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Spiralling Costs of Insurance in Ireland

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Note

The opinions contained in this paper are expressed in an individual capacity by the respective authors and do not represent the opinions of

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Spiralling Costs of Insurance in Ireland

Part 1 Summary

1

Part II Detailed Findings

1 Motor 2

1.1 Introduction to Motor Insurance 1.2 Where does the premium go? 1.3 History of Premium Increases 1.4 Motor Insurance Profitability 1.5 Consolidation in the Irish Market

1.6 Factors affecting Claims Cost - What has changed? Investment Returns

Claims Cost Inflation Claims Frequency Non-Compensation Costs Uninsured\Untraced Drivers 1.7 Summary

Household 15 2.1 Introduction to House Insurance

2.2 Where does the premium go? 2.3 History of Premium Increases 2.4 House Insurance Profitability 2.5 Expense Ratios

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Part 1 Overview

This report is written in light of the recent increases in insurance premiums in Ireland. These premium increases have occurred across most lines of business. This report studies motor insurance and household insurance separately and highlights the following main conclusions:

Motor ●

1) Insurance business is very cyclical. Premiums show little or no increases for periods and then increase significantly to “catch up”. It is not appropriate to study any 2-3 year period in isolation;

2) Insurance costs have not spiralled over the past 10 years – wage and medical inflation outstripped insurance premium inflation in this period; 3) The motor insurance market in Ireland made losses in 1999, 2000 and

2001. These losses are explained by the premiums charged failing to keep up with the underlying elements affecting premiums.

Household

1) Household premiums are also cyclical. However, the cycle is not as pronounced as motor premiums;

2) Insurance costs have not spiralled over the past 10 years – wage and re-building inflation outstripped insurance premium inflation in this period; 3) The household insurance market in Ireland made losses 2001. While

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Part II Detailed Findings

1 Motor

1.1 Introduction to Motor Insurance

The motor insurance market has grown by over 60% in the last 10 years. There are 1,769,684 motor vehicles currently registered in Ireland with a written premium of €1,669.3m.

The law on motor insurance in Ireland is set out in the Road Traffic Act 1961 and subsequent regulations. Unlimited third party liability cover is compulsory for all cars in Ireland. It is also compulsory to get third party property cover up to a limit of €114K (IR£90K).

However, it is common to purchase other optional covers such as:

• comprehensive insurance which protects the insured against accidental damage to the insured’s vehicle;

• accidental death benefits which provide a fixed payment on accidental death of the insured;

• windscreen insurance which pays for damage to the vehicle’s windscreens;

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1.2 Where does the premium go?

The following diagram highlights the main outgoings of insurance companies: Figure 1.1 –Motor Insurer Outgoings

Insurer

Outgoing

Claims

Expenses

Injury

Damage

Uninsured

Drivers

Expenses

Commission

Reinsurance

Injury Compensation Legal Fees

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Figure 1.2 –Motor Premium Composition 47 20 21 7 2 15 Personal Injury Reinsurance Legal Costs Damage Uninsured Commission Expenses

(Breakdown based on AXA Insurance Data).

Claim costs (including legal fees) represent 85% of total insurer outgoings. The main categories of motor claims are:

• Personal Injury (including legal costs) • Accidental damage

• Third party damage • Other (eg windscreen)

Personal Injury claims account for over 70% of the total claims cost. Therefore, to understand motor claim costs it is important to understand the characteristics of personal injury claims.

Personal Injury claims can take a long time to settle, on average about 3 years is typical.

Personal Injury claims can be further subdivided into the following subsections - commonly called heads of damage:

• Future Loss of Earnings • Cost of Care

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Loss of earnings and cost of care awards depend on the occupation of the claimant, the expected absence from work and, in the case of severe injuries, the age of the claimant. The type of injury is critical as it determines the expected absence from work and the level of care required.

General damage awards are determined by the judge and vary from case to case. The total award per case is limited to €254K by court precedent.

Legal costs can be very significant as a percentage of the settlement amount. In 1998 non-compensation cost accounted for 28% of total claims cost (source MIAB report 2001 page 414).

