Third party liability insurance of vehicles is a social security mechanism designed by the modern societies to protect the victims of road accidents. It also provides security to the owners of the vehicles. Over the years, with exponential growth in the number of vehicles plying on the roads, the emerging scenario has acquired a dimension of huge significance. In the past few years, the third-party insurance premium rates have leap frogged. Though the rate related data compilation has seen huge improvement over the years, yet the mystery surrounding the workings of the premium rates is a matter of heartburning for the stakeholders. This write up is a humble attempt to analyse the reasons behind the hefty increases in motor third party insurance premiums in India. Prima facie, the insurers become the target of consumers ire caused by rate revisions. Worsening accident situation too, is faulted for these increases. Thus, insurers, vehicle owners, drivers, road conditions and traffic management are at the receiving end of the flak. The article, objectively analyses the facts to find out the true reasons behind the significant increase in premium, while simultaneously attempting to demystify the metrics of motor third party insurance premium rating. Are we right in faulting the insurers and the worsening accident scenario for the increasing premium rates? The analysis might change our perception if not totally, at least in part.
(This write up, in its analysis, uses weighted averages. Composition of vehicles (Annexure C) forms the basis for weightage. The ratio of number of each class/category of vehicle to the total number of vehicles, is the weightage assigned to respective category of vehicles. In the absence of data on the composition of vehicles for the year 2019, the composition of 2017 is considered while calculating weighted premium for 2019-20. I believe that this will not make material or significant difference, either for analysis or for the results and conclusions flowing therefrom. The analyses also omit rates of certain categories of vehicles, because these categories are not amenable to provide (because of the method of rating) precise premium figures. I again believe that this omission is also not likely to materially affect the analysis or its conclusions. The increase in premium per vehicle is the basis for analyses. Hence the number of vehicles is immaterial in the analyses, except only in the paras relating to “validation of increase by alternate methods”- Author)
Introduction
April is the beginning of financial year of the government as well as of many corporate and non-corporate, commercial and non-commercial organisations. A period full of hopes and plans for the ensuing 12 months. April is also eagerly awaited by another segment of our society for reasons other than being a beginning of financial year. It represents a season for onset of changes in motor third party premium rates. During this period the Insurance Regulatory and Development Authority of India, after following due process, notifies the rates of premium for insurance of motor third party risks. While the vehicle owners (Insurance customers) will be praying for status quo, so that their budget is not upset and the insurers will be looking for substantial relief, by way of hike in the rates, so that their struggle to balance their budget (revenue and the claims) remains smooth. The regulator will be struggling to strike an acceptable balance amongst the clashing expectations. Thus, rating of Motor Third Party Insurance is an interesting dynamic of facts, pulls and pressures.
The primary principle of rating process is economic, and is supposed to be based on the concept “rates should reflect the long-term claims experience”. Though at times, in pursuit of set objectives, this principle may be tweaked a bit by the regulator, yet the principle remains the core of the rating process. Claims ratio, more particularly the combined ratio of the industry represents this economic base. It reflects the actual cost of insurance. The claims ratio, is in fact made up of multiple components. With respect to Motor Third Party Liability segment, components which shape the size and magnitude of the element which goes by the description of claims experience / ratio (also called Pure Risk Cost) can be broadly listed as follows.
- Incidence of accidents (outcome of vehicles, roads, enforcement of rules and regulations etc)
- Rate of inflation
- Quantum of relief (Security content) which depends on
- Legal provisions
- Profile of the victims, like age, income / occupation, dependents etc
- The trend reflected in Judicial pronouncements
The role of each one of the above components, in the increase in the premium rates is the subject of this write up. Rating is also affected by other factors like the extent of acquisition costs (commission) and insurer’s operating expenses. During the period of the analysis (which covers 2002-03 to 2019-20) covered by this article, no significant changes are observed in these factors. More over relevant published figures point towards some minor reductions in these costs. Therefore, these factors are kept out of this analysis.
