Why have insurance premiums gone up so much?

Higher insurance premiums for cars and homes are being driven by a mix of factors, including changing regulations, changing human behaviour and a changing climate. Insurers have to balance the need for adequate reserves for claims, maintained profitability and affordable coverage for consumers.

Households who have recently renewed their home or car insurance are likely to have been shocked by how much their monthly premiums have increased.

This is an industry-wide phenomenon. For example, motor insurance was 25% more expensive on average in 2023 than the previous year (Association of British Insurers, ABI, 2024); and the average premium paid for a combined buildings and contents policy rose by 19% year-on-year (ABI, 2024).

The average premium paid for private motor insurance in the UK was £627 between October and December 2023, a 12% rise from the previous quarter (ABI, 2024).

Indeed, while insurance premium increases seem typically to have followed inflation in the past, they have recently shot up significantly more than the average reported rates of inflation.

Figure 1 shows data between January 2021 and January 2024 comparing the retail price index (RPI) – a measure of inflation – for all items with two specific insurance RPIs – the dwelling insurance and ground rent RPI; and the vehicle tax and insurance RPI. The chart shows the clear jump in insurance RPI, which has risen by multiple factors more than all items in the RPI in recent years.

Figure 1: RPI all items compared with dwelling and vehicle insurance, 2021-24

Sources: Office for National Statistics (ONS), all items RPI: ONS; dwelling insurance and ground rent RPI: ONS; vehicle tax and insurance RPI: ONS.

How are insurance premiums determined?

To answer the question of why insurance premiums have gone up so much, we need to consider how the cost of insurance premiums is determined.

Insurance companies are in the business of risk. To manage that risk, they must first calculate their expected future claims.

Insurers use a multitude of factors to calculate expected claims. These include historical data on past claims, the size of the pool of insured policies (larger pools have more predictable claims), and trends that could affect future claims (for example, changes in weather patterns).

They also rely on the analytical expertise and judgement of actuaries and underwriters. Actuaries assess and manage financial risks using mathematical and statistical models, while underwriters evaluate and price insurance policies based on risk analysis.

The future expected claims are used to determine the ‘pure premium’, also known as the risk premium. This is the amount of premium required to cover claims only, without allowing for things like overheads and profit.

The risk premium is combined with other costs (see Figure 2) to produce what’s known as an ‘office premium’. The office premium is the actual price that customers pay for their insurance coverage. This reflects the total cost of providing the insurance, managing the company and ensuring a profit.

Figure 2: Factors affecting insurance premiums

Source: ProActuary

Take UK motor insurance as an example.

The largest portion of the policy cost, 30%, is allocated to injury claims, according to the ABI.

This suggests that a significant amount of the insurance premium goes towards covering the risk of the insured driver causing injury to other drivers, their passengers or pedestrians.

Damage to the driver’s own vehicle accounts for the next largest portion of the premium, at 20%. This covers repairs to or replacement of the insured vehicle in the event of an accident or other damage. Damage to other vehicles and property accounts for 19% of the insurance cost.

The remaining portions of the policy cost cover theft (4%), replacement vehicles (4%), uninsured drivers (4%) and windscreens (2%).

Adding these components together, the pure premium or risk premium comes to roughly 83% of the total premium.

The remaining 17% is made up of overheads – in other words, the cost of operating an insurance firm, including salaries, rent, utilities and other administrative costs.

In addition, clients will pay a commission to their financial adviser. The ABI also highlights the fact that an insurance premium tax is levied by the government, which is an additional cost on top of the insurance coverage.

Figure 3: A breakdown of premium costs

Source: ABI

Clearly, any changes to these contributing factors, especially a rise in claims-related costs, can lead to an increase in insurance premiums. Economic factors and market conditions also play a significant role in shaping insurance premiums, affecting both the supply and demand dynamics in the insurance industry – see below.

What might affect the cost of insurance premiums?

Economic factors

The first point to keep in mind is that inflation measures – such as the consumer price index (CPI), the consumer price index including owner occupiers’ housing costs (CPIH) and the retail prices index (RPI) – are based on a ‘basket of goods’ approach.

