Car Insurance Premiums at a Premium
Mark Nathan, Managing Partner, Insurance and Financials Analyst
There has been a lot of talk about the rising costs of electricity and the associated bill shock. Those people who have not yet received their car insurance notice should also be bracing themselves for car insurance bill shock as well. Premium rates for cars are also on the rise. Insurers have been putting through hefty price increases to reflect the changing underlying industry dynamics. In insurance lingo, this is referred to as a “hardening market”. Generally, a hardening market is good for insurers. However, we expect the insurers to really only reap the benefits sometime next year, as current premium increases are only just higher than the increase in claims cost. In this note, we look at the outlook for car insurance premiums for the next few years, and look at the industry drivers behind these rate increases.
The key driver of your car insurance is the cost of claims. In Australia, about 75c in every $1 of premium goes to claims costs. This claims costs is made up of two drivers – the chance of making a claim (or frequency) and the cost of each claim (or severity).
Frequency has been surprisingly benign given the increase in distraction caused by smart phones and other devices used by people while driving. Having said that, some insurer have noticed a modest uptick in recent quarters. While the drivers behind this are not yet fully understood, likely culprits include driver distraction and lower petrol prices.
Claims severity on the other hand has been rising sharply. There are several drivers for this increase in claims severity:
Parts costs: There has been significant inflation in cars parts. IAG gave the example of a Lexus front grill, which costs $21,000, and the example of a $15,000 Hyundai that costs $150,000 to rebuild from aftermarket parts. In part this has been driven by a change in the model adopted by car manufacturers – sell the car cheap and make your money on aftermarket sales service. There is an interesting dynamic at play – as car parts go up in price, cars are being written off with less and less damage. The insurers are now exploring ways to harvest this growing pool of spare parts by driving down the costs of repairs. This will take some time to play out as there will be significant resistance from consumers for a greater use of second hand parts.
Increased technology: We have written extensively on autonomous and semi-autonomous vehicles. Each new generation of car comes with more and more smart technology. This technology is easily damaged and is expensive to repair in the event of an accident. This increase in technology started well before the latest breed of semi-autonomous vehicles. For example, sensors that turn on windscreen wipers when it rains, reverse parking sensors, blue tooth and GPS technology. The latest generation of cars go further with semi- autonomous parking assist sensors, lane hold sensors and brake assist sensors – all of which are somewhat exposed to the risk of damage in the event of an accident. In the short term, this increase in technology is driving up the costs of claims. In the longer term, we would expect to see this sort of technology reduce the incident of serious accidents and ultimately drive down claims costs. Some insurance commentators have suggested that once the car fleet reaches 30% penetration of a new technology, the benefits in terms of claim numbers begin to be seen. In the meantime, repair costs are increasing with each generation of car requiring additional components and parts to be replaced in the event of an accident.
Replacement Vehicles: Over the last few years there has been significant growth in the number of firms targeting not at fault drivers in accidents and facilitating a hire car for them. This car is then billed back to the at-fault driver. The issue here is that these third party “facilitators” are charging more for the hire cars than the insurer would have otherwise been able to source them for. An example of these firms is Right2Drive, who has grown its fleet substantially over the last 4 years.
Source: BofA Merrill Lynch Global Research
The insurers have recognised the issues surrounding this trend and have been looking at how to manage the issue. IAG has said their focus is on identifying claims as early as possible, so they can intervene in a claim before it gets dis-intermediated by a tow truck driver. Allianz, on the other hand, has partnered with some of these firms to take a greater control of the process.
While this all sounds rather negative, the Insurers have successfully put price increases through to offset these factors. We estimate, on average, premium rates will be up around 7-10%. Insurance premiums take up to 24 months to be fully realised because it may take up to 12 months to get your renewal and then another 12 months for the rate increase to be fully earned on an annual policy. Therefore, rate increases will take time to wash through the results of insurers. Further, we expect this round of rate increases to continue as it appears that all the key insurers are unified in their attempts to increase rates.
We consider the domestic motor insurance market a well-structured industry and believe the outlook for the industry remains positive.
This article has been prepared by Arnhem Investment Management Pty Limited ABN 17 129 606 775, AFSL 332484. It has no regard to the specific investment objectives, financial position or particular needs of any specific recipient. You should seek your own professional advice in relation to any financial product referred to. You should also obtain the product disclosure statement relating to any financial product referred to and consider the statement before making any decision about whether to acquire the financial product.
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© Arnhem Investment Management, 2017