Incessant, year-after year, steep hike observed in motor third party claim amounts, has been the defining story of Indian insurance industry in the last three decades. In view of the size of the Motor Third Party Liability portfolio, its performance has been the prime accused for the huge underwriting losses of insurers and also for the deteriorating solvency. “How long can this continue?” seemed to be an unending riddle. No segment of general insurance business has seen the type of extensive and close scrutiny that the motor third-party segment has been subjected to. Yet everyone has been gasping for satisfactory solutions. The high claims ratio in excess of 100% (at times going up to 200 to 250%) year after year, without any respite for several years, was a challenge which could not be surmounted by any of the insurers. It seems, of late it has moderated a little, which might have been the outcome of rate revision, rather than the result of improvements in any ground realities. Hence the unending search for solutions continues.
This write up analyses the factors listed above in one of the preceding paras, which are supposed to have contributed to the increasing claims ratio and thereby to increasing premiums, with a view to facilitate genuine and objective understanding of role of each one of these factors and also to look for some useful lessons which can guide the future of this segment. It also attempts to quantify, step by step, the impact of each of these factors in the claims ratio / rating. Attempt is made initially to separate and quantify the impact of three factors – incidence, inflation and quantum of relief, followed by further attempt to quantify the impact of different factors under the category of “quantum of relief”. Since all these factors jointly and simultaneously operate on the claims experience, while quantifying the impact of a particular factor, other factors are assumed to have remained operationally constant. Let us begin our analyses by unravelling the mystery of Incidence.
Incidence of Accidents:
Incidence of accidents is a term which defines the chance / probability / frequency of risk, devoid / stripped of its monetary attribute. As stated earlier the vehicles, operating conditions, standard of enforcement of law and regulations etc do determine the rate of incidence of accidents. Following are some (not exhaustive) incidence indicators relevant to the topic under consideration.
- Number of accidents,
- Accidents per 10,000 vehicles,
- Accidents per 10,000 kilometres of road network, and
- Accidents per 1,00,000 population.
The frequency of the incidence can also be measured by further bifurcating the accidents into fatal and nonfatal, grievous and minor injury cases. The Ministry of Road Transport and Highways, Government of India, compiles the relevant data regularly and publishes these indicators. The information for last five decades is found on the Ministry’s website. We need to carefully examine these indicators for the facts they reveal and the message they convey. Some indicators from the data published by the said ministry for the accident years 2001 and 2018 are furnished below. Why years 2001 and 2018 ? Since years 2001 and 2018 (sometimes averages of few corresponding previous years) constitute the base year for rates of 2002-03 and 2019-20 respectively (years for which premiums are compared in this analyses), the accident data of these years becomes relevant and important.
All the above three incidence indicators, convey the message unequivocally, that the accident frequency over the years has steeply fallen. The frequency severity indicated per 10,000 vehicles has seen a huge fall of 80%. As the rating mechanism uses the individual vehicle as a base for fixing premium, this incidence per 10000 vehicles is more relevant for this study (road network and population do not play any role in current rating mechanism). The message loudly and clearly conveyed by this indicator is also adequately and undisputedly supported by many other incidence indicators including the ones listed above.
Incidence rate and Premium rate: Divergence
When accidents per 10000 vehicles have come down by 80%, the premium rates too should have shown corresponding decline. A look at the premium rates, prevailing in the two years (appropriate to above referred accident years) under consideration, in the table below tells an altogether different story.
(The ratio of number of each class/category of vehicle to the total number of vehicles is assigned as the weight age to respective category of vehicles – “Refer Annexure C” for number of different category of vehicles. And columns for weighted premium are calculated by multiplying premiums of respective years with weightage relating to those year.
It is clear from the information reflected in the table, that the premium rates in 2019-20 have gone up without exception, by several times compared to premium rates of 2002-03. The increase ranges from 3 to 13 times, depending on the category of vehicle. And average (weighted) increase comes to 6 times (1754/298).
Going by the data on incidence analysed in the previous paras, and presuming all factors other than incidence to have remained unaltered/constant, logically the premium rates should have come down. But in reality the rates have gone up. How come the premium rates have galloped over the years, when the incidence of accidents has been continuously falling? Had the rates been in tune with the falling incidence of accidents (keeping for a moment, the operation of other factors constant), they would have looked like the numbers given in table below.
