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The real cost of… car insurance

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The average car insurance quote for fully comprehensive car insurance was a whopping £594.86 in July, according to research by the AA.

Yet statistics from the Association of British Insurers (ABI) suggest insurers only had to assess (never mind pay out on) claims relating to just under three million private cars in 2012. That’s less than 13% of the cars insured.

So how is it that car insurers get away with charging us hundreds of pounds for cover every year when 87% of the cars they insure don’t cost them anything at all? Why is it that, in such a competitive marketplace driven by such a huge, predictable demand from drivers, expensive car insurers aren’t undercut by cheaper competitors when they try to charge us so much for our premiums?

The answer lies not in how often and how likely we are to claim – but how much our claims actually cost insurers.

What does your premium actually go on?

Staffing and overheads

The ABI estimates that insurers spend just 26% of the average premium (so £154) on staffing and overhead costs.

The rest of the £440 goes towards claims, one of the most significant of which is whiplash claims.

In July, the ABI recently told the Transport Select Committee that whiplash claims alone were adding at least £90 to the cost of a motor policy, describing Britain as “the whiplash capital of the world”.

Honest motorists also suffer increased costs due to uninsured drivers and fraudsters. The Motor Insurers’ Bureau claims the cost of paying uninsured driver claims is £33 per policy, while the Metropolitan Police recently estimated that ‘crash-for-cash’ scams – where fraudsters deliberate slam on the brakes of their car to cause an accident and get an insurance pay-out – are adding £50 to £100 to the cost of the average policy.

These dishonest claims often make the headlines but Graeme Tudgill from the British Insurance Brokers’ Association emphasises that ‘catastophic claims’ – where the insurer has to pay for a lifetime of 24 hour care – can also be very expensive: “Whiplash claims and fraud obviously make up a large part of the cost to the average policyholder, but catastrophic claims, where an insurer might have to pay considerable care costs, also adds a sizable amount to the premium.

“Young drivers with two or less years experience of driving are more likely to have a catastrophic claim than any other age group. This is one reason that young drivers tend to pay more for their premiums.”

In total, the ABI says the average motor claim, excluding windscreen-only claims, costs insurers £2,509.

How the costs break down for the average UK motor insurance premium:

• Repair costs and replacement vehicles: 29%

• Staffing and overhead costs: 26%

• Whiplash claims: 20%

• Other personal injury claims that are less than £500,000: 15%

• Catastrophic claims: 9%

• Uninsured drivers: 3%

• Theft: 2%

More than just cheap

The eagle-eyed mathematicians among you will have spotted something rather odd about those figures. They add up to 104%.

Believe it or not, the average car insurer is currently paying out 4% more in costs than the income it generates through premiums. (Other sources, such as the AA, claim it’s nearer to 8%.)

In other words, car insurance companies today are typically making what’s known as ‘an underwriting loss’ each time they underwrite a policy.

Of course, car insurers didn’t always offer premiums at an underwriting loss. According to the OFT, even just seven years ago, the top 14 insurers – 70% of the market – used to make small underwriting profits, with costs only taking up 96% of the income they were generating from premiums.

But by 2010, following a massive 40% rise in the costs of meeting personal injury claims, this figure had risen to 117% – which meant for every policy sold, car insurers were suffering a 17% underwriting loss.

The Government has since introduced legislation which makes it less lucrative for the ‘no-win no-fee’ legal claims firms to drive up costs in the industry – resulting in the biggest decrease in average premiums that has taken place for nearly 20 years. The typical quote was cut by £65 and most drivers saw a 10% reduction in the cost of their policy.

But there is still a long way to go before the cost of premiums reflect the true cost of paying out on honest motorists’ claims, particularly when it comes to whiplash. Around 1,500 whiplash claims are made each day, yet the Institute of British Insurers estimates that up to 60% of these claims are exaggerated, misrepresented or fabricated.

For this reason, the Government is currently consulting on the feasibility of setting up panels of independent medical experts to assess whiplash injuries in the future.

So why aren’t car insurers all bankrupt?

The answer is actually pretty simple once you bear in mind that car insurers don’t stick your premium in the bank for safe-keeping. They invest it – and that’s how they make money. Lots and lots and lots of it.

For example, even at the height of the financial crisis, the ABI revealed that the motor industry had made over £800 million from investing the premiums we paid.

And that was the worst year on record. Back in 2006, when few of us had heard of Northern Rock and the idea that Lehman Brothers could go bust was laughable, car insurers comfortably made over £1 billion by investing our premiums.

So the real secret to running a profitable car insurance company, it turns out, isn’t finding the safest drivers to insure or selling add-ons like breakdown cover and roadside recovery, it’s finding the best traders to make money from premiums.

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