Why Insure Cars when People Cause Accidents

The Nut behind the Wheel:

Automobiles do not cause accidents, drivers do. This is an elementary fact. I have yet to see a car run off by itself and kill people. Yet in India we insure the car. Anyone can drive it. Let me repeat that: an insurance company will pay for damages irrespective of who has driven the car - young, old, infirm, trained, or untrained - so long as he holds a valid licence. Does that sound strange?

True, no matter who is driving, a car can fail temporarily because of bad brakes or terrible weather or bad road conditions. In each of these cases is it not a fact that a more experienced driver stands a better chance at bringing the car safely to a halt?

India is not known for great driving quality. Licenses are issued to whoever has two legs and is not a chicken. Road discipline is sorely lacking both in pedestrians and drivers with each blaming the other and together blaming overcrowding. We all expect the policeman and the government to regulate traffic and road use. While the policeman does his best under the societal conditions we live in, the government is hesitant to raise fines because it will only serve to increase corruption. It is a universal truth that without strong deterrent action, societal behaviour cannot be changed, yet we are unable to implement such mechanisms for want of will and resources.

We can Change:

Driving in India is a risky business: pedestrians are either quick or dead and a driver is either quick or left behind. Education and training have not been able to change our dare devil approach to road safety norms. Financial penalties are either measly or just not enforced. However, there is a solution that can have a deep impact on driving habits and that is by creating a monetary disincentive for unsafe driving using motor insurance.

Motor insurance premiums currently do cover a combination of non-driving damage risks and driving-caused damage risks.  India must get around to charging insurance premiums by also including driver skills. Driving skill must get adequate weightage. Why is driving skill so important? A tree can fall on a car, or it can get stolen. These are non-driving related risks. It does make sense to classify a car based on its intrinsic value and determine premium for such non-driving risks. However a major portion of premium is towards “own damage”: used to cover driver caused damage. Driving skill has a major impact on “own damage” risk.

Most accidents are caused by inexperience, either due to young age or the fact that the license owner, while not young, may be new to driving. Our case is that insurance premiums must reflect this reality. This will mean that young drivers will pay a higher premium. Young drivers remain a major danger on the road, to themselves, their passengers and other road users, with study after study showing that young people are far more likely to be involved in a crash than older drivers. Inexperience, youthful bravado, sheer recklessness and alcohol can all play a part in these accidents. This kind of segregation will introduce caution, and in India this will be a boon because as of now issuance of a driver’s license actually means that the person can practice his driving on the road putting the lives of countless pedestrians at risk. The corollary is that experienced and safer drivers will pay less.  Each insurance policy on the car must be associated with a specifically identified driver or drivers. The driving license can be the unique identifier. Since no-claim-bonuses will be tagged to the named driver, each driver will be more careful in his driving habits. Consistently unsafe drivers will end up paying extremely high premiums or even become incapable of purchasing insurance, forcing change in their habits. Just as companies share claims experience amongst them, they can share driving characteristics amongst themselves to maintain authenticity of data.

Let us Do it:

There is no reason to exclude commercial vehicles from this philosophy. Why have we not moved to this regime is a question that needs to be asked. Reasons are partly historical and partly because insurance companies are loathe to change. We believe that giving an insignificant discount if an applicant is part of an automobile association is too cosmetic. Some companies ask for educational qualifications and offer some discounts. These efforts are too small and do not address the real issue of incompetent drivers. We believe that by moving to the new regime as suggested, motor insurance companies will also be fulfilling their social responsibilities.

Life Insurance Bonus

Life Insurance policies are of 2 types:

Pure Protection: These policies only cover mortality risk, are usually for a specific term of years, pay out the Sum Assured on death and will not refund premiums already paid if the policyholder survives the policy duration. Term insurance plans are the best example.

Savings Plans: These plans have an element of saving in addition to covering mortality risk. Endowment and Money Back are 2 examples of savings plans.

On a basic level, out of the premium collected by the insurance company under savings policies one portion is allocated to covering mortality risk, another portion is allocated to paying commission to distributors and managing the expenses of the company and the rest of it is invested on behalf of the policyholder. 

At claim (maturity or death), the Sum Assured and the “returns” are paid out. The Sum Assured, which is a pre-determined amount, is always guaranteed.

The returns generated by the company are proportionately allocated to each policy. Such returns may either be:

1.       Guaranteed in advance at policy purchase and is allocated to the policy account at the promised interval. Guarantees usually specify the rate at which payment will be made, the method of calculation and the periodicity of payout. The usual terminology used is “Guaranteed Addition”. Another type of guaranteed amount includes Return of Premium. Under these policies, called the Term Return of Premium (TROP) or simply Return of Premium (ROP), the insurance company will cover risk for a certain period of time and then return all or some of the premiums paid either with or without interest. It is common for companies to highlight the fact that a guarantee is offered. Policies with guarantees promised in advance are simpler to understand.

2.       Non-guaranteed returns are allocated to the policy on a periodic basis – usually annually. There are several types of non-guaranteed “returns”.

