Why car insurers cannot make a profit

M1 motorway traffic queueAdmiral has become the latest car insurer to announce problems. The darling of the Stock Exchange – described by one analyst as "the poster boy for the insurance industry" – it shocked the City this month by saying it had suffered worse claims than expected.

It should come as no surprise. The car insurance industry as a whole has not made money since 1994. Here's why.
It is all Gordon Brown's fault (you knew it would be, didn't you).
  1. The government introduced no-win, no-fee policy so that Gordon Brown could cut his legal aid bill. That has led to a massive increase in claims, ambulance-chasing lawyers, claims management firms, referral fees and rising motor insurance fraud.
  2. Gordon Brown's handling of the economy led to the lowest interest rates for generations and a slumping stock market, so he slashed the money insurers could earn on their investments.
  3. Gordon Brown's over-regulation added to insurers' costs. He made NHS hospitals charge insurers for motor accidents and he created the Financial Services Authority, which has added to the insurance industry's costs.

You won't hear anything quite as political as that officially from the insurance industry but I bet they agree with me in private. Here are some official figures for you, from industry body the Association of British Insurers (ABI).

Last year 24.3 million private vehicles were insured and 3.7 million claims reported, leading to £22.4m per day being paid in claims. In addition 4.4 million commercial vehicles were insured, with 855,000 claims made, and £5.8m paid each day in claim payments.

Total motor insurance premiums amounted to £10.7bn, and claims to £10.3bn. With other costs, the motor insurers' underwriting loss was £1.8bn.

The ABI says on its website: "In insurers' UK business, motor insurance is currently the most challenging product for insurers, with increasing bodily injury claims, legal costs, uninsured driving and fraud in 2010."

Here's a clue to some of those rising claims brought about by Gordon Brown's law changes.

The number of whiplash claims in the UK has risen 32% to 570,000 over the past three years despite a 16% drop in the number of accidents reported to the police - 208,000. Remember, if anyone is injured in a road traffic accident, you are supposed to report it to the police.

According to the ABI, whiplash claims alone cost more than £2bn a year and has added about £90 to the average motor policy premium.

A whole industry of parasitic claims chasers has built up around insurance claims. There's even a firm that has been trawling through insurers' data trying to identify possible claimants who may have not made a claim and then selling that data on to those annoying claims firms that send you text messages.

That lucrative business will have dried up because most accident victims must make a claim within three years, so, having mined data going back three years they are now finished.

Admiral in charge of a sinking ship

Admiral is just later than most in being hit by rising claims because of the special way it operates. It does not actually insure many of its customers. Instead it passes on the business to reinsurers, such as the giant Munich Re. It then takes a share of any profit the reinsurers make.

Reinsurers operate slightly differently and report claims over a longer period. That means they pass on their profit share to Admiral later. So Admiral has been receiving profits recently on years gone by and is now to see those payments cut because of bad claims experience going back two or three years.

Other insurers reported such problems a few years ago. Two of the biggest motor insurers in the country, Equity Red Star and the giant RBS Insurance group, which owns Direct Line and Churchill, have had to report huge holes in their accounts. Heads have rolled.

Admiral's miraculous profits have been shown to have been a trick of smoke and mirrors.

Betting on the Stock Market

None of this would have mattered if investment returns had been OK. Insurers used to take your premium, invest it and, by the time they needed to pay out the claims, would have secured such a good return they could still show a profit.

It would be like a manufacturer selling items at less than the cost of making them but betting the sale price on the 2.30 at Ascot and declaring a profit every time the favourite romped home.

That kind of economic madness could never last and Gordon Brown's economic mismanagement was the final nail in the coffin.

Ah diddums

But let's not feel too sorry for the insurers. You all understand the principle that a drugs dealer stands outside the school gates giving away the first dose for free. The idea is to get the poor kids addicted and then when they come back for more the dealer can charge them over the odds.

Well that might be an unfair analogy but insurers have been giving away motor insurance in the hope of winning your other business - household, pensions, life assurance, you name it. When asked why customers chose to buy a product from a particular insurer, the most common reason is that they had already bought from that insurer before. Cross-selling is a lucrative pastime.

Motor insurance has been a loss-leader for more than 15 years. Just recently it started to look like too big a loss for the leads generated. Premiums needed to go up by 20% a year for at least three years.

Fuel prices

One thing has changed that – rising fuel prices. As a result of the hike in petrol prices, we're driving less, which means we're having fewer accidents. It looks like a few insurers, especially the direct writers, might actually make money this year.

But that will mean increasing competition again, and a halt to the premium rises necessary for the industry as a whole to make money. And once again, overall, we won't be paying enough for our motor insurance to even cover the costs.
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