U.K. insurers are in for a revamp. In light of uncertain economic conditions, life and non-life insurers' management teams have to rethink capital allocation, product strategy, and business models.

Capital strength will continue to be a key pillar for U.K. insurers' creditworthiness. While U.K. life insurance companies are somewhat less sensitive to interest rate volatility, compared to other life markets, their ability to source and allocate to high-quality assets to support their now higher funding costs and historically large annuity portfolios will be a focus area. U.K. non-life insurers are facing pressures from lower returns on capital, due to higher claims. The increase in claims is based on a rise in inflation, coupled with an increase in the frequency of claims.

On the product side, U.K. life and non-life insurers are trying to build resilient, innovative revenue streams that help navigate financial and macroeconomic challenges.

Business models, on the other hand, need to be able to defend and improve competitive positions in a highly mature market. U.K. insurers are attempting to reinvent and reorientate their strategies to differentiate themselves from competitors, without compromising shareholder demands. U.K. life insurers are walking the line between capital-intensive and capital-light strategies while also reconsidering the synergies between the two models. U.K. non-life insurers are trying to adapt to new customer demands as the environment, technology, and economies evolve.

It's Time For New Business Models

U.K. insurers and their business models face significant execution challenges. Management teams at U.K. insurance companies are grappling with competing pressures from various stakeholders. In their attempt to harmonize often diverging demands, we have seen several U.K. insurers rehaul their business models, for example by divesting operations, rebasing capital strategies, or seeking external and inorganic growth via consolidation. We believe this development will continue to gather steam. It is crucial, however, that management teams refine their operating models and decide on a growth strategy.

To maintain their position as one of the largest investors in the U.K. economy, U.K. life insurers need to secure quality capital from long-term investors, whose objectives match the long tails of assets and liabilities. Interest in the U.K. insurance market continues to be high and could provide insurers with funding opportunities. It might also require a realignment of operating models and investment strategies with new shareholders. We have seen a spate of foreign equity deals in the U.K. insurance industry, for example RSA's takeover by Intact and Tryg or Convex's private equity shareholders Onex and Sixth Street.

U.K. life insurers aiming to expand their capital-light asset management operations need to decide if they want to be a large-scale generalist or a focused and specialized fund manager. In either case, leadership teams at these insurance/asset management hybrids have to predict future interests of asset owners and develop teams and resources that are adept and agile enough to weather changing macroeconomic conditions and consumer demands. Management teams need to battle cyclical financial markets and weaker operating results, be it by building or buying capabilities. Since either option comes with significant costs, existing investors' patience or access to new investors is crucial for U.K. insurers' strategic reorientation.

Resilient Balance Sheets Are Now More Important Than Ever

Volatile earnings and competing capital demands pose a challenge to U.K. insurers

Life insurers could struggle to achieve surplus earnings and maintain strong balance sheets as demand for savings and investments products slows due to volatile financial markets, while non-life insurers may find it harder to grow top-line revenues to offset inflating claims and costs. Therefore, management teams need to allocate their capital wisely to manage asset and liability risks. Both are poised to increase due to macroeconomic challenges, weaker credit conditions, and demographic trends.

U.K. life insurers are exposed to potentially greater asset risks

Although we do not consider the sector-level leverage to be high, U.K. life insurers increased their debt over the past three years and allocated a greater proportion to potentially riskier illiquid and alternative securities.

Additional funding is going to cost

We do not envisage material requirements for additional funding. Should U.K. insurers need to raise capital, however, it is likely going to cost them. Rising interest rates based on tighter monetary conditions certainly don't help, and neither do widening credit spreads and volatile equity markets. Less diversified U.K. insurers have already rebased their growth and performance targets as they might struggle to manage earnings and capital. While headline solvency ratios remain strong and have even increased for some insurers, the permanence of improved capitalization relies on crystalizing future profits. U.K. insurers' ability to generate sufficient capital while managing balance sheet risks will be key to navigating a choppy economic and operating environment.

