The Soaring Costs of Insurance Premiums – What’s Behind the Increase?
Motor and home insurance premiums have both spiked significantly in recent years. Many households continue to struggle to afford all their essential outgoings. So further severe price rises will be causing additional concern.
Below we attempt to reduce some of the hype surrounding the price rises. They have jumped but not by as much as you’d think. We also provide a deeper dive into the reasons why premiums are rising. We go beyond the more obvious after effects of the post-pandemic supply chain issues and inflation.
Why has my insurance premium increased so much?
“Why has my motor insurance has jumped up so much?” “Why is my home insurance renewal crazy?” I’ve been on the receiving of these questions from friends, family and contacts several times. They were after explanations and recommendations. So I thought, for anyone that is really interested, I’d provide some detail on the subject. At The Plan Group we don’t offer standard home or motor insurance. We operate in more specialist areas at the fringes of these mass markets. Although we do encounter and have to navigate the same inflationary forces. So we have relevant insight into many of the relevant factors.
The first point is that things aren’t quite as bad as the popular press and social media might make out. Sensationalism can get clicks but it can also cause a lot of undue stress. Prices have risen but for those that shop around the increases aren’t as severe as the headlines suggest. The Asociation of British Insurers (ABI) tracker prices across millions of purchased policies. Their survey only looks at the price consumers actually pay for their cover, opposed to the initial price they might have been quoted.
The ABI’s figures show that in 2023 the average premium paid for a combined buildings and contents policy was £341. This was an average premium increase of 19%. Other headlines may have reported far higher amounts. However they are likely to be referencing averages supplied by Price Comparison Websites (PWCs). They often only know the figure consumers have been quoted on their own platform. If the consumer goes elsewhere to purchase a policy, they may do so at a lower cost.
The ABI state that the average premium paid for private motor insurance between October and December of 2023 was £627. This is a substantial 34% higher compared to the same period in 2022, when it was £470. To emphasis my point above, an index published by PCW Confused.com found that the average was closer to £1,000 after price rises of more than 50% last year. I’ll leave you to draw your own conclusions as to which data is more accurate.
Why has personal lines insurance increased in price up so much?
So we’ve established how big the jump has been in the last twelve months. Let’s go a bit further back and analyse some of the reasons for the current state of the personal lines insurance market. Here are a dozen or so factors, many of which are interlinked. I’ve tried to keep it as beginner friendly as possible. Though sometimes things aren’t always simple. Talking of simple let’s get to the instigator of my first point:
Liz Truss again
Back in February 2017, the then Lord Chancellor and Justice Secretary, Elizabeth Truss caused a major shock by announcing an unexpected change to what’s referred to in the insurance industry as the discount rate. Her decision, made with little warning and to the shock of many experts (sound familiar?), to lower the Discount Rate used to calculate serious personal injury compensation payments increased the financial burden on insurers, raising liability costs for policyholders. While insurers face higher payouts for long-term damages, claimants may receive larger compensation, impacting the insurance industry’s financial forecasts and the overall cost of coverage for consumers. The uninitiated might have thought insurers were crying wolf when they protested about the irresponsible and ill-considered nature of her decision. They probably thought there’s more to it and that she must know what she’s doing?
Changing the rate from 2.5%, as it had been for more than 15 years, to -0.75% was described at the time by the ABI’s director-general as a “crazy decision” and “reckless in the extreme”. The ripples of this change extend beyond insurers and include liabilities for clinical negligence claims faced by the NHS.
Liz Truss and Inflation
It’s probably a bit harsh to blame “Lettuce Liz “entirely for inflation. Supply chain issues and labour shortages caused by the pandemic as well as the war in Ukraine’s impact on energy prices contributed significantly. However the chaos caused by her mini budget definitely didn’t help. The cost of borrowing was sent sky high afterwards. Inflation was 9.9% before-hand but hit 11.1% the following month. It didn’t drop back below 10% until the following spring.
These inflationary pressures caused the cost of repairing and replacing vehicles and rebuilding damaged homes to escalate dramatically. The falling value of the pound added to the cost of importing any goods. These factors of course needed to be reflected in pricing updates for motor and property insurance premiums.
