Often when choosing a new car insurance policy or renewing an older policy, the biggest decision point for a consumer is the price of a policy. Insurance distributors know how you think and hence offer the cheapest policy to win your deal.
This article explains why lower premiums is not always a good thing from a consumer standpoint.
What are the things that decide a car insurance premium?
The three biggest things that decide your car premium are:
Although it does not take a rocket scientist to figure out how these factors affect your car premium intuitively, it certainly takes some skill to compute an exact premium value.
Very quickly, your insurance is calculated based on two unknowns –
- What is the chance of your car going for a workshop visit?
- What is the cost each time it makes that visit?
So, while a bad driver increases the chance of a workshop visit, an old car increases a cost per workshop visit. Either ways, the impact is the same and that is an increase in your insurance premium. It’s an insurance company’s job to predict the probability of repair & also the associated cost of that repair.
How does an insurance company calculate your car premium?
Insurance company tracks the repair costs per car type over its life cycle and comes up with a price chart for every car model based on its age. Here is a big secret you mostly don’t know.
What does this mean? Let’s say Rahul Gupta purchased a Maruti Swift Desire in 2012 for 7 Lac rupees. Assuming a fictitious 10% yearly depreciation, Rahul’s car value has been dropping every year as follows (assuming a linear depreciation):
So what happens if your car gets irreparably damaged because of some unfortunate accident (a phenomenon in insurance parlance is called ‘total loss’). In this case, Rahul would be paid only 459,270 by the insurance company. How does insurance company arrive at this value – through a concept called ‘Insured Declared Value’.
Insured Declared Value (IDV)
Insured Declared Value is a maximum sum assured value an insurer would pay for your car in the event of total loss or theft. Insured Declared Value. In other words, IDV defines the cap for your claim, if and when you make it. How does IDV get decided? Good Question. Insurance firms usually have a depreciation chart that computes IDV from selling price of vehicle.
A typical depreciation chart is as follows:
By the end of year 5, 50% of vehicle value will be deducted for IDV calculation. So on pure IDV terms, Rahul can only insure his 7 lac car for a sum assured value of 3.5 lacs on renewal after year 5. It is common sense that lower the IDV of a car lower will be the insurance premium, precisely the reason why an Audi sedan would have a higher premium than a Maruti sedan.
Insurance companies do not offer a single value for an IDV but a prescribed range. Tweaking this range is what changes your insurance premium – this is what brokers and online price aggregators do to lure the customer by offering low prices.
How much does a lower IDV reduce my premium?
That depends based on the age of the vehicle but let’s try to understand this by looking at an example.
Let’s say Rahul owns a 2014 Swift Dzire LDI (Diesel Version) - current market value according to websites like CarWale.com, assuming car has driven 20,000 kilometers, is 4,84,000. For our discussion, let’s say that value is 5 lacs. Now the same car when computed using our depreciation schedule would range in 4.8-5 lacs (40% depreciation on a car that is priced at roughly 6.2 lacs at the time of purchase).
Now let’s see the insurance premium quoted by different companies for this car (as per leading price comparer as on the date of publishing this blog).
Notice that IDV’s range from 2.6 lacs (L&T Insurance) to 4.45 lacs (Royal Sundaram) – that’s a pretty wide range (lowest IDV is 60% of the highest IDV). Notice also that premium varies in a relatively tighter band, from 7221-10234 (lowest premium is 70% of highest premium). Let me remind the readers that none of these policies have any additional add-ons and all of them roughly offer the same set of services.
It is unsurprising that insurers who offer the lowest premiums also offer the lowest IDV’s. By reducing the insurance premium by almost 1 lac, an insurer is able to offer a premium that is extremely competitive (by 1200-1500 rupees).
What is the problem with lower IDV?
In the previous case, while CarWale says that Rahul’s car is worth 5 lacs, some insurers seem to offer only 2.5 lacs of sum assured (incase of theft or total damage). Yes, this leads to a lower premium, but the million-dollar question is, are you as a customer better off choosing such a plan? Answer in our opinion is a clear NO.
Choosing lowest premiums is fraught with risks because such plans provide you inadequate cover. Let’s isolate 2 plans in the above table, Bharti AXA (IDV: 2.78 lacs, premium: 7800) V/s HDFC Ergo (IDV: 4 Lacs, premium 8350). Which one is better from a value perspective? Let’s see.
So for every rupee that you pay as premium, Bharti AXA is offering 35 rupees of protection (2.78 Lacs/7800) and HDFC Ergo is offering 48 rupees of protection (3 Lacs/ 8350). This is called a ‘per rupee cover’. Since HDFC is offering an additional 1.22 lacs of cover for extra premium of 500, HDFC’s ‘marginal per rupee cover’ is a phenomenal 244 rupees. So you as a customer are getting much better value to the additional 500 rupees you spend on this insurance.
Another advantage of HDFC Ergo is that its offering an IDV that is comparable to the re-sale value of Rahul’s car. It is important to insure your asset to atleast its resale value because if you lose that asset you can repurchase it in the market for its resale value. Bharti AXA falls short by that metric. If all of this looks too complicated, use Arvi to automatically crunch these numbers for you and provide a best recommendation.
Remember, the next time your agent quotes a really low premium, dig deeper and ask him the IDV, compute your ‘per rupee cover’ and compare it with your car’s present market value.