Growth and earnings could be volatile for U.K. insurers

U.K. life consolidators could likely face some profitability challenges if they want to make the most of the expected growth in the bulk annuities market. Some of these potential challenges are deploying capital and rising funding costs. Capital-light life insurers had some difficulties executing their growth strategies due to high competition in the savings and asset management sector. The current financial market volatility and strain on consumers' disposable income is likely to compress asset management fees and flows further (see "Savings Gain Greater Allure For U.K. Insurers," published Sept. 14, 2022). Meanwhile, non-life insurers are feeling the squeeze from claims inflation and potential limits in improving rate adequacy as consumers tighten their belts to offset the higher cost of living.

Upcoming Solvency II reforms in the U.K. could lead to some capital release and allow more flexibility in asset allocation

Their use of matching adjustment means that the reformed Solvency II regime is going to affect life insurers most, especially in the bulk annuities market. In general, insurers' risk appetites and their approach to additional capital release are important factors in determining their credit quality (see "U.K. Reform Of Solvency II To Support U.K. Insurers' Business Positions," published Nov. 18, 2022).

U.K. Insurers Are Busy On Multiple Fronts

Climate risks, globalization, technologization, and demographic changes are keeping U.K. insurers on their toes. Developing resilient income streams, assessing and adapting product portfolios to accurately price existing products, and attracting new clients are at the top of their agenda.

The results of the Prudential Regulation Authority's (PRA) Climate Biennial Exploratory Scenario (CBES), for example, revealed that U.K. insurers could suffer if the PRA's stylized climate scenarios became a reality. That said, insurers who manage to appropriately price and model climate risks could benefit from a material source of capital and earnings generation.

U.K. motor insurers are already facing supply chain issues and inflation, with companies like Direct Line and Admiral reporting lower earnings. Some insurers have expanded legal teams and several have a well-established network of in-house repair garages to mitigate adverse claims development. Non-life insurers also face the challenge of keeping up with emerging technological developments. Cyber risks, cryptocurrencies, and traditional technology companies are all entering the insurance arena.

Geopolitical uncertainty requires insurers to adapt their policies and review third-party risks. On top of that, they need to monitor economic and business sanctions, which might affect their operations and investments, in real time. Extreme weather events, including droughts and floods, have an impact on insurers' pricing and reserving, and their risk appetite for home and commercial property cover.

Demographic trends, including aging populations and longer life expectancies, are also shaping the future of insurance. Older generations' wealth, tied up in property, is leading to a surge in equity release mortgages, while demand for rental covers is rising as younger generations struggle to get on the property ladder. Life insurers also face the challenge of navigating potential changes to mortality and health patterns after COVID-19 has potentially skewed longevity and morbidity trends.

Room For Growth

Pension reforms and the dominance of defined contribution pension products bring growth potential. The reforms, coupled with evolving wealth management needs for consumers, are highlighting the need for growth products that come with financial advice and secure income, such as fixed annuities or guaranteed savings. Rising yield curves have allowed for pension DB schemes to improve their funding levels significantly, potentially fueling further growth in the bulk annuities market.

The U.K. real estate market may be particularly vulnerable because of weaker economic prospects, higher interest rates, and the slowing return to the office (see "Industry Top Trends: Real Estate," published Jan. 23, 2023). Even so, equity release mortgages and rental covers could become growth areas in the U.K. life and non-life insurance industry as they are under-represented in the market.

U.K. insurers that successfully make the most of these growth trends and innovate to cater to new demands and risks could further cement their competitive positions and develop sustainable earnings and capital profiles, supporting their creditworthiness.

Related Research

• Industry Top Trends: Real Estate, Jan. 23, 2023
• U.K. Reform Of Solvency II To Support U.K. Insurers' Business Positions, Nov. 18, 2022
• Savings Gain Greater Allure For U.K. Insurers, Sept. 14, 2022