Inflated values

Dave Smith is on a mission. As managing director of Zurich’s broker business, it’s his job to explain to Zurich’s main sales channel exactly why premiums are rising. With claims inflation far outstripping the retail price index, he thinks this task is something the insurance industry has to get a lot better at.

“Earlier this decade, customers saw rates going up very quickly and they didn’t understand why,” says Smith. “There have always been factors that influence how we rate our business, the difference over the past five years is that we’ve really tried to help both the broker and the customer understand what they are.”

To this end, Zurich has just finished compiling Pricing for the Future, the third in a series of explanatory booklets for brokers. The previous two have been bestsellers. Rate Increases Explained was published in 2003 when rates were rising rapidly and won the innovation of the year prize at the Insurance Times Awards. Initially 10,000 copies were printed but, in the end, Zurich shifted twice as many.

Two years later Managing the Cost of Claims told brokers and customers how Zurich was trying to keep prices down and what they could do to help themselves. The latest publication takes that a step further, flagging up the new factors that will influence the cost of casualty claims in the future.

Even though rates have softened considerably since 2003, the various pressures on insurers are increasing and pricing has to be brought into line. Smith says sustainability of pricing is key to reducing volatility in the market, those yo-yoing premiums baffle domestic customers and make planning a nightmare for businesses.

Pricing for the Future outlines 17 financial, legislative and social factors that make businesses more vulnerable to casualty claims and increase the cost to the insurer of settling them. These include the introduction of staged payments for injured claimants; the “targets culture” that “ignores” health and safety in councils; the introduction of corporate manslaughter legislation and the increased risk of liability for an employer when a former staff member commits suicide.

Claims inflation is far above the retail price index (RPI) level that customers will be familiar with, even as it hovers around the 5% mark. Pricing is far more accurate than, say, 10 years ago, with actuaries splitting the individual drains on costs down to the nth degree. One of the biggest factors in personal injury settlements is the rising cost of care, for example, which wouldn’t even factor in the RPI. Since January 2007, insurers have had to repay the NHS for the care of people injured in workplace accidents. The government initially expected a 7% increase in employers’ liability payments, but NHS tariffs rose in April by 8.3%.

For personal injury claims, Zurich believes inflation is running at 8%; for legal costs it has been in double digits for the past five years and the cost of credit hire alone is estimated to add 3% to 4% to each motorist’s premium.

“We dedicate our resources to trying to shape the type of claim that arrives in future years.

Bill Paton, Zurich

“Add standard inflation on top of that,” says Smith, “and you quickly come out with quite scary figures. Pricing over the past three years in commercial and personal lines hasn’t kept up with claims costs. If you’re increasing prices by 4% to 5%, you’re actually going backwards.”

As the figures show, one of the most contentious issues for any motor insurer is the credit hire industry, which has grown rapidly in the past five years and is worth £750m. Earlier this year, the rental car industry won a long-running battle against insurers to increase their rates by 3.5%, but hostilities continue over the negotiations for the 2009 increase.

Smith says Zurich is trying to communicate to customers how their choices will shape pricing. “The factors behind claims are generally driven by society or by legislation. If everybody gets a BMW instead of a Nissan Micra, that will push up premiums. If as a society we want to do that, don’t moan about your premiums.”

The other prong of Zurich’s pricing strategy is to look at the factors that will affect costs further down the line and try to head them off.

Zurich is a member of the ABI, but lobbies on its own account too, most recently on the Ministry of Justice’s personal injury reforms. Zurich is also one of a small group of insurers preparing a legal challenge to the Scottish Executive over its intention to make asbestos-related pleural plaques a compensable medical condition.

According to Smith’s colleague, chief claims officer Bill Paton: “That’s what differentiates us from most of the market. A lot of insurers will wait to see what happens with pleural plaques, flooding and credit hire, whereas we dedicate our resources to trying to shape the type of claim that arrives in future years.”

Paton compares the paltry £13m spent by government on Britain’s flood defences last year against the £3bn the insurance industry paid out in repairs after the summer storms.

“It wasn’t just rivers bursting their banks, there’s a lot of infrastructure involved. We need to work with the government, local bodies and the Environment Agency to take that risk and reduce it rather than just wait for the next flood to hit.”

“If the government does not invest more, people will become uninsurable and all premiums will rise.

David Smith, Zurich

Zurich is also trying to influence the government in its reforms of personal injury claims, to reduce the astronomical legal costs that insurers pay out – often equal to, or greater than, compensation. Legal cost inflation in the UK is running at 12% to 15%, far higher than elsewhere in Europe.

Paton says only 5% of victims in Swiss motor injury cases are represented by a lawyer. In the UK, it’s 98% to 99%. “We’ve probably overtaken the US in terms of the cost of litigation. When you look at who is benefiting from legal cost inflation, it’s a select bunch of lawyers. We don’t attack them, we’re trying to get government to alter the rules of the game to bring down inflation in legal costs.

“The system is broken, that’s the problem. We’ve never said we want to reduce the level of compensation to injured victims. We would willingly increase compensation by 10% if we could reduce the legal costs by 50%.”

Two of the products under the greatest price pressure are employers’ liability and motor claims – compulsory classes that the government can ill afford to let slip beyond the reach of its citizens. “The government has to help us control some of these claims costs so we can continue to offer competitive premiums that the general public can afford to buy. Otherwise they will force people to become uninsured and the victims will have to look to a central fund.”

Again, flooding is the best example, adds Smith. “If the government doesn’t invest more, people will become uninsurable and all premiums will rise. The average cost of a flood plain building is £30,000 to £40,000, so if you live on a flood plain and get flooded every three years, you can imagine what your average premium should really be.”

Zurich is also cutting costs from its own supply chain and, again, communicating those changes to customers. It now deals with just four motor repair firms nationwide and two building contractors. It can be a hard sell to customers who want their local builder or mechanic to do the work, says Smith. “It’s very difficult,” he adds, “because your natural tendency is to look towards your local contractor but our experience definitely is that our approved national suppliers have done the job more quickly.”

Smith doesn’t believe Zurich will ever beat claims inflation, but it can make it clear to customers why a lower quote might not be the best. “The danger is that companies may come in without that experience, charge lower rates and they won’t be around in future to pay those claims. We are here for the long term.”