The driverless car has been put into wide-scale trials and the thinking has moved from “if” to “when” these cars are finally seen on the roads. This is, perhaps, positive news if these vehicles deliver on their promises of an accident free future. But there are some serious questions that insurers need to consider before they become mainstream.

Is this the End of Motor Insurance as We Know It?

Most motor insurance in the current market is personal insurance. It covers a driver against the risks of their causing an accident. But with the driverless car; why would a driver need such a policy? The “driver” will be no more than a passenger as the software and hardware deals with the driving.

Those “drivers” are going to end up arguing in court, and possibly successfully, that any action of their vehicle isn’t their responsibility. That the responsibility lies with the vendor of the product, or even the developer of the on-board car systems.

If this is how the legal environment comes down; then motor insurance may need to move up a level. Personal insurance will no longer be needed. Google, or whichever vendor gets their product to mass market, will need to ensure each car sold but the individual owner won’t need to be involved in that process. It will form part of the purchase cost (as with pretty much anything that a supplier buys in bulk – it’s also going to produce less revenue per insured party too).

This leaves insurers that specialize in personal lines motor insurance particularly exposed to the potential loss of all or a substantial part of their business. It’s going to require some quick thinking on the part of these insurers to redevelop their offerings to a new market.

Insurers will also need to consider the possibilities of hacking and the impact on driverless vehicles. Cyber-crime could move from fraud and theft to kidnapping and even murder if criminals are able to secure a vehicle remotely by exploiting failures in software or hardware.

The Silver Lining

While driverless cars may already be being tested, they aren’t a mature technology yet. In fact it seems likely that trials may continue for a few years before mass market models are given permission to enter production.

As with all new technologies the first models that roll off (or drive themselves off) the production line are likely to be expensive. Possibly too expensive to be affordable by the mass market. It may take another decade (or more) before the technology becomes cost effective.

There is also the question of consumer acceptance. People who are used to driving their own cars and vehicles may be reluctant to hand over control to software. Just because something seems like a good idea – it doesn’t mean that the public will warm to it.

Though it seems reasonable to assume that new entrants to the motor vehicle market are going to prefer to put their driving in the hands of a computer – particularly if that means avoiding the high premiums that new drivers are charged for their insurance. This will not make a dramatic initial impact on the use of driverless vehicles but as those “drivers” mature; it may be safe to assume that they will slowly become the majority in the marketplace.

Driverless Car and Insurance

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Calculating the Reserves an Insurer Must Carry

by Jed Giger on April 6, 2015

We have looked, in the last two instalments of this series, at the basics of calculating insurance premiums. There is, of course, a host of additional complexity to be included in a premium calculation such as:

  • Brokerage Fees
  • Capital Costs
  • Profit Margins
  • Recovery Costs
  • Internal Costs (e.g. Operating Costs)
  • Taxes
  • Cost of Claims
  • Cash Flow/Liquidity

Some of these items are relatively simple to calculate and others are much more complex. A lot will depend on the arrangements that the insurer has to make to deliver each item on the list. Some, like brokerage fees, may not exist at all if the insurer only deals with insured parties direct.

However, once we have calculated our premiums we need to look at the reserves we must carry in order to be reasonably certain that we can meet our obligations to pay out claims under the policies.

Calculating Reserves

It should be fairly obvious that an insurer cannot carry reserves equal to the total maximum pay out under all policies that it has underwritten. Apart from the fact that it would tie up enormous sums of capital needlessly, as it is unlikely that all policies held are going to claim in the same period, it would make insurance an unprofitable venture. If you had to hold £100,000 in reserves for every £100 in premiums you collect… you would need more wealth than Apple (the highest valued company in the world today) in order to insure a large number of policyholders.

Thus most insurers will carry enough in reserves so that they are likely to meet all claims made; this leaves an outside (but distinct) possibility of bankruptcy in the event of a major event triggering a huge volume of claims. This is a risk that has to be borne by the industry as a whole. If providing insurance was to become so expensive as to be unprofitable; there would be no insurance at all.

