The emergence of “challenger” insurers in the motor sector will dent industry profitability and weaken the grip of IAG and Suncorp, according to a report by Bank of America Merrill Lynch.

It says the big two’s “duopoly-style returns” are under threat with the emergence of insurers such as Youi and Hollard and new entrants Coles and Woolworths.

However, IAG and Suncorp have dismissed the claim, arguing their dominant positions have not changed and their greater economies of scale give them a competitive advantage.

Motor insurance is one of the most profitable sectors for IAG and Suncorp, accounting for about one-third of all profits, with returns “well in excess” of 30%, the report says.

The pair write about 80% of the motor policies in Australia, which in turn accounts for about 25% of the whole insurance market.

In the year to June 30 $2.64 billion of Suncorp’s $7.95 billion in gross written premium (GWP) was from motor insurance, representing 33% of its total book.

IAG’s motor book comprises 45% of its $8.99 billion GWP.

But Merrill Lynch analyst Andrew Kearnan says barriers to market entry are falling, taking the sector’s profitability with them.

“The investment market has slipped into a happy complacency [regarding] risks from challenger brands in the Australian retail market,” Mr Kearnan says. “Challengers are alive, kicking and doing surprisingly well.

“We believe the challenger brands will chew aggressively into what is a cash-cow profit contributor for the majors, taking share and lowering returns.

“The challenger brand threat will not happen overnight but there is little doubt that ultimately they will drag down industry profitability.”

Mr Kearnan says many challengers – he cites the example of Youi, which is owned by South African insurer Rand Merchant Insurance Holdings – are making inroads thanks to well-financed parent companies.

Since launching in Australia in 2008 Youi has doubled its GWP and captured 2% of the motor market. This year it reported its first post-tax profit of $28.65 million, after losing $96 million since its inception.

Coles now controls about 1% of the retail motor market, which it achieved in just six months.

“It’s not unreasonable to think… that between Coles, Woolworths, Real, Hollard, Budget, Youi and Progressive we could be talking $1 billion in GWP [in 2012/13],” Mr Kearnan said.

An IAG spokesman says the company treats all competitors seriously, but it has seen “no noticeable impact on our volumes from newer entrants, and that remains the case”.

“While brand is important, we believe we offer a combination of factors, including business model, product breadth, service, customer value proposition and ability to leverage our scale that newer entrants can’t match,” the spokesman told insuranceNEWS.com.au.

“We expect further volume growth in motor.”

Suncorp spokesman Chris Newlan says the insurer’s multi-brand strategy allows it to target different sectors. For example, the launch of Bingle was a “key defensive mechanism” against online insurers.

The group has also invested tens of million of dollars in a new motor refurbishment site in Sydney, cutting the time needed to repair vehicles.

“One of the key competitive advantages we have is our scale,” Mr Newlan said. “Customers can now pick up cars with minor dings faster than they can get their dry-cleaning.

“When a situation like the Brisbane floods hits, we have the scale to respond to that quickly, whereas the smaller players don’t have that scale.”

Also see ANALYSIS