AUTO INSURANCE POLICY AND REFORM

 

Bar Dadon

 

 

The compulsory auto insurance industry, which deals with bodily injuries resulting from auto accidents, insures 1.5 million vehicles and has an annual turnover from insurance premiums of about $1 billion. 

 

IASPS Policy Studies No. 30 examined this industry in Israel and around the world and focused on the problems and economic distortions created by government interference in the industry in Israel.  The Policy Studies also presented recommendations for change in an attempt to eliminate these distortions.  Since the publication of this research in October 1997, significant steps have been taken by the Knesset, the state commissioner of insurance, the Israel Consumer Council and others to deal with the situation.

 

Information for this article, which will present a brief review of the problem and an update of recent events, has been supplied by a representative of the insurance commissioner.1  Other data were gathered at Knesset committee meetings attended by a representative of the Institute for Advanced Strategic and Political Studies.

 

Review

 

Auto insurance in Israel is composed of property insurance and compulsory insurance.  Property insurance is voluntary and only covers damage to the vehicle itself.  Compulsory insurance is intended to cover bodily harm resulting from an accident and is mandatory for all vehicle owners.  In Israel today there are some 1.55 million vehicles.  The total compulsory insurance premiums amounted to $1.015 billion in 1997.2

 

The Compensation Law of 1975 states that premium rates will be set by the minister of finance with the approval of the Knesset Finance Committee.  Added to the premium are charges of 6.94 percent which the insurance companies receive for the issuance of the policy, 1.6 percent to cover a state stamp tax, and 4.57 percent which goes to a “Transportation Fund” set up by the Ministry of Transportation. 

 

The rates for compulsory insurance are the same for all drivers and are determined solely by the size of the motor.  Rates do not distinguish between careful drivers who take care of their vehicles and do not drive much, and dangerous drivers who drive hundreds of kilometers per day and are high accident risks.  The rates do not reward careful drivers or those who take precautions against accidents.  The formula for determining rates results in certain groups of drivers subsidizing others.

 

A study by the insurance commissioner3 found that car drivers subsidize other drivers, especially motorcyclists.  In 1996, the number of motorcycle drivers injured in accidents was 3,699.4  While other countries do not include motorcycles, taxis, and trucks in their “No Fault” coverage,5 the method used in Israel forces drivers of automobiles to subsidize vehicles which have a higher degree of accident risk.

 

Far worse is that the 1975 law created a very centralized industry.  An official cartel was created, on top of which government institutions took advantage of various powers granted to them, in order to serve their own interests, which were not always identical to those of the public which the legislation had been designed to serve. 

 

The Policy Studies showed that $1.7 billion out of total premiums paid over the past decade was channeled into funds and special taxes unrelated to insurance.  

 

The main problem however, is Avner, a cartel of auto insurance companies founded in August 1977.  Avner was established with the agreement and under the supervision of the insurance commissioner.

 

Avner is a private limited liability share corporation.  Its shareholders are the auto insurance companies, each according to its relative share of the market.  Representatives of the companies make up Avner’s Board of Directors.  When an insurance company’s share of the market changes, so does its holding in Avner.

 

The relationship between Avner and the insurance companies was formalized in an agreement written in February 1987.  It is renewed every five years.  According to this agreement, Avner is a re-insurer.  Each insurance company is a “leading insurer.”

 

Israel’s State Comptroller warned in 1981 that the insurance companies are not responsible for potential losses.  Should Avner experience financial difficulties, the public would directly or indirectly finance the losses.6

 

It was agreed among the insurance companies when Avner was established that any gap between premiums collected and total claims would be recouped through future premiums.7  In other words a “temporary” deficit would be covered by the public through increased premiums in the future.  This creates a vicious circle:  although the shareholders of Avner are the insurance companies, they are not responsible for losses incurred by Avner.  These losses become the responsibility of the insured public.

 

This principle creates a clear interest on the part of the insurance companies to have Avner show losses.  In fact, the State Comptroller’s prophecy was fulfilled: during the past twenty years Avner showed ever larger losses which were then financed by Israeli consumers.  Beginning in 1981, an additional fee of 11.53 percent of the basic premium was tacked on, to compensate the insurance companies for past losses.  According to the State Comptroller Report No.  29, one of the principal reasons for Avner’s supposed losses was that the separate insurance companies which receive the premiums, hold onto them for about 45 days before transferring them to Avner.  Each day’s delay in transferring funds was estimated in 1977 to cost Avner about $50,000.8  Not only did the insurance companies not compensate Avner for these losses they caused, but they then shared in the revenues generated by the “past losses” component of the insurance premium, in effect adding insult to injury, or actually, compounding the injury to Israeli policy holders. 

