EY ITEM Club

Outlook for financial services
Summer 2016

Insurance forecast

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Slower economic growth as a result of the Brexit vote, and the weaker consumer demand it brings, will have an impact across the whole insurance industry. Reduced demand, slower growth in household wealth, and continued low interest rates will squeeze profitability. We expect earnings to decline this year for the first time since 2012, falling to £8.9b. Profits will stabilise in 2018 before climbing back to £8.8b in 2019.

The impact of the slowdown, and the implications of leaving the EU, will not be uniform across the sector, and we will see a divergent picture for life and non-life companies.
Rodney Bonnard
Partner, UK Insurance Leader
Read Rodney’s full insurance viewpoint

Economic uncertainty to cause a two-paced insurance market


EY - Rodney Bonnard
Rodney Bonnard
Partner,
UK Insurance Leader

Slower economic growth as a result of the Brexit vote, and the weaker consumer demand it brings, will have an impact across the whole insurance industry. Reduced demand, slower growth in household wealth, and continued low interest rates will squeeze profitability. We expect profits to decline this year for the first time since 2012, falling to £8.9b. Profits will stabilise in 2018 before climbing back to £8.8b in 2019.

The impact of the slowdown, and the implications of leaving the EU, will not be uniform across the sector, and we will see a divergent picture for life and non-life companies. ↓ [... more]

Slow growth, but not no growth for non-life

With real incomes under pressure, the demand for big ticket items such as cars will weaken, and housing transactions will stagnate. This will slow the growth in general insurance premium income to just 0.8% in 2017. But we do not expect revenues to shrink. Even if consumers are less likely to make new purchases, they still need to insure their existing motor or home. Demand will grow weakly rather than stagnate entirely.

Moreover, unlike their peers in the life sub-sector, general insurers are typically less geared to stock market movements, and so will be less exposed to a weaker outlook for equities. Longer term, the implications of Brexit are potentially far more wide-reaching for general insurers. The current passporting system offers a simple, cost-effective and capital-efficient way of handling cross-border business. That goes for UK-based primary insurers selling into the EU, and for those in the EU selling into the UK retail market, although it does not apply to reinsurance. Insurers with cross-border operations will be hoping for a deal that preserves passporting, perhaps through a regulatory equivalence mechanism similar to that in MiFID.

A ‘hard’ Brexit, in which passporting rights are lost, would prove more onerous, but there is some way to go before next steps are obvious and companies are focusing on “no regrets” actions where they are time critical.

Life goes on

Since regulatory and distribution conditions typically make it harder to sell life and pensions products cross-border, life companies with a European presence generally have subsidiaries in each market and the passporting issue is much lower down the agenda for them. More concerning is the impact of the economic slowdown and low interest rates. In the immediate term, solvency calculations can encounter technical problems if interest rates drop to zero or very close to it, and many insurers will have been relieved that the Bank of England Monetary Policy Committee has opted to keep rates on hold for now.

In the longer term, we expect insurance premium income growth to slow from 3.4% in 2015 to just 2.2% in 2017.

We predict 20 year yields on long-term government debt to average 1.9% in 2017, less than half their average over the past 10 years. This will further reduce the attractiveness of annuities, while lower equity prices and a knock to investor sentiment may dampen demand for investment products.

Despite that, Brexit has not affected the fundamentals driving the life sub-sector: increasing life expectancy, and the shifting responsibility for retirement from the government or employers to individuals. The 2015 Freedom and Choice in Pensions changes, coupled with a growing population at or in retirement with significant property and pensions assets, will drive demand for flexible retirement income products and possibly equity release. Meanwhile, auto-enrolment is boosting the number of pension savers, and slowly driving up pension contributions. None of that will alter fundamentally because of Brexit, but an extended period of low growth and low interest rates will aggravate the problem of generating growth in savings and investments.

The pensions landscape has been characterised by a constant stream of semi-annual change for the last few years, as the previous Chancellor set out to reform the system. With his departure it is unclear whether the Government will push forward with his most radical proposed change: abolishing up front tax relief. Providers will be hoping for a period of stability to help rebuild consumer confidence in the pensions system.

In spite of this possible slowdown in pensions tax reform, there are still regulatory pressures for life firms ahead. The Financial Conduct Authority’s review into treatment of long-standing customers, could still result in disciplinary action for some firms, and will definitely drive major change as providers scramble to comply with rules that the FCA has made clear they should already have been following.

Outlook

The history of the industry has consistently shown that the winners in any insurance market upheaval are the companies who are best able to reach and engage with their target end customers, whether directly or through intermediaries. This remains true regardless of how Brexit turns out. Meanwhile, with profits under pressure, the focus on cost control will continue, and many companies may reshape their portfolios to build scale and efficiency in key areas, potentially leading to merger and acquisition activity. That could mean insurers selling off non-strategic product lines, looking at asset managers or IFAs, or foreign buyers tempted by the weak pound driving lower valuations for UK firms. Whatever the outcome of the Brexit negotiations, the UK’s position as a pre-eminent insurance market with more than 300,000 employees in the sector will not change in the near-term. No other country in the EU can offer the same foundation of expertise and talent, a depth and breadth that leaves the sector well-placed to weather an extended period of uncertainty.

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Insurance highlights:

Non-life and life insurers will feel the impact of the economic slowdown and Brexit vote, but supportive fundamentals, whether demographic change or demand for reinsurance, remain.

  • Weaker consumer demand will hit general insurers, with car registrations in 2017 to see the first decline since 2011.
  • General insurance premium income is set to rise by only 0.8% in 2017 compared to 2.8% last year.
  • Life insurance to see stronger growth, with insurance premium income to grow 2.2% in 2017, albeit down from 3.4% in 2015.
  • Annuity demand will be depressed as the 20-year gilt yield will average only 1.9% in 2017 compared to almost 4% over the last decade.