Insurance and You

Why Premiums Rise After an Accident, Even with a Protected No Claims Discount.

I was speaking to a guy on Facebook about insurance. There is a common view in Britain that insurance is a personal thing and that your claims only affect you. I keep wondering if marketing is the cause of that, as Britain has a very ‘selfish’ society as a whole and the personalisation of services can give people a sense of entitlement to other peoples or company’s stuff, but that wasn’t the focus and of course, people naturally aren’t aware of what marketing is doing to them. It’s common knowledge amongst psychologists that awareness isn’t automatically protection.

Your Insurance Policy

I used to build some of the systems and the models much of the industry used for a while. What's been said about your premiums going up is true. Even if it has nothing to do with you.

It’s a statisrics exercise. The probability of being hit in the future, given you’ve been hit a first time, is different from the probability of being hit when you’ve never been hit before. Its a conditional probability. Even in the same house and parked in the same place, it puts you into a completely different risk classification. As a result, your premiums can, and almost certainly will, go up.

This has nothing to do with your no claims discount. You may still retain it (as it wasn’t you fault), but your risk bracket has now changed. Usually upwards. So you’d get a different premium value that your No Claims will then apply to. It’s why protected No Claims Bonus insurance is almost useless.

Group Securitisation

It isn’t ideal for individuals. I spent a lot of time on the other side of the fence as a CAB trustee too. Poacher turned game keeper.

To explain the statistical details are way past most people, so I’d have to teach the proper stats (A-level then degree) first, then do the explanation, but it really comes down to these few points:

1. [Frequentist] Statistics don't attribute causality to anything, they attribute correlations (you can't have causality without a correlation, but the opposite doesn't apply). So who caused it, doesn't actually matter as much as people think. Causality is sometimes used to decide who pays out the claim and model the "split" of the premium increases.

2. Car insurance insures stuff which is nobody's fault (aka the No Fault claim).

3. Car insurance spreads the "sensitivity cost" (aka the cost impact value of the claim) across several people and agencies - so if it is a write-off, the value of the car (given to you), minus its salvage costs, are spread across everyone in a risk class.

There’s more, but that will do for the following example.

Imagine if a sink-hole opens up under your car while you’re driving and you and your car fall into it. That isn’t your fault, or anyone else’s fault. The road was designed to standard, nobody crashed into you, construction company’s policy considered it force majeur, so didn’t pay them out. Then:

• Number 1 means your car insurance doesn’t care who’s fault it is.
• Number 2 means you get a payout at all (otherwise you’d have to wait until causality is established, which means waiting for a judge in a series of legal cases for your insurance company, through up to 20 tiers of construction companies, to come to the conclusion that it was the fault of that person in the chain or worse, decide it was the weather, in which case the construction company is ruled to be not at fault after 20 years of cases and you never get a payout)
• Number 3 means your premium doesn't go up by the entire cost of the car in a year. Taking it from, say, 300 quid, to 7,300 for a second hand [insert make and model] that's 6 years old.
• Number 3 also means the salvage costs (for parts or Cat-D resale) brings in some money, so the entire risk class of people (or all the people insured by the company) absorb some of those costs.
• Number 3 also means that you aren't paying for people who do banger car racing, off roading etc. So there is some limitation.
• Number 3 also means the insurance company stays in business longer. Otherwise, it could have a really bad year and go out of business immediately. That means everyone's policy instantly becomes invalid and nobody knows. In the worst case, they all go to jail and have their cars seized & crushed, for not having insurance.

People are likely to go through 3-4 write-offs through their entire lives but that’s an average. The distribution is not uniform, or [what we call] normal. There are folk out there who’s cars are written off every 1 or 2 years. Their insurance is ridiculously high, but they don’t seem to care (and it’s not just footballers). But when they go through their first one, how do you know at that point, that they are only going to have one ever? You don’t (because you would need to predict the future with no offset in the past) and you can’t just split the cost by 3 or 4 cars.

Going Deeper in Security

Most insurance exercises are just a form of what is called "securitisation". That’s where the term "secured loan" also comes from. In a secured loan, anything the loan bought can be repossessed by the loan company and resold to cover most of the debt. They can’t do that with a crashed car. If its bought for $13K and its crashed driving it home, nobody is going to buy the mangled beast for $13K.

So they securitise the car by having a salvage cost (it’s broken value, including labour) and the offset component, which is spread into the rest of the risk class. So say they get $1,500 salvage for the $13,000 crashed car, and you get a replacement. Say 1,000 people are in the same risk class as you. The remaining $11,500 is then spread through the risk class by adding $11.50 to everyone’s premiums. If the insurance company pays out 3 of these a year, for the same make and model of car, then $34.50 is added to that risk class' premiums etc.

Now, this isn’t to say that the impact cost itself couldn’t be split differently by segmenting your customer base differently. But if you go to the individual, insurance doesn’t securitise anything. So it’s back to going bankrupt again, making all those people uninsured.

It's way way more complicated than people think and this is just the tip of the iceberg.

E