Thus based on incidence experience average premium in 2019-20 should have been Rs 60/-. However, the actual average premium in 2019-20 is Rs 1754/-. A huge increase of 28 times (29 less the base) from what it was in 2002-03. Merely based on incidence improvement the premium should have remained 28 times lower than their current (2019-20) levels. This indicates that other factors (other than incidence) have contributed to this hefty increase in premium and such increase was much more than the reduction in premium which the falling incidence might have contributed. Which are these other factors and can we determine the extent of contribution of each of these factors. Before we attempt to find an answer to this question, let us validate the above inference of 28 times increase by alternate methods. Such validation by two alternate methods is attempted herein below.
Alternate approaches to work out the increase / change:
Motor third party premium rates are tariff (decided by a central authority) rates. The premium figures found in the table above are taken from the All India Motor Tariff / IRDAI prescribed rates pertaining to respective years. The increase of 28 times (29 less the base) reflected in the incidence adjusted premium rates of 2019-20 and 2002-03 is also supported by two alternative methods of working out such increase, based on the industry total premium and industry total claims. Since the premium rates and claims experience are positively correlated, it is just and appropriate to verify the increase in premium rates from the changes reflected in claims experience.
- Validation of premium increase by Industry Total Premium
The total industry premium for motor third party segment (as per data published by IRDAI) in 2019-20 is Rs 42655/- Crs. The corresponding motor third party premium for the year 2002-03 is Rs 1473/- Crs (Refer notes/explanations below, for source and calculation). Thus, the motor third party premium of Rs 42655/- Crs. for 2019-20 (also extracted from year book of General Insurance Council of India) is 29 times the corresponding premium of Rs 1473/- pertaining to 2002-03.
Notes/Explanations: –
- During the year 2002-03, premiums for third party segment and own damage segment were not compiled separately. However, the ratio of own damage premium to third party premium was approximately 70:30. The published figures of OD TP break up of premiums extracted from the Year Books of General Insurance Council of India for the periods beginning from 2006-07 are furnished in “Annexure B”, and the data validates the ratio of 70:30 mentioned above.
- The total industry net motor premium in 2002-03 was Rs 3928 Crs. (extracted from https://cag.gov.in Report No. PA 15/2008- Chapter 2). Considering the mandated rule of 20% compulsory cession to the national reinsurer, the gross premium works out to Rs 4910/- Crs., and the third-party premium component works out to Rs 1473 Crs. (being 30% of Rs 4910 Crs). – TP Premium ratio to Total premium might even be lesser than 30%. Every 5 % reduction in percentage of TP premium to total premium will result in increase of impact by about six times. (refer “Annexure D”). Therefore, increase in total industry premium is at least 29 times. It could be higher. It only goes to show that the increase in claim amounts is higher than the increase in per vehicle premium rates which appears to be contrary to the fact of moderation in the claims ratio observed in recent years. In any case the basic premise of this article of ‘hefty increase in premium’ stands adequately validated.
- Though the vehicle population during the period under examination has increased by five times (refer annexure ‘A”), coincidentally, the accident incidence during that period has come down by 1/5th. These two factors more or less cancel the impact of each other in the total premium amount of Rs 42655/- crs. Hence the above increase of 28 times (29 less the base) is in addition to the impact of increasing number of vehicles and decreasing incidence of accidents.
2.Validation of premium increase by Industry Total Claim
Another independent confirmation of the increases in premium rates is reflected in the data published by the General Insurance Council of India relating to Indian motor third party incurred claim amounts which show the following figures:
Year 2006-07 Rs 4611 Crs, and
Year 2018-19 Rs 33185 Crs.
Though this data is for a shorter period (than the period actual under study), yet it is consistent with and confirms, the hefty increase referred in preceding paras. (Alternatively, same inference can be derived by calculating the per vehicle amounts of above premium and claims on the presumption that the percentage of insured vehicles in both the years is same).
Having reasonably satisfied with the correctness of the extent of increase in the premium rates by different methods, now we can confidently proceed to examine the core issue manifested in the above paras – Which other factors (as the impact of incidence is already separated above) have contributed to 28 times increase in the premium rates during 2002-03 to 2019-20 ? Following paras attempt to identify and quantify the impact of the such other factors which might have contributed for the increase.
The quantification of the impact of incidence was comparatively simple as, ready and reliable, information (independent of premium mechanism) relating to incidence was available in the data published by Ministry of Road Transport and Highways. Though it may not be so easy with respect to other factors yet we can attempt to understand the impact by using available best tools and by deductive reasoning. Now let us attempt to understand the impact of inflation on the increase in the premium rates.
