Why are we all taking a bath on our insurance?

Why are non-life insurance premiums rising so much faster than the cost of other services? Premiums have risen 60 per cent since autumn 2014, reducing the disposable incomes of many households in the state, at a time when rental costs have never been higher, and the cost of education and health services has risen markedly, too. The sheer scale of the price increases has provoked a public outcry. Oireachtas hearings are ongoing, and an investigation into the pricing behaviour of our insurance companies is now taking place.

But we don’t know why prices have risen so fast. The answer lies in how insurance companies make money, the structure of the Irish market, and regulation.

Naturally, it will be important to understand this pressing policy problem in the context of a bathtub.

A bathtub has three elements. A flow of water in, an amount of water in the tub, and a hole to let water out. An inflow, a stock of water and an outflow.

(We’re not getting into any Celtic Tiger jacuzzis and candles nonsense here folks. Let’s keep the metaphor simple).

You pay insurers to take the risk of crashing your car off you when you drive it. Insurance companies manage your individual risk by creating a pool of premium-payers. This is the inflow. When one person does crash, the pool reduces by the amount the insurance company pays out. That’s the outflow.

The ‘float’ insurance companies need to (A) make good on all their claims, (B) run their businesses, (C) satisfy regulatory requirements set by the Central Bank and (D) actually make money for their shareholders, is the stuff in the tub, the stock of water.

Premiums are calculated by actuaries, but sometimes in practice they are guided simply by rules of thumb. The ideal, actuarially-calculated risk-adjusted price of a premium can be much higher for a customer than the premium they actually pay. Insurance companies can get more customers if they charge lower premiums, and because having loads of small premiums makes the amount of water in the tub that bit bigger, the insurance company can make a lot of money doing this in a short space of time by charging a fee-for-service, but if too many of their customers need payouts, the company can become insolvent — meaning there’s no more water in the tub — very quickly indeed. With premiums not being risk-adjusted properly, the chances of taking bad risks is obviously higher too. So the insurance company, or the bathtub, both will run dry.

The long and the short of it? Premiums should have been higher in the past, but weren’t, because of poor business decisions by fee-hungry insurance companies trying to eat up market share which then went wallop.

A good indicator is to see how Irish transport insurance costs compare to those in the rest of the eurozone and to Britain. Irish transport insurance cost around 20 per cent less than in either the eurozone or Britain from 2012 to 2014, and now is about 20 per cent more expensive, three quarters of the way through 2016, compared to Britain and 30 per cent more expensive compared to the eurozone.

This has happened several times in Ireland. Each time the costs of the bailout are passed onto other insurance consumers and the taxpayer. Quinn Insurance cost us €1 billion. FBD made losses of €100 million. Setanta’s failure will cost someone, probably us, €90 million or so.

Each time one of these companies fails, a levy gets attached to new premiums, driving up the cost for each individual. The minimum ‘float’ of water in the tub is subject to changes by regulators, who since the 2007 crisis have demanded increased minimum levels to cover potential outflows as well as much stricter record-keeping and other compliance costs.

The need to keep more and more water in the tub, plus paying for the people within the business to deal with the regulators, plus taking on more lawyers and accountants to fight claims has forced the cost of doing business up.

Each time a new regulation comes in, the premium must rise to compensate for it. Payouts for claims have risen. Since February 2014 the Circuit Court has been able to award more damages at higher rates, meaning the outflow from the tub is higher.

Since the crisis, costs for accountancy have fallen 9 per cent as measured by the CSO’s producer price index. Legal costs have risen 6 per cent. We are feeling the effects of not introducing Alan Shatter’s legal services reform bill in its entirety. I am sure history will judge watering the Legal Services Reform Bill down as one of the largest own-goals of the troika period.

Each time a new, higher claim goes through the courts system, the insurer has to pay out more, both to the claimant and to our learned friends in the pin-striped suits.

Add to this the problem that many of the long-term investments large insurance firms make in the bond and equity markets are not delivering much of a return anymore thanks to the low growth, low inflation, low interest world we live in, and the only option left to them is to jack up prices.

What is interesting is how different the increase in transport insurance is from the increase in home or health insurance. Since 2015, health insurance costs are up around 6 per cent, house insurance costs are up around 11 per cent, and transport insurance costs are up 30 per cent. The sharp point of escalation in transport costs relative to the health or house insurance is July 2015. On a graph it looks like someone taking a sharp turn in a car. This tells you something very different is going on with transport insurance relative to the other two major non-life insurance categories. (Life insurance is effectively a separate business, so it’s not wise to consider it here.)

Looking at the books of the insurance companies for 2014 and 2015, none of them look to be hurting — their bathtubs are full.

Insurance companies in Ireland are in a strong position as, with fewer of them, there is less choice for the consumer. That little bit more market power, combined with increased regulatory and legal costs, and a return to prices they should have been charging were they not being so stupid in the past, means consumers can expect to pay more for their car insurance into the future.

Whether this small group of insurers is colluding to increase the prices we pay is a matter for those investigating it. The consequences for individual motorists are reduced disposable incomes, and increased risks of getting hit by uninsured people. The government will try very hard to stay as far away from this matter as it can. But it may not be possible.