The reported figure is a weighted average of all the underlying goods and services that are affected by their own varying rates of inflation. For many inflation indices, such as the CPIH, the ‘weights’ of the various items in the basket are chosen to reflect their importance in the typical household budget (ONS, 2016).

Components of motor insurance claims – for example, the raw materials needed for repairs such as metals and paint – are still experiencing particularly high rates of inflation. These costs naturally get passed on in premiums.

In an example from the United States, according to a 2021 report from the Bank of America: ‘In the past year, the raw material cost in an average US vehicle has been steadily rising, increasing ~87% from a low point of approximately $2,200/unit in April 2020 to now roughly $4,125/unit in May 2021.’

Cars are also becoming more sophisticated with the increased use of innovative and expensive technology, which leads to higher repair costs over time. This is backed up by CCC Intelligent Solutions, which tracks automotive claims data. They report that vehicle repair costs have been rising steadily over the last few years, due to advanced safety features, such as sensors and cameras, which are more expensive to repair or replace.

Indeed, the total cost of repair (TCOR) has increased year-on-year since 2018 for all vehicle categories, from new cars to vehicles that are seven years and older (see Figure 4).

Figure 4: Average TCOR by vehicle age (all loss categories), 2018-23

Source: CCC Intelligent Solutions

The frequency and severity of claims

Over the past few years, there has been a rise in the frequency and severity of claims. The reasons behind this include increased distracted driving (such as people driving and typing on their phones), a rise in theft, higher traffic congestion and more vehicles on the road (especially compared with during the Covid-19 pandemic when lockdown measures were in place).

With more accidents occurring, insurance companies need to make higher payouts, which results in higher premiums for the end user.

According to the US-based National Safety Council, the percentage of drivers manipulating hand-held electronic devices has increased by 127%: from 1.5% in 2012 to 3.4% in 2021 (see Figure 5).

In Great Britain, the figures are slightly lower with 1% of drivers observed using a mobile phone while behind the wheel (GOV.UK, 2021). One reason suggested for this difference is the prevalence of automatic transmission vehicles in the United States compared with in Europe, which can ‘free up’ a driver’s hand to use a phone (New York Times, 2023).

Figure 5: Driver use of mobile phones, 2002-21

Source: National Safety Council

A recent rise in vehicle theft has also contributed to the increase in claims. A concerning trend over the last couple of years is the escalating vehicle theft rates in both the UK and the United States.

Over one million vehicles were stolen in the United States in 2022 – the most since 2008 and a year-on-year increase of 7%, according to the National Insurance Crime Bureau (NICB). The trend is even starker in the UK, where the number of vehicles stolen across England and Wales rose by 24.9% in 2022, according to data published by the ONS.

By the end of 2023, over 3.5% of the total loss valuation of insurance companies in the United States was from theft (see Figure 6).

Keyless cars have been targeted the most as thieves keep pace with manufacturers by using a variety of high-tech methods to steal cars (The Times, 2024). While the recovery rate of these stolen vehicles is high (around 85% were recovered), the sheer volume of stolen vehicles is proving to be a headache for the insurance industry.

Figure 6: Specific vehicle thefts as part of total loss valuation counts, 2018-23

Source: CCC Intelligent Solutions

Climate change and the increase in natural disasters

Natural disasters – from devastating hurricanes and wildfires to catastrophic floods and tornadoes – are increasing in frequency and cost.

‘Over the past five years, the United States has experienced an average of 18 billion-dollar climate disasters per year’, according to Forbes (see Figure 7).

In the UK, flooding is one of the major climate risks. Approximately 6.1 million people across the country live in flood-prone areas – a number expected to increase by 61% by 2025 under a modest global warming scenarios of 2°C (UK Health Security Agency, 2023).

Figure 7: Number of billion-dollar climate disasters in the United States

Source: Forbes

These catastrophic events can affect an insurer’s overall profitability. Insurers may raise premiums across various lines of insurance, not only for home insurance but also for car insurance, to offset potential losses from catastrophic events.