More Complex Vehicles
It’s worth considering how much more sophisticated modern vehicles are. The average value of a car has increased substantially in recent years, reflecting a superiority of product. So it stands to reason they would be more expensive to replace. As these vehicles contain cleverer kit and equipment, repairing them is more complicated and in turn more costly. In the case of keyless cars, they might be more complex but they’re actually far easier to steal. EVs in certain instances due to concerns over battery integrity are also more likely to be written off following an accident than a comparable fossil fuelled vehicle would have been.
The below stats from the ABI, comparing quarter 3 of 2023 to the same period in 2022, highlight just how significant the jump has been:
Payouts for vehicle thefts rose 35%.
The cost to replace written-off vehicles has increased 43% over a five-year period as the average costs of new cars rise.
Indicative data points to electric vehicles being around 25% more costly to repair than their petrol equivalents. They also take 14% longer to fix.
The largest single factor driving up premiums is repair costs. These jumped 32% to make up £1.6bn of the total £2.54bn paid out in claim settlements.
Supply chain issues
Vehicle credit hire claims also jumped up massively for insurers. This was due to the inability to replace written off vehicles. Credit hire vehicles bills can be several £100 a day. So, if a typical claimant would normally have been driving a hire vehicle for only a 2 week period but instead the vehicle is needed for in excess of 2 months, you can appreciate the uplift in the final invoice amount. Multiply that scenario by 1,000s of claims and the impact is enough to (almost) generate sympathy for motor underwriters from the general public. In the same period as above, the ABI state that longer repair times drove up the cost of providing replacement vehicles by 47%.
Small Claims Portal
This was introduced in 2021 as part of as part of a raft of measures known as “The Whiplash Reforms”. The changes aimed to reduce the unacceptably high number of whiplash claims made each year, with more than 550,000 in 2019/20 alone. This placed UK personal injury claims amongst the highest in Europe. It was said to be a significant factor in the cost of insurance in the UK being higher than in most European nations.
The Claims Portal enables personal injury claims to be processed quickly and more efficiently. This is achieved partly by removing the chance of legal disputes. Claim costs would also be kept down by limiting pay outs to individuals to £5,000. Insurers pledged to pass on the estimated savings of £1.2 billion from these reforms to motorists. Car insurance premiums were expected to be slashed by around £35 a year. Has that been proved to be the case? With the pandemic and resultant impact on premiums it probably isn’t easy to identify and offset this particular saving amongst the resultant surge in premiums.
Reinsurance
This is the amount required to cover large claims. Insurers will arrange with a re-insurer to allocate a set percentage of each premium to cover infrequent but serious incidents that result in substantial claims. For example the reinsurer might cover any claim pay-out costs for any amount that goes over £250,000. On motor books that we have negotiated on, the cost of this reinsurance has increased by 350% in the last 7 years. So instead 8% of the insurance premium going towards the cost of reinsurance 28% is now allocated.
This percentage figure will vary from product to product. However it’s likely that nearly all providers have encountered a dramatic increase in motor reinsurance costs in recent years. We find that a very limited amount of granular data tends to be shared by the reinsurance market with wider stakeholders regarding the breakdown of costs and subsequent pricing models. The calculations are quite opaque. However the impact on consumers and commercial clients’ insurance costs are quite clear.
Global Warming
There’s no doubt that recent decades have seen an increase in natural disasters, turbulent weather patterns as well severe storm damage becoming increasingly frequent. The threat of rising sea levels, floods, and storms contribute to elevated risks and losses. Insurers and reinsurers have to adjust premiums to account for heightened climate-related risk of catastrophic losses. Although the UK escapes the worst of its impact, reinsurance funds will be pooled globally and our domestic bills will contribute in part to covering the worldwide affects.
