What drives car insurance higher?

By BBC News Online's Orla Ryan

UK motorists have already been driven to protests by the high price of petrol at the pump.

Now the costs of owning a car are set to get even higher, as a report predicts that car insurance premiums could rise by as much as 20% during the next 12 months.

Premiums were being driven at unrealistic rates to drive business

AA Insurance Services

Comprehensive car insurance averaged £629.04 in April this year, according to the AA insurance index, compared with the average July 1994 premium of £367.27.

More people are claiming compensation, say the insurers, and this is the main reason for the rising premiums.

At the same time, competition from telephone and online insurers has driven down premiums.

While the price for an average car insurance fell by 15% between 1994 and 1997, the cost of claims rose by about 20%.

"People are much more inclined to sue after an accident. We are seeing payouts for compensation claims increase. If people are entitled to compensation, they should have it. [But] there is a cost, it is not free money," an ABI spokeswoman said.

The compensation culture is now a reality and as Gordon Aitkin, CSFB insurance analyst, said: "The man on the street can't expect to have premiums stay the same when claims are increasing."

The Association of British Insurers estimates that for every £1 insurers collect in premiums, they have to pay out £1.15.

And premiums have so far failed to rise in line with costs, argue the insurers.

These high costs are the reason why last year UK motor insurers made a combined loss of £1.3bn.

The market has become so competitive that some insurers, such as Drake Insurance, have gone out of business. Now, even supermarkets are planning to sell insurance.

Price war

UK consumers did temporarily enjoy an incredibly competitive motor insurance market.

The arrival of Direct Line and other direct sellers in the early 1990s saw premiums fall. For the newcomers this wasn't a problem - because they sold online and on the phone, their cost base was in any case lower.

However some of the incumbent insurers cut their premiums without cutting their costs and they are now hurting.

Insurance claims from accidents have become higher

"Premiums were being priced at unrealistic rates to drive business," an AA Insurance Services statement said.

"Motor insurance has been underpriced for most of the 1990s... Consumers have had an articificially low price for several years," Anthony Worsfold, editor of Post, the UK insurance magazine agreed.

Fraud and expensive cars

Other issues have conspired to push car insurance higher.

Fraud is one reason and Direct Line estimates that one in 20 vehicles is uninsured.

"All the honest motorists are having to pay extra to cover the cost of accidents," the Direct Line spokesman added, estimating that this adds about £30 to everyone's insurance premium.

Cars may have become cheaper in recent months thanks to consumer campaigns, but they have definitely become more sophisticated.

"You don't get simple damage to a car anymore. What looks like a few dents could be very expensive. You don't get as many simple repairs anymore, " Post magazine's Anthony Worsfold said. "A hard impact collision a few years ago could have been relatively cheap to sort out."

Carry on getting older - companies like you when you get older and experienced

Association of British Insurers spokeswoman

Motor insurers are the biggest buyers of replacement parts for crash repairs, according to the Motor Insurance Research Centre at Thatcham.

Jointly UK insurers buy £3bn worth of car components a year and spend another £3bn on labour, it says.

Future trends

Views are mixed as what the trend for car premiums in the future will be.

Datamonitor doubts that the heady days of competition and low prices will ever return.

Most experts agree that premiums will rise, but some dispute they will rise by the 20% or more predicted by Datamonitor.

"The cost of car insurance looks set to continue rising in the first half of this year - but we expect the rate of increase to ease in the second half," Kerry Richardson, managing director of AA Insurance Services said.

Its view is that as insurers return to profitability, the rate of increase of premiums will slow. Costs could also eventually be driven down by a growth in online sales.

CSFB's Gordon Aitkin believes prices will eventually come down as the insurance industry is by its nature cylical.

At one end of the cycle, there is high competition and low profits, squeezing some operators out of the market and ultimately forcing premiums higher. But high premiums and high profits encourage companies to dip their toe in the market, and the cycle starts again.

Most industry experts say that there are bargains to be had and encourage consumers to shop around.

"Even though some insurance companies are having to put their prices up, that is not the case across the market," a Direct Line spokesman said.

The ABI spokeswoman's advice is simple.

"Carry on getting older as companies like you as you get older and experienced," she said.