In the Irish market claim settlements are made as a single lump sum payment. This lump sum is designed to be sufficient to cover the claimant’s future needs. The claimant is assumed to earn investment income on the lump sum. An assumed discount rate is therefore taken into account when the lump sum is determined. The same discount is usually used for all settlements and is determined by a court precedent. However the rate may change if a new precedent is set. A discount rate of 4% was assumed in most settlements prior to 2002. However, settlements at lower discount rates have been made during 2002 and the precedent at this stage is unclear.

Increases in personal injury claims costs are a mixture of: • Wage inflation

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1.3 History of Motor Premium Increases

Motor premiums increased significantly in 2001. However, when viewed over the past 10 years motor premiums have not increased by unusual amounts:

Figure 1.3 –Motor Premium Increases (Year on Year)

0.0% 5.0% 10.0% 15.0% 20.0% 25.0% 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 Year Percent age Increase

Motor Insurance Inflation Medical Inflation Source: MIAB Report page 546

Figure 1.4 –Motor Premium Increases (Cumulative)

100 110 120 130 140 150 160 170 180 190 200 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 Year Base 100

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Motor premiums have increased by less than medical and wage inflation over the period 1990 to 2001. This could not be classed as “spiralling costs”. The cyclical nature of motor premiums is evident in the graphs. Premiums increased significantly in 1991. Between 1992 and 1996 premiums increased by less than 6% in total over a five year period. This was followed by rising increases between 1997 and 2001.

This report deals with the period 1995 to 2001. Motor premiums increased by an average of 6.6% per annum in this period.

1.4 Motor Insurer Profitability

Figure 1.5 details the profits made by the motor insurance market over the period 1994-2001. Insurers made underwriting losses in all periods. This is not unusual as investment income should compensate. However, in recent years investment income was not sufficient to compensate for the large underwriting losses and insurance losses have been made.

The gap between the underwriting result (yellow line) and the technical result (blue line) is narrowing owing to the reducing investment returns achieved over the past five years (see section 1.5).

Figure 1.5 –Motor Insurance Profitability

-400 -300 -200 -100 0 100 200 1994 1995 1996 1997 1998 1999 2000 2001 Loss Year €'m -25% -20% -15% -10% -5% 0% 5% 10% 15% % Premium

U/W Result Tech Result U/W Result % Tech Result %

Source : IIF Factfile (Investment Income approximated for 2001)

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Figure 1.6 –Return on Capital – Insurers v’s Banks -30.0% -20.0% -10.0% 0.0% 10.0% 20.0% 30.0% 1995 1996 1997 1998 1999 2000 2001 Year R eturn on C apital

Irish Motor Insurers Irish Banks

Source : Banks annual accounts. Insurance statutory returns and IIF data. Insurance capital assumed to be 40% of written premium.

1.5 Consolidation in the Irish Market

In 1994 11 companies wrote 90% of premium income in the motor insurance market. In 1999 5 companies wrote 84% of premium income in the motor insurance market. It is clear from section 1.3 that this consolidation has not increased insurer profits. These mergers may have been caused by insurers withdrawing from an unprofitable market or a result of the merger of international companies.

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1.6 Factors affecting claims costs – What has changed? Investment Returns

There can be significant delays between receipt of premium income and payment of subsequent claims, particularly in the case of personal injury claims. During this time insurers earn investment income on reserves. Most insurers purchase fixed interest bonds to match the term of their liabilities. Reductions in fixed interest rates therefore lead to premium increases.

Figure 1.7 –5 Year Bond History

0.0 1.0 2.0 3.0 4.0 5.0 6.0 7.0 8.0 9.0 10.0 Ja n-95 Jul-95Ja n-96 Jul-96Ja n-97 Jul-97Ja n-98 Jul-98Ja n-99 Jul-99Ja n-00 Jul-00Ja n-01 Jul-01Ja n-02 Jul-02 Month Percentage Yi el d

The returns on government bonds decreased by about 5 percentage points between 1995 and 2001.

Assuming a mean term of liabilities of 3 years, a 5 percentage point decrease in investment returns results in a premium increase of approximately 15%.

Over the 6 year period premiums would need to increase by on average 2.4% per annum to compensate for the falling investment returns.