 

Since Avner is a non-profit organization, profits cannot be paid to the owners.  Alternative methods had to be found to withdraw the funds.  The Policy Studies identified two principal methods:

 

1.  Payment of commissions and levies:  The insurance companies collect various commissions from Avner:  a fee, for example, for issuing insurance policies (6.5 percent of the basic premium).  Avner receives only 0.5 percent of this commission even though it certainly incurs as many administrative expenses as the other insurance companies.  The commission, in effect, is a profit-skimming scheme.  Another example is that since 1993, the insurance company handling a claim is paid a commission of 2.1 percent of the claim sum from the other party.  Avner paid out $4.79 million for these commissions during one period of just six months.  Finally, as mentioned, the insurance companies received, up until December 1997, revenues from the “past losses” component of the premium. 

 

2.  Actuarial Evaluation:  Avner’s expenses are composed of claims which have been settled and those which are outstanding.  The evaluation of the latter involves estimating future expenses stemming from accidents which have already occurred.  This estimate is calculated by an Avner actuary who presents his findings to Avner, the insurance companies, and the insurance commissioner.  But, these estimates were never checked by the commissioner, or any other government committee involved in setting the price of insurance premiums.

 

The Policy Studies revealed that Avner’s cash flow has been positive during the last decade; Avner’s recorded losses, however, continued to increase from 1980 through 1993, reaching $500.34 million that year.  Avner then embarked on a “recovery program” which reduced losses to only $90 million as of March 1998.

 

Since the value of outstanding claims is only an estimate, it can be overstated to show losses or underestimated to show increased efficiency.

 

In 1993, the Eliahu insurance company decided to withdraw from the Avner cartel and sell insurance on the open market.  The other insurance companies opposed this move.  Israeli courts ruled that Eliahu could not withdraw from Avner until the conclusion of the cartel agreement between them in December 1996.  Despite the setback, the case made headlines, increasing public awareness of the problem.

 

Miraculously, Avner immediately afterwards started to show annual profits.  According to Avner’s financial reports, its accumulated deficit totaled $331.35 million as of 1994.  By 1997, this deficit had been reduced to $123 million and by 1998 to only $90 million. 

 

In July 1997 the Knesset’s Legal Affairs Committee introduced legislation that would dismantle Avner in the year 2000, and allow the insurance industry to move towards regulated competition.

 

The Policy Studies recommended that Avner be dismantled and that the various insurance companies supply compulsory insurance on their own, and that differential rates be allowed. 

 

Policy Update

 

Since publication of the Policy Studies in October 1997, several far-reaching changes have occurred.  On January 1,1998 the insurance commissioner decided for the first time in 10 years to decrease compulsory insurance premiums by an average of 8.5 percent.  This included a reduction in the amount of the “past losses” component of the premium, as the insurance companies were now claiming profits.  In addition, the commissioner decided to end the cross-subsidization of certain types of vehicles.  Thus, taxis, motorcycles, and vehicles with engine sizes of up to 1,000 cubic centimeters had their premiums raised while other vehicles had theirs reduced.

 

Knesset Member Yitzhak Cohen, chairman of the Subcommittee of Insurance of the Knesset Finance Committee, read the IASPS Policy Studies and opened an investigation into the “past losses” and the effects of Avner on the insurance industry.  Committee hearings on the subject were attended by representatives of the insurance companies, the insurance commissioner, the Israel Consumer Council, and the Institute for Advanced Strategic and Political Studies. 

 

The Committee decided to examine the actuarial estimates of Avner’s accountant from the cartel’s establishment to the present day.  Special emphasis was to be placed on the “past losses” component and the collected premiums.  The examination was to be paid for by the “Research Fund,” which has been shaving approximately $435,000 annually from insurance premiums.  Ordinarily, this fund is managed by the Insurance Companies Association which decides which research topics (if any) to fund.

 

The Fund’s management, headed by Dr.  Itamar Borovitz, the general manager of the Phoenix Insurance Company, refused to fund the actuarial evaluation.  Even when the management finally conceded, it continued to raise difficulties concerning the scope of the evaluation, who would conduct it, and the amount of funds to be allocated.

 

The controversy between the insurance commissioner and the Fund continued for several months, within the Finance Committee and outside it.  This controversy, and others in the insurance industry, drew more media attention and brought new revelations.

 

Secret documents belonging to the Research Fund management were discovered and published in Ha’aretz on May 17, 1998.  These documents revealed that the Fund Management had transferred funds to various organizations unconnected, to say the least, to compulsory auto insurance.  For example, a 10-year interest-free loan of $1.75 million was given to the College for Insurance Studies.  The director of the College, Gavriela Shalev, is the common law wife of the general manager of the Migdal Insurance Company.  A contribution was made to the Committee for Preserving the Memory of Eliahu Golomb, the commander of the 1940’s Hagana, and uncle of Shmuel Golomb, chairman of the Insurance Companies Association.  Other examples include contributions to the Palmach Association, the Tel Aviv Museum, the Center for Babylonian (Iraqi) Jewry, and the list goes on.  As a result of these revelations, the insurance commissioner canceled the collection of revenues for the Research Fund; past fund expenditures are now under investigation.

