What is more risky to insure – 100 warehouses having inflammable chemicals in 100 drums each or one warehouse with 10,000 drums of the same material? All things remaining equal, which portfolio will lead to a larger loss from fire? Some may prefer the diversified base of 100 warehouses because a minor incident of fire in the latter can quickly snowball into a total loss of 10,000 drums. Risk professionals refer to this as severity risk: the possible extent of loss in case of a claim. A few may consider a single warehouse less risky. This group is likely to dismiss the ability to insure 100 independent units of similar risk profiles. They may also argue that the chances of an unfavourable incident increases with 100 locations in play. This is called claim incidence risk. Irrespective of your stance, it is easy to agree that these are two different classes of risks. In a landmark regulatory action, IRDAI has carved out a distinct product identity for fire insurance coverage catering to homes and small businesses.
Factors governing fire insurance
Currently, the fire insurance product is governed by the All India Fire Tariff, 2001. All terms, conditions, clauses, warranties, policy and endorsement wordings are uniform across insurers, and are derived from this tariff. Insurers also refer to this tariff for rating of specific risk occupancy and offer a ‘discount’ on the erstwhile rate. Over the last few years, insurers gradually gave up this discretion on rating. Among themselves, insurers have agreed to a minimum rate for each occupancy. Competition ensures that most policies are charged this minimum rate. Until now, the same rate is charged irrespective of the size of risk.
Starting April 1, 2021, all dwellings and commercial risk with less than Rs 50 crore of sum assured will be carved out of this tariff. Instead, they will fall under three new standardized products, one each for dwelling, commercial risks with up to Rs 5 crores of sum assured, and commercial risks between Rs 5 and 50 crore of sum assured. These products are substantially simplified to ensure a hassle free claims process for the insured. Insurers are allowed to file up to three add-ons to differentiate their offerings, and charge premiums as per their risk perception.
There are several positives in this for the policyholder. First, by design, the regulator has encouraged waiver of under-insurance. Often residential owners and small businesses end up estimating a low sum assured for their risks. This leads to deduction at the time of claim. In the new product, home insurance will now have complete waiver of under-insurance. So, in case of partial loss, there would not be any deduction in claim amount. For commercial risks, under-insurance is waived to the extent of 15 percent. Currently, insurers rely solely on an insured’s self-declaration of sum assured at risk. Under-insurance waivers will push insurers to devise alternative methods to help insured to estimate the sum assured. Second, insurers are likely to file innovative add-ons to differentiate their offerings.
Since the risks are small, they will have a higher ability to manoeuvre. I expect a few add-ons will include fixed benefits covers that pays lump-sum in case of a natural catastrophe such as earthquake, and a more comprehensive business interruption insurance. Third, for home insurance, the policy will automatically cover general contents up to 20 percent of the building sum assured up to a maximum of Rs 10 lakh. Insured need not declare the details of these contents. This substantially eases the policy administration. Higher amounts can be opted by declaring the details. Fourth, the policy wordings has been simplified to a large extent. In the Tariff, bush fire was a default coverage but forest fire had to be covered explicitly.
Similarly, impact damage due to third party vehicle was a default coverage, however impact damage due to insured’s own vehicle was required to be covered explicitly. Small businesses are not able to spend much time to appreciate and plan for such nuances. In the new product, these distinctions have been done away with. Impact damage of all kinds will be covered by default, so will be bush and forest fire.
Concerns in certain quarters
Not all insurers are bullish about this change though. In my conversations with senior executives of some insurers, I realised that they were apprehensive. For one of the leading private sector insurers, the big concern was technology change. Most insurers use legacy policy management systems. This change will require them to setup unique product codes, policy issuance system, claims process etc. He was sceptical, if they would be able to meet the launch deadline.
Another insurer was sceptical of the actual change that will get implemented. Early conversations with re-insurers had not been very encouraging. They were keen to maintain status quo in terms of charging the same minimum rate as for larger risks. A third insurer was concerned that some of the built-in covers may increase the overall price. Terrorism is now a built-in cover. If the rate of terrorism is same for large and small risks, it may discourage first-time buyers.
The above concerns are addressable. For starters, insurers ought to reduce their dependence on re-insurers for smaller risks. If they are able to build a strong balance sheet to underwrite on their own, some of the above systemic challenges will get sorted. It will encourage pricing differentiation based on loss experience of individual insurers, and reward good risk selection.
SME and home insurance products have a large potential market. An easy-to-understand product that is attractively priced will help drive adoption. A large base will help in risk diversification, and fuel a virtuous cycle. The opposite will be true if we are not able to expand the insured base. For example, if an office in Delhi wants to add terrorism cover to their Fire insurance, which includes flood and earthquake cover, their premium would go up by as much as 30 percent. As a result many businesses opt out of the terrorism cover. In 2018-19, the total premium income for terrorism was Rs 531 crore, as opposed to total Fire premium of Rs 11,667 crore. I am hoping that a few insurers would take this opportunity to lead the case for higher adoption. Others will take the cue soon.