When I passed my driving test aged 17, the annual car insurance premium for my little one litre Nissan Micra equalled around one third of the total value of the car.
This was accepted as a fact of life by me and (more importantly) my parents.
At the time I fell within that most irresponsible of driving demographics: young males, between 17 and 25, who live in Essex. As far as the insurance company was concerned, it was almost a certainty that at some point in the near future, I would be in a car accident.
Some of my mates seemed to be actively trying to fulfil this prophecy. One, for instance, wrote off his first car just two hours after having passed his test by driving it into a lamp post. To his credit, it took him another two months to write off his next car.
He was certainly not the only one.
Meanwhile, my girlfriend (who drove exactly the same model of car as I did), was charged a premium of just over one sixth of the value of her car. Naturally, I didn't consider myself a greater risk than my girlfriend so this did appear unfair from the perspective of a 17-year-old studying for his A levels.
With the benefit of hindsight, however, all I needed to do was look over at my mates, scratching their heads as they stood over the smoking wreckage of their cars, to realise why I was being discriminated against.
And it is, indeed, discriminatory.
The tendency to price discriminately is by no means peculiar to insurance premiums (and certainly not just motor insurance), but the fact that a) the disparity is so obvious; b) the cost is often sizeable; and c) the unavoidability of buying some forms of insurance, makes discrimination a frequent bug bear for many consumers and, thus, raises its profile.
This high profile issue of discriminating by gender is one which has been addressed by the European Court of Justice in recent times, which has ruled that Directive 2004/113/EC, which prohibits all discrimination based on sex in the access to and supply of goods and services, should be applied to insurance contracts.
However, from an economic perspective, is price discrimination really all that bad? It exists seemingly legitimately in a wide variety of circumstances.
Age discrimination is commonplace through student or senior discounts, (or, indeed, through insurance premiums). Geographical price discrimination is behind the extortionate prices that UK consumers pay for, amongst other things, electronic goods compared to their US or European counterparts.
Equally, significant differences in price for aeroplane tickets for people travelling on different days also demonstrates the widespread use of inter-temporal price discrimination.
In fact, the ability of producers to accurately price discriminately actually tends to increase total welfare, and so has a positive net economic effect (though this does not necessarily mean that consumers are better off).
In a perfectly competitive world, prices tend towards the marginal cost of production. This model is clearly not viable in a world where fixed costs exist in most cases. The 'next best' alternative, therefore, is to use an economic pricing model, known as Ramsey Pricing, in which consumers pay the marginal cost of the product or service plus a share of fixed costs which is proportionate to their ability and willingness to pay.
Under this model, consumers who value a product more and can afford to pay more, do so. It is widely accepted that this generates socially optimal pricing, but is clearly a form of price discrimination (i.e. the same product or service being sold at different prices to different consumers).
In the case of insurance premiums, it is intuitive that those who are more likely to claim will place a greater value on the insurance policy than those who are less likely. It makes sense, therefore, that those individuals (or groups thereof) that are statistically more likely to claim, pay more for the service.
The insurance market is built on a foundation of risk assessment and quantification. It is clearly not possible to accurately discriminate for each individual but, to the extent that they can, underwriters try to determine the riskiness of a policy based on a wide variety of categories.
To take one of these statistically significant categories away is to introduce a culture of cross subsidisation between types of consumer. In other words, those who are statistically less likely to claim will have to pay more than they currently do to subsidise those who are statistically more likely to claim who, theoretically, will pay less than the status quo.
In some cases, this cross subsidisation is likely to increase premiums above the value that is placed on the policy by the less risky demographic. If women, therefore, are to be charged more for comprehensive motor insurance, they may prefer to switch to third-party, fire and theft policies.
The directive from the European Commission is not based in economics. Rather, it is a piece of legislation which is dependent upon the often hugely subjective concept of 'fairness'.
However, adding uniformity to pricing is not necessarily a 'fair' approach as it implies not just financial cross subsidisation, but a transfer of consumer welfare from low value consumers to high value consumers. In the name of equality, the EC has made some consumers more equal than others.
Therefore, like the 17-year-old version of myself complaining about car insurance premiums, the EC should have realised that fairness is a subjective concept. All you need to do is look at the numbers to realise that it means nought.
Tom Robinson is an economist at RGL Forensics
A huge well done to all involved with organising our Remembrance Day event on Friday, including our Corporate Real Estate team. One of them, Ibrahim, took this incredible footage of poppies dropping as he (along with others) leaned (safely!) over the gantry to let them go. pic.twitter.com/pSbapkWBBR— Lloyd's (@LloydsofLondon) November 12, 2018
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