A common calculation for insurers for reserves is to assume that they will have two years with a 99% shortfall in claims:

shf (S) = <S¦S>Q(99%)>

This assumes that there will be bad years and that the insurer will be able to ride out such a period. It does not, however, assume that this scenario will continue indefinitely. Each insurer will use their own judgement and any regulatory requirements to determine their own minimum level of reserves. The idea is to optimally balance the needs of the insured with the business needs of the insurer.

In the UK there are certain regulatory protections for certain classes of insurance; if the insurer does become bankrupt. Insured parties should understand any such protection before taking out a policy. Ideally, their insurer will explain any protections as part of the insurance sales process.

Responsible insurers monitor conditions in order to re-evaluate their minimum reserves if external factors suggest that this would be sensible. For example, in the event of an Ebola pandemic it can be safely assumed that the business environment of a nation would become depressed. This could lead to bankruptcies, increased criminal behaviour, etc.

They also monitor the emergence of new technologies and markets to test for unforeseen impacts on insured parties. For example; black box technology for monitoring vehicles can be used to decrease the risks to the insurer and lead to fairer premiums for drivers. Conversely, the risks of nano-technology are less well-understood and may increase the risks to the insurer and lead to higher premiums overall. Reserves as well as premiums will be affected in these instances.

telematics insurance

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Health Care Goes Mobile and Insurers are Backing the Change

by nickkMarch 23, 2015

The smartphone has brought a lot of useful functionality to our lives. There’s an app for nearly everything from ordering flowers to finding your way in strange lands. Yet, while there have been many improvements in the area of health; such as the heart monitoring functions and pedometers – you’ve still always had to visit […]

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Insurance Premium Modelling – Introducing Multiple Insured Parties

by Jed GigerMarch 6, 2015

Last month, we took a look at the way an insurer would have to operate if they only insured a single party. As we discovered, it would be a hard business to run and not a very profitable one if an insurer only dealt with a single incidence of risk. They’d need to keep reserves […]

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The Skills that Are Most Needed from Insurance Technology Professionals

by nickkMarch 2, 2015

It can be hard hiring the right talent to take your insurance brokerage to the next level. The insurance industry in the UK is lagging behind other sectors in implementing technology but given the size of investment required; brokers and insurers need to focus on bringing the right talent in to implement new technology for […]

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Is Your Insurance Brokerage Ready for Windows 10?

by nickkFebruary 16, 2015

Last year Microsoft pulled the plug on official support for Windows XP. This was meant to drive businesses to Windows 8. In some cases this was a success; in many others it wasn’t. Windows 8 may be the worst received Microsoft Operating System since the Windows Millennium Edition. An interface that was designed for phones […]

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Insurance Premium Modelling – An Introduction

by Jed GigerFebruary 6, 2015

This week, we’re going to start looking at the basics of how premiums are calculated and over the next couple of months; we’re going to see how these models become more complex and how what initially, seems like an easy task, isn’t quite so simple. The Basics of Insurance Premium Calculation Let’s say that you […]

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Insurance Technology and the Customer Relationship

by nickkFebruary 2, 2015

As you know, here at Riskheads we’re huge fans of the power of software to improve insurance businesses. The ability to automate processes and generate greater granularity in analytics leads to better products and services. However, we also think that there’s a balance to be found between software and humanity. The Customer Relationship is at […]

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Will the Bitcoin Blockchain Model Change Insurance?

by nickkJanuary 19, 2015

Bitcoin, the alternative currency, is changing the way that the world operates. It uses a decentralized system to create a secure and anonymous payment system that can be used nearly anywhere in the world. The currency has not been without its ups and downs and the value of a bitcoin has become immensely volatile with […]

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Preparing Your Insurer for Unauthorized Access to Data

by nickkJanuary 5, 2015

It’s not a mark of shame to have your data breached; it happens to the biggest companies on earth – cyber-criminals have large amounts of resources to their name and spend a lot of money breaking into other people’s data. That means insurers need to examine their preparations for what should happen when their data […]

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