If the title sounds provocative, a quick clarification should provide the context. The received wisdom amongst the insured public is that motor insurance premium rates are mandated and insurance companies are giving big ‘discounts’ on benchmark rates. Very few ask the question: Are they really getting a fair deal? The principle behind insurance premium is risk-based pricing – that is, premium should be based on the risk that an insurance company assumes. Are the insurance companies really charging for the risk that the motor buyer presents to the insurance company, or are they resorting to omnibus pricing? The reality is that insurance companies in India still use an archaic approach to motor insurance pricing instead of one based on the risk that a vehicle and its driver present. The result is that good drivers subsidise the reckless ones.
Motor insurance premium in the country are outdated and unscientific
Why outdated? An analogy may explain the point. Those of us who pay health insurance premium know that the premium differs according to age, state of health, occupation, etc. of the person insured. A healthy young person is charged a lesser premium than an elderly person or a person known to be not in very robust health, that is, the nature of the risk influences the premium. The same logic should apply to motor insurance too.
Motor insurance covers basically two types of risk, physical damage to the vehicle and third-party liability. Physical damage premium rating in our country is based on the erstwhile motor insurance tariff. A tariff is a pricing guideline which was scrapped ages ago but is still relied upon by the insurance companies. Its main feature is that there are two broad classifications for motor vehicle premium computation (excluding two-wheelers), private and commercial.
Private car premium is based on the cubic capacity of the engine, which has three categories - below 1000cc, between 1000cc to 1500cc and above 1500cc. This formula may have worked reasonably well in the past. Until the mid-1970s, India had barely three car models on the road. The number of private cars across the country was also very limited; the annual production of private cars was around a couple of hundred thousand or less. However, after the liberalisation of the economy, private car ownership increased exponentially and so did the number of models. In this scenario, pricing that is solely based on the cubic capacity of the car is patently outdated and unscientific.
Why unscientific? There are two basic fallacies when the premium is based on cubic capacity. One, this doesn’t take into account the large variety of car models within each engine capacity band and two, it doesn’t provide for significant variations in the ability of drivers.
The more critical part of motor insurance, however, is the premium for third-party insurance. This being mandatory in nature, anyone who uses a motor vehicle, which includes two-wheelers, becomes a captive customer of the insurance industry. And this is possibly the most opaque area of insurance pricing. Why? Please read on.
Third-party insurance has two elements: third-party property damage and third-party personal injury or death caused by a motor vehicle. Quite a few motor owners take out insurance only for third-party liability, which is statutory.
Whereas the liability for third-party property damage is limited by law, the liability of the insurance company for third-party personal injury is open-ended. This is logical, as the unsuspecting victims of unlicensed drivers or unfit vehicles need to be compensated. The insurance company remains responsible for paying the claim of a third party regardless of the insured’s culpability.
The elephant in the room
Insurance companies pay these claims out of the premium they have collected on third-party insurance. Third-party premium rates are notified periodically by the ministry of road transport and highways based on loss statistics furnished by the insurance industry, in consultation with the Insurance Regulatory and Development Authority of India (IRDAI). Here too, within the private car category, premium rates are based on the engine capacity; cars below 1000cc attract the lowest rate and those above 1500cc attract the highest. (Commercial vehicles are rated differently). This is where the issue of fairness comes up. Premium rates based on cubic capacity are generic and do not take into account the critical factors that impact loss frequency and severity. While the engine capacity of the vehicle may have some bearing on the extent of impact and consequential damage, this is merely one of the factors that go into quantifying the risk exposure.
It therefore becomes relevant to see as to how the premium is determined in more evolved insurance markets. Motor insurance pricing starts with the make and model of the car, but the principal rating factor is the driver behind the wheel. Driver profile covers age, driving experience and accident record.
In more developed markets, the premium charged to a young driver, for example one below the age of 25 years, for both physical damage and third-party liability, is several times higher than that charged to an older driver. It follows that if the premium is based on driver profile, then there would be some restriction on who can drive the vehicle. The insured driver is generally named in the policy and if any other person is included in the list of drivers, then a suitably higher premium is charged. Factors such as age, experience, physical condition, driving record and usage of the car are critical factors in premium rating. This goes a long way in ensuring fair treatment of low-risk drivers.
Currently, all that our insurance companies do for drivers who have made no claims is to offer a no-claims bonus on the physical damage component of the premium!
The fairness test
When we look at road accident statistics, one fact that stands out is that quite a few are caused by driver error – over speeding, drunken driving, unlicensed drivers or underage drivers. (All of these were present in the recent Porsche accident case in Pune). We know that it is not the vehicle (unless it is a badly maintained, defective vehicle) that causes accidents, but the driver behind the wheel.
In our environment, since insurance premium is based primarily on the cubic capacity of the vehicle regardless of the profile of the person behind the wheel, it is fair to assume that good, law-abiding drivers are paying for those who are not. How does a mature and experienced private car owner present the same risk exposure to the insurance company as a young driver with limited experience? Engine capacity is merely one of the factors that influence risk exposure.