Inflation
Inflation, has been a defining economic feature of all modern societies. No citizen can claim its ignorance and nor any particular sector can be immune to its effects. This monetary phenomenon constantly erodes the value of money. What can be bought by one rupee today needs two rupees a year after. Hence tomorrow’s two rupee is equal to today’s one rupee. The accident relief provided is intended not only to reimburse the expenses caused by the accident but also to compensate the economic, personal and social deprivation caused to the victims of such accident. While reimbursements and income-based dependency calculations automatically compensate for increased costs, the other components of nominal compensation have to be increased to ensure that the value of real compensation is not eroded. Thus, inflation contributes to the increase in the number of claims and thereby to the increase in premium.
Therefore the premiums of two different periods cannot be compared without considering the effects of inflation. Fortunately, few indices on inflation are available to facilitate the conversion of nominal figures into real figures with reference to a base year. There are several indices in use, each one designed to serve some specific purpose. There is no separate inflation index meant to be used for the matter under consideration. The index being considered here is Cost Inflation Index (CII) used for ascertaining the capital gains by the income tax department. The Cost Inflation index for the year 2019-20 is 289 against the index of 105 for the year 2002-03. This Index of 289 in 2019-20 over 105 of 2002-03 represents an average inflation rate of 6.5% per annum. To confirm the appropriateness of it’s use a comparison is made with an alternative index (The CPI for India published by IMF with a base year of 2010, shows a change of 1.7 times during 2010 to 2019, as against 1.9 times change for the same period in cost inflation index (CII)). This consistency in CII and IMF CPI, clearly validates the use of cost inflation index for this analysis. Yet there could also be a suggestion to use medical inflation index which is likely to reflect higher increase than the general index of inflation. Some recent figures of health/medical inflation are as follows (Published in Business Line dated 23rd June 21)
Jun 21 7.7%
May 21 8.4% (Headline inflation rate 6.3%)
Jan 21 6.0%
Dec 20 3.8%
It may be noted that medical inflation index is relevant only for hospitalisation expenses arising from accidental injuries and not for other components of compensation. Even if we decide to take a higher rate of inflation the impact of such higher rate as worked out in “Annexure E” will be as mentioned below.
“Every 0.5% higher inflation rate will result into an increase in premium by 0.70 times”.
Thus, use of a slightly higher inflation rate will not alter the inference of this write up derived, based on cost inflation index, but only lays a little greater emphasis on dominance (by 0.7 to 1.4 times) of contribution of inflation to the increase in premium.
(Actual premium figures of 2019-20 are divided by the index of 289 (relevant to year 2019-20) and multiplied by index 105 (relevant to 2002-03) to arrive at the inflation adjusted premiums of 2019-20. And the average rate in the above table is the average of such inflation adjusted figures).
Using the above index figures and the index adjusted premium figures, it should be possible to calculate the impact of inflation in the increased premium. There can be two approaches for calculation of inflation impact on premium figures. It can be done either by adjusting the premium figures of 2002-03, or by adjusting the figures of 2019- 20. Both these methods have been used. And both the methods yield almost same results.
Approach I :
- Average actual premium rate for 2002-03 is Rs 298/-
- Removal of Incidence impact 80% reduction Rs 238/-
- The premium for 2019-20 should have been Rs 060/-
- (assuming other factors to have remained unaltered)
- Inflation should have increased this premium of Rs 60 to Rs 165/-
- (60*289/105)
- Inflationary content in Rs 1754 Premium of 2019-20 Rs1117/-
(1754-(1754/289*105), alternatively (1754-637) refer table IV above)
The total increase in premium being 28 times, once we separate the impact of inflation from total increase the balance will naturally represent the impact of quantum of relief. Hence the above figures can be used to quantify the impact of inflation as well as that of quantum of relief. The inflationary content of Rs 1754 is Rs 1117/- (1754-(1754/289*105) (refer table IV above). Thus, the inflation impact of Rs 1117/- amounts to 18.61 times the incidence adjusted premium of Rs 60/-. Actual premium of Rs 1754/- against the expected premium (with inflation) of Rs 165/- represents the impact of factors other than inflation and incidence. This is 11 times.
