability insurance markets under review. In particular, the OFT will look again at:

• premiums during late 2004 by which time, assuming there is no single significant effect, like the World Trade Centre, premiums should have adjusted to take account of cost increases. This also gives time for the various initiatives we have highlighted to be taken forward. If the markets are not working better at that point we will need to consider whether further action is appropriate
• the issue of legal costs to see whether there is any further work which OFT needs to undertake.

In the light of the study's findings, the OFT recommends that businesses:

• check renewal dates for policies and request information on renewing policies as early as possible
• shop around for both brokers and insurers
• examine whether health and safety practices can be improved
• ask for advice from brokers and trade associations on how to improve systems and present their risk most effectively to an insurer.

The liability insurance sector has been unprofitable for much of the last decade. For example, in 2001 claims plus expenses exceeded premium income by 20 per cent. The most unprofitable sub-sector was employers' liability insurance where claims plus expenses exceeded premium income by an average of 50 per cent over the last decade.

Jonathan May, Director of the OFT's Markets and Policy Initiatives Division, said:

'This study on the UK liability insurance market will help inform the debate on changes that should enable this important and complex market to work more effectively.'

The study also found that:

• while there are no absolute barriers for new entrants to the sector as a whole, there are a number of factors that might discourage entry such as access to capital, access to historical claims data, the cost of running off liabilities when exiting the market where a liability to pay claims in the future continues and the requirement for Financial Services Authority (FSA) authorisation
• the new FSA risk-based capital requirements for insurers are likely to encourage insurers to improve measurement and monitoring of risk and to focus more on longer term profitability which should in turn lead to more competitive and steadier pricing. However, it is generally accepted that the changes may result in increased costs and a need for capital. It is possible that firms will need to raise premiums for riskier lines of business to reflect the need for more capital to support that business
• the possibility of long delays between underwriting risks and settling claims leads to uncertainty about costs and hence the level of premium that is necessary. Inflation, investment returns and potential increases in the size of court awards over long time periods add further uncertainty.

The OFT consulted a wide variety of interested parties including insurers, policyholders, brokers, the ABI, trade organisations and other Government departments.

NOTES

1. Liability insurance is insurance against a legal liability which the insured may incur to third parties. It includes policies to protect the insured against:

• liability to third parties as a consequence of negligent acts in the discharge of professional duties (professional liability)
• liability to pay damages resulting from claims for accidental death, bodily injury, illness and disease, to employees arising out of, and in the course of, their employment (employers' liability)
• liabilities to third parties (the public) for accidental death, bodily injury and for any loss of, or damage to, property which is caused by the negligence of the insured or that of his employees in the course of his business (public liability)
• liability for accidental death, bodily injury, illness, loss or damage caused to third parties by their products or products which they are selling (product liability).

2. The OFT announced its fact-finding study into the UK liability insurance market on 10 December 2002 (see PN 86/02). The OFT published a summary of key findings on 3 June 2003. Download a summary of the key findings in pdf format (288 kb).  A more detailed report will follow shortly.

3. The Department for Work and Pensions (DWP) is also publishing a report on employers' liability insurance on 3 June 2003. Copies of the DWP report and press release are available on the DWP website

4. The OFT commissioned Dr Chris Parsons of the Cass Business School to undertake some of the detailed research.
Download An analysis of current problems in the UK liability insurance market in pdf format (787 kb).

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