City: Insurance woe

IF you think your house, car or even company insurance already costs a small fortune, you ain't seen nothing yet. By next year it is likely to cost about a third more, and you may as well resign yourself to paying two or three times as much in the next few years.

That is assuming the Government gets anywhere near achieving its aim of zero inflation. If it does, it is going to turn one of the fundamental assumptions of the insurance industry on its head. For more than a decade, insurance products have worked on the principle of high investment returns well into double figures. The lower rate of investment return that will come with low inflation will force insurers to change the way they think.

Look at car and house insurance, or any other kind of cover, for that matter. It is an astonishing fact that for more than a decade insurance companies have not matched the premiums they charge to the risks they are underwriting. Since the 1970s, claims have consistently outstripped premium income.

That shortfall was once made up from the industry's high returns on its assets. This cushion allowed insurers to under-charge on their products.

But it also led the industry to get lazy and underwrite silly risks at silly prices. Last week, Sun Alliance announced provisions against mortgage indemnity losses of pounds 435m. The industry as a whole faces losses of more than pounds 1bn on this type of risk alone.

That kind of poor performance makes the clearing banks look almost clever. It is hardly surprising that the Consumers' Association has been accusing the insurers of jacking up premiums to pay for their underwriting mistakes. It is more than a little reminiscent of accusations that the banks are milking their personal customers - through higher charges - to pay for their lending mistakes.

The insurers' blunders would not matter if the industry was as safe as, er, houses, as it once was. Unfortunately, it is now in a worse state than it has ever been. The solvency ratio of most composite insurers has sunk to an all- time low. Some, such as Royal Insurance, have seen shareholders' funds halved in two years. They have been hit by a combination of rising claims, excessive competition and falling investment returns. Of these, declining returns are by far the most important.

Insurers cannot carry on this way for much longer. A recovery in the stock market would improve their financial strength, but would not restore profits. Sooner or later they will have to acknowledge that underwriting premiums must reflect the risks they relate to. Only a massive and permanent increase in premiums can do this.

It will be a painful experience for consumers, and will make insurance companies deeply unpopular. But it will have to happen. Time, perhaps, to swap the BMW for a Metro.