Is selling insurance worth it to the car insurer? As with any decision, it depends on weighing up the costs and benefits. If the costs of offering insurance are greater than the benefits, then selling insurance would make the car insurer worse off (they would make a loss), and so they shouldn't sell car insurance. If the benefits are greater than the costs, then selling car insurance makes the car insurer better off (they would make a profit), and so they should sell car insurance.
How does the car insurer decide on the insurance premium? Obviously, they need to know how much it will cost them, and then set the premium to be higher than the cost (to ensure that they make a profit). Let's simplify things and say that all cars are the same, and all have the same chance of being involved in an accident. In simple terms, the cost of selling insurance to a car owner is the repair and other costs that the insurer would have to pay in the case of an accident, multiplied by the probability of there being an accident. For example, if there is a 5% chance on average of there being an accident in any year, and the accident would cost $20,000 in repairs and other costs, then the cost of providing insurance would be $1,000 ($20,000 x 5%) per year. In order to make a profit, the insurer would have to charge an insurance premium of more than $1,000 per year.
So, what happens to the car insurance premium if cars get safer? The probability of an accident probably goes down, but the cost of repairs goes way up. So, does the cost of providing car insurance go down (less chance of having to pay the repair costs), or up (when there is a repair, the cost of the repair is much higher)? We can't tell - the effect on the cost of providing insurance is ambiguous, because we can't tell if the cost goes up or down.
However, as this recent article in Wired reports:
American car insurance rates are going up up up. In the past decade, they climbed 29.6 percent, to an average of $1,548 in 2019 from $1,194 in 2011. The surge, detailed in a new report from insurance shopping site The Zebra, outpaced both inflation (by far) and the increase in average car prices (more narrowly). And it came even as the rate of crashes has fallen year over year.
Aggrieved drivers have plenty of directions to point their fingers. Vehicle theft is on the rise, and extreme weather fueled by climate change can destroy swaths of vehicles in short order...
A more surprising, counterintuitive culprit isn’t the wider world or the person behind the wheel but the car itself. It turns out that new features designed to keep vehicles in their lanes and out of trouble are contributing to rising insurance rates.
That’s because the sensors that power those systems make cars much more expensive to fix when they do crash. Dent a steel bumper, and a few hammer blows gets you back on the road. Smash one on a new car, and it could mean replacing a radar, a camera, and ultrasonic sensors, then calibrating them so they work properly. Replacing a cracked windshield now comes with the extra cost of having someone readjust any cameras that look through the glass. “Technology is playing a bigger role than ever in pricing,” says Nicole Beck, The Zebra’s communications chief. “It’s not actually making it cheaper for people.”
While some studies have shown the effectiveness of emergency braking, insurance companies haven’t yet seen enough evidence to justify a break in rates for most of these features. That’s not to say lane keeping, parking assist, and the rest don’t work. They’re all relatively new, and the actuaries aren’t yet confident that their benefits outweigh the extra costs they incur to repair.
So, these new safety features do reduce accident rates, but because they cost so much more to repair, the cost of providing insurance is increasing. So, insurers are passing the cost onto consumers, in the form of higher insurance premiums. However, this increase in insurance premiums might not last. As the article notes:
The good news for car owners is that the steep upward trend in rates may not last. More data showing the upsides of driver assistance tech may accrue. Repairs should get cheaper as more mechanics learn to replace and calibrate sensors and as the prices of those parts drop. The mystery lies in figuring out how long those trends will take to make their effects felt. “Knowing that it’ll happen eventually is pretty easy,” Carges [the chief actuary at Root Insurance] says. “Knowing exactly when the inflection point is, is not.”
When the costs of repairs come down, the cost of providing insurance comes down, and insurers will start to charge lower premiums for car insurance.
[HT: Marginal Revolution]
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