Description and Impact
Risk
Admiral’s UK business has grown every year since the business was launched in the early 1990’s, and has enjoyed regular outperformance against the market throughout that time. We now insure over 11% of the UK market and continue to write very profitable business.
The Directors remain confident that the key strengths of the business which contribute to the outperformance (including targeted pricing and claims handling on the loss ratio side; lower cost infrastructure, efficient acquisition costs and cost control on the expense ratio side) are sustainable.
There are regular reviews of the interactions between vehicle growth, pricing and claims experience. Claims and other senior management continue to pay close attention to the key indicators of adverse developments in large bodily injury claims. The Group’s ownership of Confused.com, which is one of the leading UK price comparison websites and operates independently of the UK car insurance business, helps to mitigate the risk of over-reliance on this distribution channel. Admiral also contributes materially to the revenues of the other price comparison businesses and therefore it is not considered probable that a material source of new business would be lost.
1. UK Car Insurance – erosion of competitive advantage
Admiral has typically been able to produce a significant advantage over the UK market in combined ratio terms. There is a risk that this advantage and/or the level of underwriting profit generated by Admiral could erode.
A number of factors might contribute to this, including:
a) Flat or falling average premiums as Admiral’s portfolio trends towards the market average (expense ratio impact) b) A need to either cut rates, or increase rates at a slower rate than the market in order to deliver growth (loss and expense ratio impacts)
c) A deterioration in the ability to obtain or use data to price effectively d) Adverse changes in claims costs
or ability to handle claims
Admiral has also been able to increase its market share significantly over recent years, and (to varying degrees) is dependent on the four main UK price comparison websites as an important source of new business and growth. The growth in this distribution channel could slow, cease or reverse, or Admiral could lose one or more of the websites as a source of leads.
The impact on the business would be a less profitable UK Car Insurance result and lower return on capital employed.
Many of the potential causes of claims shocks are outside the control of the Group and focus, therefore, is generally on how to prepare and react to the occurrence of such events.
In the current economic environment there has been an increased focus on the management of claims fraud.
In the case of legislative changes impacting existing claims, the Group holds an appropriate and explicit buffer in reserves to cover significant changes.
To cover other potential claims shocks, we continue to hold an additional buffer in our reserves over the projected ultimate outcomes.
For very large claims (catastrophe and otherwise) the Group purchases excess of loss reinsurance, which mitigates the loss to the selected deductible amount (typically around £5 million at the total claim level).
2. UK & International Car Insurance – claims shocks
The Group is exposed to underwriting risk through its underwriting of motor insurance policies. There is a risk that claims costs could rise significantly above historic or expected levels, for a number of reasons including:
a) Legislative changes (for example, periodic payment orders, Ogden discount rate changes)
b) Weather-related catastrophe events (for example severe storm or flood) c) Very large, non-catastrophe individual
claims
d) Fraud or other changes in claimant behaviour
e) Significant increases in large bodily injury claims cost inflation
The Board also considers the following risks to be significant:
• Operational risk – for example, major fraud (considered to be relatively low impact, and mitigated by a wide range of internal controls) and the resilience of IT systems
• IT Development risk – failure to invest in appropriate technology to support the Group’s future business Mitigation
Description and Impact Risk
The Group’s approach to expansion is cautious. Our insurance businesses start small and are all backed by proportional reinsurance support which provides substantial mitigation against start-up losses in the early years.
New price comparison businesses also focus on modest starts with low set-up costs and relatively small initial media spend budgets. This tends to mean that the losses a new operation can incur are minimised whilst management assess the likelihood of the business succeeding.
The Directors are mindful of management stretch and monitor this risk on a regular basis though at present the Board is confident there is a suitable management structure in place for the Group’s international operations.
The Directors are not prepared to let unprofitable businesses continue to generate losses where there is limited foreseeable chance of success.
3. International expansion – risk of failure
The Group has launched eight new operations outside the UK in the past five years. AdmiralDirekt in Germany was sold in early 2011. There is an ongoing risk that one or more of the operations fails to become a sustainable long-term business. The impact on the Group could be higher than planned losses (and potentially closure costs) and distraction of key management.
Admiral earns ancillary profits from a portfolio of products and seeks to minimise reliance on any single item. This would mitigate the impact of a regulatory change which affected a particular product or income stream. Admiral continuously assesses the value of the ancillary products it offers, and makes changes to ensure the products offer value to policyholders. The Group’s risk management framework leads to potential risks to ancillaries being identified and monitored, providing management time to respond appropriately to any such regulatory changes and minimise financial impacts where possible.
4. Ancillary profits – potential diminution
There is a risk that the level of ancillary profit earned per customer will diminish. This might be due to regulatory or legal changes, or customer or market behaviour. The impact on the Group would be less profit earned on the car insurance portfolios and a lower return on capital employed.
The most immediate risk to ancillary profits arises from the OFT market study in motor insurance. Whilst there are a range of possible outcomes from this study, Admiral welcomes any changes that are likely to lead to lower claims costs.
Confused management continually analyse the success or otherwise of all media activity.
The Directors believe Confused is a fundamentally strong business and is well positioned to maintain its position in the UK price comparison market.
5. UK Price Comparison – effects of continued competition
Confused.com operates in a highly competitive UK market with four main businesses currently attempting to increase their market share through aggressive media activity.
Admiral mitigates risks to its reinsurance arrangements by ensuring that it has a strongly rated and diverse range of partners. Admiral has enjoyed a long-term relationship with one of the world’s strongest reinsurers, Munich Re, which has supported Admiral since 2000. The Group also has strong relationships with a number of other reinsurers, including Amlin, Hannover Re, Mapfre Re, New Re, Swiss Re and XL Re (avoiding reliance on a single partner).
In the UK, co- and reinsurance arrangements have been agreed up to the end of 2014, reflecting confidence in the Admiral UK car insurance business. Pricing on these deals was in line with existing arrangements. The long-term co-insurance agreement with Munich Re will remain in place (at 40% of the business) until at least the end of 2016.
6. Co-insurance and reinsurance arrangements
Admiral uses proportional co-insurance and reinsurance across its insurance businesses to reduce its own capital needs (and increase return on the capital it does hold) and to mitigate the cost and risk of establishing new operations. There is a risk that such support will not be available in the future if the results of either the UK business or (more realistically) one or more of the international operations are not satisfactory to the co- and/or reinsurers. The impact on the Group would be the need to raise additional capital to support underwriting. This could be in the form of equity or debt. Return on capital would potentially be lower than current levels.
The mitigation of these risks is discussed in note 17 to the financial statements.
7. Credit risk Admiral is exposed to credit risk primarily in the form of a) default of reinsurer; b) failure of banking or investment counterparty.
Gover nance Financial statements Other infor In this section:
GOVERNANCE
27 Corporate Responsibility32 The Admiral Group Board 34 Directors’ report
37 Corporate Governance 46 Remuneration report 52 Independent auditor’s
report to the members of Admiral Group plc