Insurance services in the CPI

Insurance services in the consumers price index (CPI) had an expenditure weight of 1.70 percent as at the June 2006 quarter. The concepts, sources and methods used to compile each of the insurance services are explained in this article.

Conceptual approach

The actual cost faced by the insured to obtain the desired cover can be viewed in two ways. Each approach has implications for the weight and price to be used in the construction of a price index.

The ‘gross’ approach views the cost to the consumer of having insurance cover as the full amount of the premium paid to the insurance company. The service obtained by the household in exchange for this payment of the insurance premium is the security of knowing that, when necessary, property will be repaired or replaced or the health services or income supplied as specified in the policy. When payments are made for repairs, replacements, medical services or income these are regarded as being met by the insurance company not by the households.

The ‘net’ approach sees the cost of insurance as being the cost associated with the provision by the insurance company of the administration of a risk-pooling service (that is, allowing households to pool resources to cover the eventuality of individual loss at a point in the future); this is termed the (implicit) service charge. Under the net approach, the overall premium paid by households is composed of payments for administration costs and profits of the insurance company (that is, the service change), and payments for possible future consumption, as the need arises. It is the service charge that is the relevant price faced by the households for insurance under the net approach.

Statistics New Zealand currently uses the net approach for weight allocation and the gross approach for price collection. While it would be desirable to use the net approach for both the weight allocation and pricing methodology, the service charge is not directly observable, and so is not practical for ongoing price collection. This is broadly consistent with international practice. There is also an argument for including only directly observable prices (and not notional prices) in an index using an 'acquisitions' conceptual base. The New Zealand CPI is an acquisitions-based index.

Most types of life insurance are excluded from the CPI because they are considered to represent savings and investment, rather than consumption. However, 'term' life insurance provides risk-only cover and has no surrender or residual value. Claims are paid out only in the event of death, disability or personal accident. With respect to the CPI, the service provided by term life insurance can be regarded as protection against the risk of disability, personal accident and loss of life. Given that there is no investment element in this type of life insurance, it is appropriate to include it in the CPI.

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Position in CPI structure

The following table shows the position of the insurance indexes within the miscellaneous goods and services group of the New Zealand Household Expenditure Classification used in the CPI.

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Expenditure weight estimation

The expenditure weights allocated to the various types of insurance services have been estimated using the net approach. Under the net approach, the weight given to insurance relates to the cost associated with the provision by insurance companies of administration and risk-pooling services. The value of the insurance service charge can be defined as:

gross insurance premiums payable by households
+ premium supplements (income earned on investing prepaid premiums and actuarial reserves)
– claims
– changes in actuarial reserves.

Under the net approach for insurance services, the expenditure on goods and services by insurance companies on behalf of households (claims) are allocated directly to these goods and services rather than to insurance. For example, expenditure from claims made in the event of vehicle theft or loss would be allocated to new and second-hand vehicles.

Information obtained from the insurance industry was used to estimate the service charge for dwelling, contents and vehicle insurance in the CPI. These calculations were based on the premiums paid by households less claims received for dwelling, contents insurance and vehicle insurance. Adjustments were made to exclude out-of-scope expenditure that was not attributed to private households living in permanent dwellings. Because expenditure by landlords on, or relating to, the properties they rent out is excluded from the CPI, a further adjustment was made to exclude landlord spending on dwelling and contents insurance. Statistics NZ tenure estimates and information obtained from the industry were used to calculate this adjustment.

The expenditure weights for health and life insurance were based on Household Consumption Expenditure (HCE) data from the National Accounts. Some adjustments were needed to bring the scope of the HCE insurance service charges in line with the scope of the CPI. The HCE estimate for health insurance includes a proportion that is funded by employers, which was excluded from the CPI weight calculations (as the value of fringe benefits, or income paid in kind, has not traditionally been included in the CPI weights). Information was obtained from the industry on the share of premiums funded by employers.

The HCE estimate for life insurance includes the service charge for investment and savings products, in addition to that for risk cover. An adjustment was made to exclude the proportion of the life insurance service charge that is not attributable to term life insurance, and the proportion attributable to employers subsidising the cover of paid employees. Information giving a breakdown of premiums and claims by type of life insurance policy, and an estimate of the proportion of premium income funded by employers, were obtained from the industry and used to adjust the HCE estimate.

