Tuesday, August 23, 2011

Old vehicles on third party insurance are costing the insurance industry hundreds of millions annually…. but would converting them to comprehensive helps?

                                             Are you doing it right retaining the old vehicles?

Performance of old vehicles in a nutshell. It is already common knowledge that old vehicles (≥ 15 years category) in the absence of adequate loading on the tariff gross premium are not writable risks, and especially so where more than 90% were on third party cover. Given ample opportunities to analyse industry statistics, I have made a conclusion that portfolio consisting of old vehicles is not something for the industry to savour in.
Portfolio of Old Private Vehicles. The trend for portfolios underwritten during underwriting year 2007 and prior shown deterioration with claims ratios (ie. total claims from old vehicles divided by total gross premiums emanating from this same category) hitting pass the 150% mark as losses from ACT-related developed towards “full blown”. Well, can’t help…relating this with Aids or cancer growth… It seems many insurers were caught during the final quarters of 2008 and first quarter of 2009 when professional actuary started digging deeper into their resources in assessing the General Insurance Liabilities (ie. Premium and Claims Liabilities) in line with the RBC regime; and in the process blowing up the Incurred But Not Reported (IBNR) reserves or was this also about Incurred But Not Enough Reported (IBNER)??  To matter worse, such assessments are all on 75% confidence level, a 25% deviation from the usual Best Estimate (or 50% confidence level) computation.
Furthermore, management expenses and commission have yet to be factored in – which if done should hit about 200%.
Conversion of third party to Comprehensive Coverage.    Management of most insurers have already put third party cover under declined and the Central Bank has directed insurers not to imposed additional policy purchases (like PA) against the intention of the customers. Under pressure from agents and to circumvent business outflow, marketers (with the usual creative ways) have started converting existing third party renewals (or even competitors’ third party policies) to Comprehensive policy. Is this good for insurers already holding a substantial Motor portfolio in their books?
The Testing Scenarios for Third Party risk portfolio.           Let us start some scenario testing in respect of what is in store in the process of converting your existing third party policy portfolio to comprehensive….
The following table shows a typical third party private vehicle portfolio – Average loading imposed is about 75% on the basic tariff premium and you have a 20,000 private vehicles in your underwriting books.

Private Vehicles with Cubic Capacity not exceeding 1,650
Third Party PortfolioBasic unit Premium75% load on BasicPremium for 20,000 vehiclesClaims ratioEst. Total Claims
ACT 67.50118.132,362,500220%5,197,500
Total 81.00141.752,835,000203.33%5,764,500
Commission (10%)    283,500
Management Exp (18%)    510,300
Total UW Costs    6,558,300
Total UW Loss    3,723,300
Gross Loss Ratio    231.33%

(Loss Ratio is inclusive of commission and management expenses. Claims Ratio is derived based on claims case-reserves inclusive of Adjusting and other direct handling fees – the ratios depicted in the scenario tests are worked out from various ISM’s derived statistics.)
The test scenario adopted for the above is quite conservative – Firstly, we take it that the industry did impose an average portfolio loading of 75% of the basic third party tariff premium. The industry claims ratio for ACT is 255.41% for calendar year 2008 but here we work on a 220%. The industry indicator for number of accident involving a third party vehicle stands at nothing less than 1.8% of the total number of vehicles underwritten – this means for every 100 cars underwritten, there will be 1.8 (~ 2) cars involved with accident causing damages to a third party vehicle. If each and every case involve a TPPD claim of RM2,000 the total claims quantum on TPPD should hit 1.8%x20,000×2,000 = RM720,000
However, we did not take the 1.8% factor, instead work conservatively (giving more than the usual benefit of a doubt to the agency and marketing personnel) at ~ 1.41%, and this gave us RM567,000 in TPPD claims or 120% claims ratio.
The total therefore, works out to RM5,764,500 or 203.33% of Gross premium. Therefore, even if conservative factors are applied the loss ratio is still damned high! So high that all insurers are determined to have third party insurance policy thrown out of their books.
Scenario testing for conversion from third party to Comprehensive.                 It was good feeling to have converted the third party renewals to comprehensive but was the original objective of out-casting the third party risks met in the process? Thus back to testing again…..
We used the following factors in this test scenario:
  1. The minimum Sum Insured for such conversion is RM8,000 per vehicle irrespective of its actual market value. You may say the industry is forcing some customers to buy what I termed “clouds” – they will never get paid the full Sum Insured in event of a total loss….
  2. Assuming the ACT and TPPD claims (both quantum and frequency) are similar to the above “third party” test scenario. Thus, the claims ratios arrived at are 257% and 140% respectively.
  3. For the Non-ACT, “Others” claim figure, we based it on 54% of the unloaded (or basic) portion of its premium. Before the 50% loading the total Non-Act (Others) premium is RM7,050,000 computed as 20,000×352.50. Why 54% loading? The industry non-Act claims ratio is 59.34%, thus it is fair to work on 54% if we take out the TPPD aspects of the claims.

Private Vehicles with Cubic Capacity not exceeding 1,650.
Sum Insured of vehicle pegged at RM8,000 minimum
Conversion to Comprehensive Basic unit Premium50% load on BasicPremium for 20,000 vehiclesClaims ratioEst. Total Claims
ACT 67.50101.252,025,000257%5,197,500

Total 433.50650.2513,005,00073.60%9,571,500
Commission (10%)    1,300,500
Management Exp (18%)    2,340,900
Total UW Costs    13,212,900
Total UW Loss    207,900
Gross Loss Ratio    101.60%

Not too bad…. the Total UW loss now stands at RM207,900 indicating a breakeven is near! Thus if you have loaded the “poor” customers nothing less than 50% in addition of hanging “clouds” over him…. your conversion portfolio should be acceptable for the timebeing.
The Reality counts. However, in reality….very seldom loading of 50% occurred although you may get something between NIL loading and 25% loading. Thus, if you work out the figures with the 25% load factor… you should get a 116.32% in gross loss ratio, which is not a good bet in this conversion exercise bearing in mind we have assumed that this ACT claims quantum of RM5,197,500 would remained and not developed beyond the deterioration curve.
Are those Non-Act premiums capable of providing additional support to the ACT losses? This is not about the conversion exercise having produced a better UW position than writing third party risks with an average portfolio loading of 75%. It is really about that portion of the Non-Act premiums – whether the amount is capable of supporting the unexpected deteriorating Act losses……. bearing in mind the ACT premium is now lower at 25% loading compared to the 75% load previously. In cases of new vehicles the amount of Non-Act premium is sizeable thus there are likelihood of the balance (after deducting for OD, TPPD and Theft claims) capable of supporting the deteriorating patterns of the Act losses – at least in the shorter term.
On the other hand, if we are to mix this with those conversions made in respect of commercial vehicles…..the pressure on the bottom-line is surely unrelenting…

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