As mentioned earlier, driver profile is the most important factor, including age, driving experience and accident record. It follows that if the premium is based on driver profile, then there would be some restrictions on who can drive the vehicle. The insured driver is generally named in the policy and if any other person is included in the list of drivers, then a suitably higher premium is charged. In our environment, since insurance premium is based primarily on the cubic capacity of the vehicle, there is no element of penalty for reckless driving. Add to this the fact that anyone can drive the insured vehicle regardless of age, experience or driving record.
Since claims are paid out of a common premium pool, losses caused by ‘rogue’ drivers are shared by more conscientious and law-abiding drivers. This was perhaps not a big factor when private car ownership was limited and roads were less crowded, but with widespread vehicle ownership, differential pricing has become necessary and possible.
The question that now arises is why we, the buyers of motor insurance, are being made to pay for rogue drivers. This is because of two factors. First, there is still enough elbow room in the ‘erstwhile’ tariff pricing, which shows up in the “unofficial” discounts offered by the insurers on physical damage premiums.
What makes the insurance companies offer such “discounts”? The current third-party pricing regime allows insurance companies enough elbow room to charge a lower physical damage premium. This is actually a cross-subsidy as a good driver pays the same third-party liability premium as a bad driver, and worse, it does nothing to promote good driving habits.
Ideally, insurance companies should be able to charge lower rates for both physical damage and third-party insurance, depending on the driver's profile. They don’t seem to do this for two reasons. Firstly, the inertia is attributable to a growing market. Almost all insurance companies have been chasing market share while taking chances on the profitability of the business, simply because apart from health insurance, this is the only growth sector of the non-life insurance market.
Secondly, officially notified third-party premium rates more than effectively cover physical damage losses too, spread across different classes of vehicles, that is, private and commercial. This is evident from the fact that the intermediary commission on third-party premiums for a new commercial vehicle can be as high as 50%. Instead of charging the insured an omnibus premium, can insurance companies not utilise differentiation to reward good drivers?
Insurance premium refinement needs a large universe of insured risks, and the growth in the vehicle population in the country offers the opportunity for premium differentiation. There is a case for charging a lower third-party premium to good drivers since, contrary to public impression, the official circular nowhere categorically states that a lower or higher TP premium cannot be charged. This is a debatable point and needs to be taken up with the lawmakers with the aim of incentivising good drivers and penalising bad drivers.
There is yet another way to encourage good driving habits and penalise errant drivers, which will also reduce the losses incurred on third-party claims. The prospect of prosecution by police for negligence or drunk or unlicensed driving is not a deterrent enough. Prosecution is generally very lax and eventually peters out for various reasons. In other words, there are no effective measures to enforce driving rules. This has dangerous consequences as evident from the high rate of road fatalities in our country. Differentiated premium pricing can improve compliance and promote road safety.
What needs to be done? Several measures can be adopted by insurance companies in this regard. Firstly, after paying a third-party claim, the insurance company can file a counterclaim by way of a civil suit against an errant driver or the driver's owner. Admittedly, recovery suits may take time to wind their way through our sclerotic court system, but the fear of legal action itself may deter some of the errant drivers. Further, if the state is unwilling to bring prosecution against an errant driver, the insurance industry can work on measures to do so.
In many countries, ‘private prosecution’ is a remedy available under the law. An enabling provision under our Criminal Procedure Code (CrPC) can enable insurance companies to pursue private prosecution where driver criminality is evident, such as unlicensed or drunk driving. An authority parallel to the motor accident claims tribunal (MACT) can be set up to deal with civil action arising from auto accidents.
This may not bring an overnight improvement in the driving habits and improve compliance but can be a useful first step towards instilling some discipline amongst drivers.
There are reports that the industry is lobbying for an upward revision of third-party (TP) rates. One wonders what the justification for this is, given that a huge commission is paid on commercial third-party premium, besides using the third-party premium to subsidise physical damage premium. The government should do away with regulated TP pricing and let the price find its own level, since the main reason for the government's intervention in TP pricing is the transport lobby.
This may temporarily result in a higher TP premium for commercial vehicles, but within a very short time, the TP rates for diligent commercial vehicle operators will come down. Along the way, the prospect of penal third-party rates for errant commercial vehicle owners will force them to focus on driver skill training and better vehicle maintenance.
As an interim measure, the authority can allow insurance companies to charge a lower third-party premium in two ways. Firstly, ‘Pay as you drive’ pricing, which is currently available for physical damage premium, can be extended to third-party personal injury (TPPI) premium. Secondly, no claim bonus (NCB) can also be extended to the TPPI component of the premium. This will ultimately result in our paying a fair price for our vehicle insurance.
Only consumer awareness and activism will ensure a risk-based pricing regime for motor insurance, which will eventually result in a reduction in premium rates for good and diligent drivers and penalise ‘rogue’ drivers. This will ultimately lead to substantial improvement in road safety as well.
(Shrirang V Samant has worked in senior leadership roles in the general insurance industry, both in public and private sectors, in India and abroad. He has been privy to the transition of this industry from public to private sector in the country and was the founding CEO of a multinational insurance joint venture- JV in India.)
