Only the market, and not politicians or regulators, can accurately price risk, writes Paul McDonnell
Insurance exists, amongst other things, to help us get through the unexpected. However, in recent times, insurers have also suffered a nasty dose of the unforeseen, including falling stock markets (where a lot of your life and pensions premiums get invested), AIDS, SARS and, at home, various external costs such as hospitals charging insurers more to treat road accident victims than other patients. The resulting price increases were a surprise and nobody likes surprises. Part of the public relations challenge for providers is that they are unable to warn customers about things that cannot be foreseen.
Well here's something that insurers can foresee and you need to be warned about it now.
The European Commission is planning to ban gender "discrimination" in the pricing of insurance. Now if you think this sounds like a good idea, think again.
Pricing some insurance products according to the gender of the insured customer might sound strange; but, in fact, it's essential. It's why young women pay less for motor insurance than young men. Decades of observing accident rates and costs have taught insurers that providing cover to young men costs more than insuring young women. Hence insurers charge young men more for motor insurance. If they didn't, it would mean that young women would pay more to subsidise young men. It would also mean that, with artificially low premiums, more dangerous young male drivers would be on the road, resulting in more deaths and injuries.
That, by the way, is one of the socially beneficial effects of allowing the market, rather than politicians or civil servants, to price risk. But higher motor insurance costs for women are a minor problem compared to what the ban on gender "discrimination" will do to your efforts to save for retirement.
Women tend to pay more for pensions products that pay a stream of income (i.e., an annuity) after retirement. On average, the pot of money they have to accumulate needs to be greater - or the income they are paid needs to be smaller - than men's because they live longer: in Ireland 5 years longer.
If a woman aged 65 has a life expectancy of 19 years and retires with a pension fund of €100,000, she might receive around €6,000 a year from an annuity. By the time she dies 19 years later she will have received 19 times €6,000, or €114,000 in total.
If a man at age 65 with a life expectancy of 16 years buys an annuity with a pension fund of €100,000 he will receive more income per annum than the woman - €7,125 - but it will only be paid out for 16 years so in total he will have received 16 times €7,1250, or €114,000, the same amount of total income as the woman. Because women draw more from these funds then more must be put into them.
On the other side of the coin, but for the very same reason (longer life expectancy), women pay a lower regular premium than men for equivalent life assurance protection.
The issue is not gender but life expectancy. The use of gender-based annuity rates is based on the same principle that means that a 60-year-old will receive a lower annual income than someone buying an annuity with the same sum in their 70s. That is, a finite fund to be used for a longer period of time must provide a lower annual income, but not a lower total income, than one disbursed over a shorter period. Is this age discrimination? No. Should it be outlawed? Hardly.
If the Commission forces insurers to charge the same annuity rates (for retirement) to women as men, then a number of unexpected and unpleasant trends will emerge.
Firstly, male retirees will lose part of their savings to cross-subsidise the pensions of women. Secondly men will simply withdraw from the pensions market in large numbers - hardly a desirable outcome for an EU that is already facing a crisis in paying for old age. Thirdly, the proposal will lead to a big increase in the numbers of people living off their capital in retirement and so outliving their savings, leading to a much bigger poverty problem among very old people.
Having voted with their feet and left the market there will be fewer men to cross-subsidise women. Insurance premiums will rise for everyone and all consumers, especially poorer people, will be worse off.
Only by taking account of the facts - such as the fact that women live longer than men or the fact that they are safer drivers than men within certain age groups - can risks be measured and insurance cover accurately priced. If the Commission outlaws this principle of calculation then it will damage the insurance market. And remember the market is you as well as the insurers. The political goal of making pension coverage less expensive for women by prohibiting gender-specific annuities will fail.
So what is the Commission at? Doubtless they are trying to do the right thing. But just as privately run businesses can fall into dishonest behaviour so governments and regulators can develop a false belief that they alone are the guardians of the common good. Just as with dishonest businesses, this is often nothing more than a combination of power and ignorance.
In this instance the Commission is threatening to undermine the common good that is already served outside its sphere of power. What those who attempt to community-rate insurance premiums forget is that the whole concept of insurance itself arises from a recognition - within the community itself - that when people come together to share risk then life is more tolerable, investment (like buying a house) can be planned and everyone is better off.
So successful is the insurance industry at pricing and sharing risk that multi-billion euro claims can occur from single events without any lasting damage to society or to insurers.
It would be understandable if the Commission were trying to right some identified problem - such as poverty in old age. They should be reminded that insurance is already a successful form of community-sharing risk.
Paul McDonnell is regulation and planning manager of the Irish Insurance Federation