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Claims Cost Inflation

As discussed in section 1.1 claims costs are made up of many different elements. No simple index can be used to capture claims cost inflation. Medical inflation applies to cost of care awards. Wage inflation applies to loss of earnings elements. General damages can increase in an ad-hoc manner. Motor insurance claims have increased significantly in recent years. Based on AXA data, the average bodily injury award across the European markets is about €12,500. In Ireland, the average award is between €50,000 and €60,000. The average award has increased by between 8% and 10% per annum between 1996 and 2001.

As claims account for 85% of total motor insurer outgoings a 9% per annum increase in claims costs increases the premium by 7.5% per annum. This figure incorporates increases in legal costs and uninsured drivers as well as general claims inflation.

Claims Frequency

Personal injury accident frequency decreased by about 28% between 1995 and 2000.

Figure 1.9 –Personal injury accident frequency

0 1 2 3 4 5 6 7 8 9 1995 1996 1997 1998 1999 2000 Number ('000) 0.00% 0.10% 0.20% 0.30% 0.40% 0.50% 0.60% 0.70% Number Frequency

Source : MIAB report page 48.

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Note that the above frequencies relate to the number of accidents involving a personal injury. The actual number of personal injuries is higher as some accidents involve more than one injury.

Property damage accident frequencies have also decreased in the period. However, the decrease is not as marked as personal injuries.

Figure 1.10 –Damage accident frequency

0 5 10 15 20 25 30 1995 1996 1997 1998 1999 2000 Number ('000) 0.00% 0.50% 1.00% 1.50% 2.00% Number Frequency

Source: MIAB report page 45

Damage accident frequencies reduced from 1.57% in 1995 to 1.49% in 2000. The small percentage improvement coupled with damage being a low percentage of the total claims cost means that the annual effect on the premium is very small.

Accident and injury figures are calculated from Garda accident reports from the accident scene. The figures do not account for changes in:

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Non-Compensation Costs

Non-Compensation costs have increased as a percentage of total claims costs from 25.6% in 1996 to 28.3% in 2000. This leads to an average increase in premium of 0.7% per annum over this 4 year period.

Figure 1.11 –Non Compensation Costs

24% 25% 25% 26% 26% 27% 27% 28% 28% 29% 29% 1996 1997 1998 1999 2000 Year Percentage of T otal Costs Non-Compensation Costs

Source: MIAB Report pg 416.

Non-Compensation costs in the above graph cover costs paid to parties such as solicitors and experts employed by the insurer on behalf of the defendant policyholder and also those employed by the plaintiff. No internal expenses of insurers are included.

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Uninsured \ Untraced Drivers

The Insurance Industry undertakes to pay for claims arising from accidents where the driver is either uninsured or untraceable. These claims are paid through the Motor Insurance Bureau if Ireland (“MIBI”) which is funded through levies on Irish insurance companies. The insurance premium paying population indirectly pay for these claims through higher premiums. An increase in the number of uninsured drivers or a change in the mix of uninsured drivers towards more risky groups leads to higher premiums for premium paying drivers.

Figure 1.12 –MIBI Incurred Costs

0.0% 1.0% 2.0% 3.0% 4.0% 5.0% 6.0% 7.0% 8.0% 9.0% 1995 1996 1997 1998 1999 2000 Levi es \ E a rned P remi u m MIBI Levies

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1.7 Summary

Motor insurance premiums have increased by an average of 6.6% per annum over the period 1995 to 2001. This average increase is lower than either wage or medical inflation over this period. Increases have not however been uniform over the period. The general population have noticed the large increases applied recently while forgetting the years of relatively small increases in the mid-90s.

To match the underlying cost drivers and maintain insurers level of profitability premiums should have increased by 6.8% per annum during this period.

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2 Household

2.1 Introduction to Household Insurance

Household insurance is mainly designed to cover household buildings and contents. The major perils covered are:

• Fire • Subsidence • Escape of water • Storm • Flood • Theft

Optional extensions to cover are also available: • Personal valuables ( Cash, Visa Cards) • Personal Accidents

• Public Liability

With the exception of liability, claims are reported and settled quickly. The short tail nature of household business means:

• companies are more quickly aware of changes in the claims environment than in the motor market and hence are able to act faster;

• Insurance premiums are not as affected by changes in investment returns as motor premiums.