1.       Reversionary Bonus: The insurance company generates a return on the policyholder’s funds and decides to allocate a certain portion of the return to the policyholders in the pool. This is called reversionary bonus. Some of the common features of a bonus are:

a.       Bonuses are declared retrospectively and allocated retrospectively.

b.      Bonus rates are not known in advance and amount declared will depend on the investment experience of the company.

c.       Once bonus is allocated to a policy, it is almost always guaranteed to be paid out. What this means is that while the exact amount cannot be guaranteed and depends on the company’s performance and inclination to allocate, once allocated it is guaranteed to  be paid out.

d.      Once allocated, the amount so allocated is called vested bonus.

e.      Vested bonuses are of 2 types:

·         Simple Reversionary: The amount of bonus allocated is always a percentage of the original maturity Sum Assured.

·         Compound Reversionary: The amount of bonus allocated to a policy is added to the maturity Sum Assured and bonus is calculated as a percentage of the maturity Sum Assured and any bonus already vested.

f.        Reversionary Bonuses are usually paid out at the end of the policy term.

Let us take an example:

Maturity Sum Assured	Rs. 100,000
Year 1 Bonus Declared	4%
Year2 Bonus Declared	5%

Total Bonus under Simple Reversionary Method	Total Bonus under Compound Reversionary Method
Year 1:  (100,000X 4%) =  4000	Year 1:  (100,000X 4%) =  4000
Year 2: 4000 + (100,000X 5%) =  9000	Year 2: 4,000 + (104,000X 5%) = 9200

Bonuses declared under Compound Reversionary mechanisms are usually lower in absolute numbers than Simple Reversionary methods. Sometimes insurance companies declare reversionary bonuses other than as percentage. The most popular is as a value against Rs. 1000 Maturity Sum Assured. For example, 4% will be represented as 40/1000 Sum Assured. This larger number serves to create a sense of assurance in policyholders.

Some companies use the term cash bonus. These are usually simple reversionary in nature and by implication is paid out periodically – usually annually.

2. Terminal Bonus: Some bonuses are only declared, allocated and paid out towards the end of the policy term. These are Terminal Bonuses or (as LIC calls it) Final Additional Bonus. Like reversionary bonus, terminal bonus is calculated based on the company’s experience and is non-guaranteed. Terminal bonuses will not be paid out if the policy is voluntarily ended by the policy holder as when he lapses it or surrenders it.

3. Loyalty Additions: These are payments are calculated in a manner similar to reversionary bonuses with the exact amounts not known in advance. As the term implies, this kind of bonus is paid out only if the policy holder stays with the company for the duration specified.  

In a strict sense, rates of bonus allocated in the past do not guarantee that the same rates will continue in the future. However companies do try and maintain allocated bonus rates. Savings policies do not provide great returns but are steady assets, remaining hidden in one’s portfolio till needed. Coupled with any applicable tax advantage, these policies can serve as a good means to diversify financial risk.

You can now compare savings type insurance policies on www.policylitmus.com and take the most appropriate decision to meet your financial needs.

The Wise Buy Insurance: The Not so Wise Buy Policies

We all know the local insurance agent whom we try and avoid. His sole aim in life is to tell you of a new “scheme” that will bring us eternal happiness. We avoid him or run away from him or do not pick up his calls, yet, somehow, we do end up buying from him. The primary weapon in his arsenal is persistence. You will have never encountered another human being who can take rejection so well and still keep up the effort. He is unfazed by the word “no”, will wait patiently for times to change and still pursue his profession with the enthusiasm of the convert.

His reasons are many: the latest contest, his target achievements, or the upcoming tax season. The net result: we end up with several insurance policies that we struggle to manage. Our portfolio will have small policies, unnecessary policies, lapsed policies and unknown policies. A large proportion amongst us does not even know what is in our portfolio. This is not economic protection but favours done. We have not purchased insurance, we have purchased policies.

What is the difference? Insurance is the creation of an asset that will substitute economic value. The purchase of insurance is a reasoned out process based on need, right fit and price. Insurance is valuable only if it can be encashed at the time of need. Imagine buying from a company that rejects a large percentage of claims on flimsy reasons. Not only are paid premiums wasted, the objective of the purchase is defeated. Most of us are under insured, or have purchased the wrong type of policy.

Truth be told, very little can be done about what has already happened. In most cases surrender of older policies will produce insignificant returns. General insurance policies like health insurance or motor insurance will fetch you nothing on surrender. Our recommendation is that for your life insurance requirements, make a review and ensure adequate coverage. The product you buy should be the one that gives you the greatest confidence regarding reliability of claim payment. For your Health, Motor and Home protection requirements review your portfolio today and take charge. Health policies are portable and can be changed without trouble. Motor policies protect your No-Claim-Bonus (NCB).

Before you start changing your portfolio, compare on www.policylitmus.com to find out the product that fits you the best. Choose not only on price but on claims performance  and customer satisfaction parameters without surrendering your privacy.