Approach II:
Average premium rate for 2019-20 is Rs 1754/-
Remove the hidden benefit of incidence reduction of 80% Rs 7016/-
The premium for 2019-20 (without incidence benefit) should have been Rs 8770/-
Remove the inflationary content (8770-(8770/289*105)) Rs 5584/-
The average premium (without inflation and without incidence benefit) Rs 3186/-
Inflation content of Rs 5584/- on original premium of Rs 298 works out to 18.73 times. Similarly the current premium (without inflation and without incidence benefit) of Rs 3186/- compared with premium of Rs 298/- of 2002-03 works out 11 times This represents the impact of factors other than incidence and inflation. Both results are similar to the results of approach I. (Since the premium is per vehicle the increase in number of vehicles makes no difference)
Thus the increase of 28 times in premium figure (from Rs 60/- to Rs 1754/-) can be summarised as follows.
Caused by Inflation about 17/18 times
Caused by Quantum of relief about 10/11 times
The element of incidence improvement (Rs 7016/-) mentioned in approach II above workout to be 23 times the premium of 2002-03 of Rs 298/- Thus the increase of six (6) times mentioned in the para after table II can be analysed as follows.
Incidence improvement (-)23/24 times
Inflation 17/18 times
Other factors 10/11 times
Having attempted to quantify and separate the contribution of factors of Incidence, Inflation and Quantum of relief in the increase in premium rates, now we can try to further direct the contribution of quantum of relief which appear to have led to 10/11 times increase / change in the premium rates. In view of absence of factual data to facilitate this analysis, the inferences are drawn based on deductive reasoning, from relevant common knowledge. Let us continue our analysis.
Quantum of Relief :
a) Legal provisions: The Insurance of vehicles for third party liability is a statutory mandate. The scope of the coverage is also defined in the law. The said law in India is “The Motor Vehicle Act”. Hence any change in the provisions of the Motor Vehicle Act is a factor which might affect the claims experience and thereby the premium rating. The Motor Vehicle Act has seen several amendments during these years. Though some of the amended provisions are yet to be notified, many changes have already been operationalised. The changes in amount of no-fault liability and solatium payments have definitely contributed in some measure to the increasing claims experience. They were made effective only from the middle of 2019. Hence the impact of these changes remains minimal. Considering the number of cases and the amount of increase in the compensation of such claims (in comparison with the total amount of claims), all those familiar with the mechanism will agree that extent of their contribution in increasing the rates is not likely to be really significant. Therefore, operationalised changes in legal provisions cannot be faulted for hefty increase seen in premiums.
b) Profile of the victims, like age, income/occupation, and dependency.
The amount of compensation (except for ‘no fault liability’) depends on the profile of the victims. India has seen significant socio-economic and demographic changes during 2002-03 to 2019-20. Has it also changed the profile of the road accident victims? If so what is the extent of such changes? In the absence of relevant factual data, it is difficult to get a fully satisfactory answer to this question. However, again, people keeping track of demographic developments during the period of analysis will agree that the said profile, from the point of view of third-party insurance liability is not likely to have changed significantly and might not have been responsible for the huge increase in premium rates. Even if there is some impact, it might be in a small measure. The profile of victims being a chance factor (there cannot be a selection), statistically it must have remained same.
Assuming the effect of factors mentioned above under sub-titles “legal provisions” and “profile of the victims” to be minimal, we have to probe further to seek an explanation /answer to our issue of 10/11 times increase caused by factors other than inflation and incidence.
c) Security content reflected in Judgements (in liberal interpretation of legal provisions, as well as in defining the security in terms of amount of compensation, independent of inflationary content). This security mechanism is in place for last several decades. The working of amount of compensation payable to the victims of road accidents has seen several improvements. The compensation is not a consolidated amount. It is a sum of amounts logically worked out separately under different identified heads. And amount payable under each head is determined by the judiciary on what judges deem to be just and adequate under the prevailing conditions. In a changing society, with the passage of time, the notions of justness and adequacy have also changed. Over the years, liberal compensations are granted. Apart from the liberal approach in terms of amount under each identified traditionally accepted heads, some new heads (which were not recognised earlier) of compensation and improvised procedure to ensure delivery of justice were also added/initiated during this period under examination. Some such major initiatives during the period under consideration, which were seen to be making significant difference are,
Concept of “Future / Prospective Income”
Earlier the compensation was based on the income of the victim at the time of accident. Under the new concept of ‘prospective/future income’, the expected future increases in income are also incorporated into the calculations of the compensation, thereby increasing the compensation by a huge margin. Though it depends on facts of specific case, it is observed in many cases the consideration of prospective income in calculation of dependency has the effect of more than doubling the amount of compensation.
