COVID-19: What’s really driving CTP costs?
As consumer groups advocate strongly for relief in compulsory third party insurance – saying a decline in car usage and risk due to pandemic restrictions justifies the move – pressure is on insurers to discount premiums. But the proposition is far more complex than it seems and the devil is in the details.
With the country, indeed the world, in the midst of a social and economic lockdown, one of the more visible impacts has been that people are driving less. There are notably fewer cars on our roads – confirmed by publicly available mobility data from government (e.g. Transport for NSW) and from the omniscient tech giants Google and Apple.
Does less traffic on the road mean fewer accidents? Likely, yes, to some extent. But this question generally arises because people are actually interested in knowing whether it warrants a reduction to their car insurance premiums. Are drivers now paying too much for insurance?
Answering this question isn’t straightforward. We’ll look into it by asking more targeted questions:
- Who is driving less? Insurance is a risky business, in that each of us has a different risk profile and, from the insurers’ perspective, a different expected cost (known as the ‘risk cost’). Is everyone driving less? Or just the higher-risk drivers – such as young people with older cars and a history of previous accidents? Or is it the lower-risk group – including recent retirees with a new car who haven’t made a claim for years? If it’s the former, then the number of accidents will fall by more than if it’s the latter. Of course, there are many more factors that affect the cost of insurance and these need to be re-investigated and understood in a COVID-19-affected world.
- Where are people driving less? In city centres, accidents are relatively lower speed with comparatively less damage. Are people driving less in these areas? Or are the reductions also out on the highway where accidents have, on average, more serious repercussions?
- How has driving behaviour changed? Are people driving faster or slower? Having fewer vehicles on the road might actually translate into drivers travelling at greater average speed. Higher-speed accidents tend to result in a greater degree of damage and higher cost. And are there other adverse effects on driving ability and behaviour that stem from a prolonged period of home stay and social restriction?
- Are there other effects of COVID-19? Many other dynamics influence the price of insurance, ranging from the availability and cost of imported vehicle parts in motor property insurance to the investment income allowed for in setting premiums for CTP insurance. Adverse movements in these areas could offset, at least partially, any reduced costs due to fewer claims.
- How long will current conditions last? How severe will the economic downturn be? How long will there be less traffic on the road? Will traffic volumes rebound quickly, or will they be reduced for a year or more?
Answers to the above questions affect the cost of insurance – and therefore also affect how much an insurer can afford to offer as a rebate for the reduced traffic volumes resulting from COVID-19. The reported 50 per cent reduction in traffic volume will likely reduce the cost of claims for insurers. But that reduction in claims cost could be quite different from 50 per cent.
Some motor (property damage) insurers have already started to offer premium rebates on an opt-in basis. The magnitude of these rebates is much less than the 40 to 50 per cent reductions observed in traffic volumes.
CTP insurance is especially complicated
While the impact of COVID-19 on insurance is complicated, CTP insurance is especially complicated.
Compulsory Third Party (CTP) insurance (or ‘green slip’ insurance as it is known in NSW) protects vehicle owners from the significant financial consequences of injuring someone through the use of the vehicle. There are several characteristics of this insurance that make setting premiums particularly challenging, even at the best of times.
CTP claims are infrequent, but costly when they do occur
The expectation that a CTP claim will arise is, on average, very low. Over their entire life, most people will never injure themselves or another person through the use of their vehicle, and so will never trigger this insurance. The expectation of a claim in any given year is typically lower than one in 400 – meaning, on average, a person would need to drive and be insured for more than 400 years to give rise to a single CTP claim. With such a low incidence of claims, even an insurer with a large CTP portfolio will need several months of claims data to be able to reliably estimate claim frequency reductions for different policyholder segments.
In further contrast to comprehensive motor claims, CTP claims are large, complicated and often take years to settle. Claimants’ injuries take time to stabilise and their health outcomes can be affected by issues such as access to medical services, depression and anxiety, and insurers’ ability to pro-actively deal with their claims. Their economic losses can be affected by their employment situation.
It’s likely COVID-19 and the resulting economic situation will impact all these factors, and therefore the size of CTP claims. To what extent, we don’t yet know. It will be several years before these impacts can be reliably quantified.
CTP insurance is ‘community rated’
Community rating means the total costs of CTP insurance are averaged and borne across the entire community of vehicle owners. In other words, premiums don’t fully reflect the different risk profiles of each individual – a significant part of the expected cost of high-risk vehicle owners is shared by the low-risk vehicle owners. Why community rate? It keeps premiums more affordable for all, ensuring a viable system.
This restricted approach to pricing (where low-risk policyholders subsidise the premiums of high-risk policyholders) means that for any individual, their premium is not just about them – even if an individual is driving less, their insurer can’t offer them a premium rebate based just on this. The insurer needs to know what is happening across all of the policyholders in its CTP portfolio, so it can offer an average rebate that takes everyone into account.
Put another way, community rating means a better-than-average CTP risk pays a large part of their premium to cover the expected claims from other drivers that are worse than average. This component of their premium is unaffected by how they themselves drive – it depends on the behaviour of others.
CTP insurance is regulated
As the name makes clear, CTP is a compulsory insurance. For this reason, it’s more highly regulated than most other insurance products. State governments either provide the insurance directly or they regulate the prices and services of insurers. In the latter case, premium rebates under consideration would necessarily involve input from more stakeholders and would take more time to work through and implement.
So, what does this mean for CTP insurance?
CTP scheme regulators will no doubt come under pressure to facilitate a reduction in premiums, given the visible reduction in vehicle use. Consumer advocate group One Big Switch has already indicated that its “… first goal is to get state governments to agree that some relief is fair and deliverable – the details will come next”.
But the devil is in those ‘details’, and any rebates given in the short term will require educated guesses from both regulators and insurers, the effects of which won’t be known for some years. This guess work will be more uncertain than it is for comprehensive motor and it will take longer to be validated by the experience. Using historical scheme data, regulators are well placed to analyse the link between traffic volumes and CTP claims to best interpret the changes we are seeing during this pandemic, enabling both regulators and insurers to make sounder decisions.