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2.2 Where does the premium go?

In 2001 outgoings totalled €115 per €100 of premium earned. Investment income is used to compensate for the difference in premiums received and insurance outgoings. However investment income did not bridge the gap and insurers had an overall loss in 2001.

Figure 2.1 –Household Premium Composition

78 14 16 8 Reinsurance Claims Commission Expenses

Claims represent 68% of total household insurer outgoings. Factors affecting claims inflation have a large effect on premium inflation. The main factors affecting claims inflation are:

• Frequency of large events (i.e. floods, storms, freezes) and possible climatic changes

• Changes in claim frequencies

• Changes in the cost of getting repairs done

The following factors can also have a big effect on household premium increases:

• Reinsurance Costs

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2.3 History of Premium Increases

Household insurance premiums increased significantly in 2001. However, premium inflation did not match rebuilding cost inflation in the period 1991 to 2001.

Figure 2.2 –Household Premium Increases (Year on Year)

0% 5% 10% 15% 20% 25% 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 Year Percentage

House Premiums Wage Inflation Re-Building Inflation

Figure 2.3 –Household Premium Increases (Cumulative)

100 110 120 130 140 150 160 170 180 190 200 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 Year Base 100

House Premiums Wage Inflation Re-Building Inflation

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2.4 House Insurance Profitability

Household insurance profits have been volatile over the period 1994 to 2001. Volatility is a necessary feature of household insurance as the claims are sensitive to large weather related events.

Figure 2.4 –House Insurance Profitability

-60 -50 -40 -30 -20 -10 0 10 20 30 1994 1995 1996 1997 1998 1999 2000 2001 Loss Year £'m -20% -15% -10% -5% 0% 5% 10% 15% % Premium

U/W Result Tech Result U/W Result % Tech Result %

Source : IIF Factfile (Investment Income approximated)

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2.5 Expense Ratios

Expense ratios have decreased between 1994 and 2001. However, the average expense per policy has remained reasonably stable. Figure 2.5 reflects the increase in average premium more than the reduction in average expenses.

Figure 2.6 –Household Expense Ratios

0% 2% 4% 6% 8% 10% 12% 14% 16% 1994 1995 1996 1997 1998 1999 2000 2001 Loss Year % Premium

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2.6 Retail Sales

The CSO produce an index of durable goods inflation. This index increased by a very small percentage over the past 4 years. The CSO also calculate inflation in retail sales. It is clear that while the cost of a particular good has not increased people are trading up to more expensive goods. Retail sales inflation has been running at an average of 8% over the past six years.

Figure 2.7 –Durable Goods v’s Retail Sales

-10% -5% 0% 5% 10% 15% 1996 1997 1998 1999 2000 2001 Year Percent age

Durable Goods Retail Sales

2.7 Under-Insurance

Underinsurance developed in the Irish household market when the re-building index increased by more than inflation clauses in the household policies. Some of the large premium increases in 2001 are due to a catch up of underinsurance.

2.8 Weather Related Large Events and Reinsurance

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may have been significant reductions in reinsurance cover. The real reinsurance costs increased dramatically in recent years in response to the frequency and size of large weather related events. Reinsurance costs have increased by at least 10% of written premium between 1995 and 2001. This equates to an annual increase in premiums of 1.6% per annum.

It is worth noting that 2002 has seen dramatic changes in the reinsurance market. This is partly a result of September 11 2001 attacks. Also, there was a large flood event in February 2002 and a significant freeze in January 2002. This will increase the 2002 and 2003 premium costs.

2.9 Summary

Premium increases over the period 1995 to 2001 have been insufficient to cover increases in the underlying premium drivers, moving insurers from a point of profitability in 1995 to loss in 2001. 1995-2001 Premium Increases 5.2% Claims Inflation 7.3% Re-Building 6.5% Retail Sales 8.0%

Expense Ratio Improvements 0.0%

Reinsurance Costs 1.6%

Combined Effects 9.0%

Household premiums may continue to increase in excess of inflation over the next few years as:

• reinsurance costs continue to increase;

• climatic changes could lead to an increased incidence of large events; • claims inflation could be outstripping the buildings cost index;

• claims inflation still lags the buildings cost inflation index when viewed over the past 10 years;

References

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