 

In September 1998, the Finance Committee took two very important steps:

 

1.  An additional 8 percent average reduction was made in insurance premiums for all types of vehicles based on totally ending the collection of revenues to cover Avner’s past losses.  Though Avner’s books show a cumulative loss of NIS 325 million, the insurance commissioner proved Avner had already covered all its losses.  It seems Avner was not recording on its balance sheets any of its profits from the past three years. 

 

2.  A British actuary, Dr.  Stuart Koch, was appointed to carry out an objective actuarial evaluation.  The cost of Koch’s investigation, NIS 900,000, will be covered by the Research Fund.  Perhaps, in principle, the Fund’s monies should have been returned to the public from whence they came; but considering the alternatives, spending the money on an investigation of the insurance companies’ corruption beats spending it on museums run by the spouses of insurance company presidents.

 

The reduction in compulsory auto insurance rates mandated by the Insurance Subcommittee has saved Israelis $161 million in only nine months.  In addition, the Eliahu insurance company decided to sell its policies at an additional 7 percent discount; collection of the premium of approximately 1 percent for the Research Fund was ended; and the 2.1 percent commission paid to insurance companies for handling claims was canceled.  All these factors resulted in substantial further savings. 

 

As a result of the changes described above, insurance premiums now cover the following components:

 

 

 

 

 

 Before the Changes

 

 After the Changes

 

 Risk Premium (coverage      of accidents)

 

         70%

 

       89%

 

 Kranit

 

        5.15%

 

      5.15%

 

 Safety Fund

 

        4.57%

 

      4.57%

 

 Stamp Tax

 

        1.6%

 

      1.6%

 

 Past Losses

 

       11.53%

 

        -

 

 Research Fund

 

        0.06%

 

        -

 

 Processing of Claims

 

        2.1%

 

        -

 

 Registration (voluntary)

 

        6.94%

 

      10%

 

 

These changes have not been effected without opposition.  The insurance companies, led by Carmi Gillon, Avner’s general manager, are lobbying hard for cancellation of the law already enacted by the Knesset.  As part of this effort, two bills were tabled before the Knesset recessed in July to delay by two years the dissolution of the Avner cartel, and the introduction of regulated competition into the insurance industry.  Several Knesset members, including Hanan Porat (NRP), Beiga Shohat (Labor), and Michael Kleiner (Gesher-Likud), argued that the opening of the industry to competition is liable to discriminate against low income groups, and that there is presently an insufficient data base about accidents in Israel to allow such a move.  The purpose of the bill is clearly to reverse current law in order to preserve the cartel.  Amazingly, the bill passed in a pre-reading in the plenum this November; it needs to be voted on three more times before taking effect.

 

The policy reforms begun by the Subcommittee on Insurance, are still being implemented by the insurance commissioner, who says several steps still need to be made:  ending the earmarking of part of the premiums for the “Transportation Fund;” the issuing of an international tender to provide the commissioner’s office with an independent database, not emanating from Avner itself, about the auto insurance industry in Israel (essentially, outsourcing the collection of data necessary for the commissioner’s office); changing the law to allow differential premiums; and, actually opening the industry to competition next year. 

 

Grades

 

The work of Insurance Commissioner Tsippi Samet and Knesset Member Yitzhak Cohen, among others, is certainly worthy of praise.  Their activities merit a high grade.  However, the steps taken so far fall well short of the all-encompassing reform needed in the insurance industry.  Prices are still not determined by competition and just as they declined as a result of the present regulatory framework, they could increase as a result of different supervision and a reduced level of public awareness.  This has, in fact, been our experience over the past 22 years.  State intervention is the problem, not the solution.  The principal distortion lies in Avner’s existence and methods of operation, and the state’s use of auto insurance as a cloak concealing its raid on the public’s wallets.  I give the reformers a grade of Very Good, but I would warn that the price of auto insurance reform is vigilance at least until the year 2000, for the statists, insurance barons, and several less-than-alert MKs may yet scuttle the reform.

 

Bar Dadon is an IASPS Koret Fellow at the Institute for Advanced Strategic and Political Studies in Jerusalem and Washington, D.C.  She is the author of IASPS Policy Studies No. 30, “Reforming Israel's Automobile Insurance Market.”

 

Notes

 

1.  Alon Barzilai, director of the Elementary Insurance Department, State Commissioner of Insurance, interview, October 14, 1998. 

 

2.  Ibid.

 

3.  Globes, January 22, 1977, p.  14.

 

4.  The Central Bureau of Statistics, Statistics on Land Transportation (Jerusalem:   CBS, November 1996), Table 16.  [Hebrew].

 

5.  Kesselman and Kesselman, No-Fault Automobile Insurance (January 20, 1997).     

 

6.  State Comptroller, State Comptroller’s Report 31 (Jerusalem:  State Comptroller, 1980).  [Hebrew]

 

7.   Professor Nissim Arania and Co., certified public accountants, Avner, Ltd., and Application of the Compensation for Traffic Accident Casualties Law, p.  12.  [Hebrew]

 

8.   State Comptroller, State Comptroller’s Report 29 (Jerusalem:  State Comptroller, 1978).  [Hebrew]

 

 

 

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