Regulation
The FCA have been churning out new regulations at a steady rate. In recent years we’ve had: Senior Managers and Certification Regime, Fair value, Consumer Duty etc. The bizarre thing from my perspective is that we already had Treating Customers Fairly as a very sensible guiding principle of regulation in the market. There was a very low rate of poor practice being exposed. What we did have was a slightly broken trading model in the market place (which the regulator has partly tackled and I’ll cover in more detail a little further on.) A more logical approach to rafts of time consuming and energy sapping rules, in my opinion, would have been to enforce the existing ones more stringently. Annual audits on a decent ratio of randomly selected firms in the market could have been conducted. Any poor practices these investigations revealed could have been highlighted and punished accordingly. The market would take note and then realign itself accordingly.
Many small firms have talked about regulation requiring one head just to appraise the new requirements. Then considerable funding to implement and train it through. I’m not saying by any stretch that I think all the regs are bad or illogical. What I would argue is that perhaps many elements weren’t necessary or there would have been better ways to go about achieving the aim.
Hyper Competition
A primary objective of the FCA is to promote effective competition in the financial services industry to encourage innovation, better services, and competitive pricing for the benefit of consumers. There are a number of areas outlined below that you hope they’re putting equal focus into!
Now you might think that an incredibly competitive market place is good for consumers. And it has benefitted from them for many years. Contrary to the commonly held view the insurance industry has made an underwriting loss on motor and home insurance premiums in most years. (They might make up most of these losses via investment returns but that’s another subject altogether.) Analysts at EY estimate that in 2023 for every £1 motor insurers received in premiums, they paid out £1.14 in claims and operating costs.
Premiums have actually been suppressed by overwhelming competition in the market place. So much so, particularly in the motor market, that new insurer entrants have been scared off. The chances of making large losses appeared far greater than significant gains. Thus, following some of the issues touched on further on, the number of insurance providers started to dwindle. The market is that much less competitive. Hence those left are able to raise premiums to reflect a truer rate for the risk being covered.
Consolidation
Brokers are by their nature entrepreneurial. They’re small, agile and client-centric firms. They know what clients want and need because they speak with them every day. As business owners they spot gaps in markets and attempt to fill them. Consolidation amongst brokers has been relentless and aggressive in the past 20 years. Many have decided to exit due to tough trading conditions and strong valuations being offered for what remains an attractive industry for investors. Subsequently, the number of broking firms has dropped from the thousands to just a few hundred. Truly independent brokerages are an increasingly rare breed. Most business owners would welcome a reduction in the competition but I’m not sure the market is better for it. As an owner of an independent brokerage I would of course say that!
Solvency II
This was another regulatory measure. It came into effect in January 2016. It was established by the European Union. The primary intention behind Solvency II is to enhance Consumer Protection by ensuring that insurance companies have sufficient financial resources to meet their obligations. Essentially this means insurers need to be hold more funds in reserve in case the claim costs they incur reach higher than anticipated totals.
When you look at the impact of unrated insurers collapsing in the period since it was introduced, such as: Alpha, Gefion and Enterprise it’s difficult to argue that the intention of Solvency II was incorrect. However it has a left a void. By the early part of this decade many other smaller insurers had withdrawn from the UK motor market due to the weight of capital requirements. They apparently couldn’t make the sums work to generate the type of returns required by investors.
The market is now dominated by a few major insurers. Specialist providers known as Managing General Agents have attempt to fill this gap. Yet they are beholden to the large insurers for facilities to write motor insurance on their behalf. This elongates the supply chain. With limited margins to play with these MGAs often struggle to reach profitability in the UK motor market. As a result they often have a short lifespan and consumer faces more pricing dispruption.
Fronting insurers
Have come to prominence in the wake of Solvency II. They receive a “fronting” payment for allowing a reinsurance providers to use their regulatory licences and balance sheet. This arrangement supplies market capacity to alleviate the constraints outlined above. These Fronters enable UK Managing General Agents (MGAs) to overcome the lack of insurers in the UK market who are willing/able to write certain risks. According to the Managing General Agents’ Association, MGAs place more than 10% of the UK’s £47bn general insurance premium.
The Bank of England regulates insurers through the Prudential Regulation Authority (PRA). Post-Brexit there’s been the “Temporary Permissions Regime.” The UK is now beginning to require many fronting insurers to formally establish themselves in the UK. To enter the UK market. This places a much higher hurdle before firms can offer motor and home policies.
