I don’t work for or own an insurance company. I have worked for LV and Aviva in the past, although not in any way relating to insurance.
I have a reasonable understanding of the market. One of my parents and my other half both for (different) Lloyds reinsurers.
People tend to look at themselves when looking at insurance. That is of course what counts to them but to understand how you are affected you have to understand the whole market.
If we take reinsurance out of the equation, as that adds a layer of complication that isn’t immediately relevant, the insurance industry really is remarkably simple like many aspects of financial services – it is a balancing act.
The balance is to bring in more premiums from customers than they have to pay out in claims. And to back up the big claims they might have, they keep a nice healthy chunk of capital in reserve. This is often invested to make more money. In the UK and other countries, the industry regulator prescribes the minimum amount of capital they need to keep in reserve according to the sort of business they insure.
The output of this balancing act is generally called the combined ratio. If it is under 100% that means generally that they’re collecting more cash than they’re paying out. A ratio of over 100% means they’re paying our more, and likely to be making a loss.
Pretty simple so far. Now the next step is to consider the risk – what are the risks and associated costs with the things that have been insured.
I can understand the comments about transparency, but the insurance industry is anything but. Being transparent would be giving away the keys to the safe. Hidden away in each insurance company are years and years of experience and data upon which their underwriters set the levels of risk and prices attached to insure it. Over the years, as technology advances and more elements can be measured, more and more elements feed into what sort of price you pay. So that’s why today we now have things such as postcode affecting your premium. Previous claim and underwriting history will have shown them that things such as where you live, how many miles you do on average, what your job is, what car you drive, how old you are etc etc all affect the level of risk that they’re insuring. And that’s just you. Then there are all the costs associated with the risks they’ve insured. They have no idea if you’re going to crash into a £100,000 Merc or a Citroen 2CV. They’ve no idea if you’re going to be hit by an uninsured driver and need medical and legal cover paying out. The bad driver that paid his premiums for the year and resulted in tens of thousands of pounds of claims – yes, he’ll pay more but yes, you will too. If the books don’t balance, insurance doesn’t work (unless you start looking at reinsurance, but I promised we wouldn’t bother here today
). If you don’t pay for this, exactly who is going to? Please don’t suggest the government, because we all fund that anyway. Well, some do (same argument here – why should I pay for the benefit claimants?!).
Capping the numbers simply doesn’t help with this problem, and indeed would prevent some companies from bothering with the market. If they don’t believe they can win more of it and be profitable, they won’t bother.
If, as some suggest, people are that bad at driving and have a claims history as long as their arm, then they’ll certainly pay for it. Or, they simply won’t be insurable and will not be able to drive.
Insurance companies rarely do say know – they don’t want to be known for not offering cover – but there is often areas of business that they simply don’t want, and this is where the commercial aspect of their business really comes in.
Having set their risk and priced it at what they believe is correct, they now make commercial decisions about what sort of business will be best for them and will price accordingly to attract it. They’ll also price differently if their focus is on maintaining and retaining parts of their existing business, or instead focussing on acquiring new business. Car insurers also tend to insure lots of other things too, and so there are opportunities for cross-selling.
So that’s why some companies who specialise get a ‘name’ for being good for some sectors. Adrian Flux are known for specialising in modified cars – perhaps taking on riskier business but they’ve history in that sector of the market and believe they can price risk more accurately (and lower) than others. Aviva and LV are known for wanting safer drivers and compete on price, and so have to shift higher volumes to make the same money on lower margins. So yes, Aviva probably will insure the 18 year old who’s just climbed into his Citroen Saxo, but they’re probably not really interested in the business and will price themselves almost out of the market. If someone still buys then great.
Finally, I don’t think it is really necessary to talk about distribution but a couple of comments probably warrant it. This is absolutely NOT a scam, and I’m really surprised that anyone thinks it is. We’re talking about a product that has a huge number of variables that can affect the price, and a market in which there are dozens of insurers competing. Without brokers or online quote aggregators it would simply be impossible (or just hugely time consuming) to make any sorts of decent comparisons between different firms. It would also be impossible for smaller insurers and new entrants to the market to compete. Any new entrant would need to invest a huge amount of money into technology and distribution of their own product if they weren’t there, along with all of the advertising. If I go to Gocompare or any of the others, I see search results for companies I’ve never heard of. And I would never have heard of them without tools such as these. Yes, there is an overhead and commissions but my personal choice is that I choose to pay that in return for the service. Nobody built their website and data integration with 100 insurance companies for free.
So it still isn’t rocket science but there is a bit more to it. As I’ve said a couple of times, it is still far from perfect and to be honest, most insurance companies do themselves no favours at all – selling details to claims management companies, some deliberating refusing genuine claims etc – but equally suggestions that it is unfair or a scam are a long way from the truth. The long term trend of the costs of the risks they’re insuring has been rising for some time. Competition kept the prices artificially low for probably too long and right now we’re seeing a rapid adjustment to return the balance.
Right – I’m off to have a beer. I won’t be driving and adding to the risk afterwards J