Standard Poor's Ratings Services issued a statement today charging that the fundamental structure of the U.K. life insurance sector is changing. Life insurers over the next few years will have to adapt their business models at both the local and European levels to accommodate changes due to economic weakness and regulatory changes, notes the rating agency. Market consolidation could accelerate and product economics could be reappraised, with renewed attention on distribution models, notes S&P.

S&P based its comments on a report published today. "Financial And Economic Risks Continue to Exert Downward Ratings Pressure On U.K. Life Insurance Sector." The report argues that the financial crisis has precipitated shifts in product mix and asset and capital allocation ahead of the European Commission's Solvency II directive on insurance regulation. New business growth against the current economic backdrop remains difficult; in addition, top-line sales may appear flattering, but can be illusory when viewed against the net outflows from the sector, notes S&P.

"The prevalence of upfront commission payments to advisors that has been a feature of the U.K. distribution model facilitates a high level of churn," said Standard Poor's credit analyst Mark Button. "Implementation of the changes contained in the Financial Services Authority's retail distribution review (RDR) will remove these payments from remuneration structures, thereby reducing the potential for commission bias and improving product economics. However, it may lead to reduced new business volumes as independent financial advisors struggle to adapt." Mr. Button continued:

The picture painted for the non-life insurance sector is one of potential positives mixed with continued uncertainty. In its report, "Price Rises Give Cause For Cautious Optimism Over Underwriting In The U.K. Non-Life Insurance Market," S&P said that it believes underlying underwriting performance in the U.K. non-life insurance industry has come under increasing pressure from margin erosion. Its analysis of the performance of U.K. non-life risks written by insurers, leads the rating agency to report that this margin erosion has largely been masked by reserve releases overall, although its analysis of the auto, property, and liability classes show varying impacts from reserve movements.

Meanwhile, investment returns have been limited by the current low interest rates and the conservative investment strategies that insurers have maintained over the course of the financial turmoil of the past two or three years. It is no surprise, notes the agency, that evidence of real price increases has emerged over the past nine months or so, especially in auto insurance. "These price rises should, in our view, lead to an improving underlying underwriting performance, but the extent and longevity of this improvement is not yet clear," said Standard Poor's credit analyst Nigel Bond. "We think the actions of industry leaders, particularly actions that support strategic risk management, will determine how the cycle develops in each class of business."

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