Litigation costs

The insurance industry is affected by the legal landscape, including the cost of litigation.

In many areas, there has been a trend towards larger settlements and judgments, which increases the cost of claims. These higher settlements have come from higher costs of surgery and medical care (medical inflation) and new types of claims such as post-traumatic stress disorder (PTSD), among other things. Insurance companies, in turn, raise premiums to cover these higher expenses.

Reforms to personal injury compensation systems, such as changes to the calculation of damages or limits on compensation, can also have an impact on insurers’ costs. For perspective, consider the ABI finding that ‘more than 1,500 whiplash claims are made in the UK every day, costing the insurance industry more than £2 billion a year – and adding £90 to the average annual motor insurance premium’.

A positive change has been the recent UK whiplash reform, which is likely to limit the cost of litigation in this area. The reform will limit the maximum amount per payment and require medical evidence for certain claims, among other things.

Regulatory changes

Regulatory changes can also influence insurance premiums.

New laws and regulations may impose additional requirements on insurers, such as higher capital reserves or more comprehensive coverage mandates. Incorporating and implementing these changes often results in increased operational costs for insurers, which are again passed on to consumers in the form of higher premiums.

An example of this is the recent change to solvency requirements for insurers (IRFS17 reporting standard), which has used valuable resources and teams of actuaries to implement. This can influence premiums indirectly. Insurers may increase premiums to ensure they have sufficient capital reserves to meet the regulatory requirements and absorb potential losses, particularly in case of catastrophic events.

Fraud

Insurance fraud remains a significant concern for insurers. Fraudulent claims cost insurers billions of dollars annually in the United States alone, according to the Coalition Against Insurance Fraud.

Staged accidents, exaggerated injury claims, and other forms of fraud contribute to higher costs for insurers and increased premiums for policy-holders.

Instances of fraud increase in times of recession. Recently, the combined impacts of Covid-19 and the cost of living crisis have caused a significant increase in fraud-related claims. In the UK, the City of London Police’s Insurance Fraud Enforcement Department (IFED) has reported that the cost of living crisis ‘has contributed to a dramatic increase in insurance fraud, with a surge of 61% reported’.

Investment income

Insurers often have large balance sheets of capital held in reserve to pay future claims. There are strict rules governing how these assets may be invested. This ensures an acceptable level of matching between their assets and liabilities (the future expected claims).

For example, insurers are allowed to invest in safe assets like cash and bonds (government securities), while they typically aren’t allowed to make large allocations to riskier assets such as equities and property.

While most of their assets are invested in money-market instruments like cash and bonds, they expect to receive a small return on the money invested. This return is used to supplement premiums collected from policy-holders.

But in times of economic uncertainty or low interest rates, as we experienced up until 2022, investment returns may not have met expectations. In these circumstances, insurers may have adjusted premiums to maintain profitability and we are possibly seeing a lagged effect of these measures.

Conclusion

The rise in insurance premiums is a complex issue influenced by a range of economic, industry-specific, regulatory, environmental and social factors.

Looking at the reasons behind the recent steep rise in insurance premiums, it is evident that certain factors have had a more pronounced impact than others. In particular, the escalating costs of vehicle repairs (which has been exacerbated by supply chain issues) appear to be a primary catalyst.

Looking ahead, it is plausible that premiums may continue to adjust upwards as insurers recalibrate their risk assessments to account for various dynamic factors. But suggesting that premiums have reached a ‘permanent new plateau’ might overlook the inherent volatility and adaptability of the insurance sector.

As such, while many insurance premiums are likely to remain high relative to past benchmarks, their future course will depend on how the complex and interlinked factors discussed above evolve.

As the industry navigates through these challenges, and the future of premiums is inherently uncertain, the goal remains to strike a balance between ensuring adequate reserves for claims, maintaining profitability, and providing affordable coverage to consumers. This delicate balance is essential for the sustainability of the insurance sector and the protection it offers to individuals and businesses alike.