Auto insurance pricing model: Insurance or extortion?

By Jacob AZAARE (PhD)

The significant contribution of auto insurance markets in every country’s economic growth and development cannot be underrated^{(1, 2, 3).}

As one of the driving forces for a country’s economic growth and development, the market needs to be well structured and established in the areas of risk prediction where policies are priced to assure sustainability^(4).

Unlike developed countries where auto insurers have robust pricing systems that capture policyholders’ claims and risk exposures, the Ghana National Insurance Commission (NIC) and the Ghana Insurers Association (GIA) uses a tariff guide that pays little attention to these variables^(5).

However, the danger posed by policyholders’ claims and his driving risk exposure can never be undermined. Driving comes with risk exposure, necessitating insurance protections⁽⁶⁾ to mitigate possible losses that may arise due to the usage of automobiles.

The introduction of automobile insurance is intended to protect policyholders from possible enormous financial loss and loss to others (third parties). However, the decision to buy a policy sometimes partially depends on the premium, which is calculated based on the policyholder’s risk^{(7, 8).}

The history of the insurance industry in Ghana dates back to the 1920s. The Guardian Royal Exchange Assurance Ghana Ltd was the first insurance company to start operation in the then Gold Coast in 1924⁽⁹⁾.

From the year 1924 till date, the Ghanaian economy has been experiencing unprecedented penetration of insurance companies from both local and foreign front.  According to the National Insurance Commission (NIC) annual report, the number of insurance firms authorized to operate in the country had expanded to 49 at the end of 2022.

The statistics shows that 28 of these companies operate Non-Life (mostly auto) policies whiles the remaining 21 do Life policies. Additionally, there are 3 Reinsurance companies, 118 Insurance Intermediaries, 2 Loss adjusting firms, 5 Reinsurance brokers, 3 Technical providers and 2 Contact offices ^(19).

The NIC oversees the insurance sector in Ghana, ensuring proper management, supervision, regulation, and control of insurance activities within the country.

As posited, and also found in ⁽¹⁰⁾, unlike other countries where auto insurance business is well developed to the level that insurers use parameters such as the age of the auto and the claim history of the policyholder to predict risk, auto insurance premiums in Ghana use tariff guide from the NIC. As a result, ^(10,11) revealed that the tariff guide used by the NIC in the Ghanaian auto insurance industry is not robust and fails to consider the claims history of individual policyholder portfolios.

Originally, the BMS in Ghana was acknowledged within the market as No-Claim Discount (NCD), which officially identified three classes of cars in consistent with the provision of the Ghana Motor Tariff structure organized by GIA and NIC. The first category was X1 and X2, for private individuals and private corporate, respectively.

This category allowed discount based totally on a scale calculated on the basic or net renewal premium in respect of every motor vehicle. As indicated in Table 1 (B), policyholders who had no Claim in their previous first policy year, and second year were been given a discounts (bonus) of 25% and 30% respectively during renewal.

For the third, fourth, and fifth claim-free coverage years, the discount were 35%, 45%, and 50%, respectively, but couldn’t , however exceeded 50%.

This model, as shown in Table 1 (B), grouped personal vehicle policyholders into six classes, with premium levels 100, 75, 70, 65, 55, and 50, specified as, L₁ – L₅. Where a claim is presented in any of these periods, irrespective of the policyholder’s risk class, all the discounts is wiped out with renewal premium starting all over again from class L₀ (100%) ⁽⁵⁾.

With the old pricing model, the discount was not always cumulatively operative, and in the event of any claim, the period of discount classification starts from the following renewal year. Thus, irrespective of the policyholder’s class whilst claiming, he lose all the bonuses and start as a new customer in the following renewal year as already indicated.

In Table 1 (A), is the current auto insurance pricing model used in the market after the NIC with no proper justification abandoned the model in Table 1 (B) in 2020. This current system has no discount levels. Implying that, premium for policyholders are the same irrespective of the number of years under policy observation.

Though the old model in Table 1 (B) was a bit motivating comparing with the current one in Table 1 (B), both failed to acknowledge the frequency and severity of policyholder’s claims in the design, with the assumption that they are independent, a situation clearly stated in ⁽⁷⁾.

This results in equal punishment to all policyholders, irrespective of their number and size of reported claims in a period ^(10,11). However, according to ^(12,13), NCD, also known as the Bonus-Malus System, is a robust auto insurance pricing model being used globally to help increase the incentive for careful driving.

Additionally, the Ghanaian auto insurance market considers the vehicle’s age, cubic capacity, type of use for third party policy, and the inclusion of a vehicle’s cost (sum insured) in the comprehensive (C) premium case^(5,15).

Nonetheless, a critical analysis has revealed that appropriate risk exposures are not applied leading to non- optimal pricing system for policyholders ^{(5, 15).}

The tariff structure from the NIC does not charged any age loading for autos less than 5 years old , but those from 5-10 and more than 10 years are charged with 5% and 7.5%, respectively, of the basic premium as age loadings. Also, policyholders pay 5% and 10% of the basic premium on vehicles with 1601-2000 and > 2000 cubic capacity (CC), respectively.

Further, an insured auto’s seating capacity in Ghana plays an influential role in final premium determination even though there is no clear evidence in the literature to support its inclusion ⁽⁵⁾. Exceptionally, the proportional relationship between vehicle’s size and mass reduction and accident occurrence is well-cemented in the literature ^{(16, 17, 18)}.

These authors postulate that, when the size of a vehicle is increased, the probability of being involved in an accident is much lower; but yet, the nature of the claims particularly to third parties are always severe anytime it occurs.

The standard number of seats captured in the flat-rate system for both third-party and comprehensive seats is five in the Ghanaian auto insurance pricing model.

Thus, for any auto with seating capacity >5 the policyholder pays additional Ghana cedis per seat, which varies depending on the purpose of used of the vehicles. This leaves an open question regarding the relationship between risk exposure and auto insurance premiums for policyholders in the developing country of Ghana.

In actual sense optimal auto insurance pricing as postulated in the literature, is incentive for careful driving in order to minimize the occurrence of accidents and keep the existence of the insurers.

However, the flat rate model adopted by the Ghanaian market is considered as extortive since it fails the optimality test with unjustified pricing variables. Subsequently, unhealthy competition is created paving way for pricing regulatory breaches among insurers in the market.

As indicated, the sole aim of auto insurance is to ensure the wellbeing of both insurers and policyholders where policyholders are given incentives in the form of discount and also punished for reporting claims.

The BMS adopted by the NIC initially though had its flaws, but was giving some incentives to policyholders.

However, the flat pricing rate used currently in Ghana does not consider discounts for policyholder neither does it pose punishment to drivers who are not careful when driving. Policyholders still pay the same amount as premium if they do not report claims like those who take claims after reporting accidents.

Also, most of the variables employed in charging premiums, contributing to the current flat rate system are not statistically significant.

Therefore, the NIC and the GIA should focus on an optimal pricing systems that incorporate both the frequency and severity components to ensure that policyholders pay premiums proportional to their respective risk ^{(5, 15).}

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The author is a Lecturer, Department of Business Computing,  .C. K. Tedam University of Technology and Applied Science, Navrongo