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The Actuary The magazine of the Institute & Faculty of Actuaries
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Rise of the motor aggregators

The UK motor insurance market is now in a situation similar to the airline industry where competition is making profitability elusive. The situation is unlikely to improve until some consolidation occurs or someone comes up with a new business model.

Figure 1 plots the Herfindahl Index (HI), a common measure of the competitive structure of an industry, for the UK motor market over the period 1985 through to 2009. To put this into context, comparison points are shown for several other industries.

Equivalently, the inverse of the index gives a rough estimate of the number of effective competitors in the market. For example, the HI of 13% for 1985 through to 1990 implies that there were eight main firms vying for market share back then; and the HI index of 6% in 2009 implies that there are now 16 main firms vying for market share. In effect, competition has doubled over the last two decades.

Like the rings on a tree, this graph tells the history of the UK motor market. Prior to 1991, the majority of motor business was placed through brokers. There were only a handful of firms in the marketplace with the brokers effectively controlling market entry by only funnelling business to these larger firms and ignoring new entrants.

However, in 1991 everything changed with Direct Line. Rather than relying on brokers for business, Direct Line skipped the middle man and went directly to the people. This allowed them to rapidly grow over the next decade, expanding from a market share of almost 1% in 1990 to a share of 10% in 2000 and now stands at almost 16%.

The spike from 1997 to 1998 is the merger of Commercial Union and General Accident. The sharp increase in competition in the subsequent period is attributable to UK insurance and Esure entering the market and Churchill, Groupama and Zurich expanding their writings, while Aviva’s shrunk. All of which brings us to 2002 and the first aggregator.

The rise of aggregators and the fall of profitability
The first insurance aggregator was launched in 2002. Previously, only about 1% of insurance had been placed online; but in the subsequent year that number had risen to almost 10%. Currently, upwards of 40% of motor insurance is placed online, with the majority of that business coming from aggregator sites. However, in the next five years that number will be closer to 75%.

But the aggregators have cost the insurance industry enormously in terms of the unnecessary competitiveness. Figure 2 illustrates to what extent. Here, we have overlaid the combined ratio for the UK motor market over the same time period.

Focusing on the period 2002 and subsequent years, the conclusion is obvious and rather damning – the aggregators have encouraged greater price competition while not showing much profitability themselves, channelling revenue to advertisers in the process. Aggregators cost the industry £1 billion last year in unnecessary price competition, while generating only £50 million in profits for a select few insurers. Further, advertisers have more than doubled their revenue with £100+ million due to advert spends for price comparison sites. Effectively, aggregators have commoditised the motor market.

Where there was at best a tenuous relationship between the market structure and profitability prior to 2002, after 2002 as competition increased, profitability decreased with a correlation of almost -96%. This is only natural as insurers are no longer competing on brand, marketing, service or other intangibles to the same extent; rather, they are competing almost solely on price and their position on the aggregators’ screens.

In situations like this, classic economics is very clear: each new entrant creates additional supply, driving down industry profits. Although, in theory, this occurs until no excess profits exist, in fact the current situation is much worse. What we are seeing is insurers cutting prices below the actuarially fair rate in order to maintain volume and, as a by-product of their participation in these aggregators, writing business that they previously would not have actively pursued.

What is most worrying though is that the last 10 years should have been extremely profitable with inflation steady at around 2%. But rather than several years of profitability allowing insurers to build up their capital reserves, the industry has been taking larger and larger P&L hits.

As Ted Kelly, CEO of Liberty Mutual, recently noted, “we’ve had no inflation for 10 to 12 years, any idiot can make money in personal motor”. Where this might have been true for the US motor market, where aggregators have been completely unsuccessful (and it is better for everyone that they stay that way),the opposite is true for the UK motor market.

With many economists forecasting several years of high inflation much akin to that of the ‘80s, these ultra-thin/too-thin margins that the aggregators have forced on the industry are not sustainable.

Future of the UK motor market
Without a fundamental shift in the structure of the marketplace or the way business is done, the future of the UK motor market looks bleak. Mergers would certainly help things, as would consolidation of single insurer brands into a single marketable product. On the other hand, breaking up the various insurance arms of larger multinationals is likely to do much more harm than good.

In the absence of any change in the market structure, the question is really: what is the next big innovation? Pay-as-you-drive insurance is certainly a contender as it has been rapidly adopted by several large US insurers and piggy-backs on the green movement.

As the structure of the industry is outside of any one insurer’s control, and fundamental changes in insurance don’t happen all that often, the key is for insurers to retool their business plan with the intent of carving out a niche market where the aggregators have no influence.

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George Maher, Andy Staudt and Ryan Warren all work at Towers Watson