Concept of “Pay and Recover”
Earlier, a breach of policy condition by the insured, discharged the insurers from the liability. But under this concept of ‘pay and recover’ insurers are asked to first pay the compensation to the petitioners and subsequently recover the said amount from the insured. Chances of recoveries being remote, insurers end up with this additional burden.
Enhanced Scope of Compensation for Loss of Consortium
Compensation for loss of consortium which was traditionally restricted to spousal consortium is now extended to parental consortium (to a child dependent) and filing consortium (to a parent dependent).
In the absence of any other verifiable reasons, the impact of this judicial trend (apart from inflation) appears to be the main reason for the rising claims experience. Thus, under the circumstances analysed in the preceding paras, it can safely be concluded that the hefty increase in the premium rates attributed to the category of quantum of relief (if not all, a major portion of 10/11 times change referred above) is most likely, due to the a two new concepts referred above representing expanding social and security quotient of judicial pronouncements of learned judges. Some of it might have been contributed by increasing amounts awarded on the traditional heads of compensation. Impact of the legal provisions mentioned in one of the previous points, might, as stated, not be significant, yet whatever little impact they must have had, is again all about the social and security content impact only.
Concluding Remarks
Statistical technicalities and niceties, like, some data on financial year basis and some on calendar year basis, choice of index, omission of data of some categories of vehicles, element of time lag in the behaviour of different economic drivers involved in the analysis, might slightly alter the situation reflecting indicators (percentages / times), but in any case, change in indicators is not likely to be to the extent of altering the inferences arrived at. Steps to develop systems to collect the relevant data might facilitate future objective and accurate analysis. This analysis might clear our vision about the factors which drove the motor third party premium rates in India in last two decades.
It is necessary to mention here, the following three factors, the relative indicators of which are assumed (for the purpose of above analysis) to have remained more or less same during the period under consideration.
The irresponsible attitude of owners and drivers, poor maintenance of vehicles and roads, poor traffic management, and poor traffic sense amongst other road users, clearly visible in everyday life, might have definitely applied brakes on the sliding incidence rate. Otherwise things would have been much better. Thus, today’s rates do have an element of charge on this count and it cannot be totally ignored.
Often, insurers are blamed for poor management of their Third-Party Liability claims portfolio. Export awards, poor drafting of written statements, absence of effective control over dealing advocates, lack of coordination amongst offices and similar other deficiencies are widely noticed. It is possible that some amount of blame for increase in premium rates may have to be attributed to these factors, if they are found to have aggravated over the years. At the same time, it might be noted that the Motor Third Party Liability portfolio has been the focus of managements of these units and continuous and constant efforts are made to improve its management.
Scope for frauds, corruption and inefficiencies in the system and processes seems to be relatively higher in this mechanism than in other segments of human activities. The premium rates do carry an element of this cost.
In any case these will not undermine the dominant role of inflation and enhanced security content of judgements in the huge hike seen in motor third party premium rates in the period under review. Thus it can be concluded that inflation and enhanced relief content have contributed to the hefty increase in premium during 2002-03 to 2019-20.
Though it is risky to predict the future, yet the scope for further liberalisation in the security content discussed above seems to be limited (Only possibility of liberal treatment, may relate to due recognition of services of housewife). Hence coming decades may not witness the type of increase in claims ratio / premium rates which was observed in the period under study. Some amount of inflation being a normal feature of modern economies, it will continue to drive (might be at a moderate rate) the increase in claims and premium rates. As against this, despite several initiatives by the government, the future improvement in incidence remains a matter of guess. Therefore, under any circumstances we should not be lulled into any complacency in matters relating to a mechanism so vital to a healthy and safe society.
