IAG this morning announced it will radically realign its UK business and push further rate increases after announcing its third profit downgrade this year.

The insurer is now expecting a 2010 fiscal year insurance margin of 6-7% after its UK business took a $365 million hit by raising reserve levels, including a new $60 million reinsurance arrangement to stem future losses.

The downgrade continues a horror start to 2010 for IAG, which has slashed its insurance margin by six percentage points from the high end of 13% after the Perth and Melbourne hailstorms caused industry insurance losses of nearly $2 billion.

The company’s UK business has taken a pummelling from rising bodily injury claims in its Equity Red Star motor specialist business, where cost per accident has risen by 10%.

CEO Mike Wilkins told a market briefing in Sydney the company will also write down $86 million in goodwill and intangibles to get the business back on a profitable footing.

“This is a challenging time for the UK motor insurance industry as a whole,” he said. “We remain confident that Equity Red Star retains a strong niche position in UK motor classes and is capable of delivering attractive returns for IAG over the longer term.”

Mr Wilkins says he stands behind the business and its management, led by UK CEO Neil Utley, who told the briefing the business has “moved quickly to rectify its impact”.

Beginning with aggressive rate hikes of 10-20% across different classes of business, IAG will shed 5% of its UK brokers while recruiting several “experienced individuals” in underwriting and actuarial roles.

Perhaps most surprising is IAG’s planned withdrawal from all external aggregator-sourced business of a “non-bike nature”. More than 40% of all personal lines insurance in the UK is sourced through online comparison websites, and IAG’s decision to extract itself represents a tacit admission of defeat in the cut-throat UK motor vehicle market.

IAG purchased Equity Insurance Group, the UK’s fifth-largest motor insurer, in 2006 for $1.4 billion. However, the aggressive expansion has so far failed to live up to expectations.

Described by Mr Utley as the “toughest insurance market”, the UK motor vehicle sector has squeezed the profitability out of Equity in recent years. From an insurance margin of 20.2% in the first half of 2009, IAG’s UK business fell to 6.6% in 2010.

Mr Wilkins says the UK business will go into the red in the 2010 fiscal year, before returning to “small digit” insurance margin profitability in 2011.

IAG says it will also pass on small rate increases across its Australian business. Mr Wilkins says insurance margins will bounce back to between 10.5%-12.5% in fiscal 2011 with gross written premium rising by 3.5-5%.