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Published On  Nov 13,  2011
   
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Editor's Note Share
 

Capping Third Party Insurance Premium Distresses Industry Solvency; Free Markets

 

 

 

Rapid urbanization brought chaos to the streets of Addis Abeba that traffic often goes awry. Increasing number of cars and unmet demand for road infrastructure aggravated the problems, resulting in rising accident causalities. No more is the traffic problem of the city ignorable for both drivers and pedestrians, not to mention policy makers.

It is to avert the crisis of the growing road causality that the government ratified the mandatory third party insurance proclamation for motor vehicles, in 2008. With the fast approaching deadline for subscription, set at December 10, 2011, vehicle owners are rushing to insurance companies to buy policies. As of the cut-off date, the law behests, all vehicles on the street should be insured for third party risks. An oversight role is endowed for the Insurance Fund Office, a new addition to the breeds of sector regulators.

Based on a study conducted by a private consultant, the implementation of the law has seen a capping of premium varying with types of cars. Still under establishment, the office has outsourced most of its major obligations for the oldest government owned insurance company, Ethiopian Insurance Corporation (EIC), established in 1976 after the nationalization of 13 private insurance companies. In testing the roads of universalizing third party insurance, the implementation of the law elucidated the challenges of the Ethiopian insurance industry.

With a branch to people ratio of one to 437,161, the industry serves around 300,000 formal clients. Yet, 52pc of the branch networks locate in the capital city with an expansion rate of 10pc to 15pc, annually. Not surprisingly, 40pc of the assets of the industry are exposed to the banking sector, propagated through sister establishments. As it happened, 43pc of the total premium collected by the industry is generated from general insurance within which motor vehicle insurance constitute the majority share.

In the backdrop of such an underdevelopment comes the new law that obliges third party insurance coverage. Aimed at creating comprehensive social safety net for road casualties, the scheme envisions reducing on-road risk exposure. It also ensures risk financing in case of casualty.

Ratification of the law has witnessed a rare positive appraisal from the private sector. Fewer incongruities prevailed on its essentiality. Yet, the implementation procedures stirred an outcry from insurance companies.

As it happened, the maximum premium rate for different categories of cars is defined by the office based on a recent study. Along with the obligation to indemnify, as stated in the law, however, comes the inclusion of high risk vehicles including minibus taxies and Isuzu trucks. To the dismay of insurers, the implementation brought a flat rate of premium rating with little margin for competition.

Naturally, the insurance industry determines premium on the basis of risk magnitude and appetite. A risk that one insurer classifies as uninsurable might be welcome by another with a different set of risk appetite, expertise, capital capacity or policy composition. Level of risk, frequency of occurrence, and estimated maximum loss also help to set premiums.

As the governmental argument goes, instituting comprehensive third party insurance demands instilling a system of full coverage that could not leave any one behind. Sealing premiums reduces the incentive for selective prioritization and ensures universal access. Both high risk and low risk vehicles could be covered under regulated insurance system so that the intended social safety net could be guaranteed.

Yet, all the global industry fundamentals show otherwise. Although governments have a role in setting policies and regulations, it is up to the market to fix the right premium rate. It is only if the demand and supply forces are let free that premium prices could reflect the level of risk that polices represent.

If prices are left for the market, it would innovatively respond even for riskier underwritings. Certainly, market-based premium setting could discourage risky behavior for it precisely values opportunity cost. Regulatory intervention, however, would reduce the incentive for minimizing riskiness.

For liability insurances, it is change in the behavior of policy buyers that is more important than risk refinancing as the former helps to retain productive capacity. It is even more important for universalizing causality treatment coverage. Letting insurability for competitiveness would also provide the buyers with choices.

As in any other trading activity, profit motive drives the operations of insurance companies. Any reasonable premium definition, then, takes into account the level of risk, overhead costs and predefined profit margin. The lesser the premium, the more attractive the insurance policy.

Hence, a rise in premium price affects customer attraction and profitability. For liability insurance, transferability of risks often takes policy purchase decisions beyond mere cost factors. Reputation and capacity of insurance companies could not less be important.

Even then, insurance companies could stay solvent only if they provide attractive policies for customers. Surely, policies could not be attractive without premiums reflective of actual risks. It is in bridging the two that the market plays crucial role.

Equally important is the implementation capacity of the Insurance Fund Office. Effective third party insurance system heavily relays on the resilience of its regulator. As it appears, the office is under-resourced. It could not even oversee trivial functions such as preparing certification stickers.

Noting that it is expected to lead a vast network of stakeholders, who would have timely monetary interests, it should come aboard with reliable professionalism, responsiveness and proactivity. Comparatively, the reality is way behind the expectation. Alike other sector regulators, passivity is definitive of the office. It is not yet fully operational and deprived of essential human capital.

Indisputably, institutional passivity could have a market price, at least in the future, especially for health care providers. For they abide to the law hoping that they will be timely refunded by the office, extended bureaucracy could put them in the defensive. Noting that first impression is last impression, the office ought to ensure that it has rightly sent the proper signal for all market players.

Indisputably, universal liability insurance is beneficial for societal risk mitigation. Besides assuring sustained productive capacity for the nation, it also opens wide market opportunity for insurance companies. Yet, the end heavily relays on the means.

Determination of premiums must be left for the forces of demand and supply. The state must be limited to its role of regulation and oversight. Acts of price fixing, colluding and preferential discouragement could warrant state intervention. In all other cases, insurance fundamentals of risk analysis and valuation need to prevail over legislative burdens.

The Insurance Fund Office must bring a new trend within the current regulatory environment; embarking oversight with utmost legitimacy from key players such as health care providers and insurance companies. Systemic responsiveness need to be the prior objective for the office as it defines its future credibility.

With on-road damage as a ratio of Gross Domestic Product (GDP) standing at four per cent, the essentiality of universal liability insurance is inarguable. For the debate settles on implementation, the government must capitalize on the rare consensus and rectify it accordingly. Since this could realize a successful public-private partnership in the insurance industry, adequate attention must be given to its success.

It is no more bearable to leave successful projects for unsubstantiated implementation excuses. 

 
 
 
 
 
   
   
   
 

 

 

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