Motor Portfolio: Claims Inflation, Price Comparison Sites and a Loss-Making Segment
Midway Mutual is a UK motor insurer with 800,000 policies. In 2024 its combined ratio was 112%, having been 98% in 2022. Claims inflation has run at 14% for repairs, 11% for bodily injury and 9% for credit hire over the past two years, while the average premium rose 22% to £560; the market average rose 28% to £610. Price comparison websites now account for 85% of new business, the four largest insurers hold 65% of the market, and switching rates are at a record high. Midway's retention fell to 68% and new business fell 18%; it has just strengthened reserves by £40m for the 2021–2023 accident years. A telematics-focused competitor reports a loss ratio six points lower than Midway's. The board is debating whether to raise prices again, hold, or withdraw from the young-driver segment, which accounts for 22% of policies and 38% of claims cost.
1. Use microeconomic reasoning to explain why Midway's combined ratio deteriorated despite raising premiums 22%, and what the market structure implies for its pricing power.
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A 14% repair-cost and 11% bodily-injury inflation shock raises technical cost faster than the 22% average premium increase in some segments. Market structure amplifies this:
- Price comparison sites make price the dominant visible attribute, so demand is highly elastic and competition resembles Bertrand competition for homogeneous risks.
- With four insurers holding 65%, the largest players influence the market price. A smaller insurer that lags the market increase becomes the cheapest in its segments and attracts volume priced below its own cost.
- Where Midway raised more than the market, it loses volume.
The average hides this: a 22% average increase could be 35% in young drivers and 10% in older drivers. Retention and new business fell because Midway's relative price position worsened in some segments while underwriting criteria tightened in others. The £40m strengthening confirms earlier premiums were inadequate. The correct diagnosis needs a segment-level price index against competitors, not an average.
2. Recommend whether Midway should raise prices further in the young-driver segment, using marginal cost and elasticity concepts.
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Young drivers are 22% of policies but 38% of claims cost, so the segment loss ratio is well above the portfolio average. The decision rule is marginal: if the premium for a risk is below its marginal expected cost plus marginal expenses, writing it destroys value regardless of contribution to fixed costs.
Raising prices will reduce volume - elasticity is high on price comparison sites - but the remaining business should be priced above marginal cost. The risk is a spiral if the segment is also adversely selected. Withdrawal is an option but is hard to reverse and may damage the brand and intermediary relationships.
Better: reprice sharply using segment-specific data; invest in telematics or other risk-selection data to separate good young risks from bad; and consider a telematics-based product rather than a blanket exit. Set a clear hurdle: each segment must cover marginal cost and make a defined contribution to fixed costs. Monitor volume and loss ratio monthly after repricing.
3. Explain how claims inflation and the reserve strengthening should affect Midway's reserving and capital modelling.
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Claims inflation affects reserving in two ways: it raises the cost of already-incurred claims, especially long-tailed bodily injury, and it changes development patterns. A standard chain-ladder assumes stable inflation and settlement patterns; with 11–14% inflation, historical link ratios will understate ultimate costs. Use an expected-loss-ratio or Bornhuetter–Ferguson approach for immature years, explicitly inflate claim costs to the payment date, and separate frequency from severity.
The £40m strengthening is evidence of model error, not just bad luck. The capital model should therefore include reserve risk with parameter uncertainty, not just process variance. Use stochastic reserving (bootstrap or Mack) to obtain a distribution, and stress for continued 14% inflation and for social inflation (legal costs and higher awards).
Consider discounting: reserves should be discounted consistently with the asset and liability valuation basis, and higher interest rates should not be allowed to mask the inflation effect. Report the sensitivity of the combined ratio to a further 5 percentage points of claims inflation.