Editorial The Economic Times, The price of risk Premia Must Reflect Profile of Insured. A group constituted by the Insurance Regulatory Authority of India (IRDA) has proposed fixing of motor insurance premium (own damage) based on a combination of risk factors and the policyholders’ risk profile – Risk Factor Rating System. This proposal is part of a roadmap towards de-tariffing motor (own damage) insurance from 1 April 2005.
This is a laudable idea that needs to be extenance pricing in India is tariff-driven – across categories, there is usually only one product available and it does not distinguish one policyholder from the other. This introduces an element of cross-subsidization in the pricing of insurance products. For instance, an age-wise break up of over 2,000 claims done by the group shows that in over 67% of the cases, the driver was below 35 years of age. In contrast, those aged 55 and above accounted for just over 3% of the claims.
This figure does not find reflection in the current pricing of motor insurance – premia are based mostly on the make and price of the vehicle. Differential pricing factoring in the profile of the driver is a more equitable way of pricing motor insurance. The same logic applies to life insurance. The premium amount is primarily based on the age of the policyholder. It does not take into account the lifestyles, economic status, and health of the insured.
If the proposed regime were accepted, the final premium and discount or load factor depending upon the ranking of the insured on different risk parameters. Indeed, this is how insurance products are priced in most developed countries. Yes, the lack of an authentic database to bring in this kind of pricing is an obvious deterrent.
Nonetheless, it is time to make a beginning. For instance, differential pricing based on the age of the driver and make of the vehicle is not difficult. Likewise, in the case of life insurance, a medical check-up could be made mandatory for prospective insurers, irrespective of age. Apart from being fair to the insurer, this kind of pricing makes the insurance business more scientific and sustainable.
In the editorial of the Economic Times under the heading, the price of risk Premia must reflect the profile of insured, the editor has ventured into an unknown area and in the process has exhibited his pathetic ignorance about life insurance.
In the motor insurance, the insurance premium is charged as per the tariff which is based on the type and cost of the vehicle. The proposal of motor insurance does not go through a process of underwriting, where the underwriter uses his discretion to allow the insurance and if yes, how much and at what premium. On the other hand, in life insurance, though the base premium depends upon the age of the life to be insured, through a process of underwriting, this base premium is loaded or discounted based on the lifestyles, economic status, and health of the insured.
A person with substandard health, i.e. suffering from certain diseases like blood pressure or diabetes, is charged a loaded premium depending upon the severity of the disease. Similarly, some life insurance companies discount the base premium marginally in case the person to be insured is a non-smoker. Even the nature of occupation is considered while fixing the premium in life insurance.
Thus the nature of life insurance business is very much different from the general insurance business and motor insurance comes under general or non-life insurance business. The death claim payable to the next of the kin of the motor accident victim is decided by the judge depending upon the deceased income.
But in fact, a lot more factors come to be considered like the standing of the defending lawyer, because of which the decision is often arbitrary. These third-party claims can go up to crores of rupees depending upon the pleasure of the judge. In life insurance, the death claim amount is always equal to the predetermined sum assured for which the insured has insured himself and paid the appropriate premium.
Therefore the death claim amount is never arbitrary. The life assured has consciously estimated his life value and therefore in case of death whenever it occurs, albeit, during the validity of the life insurance policy, the life insured’s family receives the sum assured plus the declared bonus if any, as the death claim.
However, this discussion triggers an idea as to how the judges, in case of a third party motor insurance claim, can decide the amount of compensation that the family of the accident victim deserves.
The sum assured in life insurance that a person has purchased is normally equal to the estimated economic value of his own life. If he has more than one life insurance policy, the total of all the sum assured of all the policies has to be taken into account. I am aware that most often, the life insurance policies sold by the insurance companies are not pure life insurance policies or technically term insurance policies.
The popular policies contain a savings element and therefore the sum assured is much less than what can be purchased, with an equal amount of premium, term insurance. Therefore the premium that the insured pays, annually, is a better measure for the judge to decide the compensation to be paid to the victim of the third party death claim.
With the help of the annual premium, the total sum assured available under term insurance can be easily calculated and the compensation can be awarded. For the benefit of the uninitiated let it be told that the annual premium for term insurance of a sum assured of say one thousand rupees is as little as rupees two to three depending upon the age of the insured. Thus in most of the third party motor claims, the amount of the award would be quite substantial. But it shall not be arbitrary. This suggestion provides a scientific basis for determining the amount of the assured.
This proposal suffers from one defect. Hardly 20% of the breadwinners of our country have any life insurance at all. The resistance to the sale of life insurance products is almost universal. Nobody ever thinks of death, when he is hale and hearty.
But its real value is understood when the death occurs. But then, it is too late. In advanced countries like the USA and Britain, 80% of the breadwinners are insured. In Japan, the percentage of the insured person 80 up to 90%. Linking existing life insurance to the third party motor claim shall be of immense help to the deciding judge to determine, on a scientific basis, the amount of the third-party claim to be awarded. Secondly, this will go a long way, in popularising life insurance.
The motor vehicles department should insist upon an appropriate amount of life insurance, maybe term insurance, while issuing the driving license. Even the person concerned can decide the amount of life insurance he wants to take, with the knowledge that the third party motor claim shall be decided based on the life insurance that he holds, in case, he ever becomes a victim. The more life insurance he has, the more shall be the third party claim that his family would receive.
Presently the general insurance companies are reeling under the third party motor claim. Most insurance companies are unwilling to issue third party motor insurance. The problem is rather serious as without a third party motor insurance, a motor vehicle is not allowed to ply on the road and the third party motor insurance is not available.
Therefore the above suggestion, if accepted that provides a scientific basis for determining the amount of claim to be awarded to the next of the kin of the victim. The assured would not be arbitrary. It need hardly be mentioned that the death of the breadwinner brings great distress to the bereaved family. It does not matter how he dies. Death can be by disease, by suicide as an in case of the farmers of Andhra Pradesh and Rajasthan or by accident under the train or due to a fall from a bridge or a tree or by snake bite. Never the family of the deceased gets as much compensated as in case of a motor accident. In all other methods of death, the compensation if any is determined by the life insurance that he holds.
The death by a motor accident has become a privileged death, with compensation to the family, coming from the insurer of the motor vehicle. How I wish that the farmers of Andhra Pradesh bent upon committing suicide, should go to a nearby highway and jump before a running vehicle, thus ensuring a handsome compensation to the family.
I know this is a bit of caber advice to be given to the farmers of Andhra Pradesh. But it shall be a great blessing. For, in that case, they don’t have to wait for the arrival of the benign prime minister, to receive some relief. It can be argued that the poor farmer has no money to feed his family, so how can he afford to take life insurance.
The reply is that the farmer has taken a lot of loans he cannot repay. Let him take a little extra loan, to pay the life insurance premium. It is not the money that stands in the way of taking life insurance. It is the lack of knowledge of life insurance that stands on the way. If the learned editor of the Economic Times suffers from such ignorance about life insurance as is evident from or reading of the editorial, what to speak of the laymen.
By Mr. G. S. Agarwalla, Resident Editor, Jaipur, Published in The Insurance Times, January 2005