It can be argued that Fronters are good for insurance market and customers. Some higher risk customer bases and markets would struggle to obtain over or would face much higher premiums without their existence. Though the regulator now wants Fronters to retain much more of the risk, rather than take a cut of the premium and pass on nearly all of the exposure.
Fronters essentially are a good thing for customers. Where else and at what premiums would these policies otherwise be written. However it does represent the unhealthy nature of the supply of insurance in the UK.
Brexit
Prior to Brexit Fronters could use the European Union to “passport” their way into the UK. However, post Brexit, there are fresh compliance hurdles. The regulator is scrutinising their insurance structures and domicile location. Insurers domiciled in continental Europe, benefit from much lower levels of conduct regulation than the UK. They’re likely to need more capital in the UK.
The precise impact on insurance premiums of the UK’s departure from the European Union (Brexit) on December 31, 2020 is complex. Its challenging to provide a conclusive assessment. However the UK is now exercising its freedom to liberalise the EU Solvency II regime. The reformed regime will be known as ‘Solvency UK’. It’s expected to release a considerable amount of regulatory capital from UK carriers’ balance sheets. Hopefully it might encourage new entrants into the market?
Insurance Premium Tax
This remains at 12%. The government has not sought to reduce it despite protesting about the significant price increases and the cost of living crisis in recent years. The treasury receives on the average £67 from every motor premium.
Unlimited Motor Liability
An explanation as to why the following is the case is above my paygrade (or to be more accurate beyond my expertise.) Regularly when I’m seeking to place a UK motor risk I am informed that the international insurer in question won’t be keen due to the UK’s uncapped motor liability for third party damages. Across European territories this exposure would often be capped at £10 million. The chances of a third party claim exceeding £10 million are of course very rare. Yet many insurers are wary about placing this exposure (no matter how unlikely) on their balance sheets. This contributes further to the drop in competition. With less insurers interested there’s less incentive for underwriters to sharpen their pricing pencils to produce a figure that’s more pleasing to the customer’s finance team.
Weaker Comparison Website Panels
Price comparison websites (PCW) emerged in the noughties. They quickly dominated insurance advertising and google search results to attract consumers. PCWs enabled and encourage consumers to quickly compare price without promoting the need to delve into the details of the cover offered in equal measure. This price focused process and competitive environment helped to supress insurance premiums. Though PCWs increasingly sought larger chunks of the premium pot as their reward. Insurers in need of trading volume would part with up to a quarter of the insurance premium to generate sales. Hence you ended up with a farcical charade, where insurers would offer new customers unsustainably low rates to attract clients only to whack up the price the following year. Meanwhile the PCW would be marketing their services again at renewal to those same customers. It resulted in a big merry-go-round and a clearly broken trading model for insurers.
Canny consumers were able to game the system by switching each year. However the FCA rightly took action to protect unassuming, vulnerable customers who were being dramatically “price walked” at renewal. However they simultaneously may have saved insurers from themselves as well. The introduction of Fair Value regulations has meant insurers can only offer the same price to both new and existing clients. The PCW’s syringe that provided a wonderful supply of lovely (but increasingly disloyal) new clients each month, has effectively been removed from many insurers’ metaphorical arms. I’ve not studied their numbers but logic would suggest that for this reason many insurers may have decided to pull away from using PCWs. If they haven’t removed their rates entirely their ability to attract new clients purely on price promotions has been greatly reduced. Thus savvy consumers, who used to rely on PCWs, are likely to have realised that its worth trying one of two direct insurers before committing to any policy purchase. This could explain the discrepancy between the significantly higher quoted premiums being touted by the press releases of the PCWs and the much lower actual purchased premium figures provided by the ABI.
In conclusion
So there you have it, a fairly lengthy explanation of the multiple factors that have result in significant increases in motor and home insurance premium. Some are obvious, others less apparent. Some are sector specific, others are part of wider economic factors. Some are UK based, others are global issues. Largely they are out of the average member of the public’s control. Although, as a UK consumer there are two ways that you can help to minimise your premium rises. Firstly, take care to make sensible decisions in order to control exposure to risks wherever possible. Secondly, shop around to ensure you receive a competitive rate from the market.
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