The administered pricing and a liberalised market seemed to be quite a paradox. To correct this anomaly of pricing barriers in fire, engineering and motor (own damage part) insurance lines were removed from 1 January 2007 in a calibrated manner. However “free pricing” has been highly misunderstood by everyone as merely “discount over tariff rates”. This led to a peculiar situation of falling prices and worsening combined ratio in the industry, which is detrimental to the customers as well as the insurers. One has to realise that claims is a reality and insurers should not be in a situation where they abdicate their primary responsibility of paying claims. The true intent of free pricing is the freedom to price a risk as per the risk profile or put simply a shift from “rule-based” pricing to “risk-based” pricing.
The free fall in premium rates triggered by the free pricing regime has led to a situation where insurers are blindly offering discounts. This indiscriminate pricing defeated the purpose of removal of price barriers. As a result of this indiscriminate pricing, the fire and engineering portfolio shrunk across the industry from its earlier years. From the standard tariff rates five years ago the rates have dropped by over 85%. Many players are resorting to mere reduction in pricing without considering the risk in its entirety leading to a price deflation. This is definitely not sustainable from the overall pricing aspect in the long run. This trend was evident in the motor insurance portfolio where prices stabilised to some extent within three years. The increase in the Indian auto sector also helped in increasing the volume for quick stabilisation in prices. The worsening underwriting results and the reality of claims occurrence in the fire and engineering portfolio serve as grim reminders for not pursuing irrational pricing.
Consequences of inadequate pricing
Inadequate pricing may lead to increased loss ratios and hence the overall combined ratio (COR) goes beyond economical levels. After a couple of bad years, we may be in a situation where insurers will not look favourably at the fire and engineering portfolio. During the tariff era, the loss ratios used to hover around 40%-50% whereas currently they are touching over 90% which indicates that inadequate pricing is unsustainable going forward.
The overall loss ratios for the industry for fire would be around the 80% mark which could have been worse had we had any major calamity like the 26/7 floods in Mumbai. In this context the pricing looks thin and the industry as a whole would bleed if there were to be a major catastrophe event like earthquake, heavy floods, etc. Considering the unfolding of such events in our neighbouring countries—like Japan and Thailand—the GIC (General Insurance Council) in coordination with the local insurance companies worked out the revised STFI (Storm, Tempest, Flood and inundation) / EQ (earthquakes) rates to be strictly applied for all risks incepting from 1 March 2012. This seems to have been accepted in the market and we have seen an increase of 10%-12% rise in price since April 2012.
The other major consequence of inadequate pricing will be that it may lead to poor claims servicing as the intention sometimes becomes to delay or repudiate the claims and which leads to loss of brand value for any insurer. All other expenses like commissions which have to be paid upfront and management expenses can be controlled. However admissible claim payment on happening of the event insured cannot be delayed or denied. Inadequate pricing also results in reinsurers staying away from an insurers’ portfolio resorting to such practices or offering capacity at higher rates or at higher attachment points.
Way forward
Insurers need to look at their balance sheet and decide on the optimal business mix. It will be better when insurers use the pricing freedom and “right price” the risk rather than pricing below the risk profile. They also need to find ways and means to grow their business through new avenues and encourage out of the box thinking. At current levels many insurers may not be able to sustain their existence for long and only prudent underwriting discipline would help insurers to generate a decent profitable portfolio.
The author is the MD & CEO of Bajaj Allianz General Insurance
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