Adjustments were also made to exclude the estimated shares of health and life insurance service charges attributable to people who are not part of private households living in permanent dwellings.

When claims are paid by insurance providers directly to households, the resulting expenditure made by households to repair or replace insured property is captured directly in the HES. However, when insurance providers pay claims directly to the goods and service providers repairing or replacing insured property, this expenditure on behalf of households would not be captured in the HES.

Information was obtained from the industry on the proportion of claims paid directly to service providers for the different types of general insurance. These proportions were applied to the claims figures used to derive the service charge weights, and the resulting amounts were added to the expenditure weights of appropriate insurable goods and services. The total estimated amount of general insurance claims paid directly to goods and service providers was $558 million (more than half related to vehicle insurance), and $490 million of this was allocated to the weights of appropriate insurable goods and services (as the remainder of the claims paid directly was estimated to have already been included in the independently sourced estimates of insurable goods and services).

A weight reference period of the three years ending with the HES period was used to derive annual average CPI expenditure weights for insurance services, to smooth the impact of unusual claims years and to minimise the risk of negative weights. For the June 2006 quarter weights, information for the three years to June 2004 was used.

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Sample selection

The sample of providers for the different types of insurance were selected to give significant coverage of insurance companies serving New Zealand households. Survey information was used to identify the major insurance providers for each sample.

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Price collection and quality control

Insurance premiums are collected quarterly for each type of insurance through postal questionnaire. Premiums for dwelling, contents and vehicle insurance are collected quarterly through the Quarterly Survey of General Insurance. Health and life insurance providers are sent separate questionnaires. Premiums are collected for a variety of policies and risk factors. Each survey asks for a fixed set or criteria and risk factors to ensure that the policies priced provide the same cover quarter after quarter.

For dwelling and contents insurance, each policy asks for both the indemnity premium and the replacement premium. A replacement policy allows policy holders to replace lost items with new items. An indemnity policy provides policy holders with the amount required to return to the same financial position policy holders held immediately before the loss occurred (usually up to a maximum sum insured). This is either:

• the market value of the lost items at the time of loss or damage (market value means the reasonable value immediately prior to the loss or damage); or
• the cost of replacing, repairing or reinstating the lost item to a condition no better or more extensive than when new, less an allowance for depreciation and wear and tear.

In more common terms, a replacement policy will replace the old item with a new item, whereas an indemnity policy will compensate the policy holder to the second-hand value of the item lost. For example, most vehicle insurance is indemnity, and in the case of theft, the insurance provider would compensate the policy holder for the value of the car insured if it was purchased on the second-hand market, rather than purchasing a new car for the policy holder (as would be the practice under a replacement policy).

The information collected for each type of insurance is detailed below.

Dwelling insurance

The dwelling component of the general insurance survey collects the premiums charged by surveyed insurance providers for insuring a dwelling in different locations around New Zealand for both replacement and indemnity policies.

For dwelling insurance (replacement and indemnity policies) the respondents are given a number of dwelling criteria and risk factors to ensure the same level of coverage is maintained from quarter to quarter. Such criteria and risk factors include:

• excess level
• age of the policy holder
• policy characteristics (eg claims history and additional policies held)
• dwelling characteristics (eg location, size and age of dwelling, construction materials).

With respect to the indemnity policies, the sum insured quoted each quarter is adjusted according to the CPI movement from the purchase of new housing class. This is to ensure that the nominal value insured represents the same quantity and quality of dwelling over time. Note this is not necessary for replacement insurance policies as no sum insured is quoted, and insurers would implicitly take price changes into account when setting premiums to cover replacement of dwellings.

Contents insurance

The contents component of the general insurance survey collects the premiums charged by surveyed insurance providers for insuring household contents in different locations around New Zealand for both replacement and indemnity policies.

For contents insurance (replacement and indemnity policies) the respondents are given a number of criteria and risk factors to ensure the same level of coverage is maintained from quarter to quarter. Such criteria and risk factors include:

• excess level
• age of the policy holder
• policy characteristics (eg claims history and additional policies held)
• location of the dwelling
• burglar alarm status.

With respect to both the replacement and indemnity policies, the total sum insured quoted each quarter for the insurance policy is adjusted according to an index of household insurable items compiled from selected CPI components. The aim of adjusting the sum insured is to ensure that the same quantity and quality of household goods is insured over time.

Vehicle insurance

The vehicle component of the general insurance survey collects the premiums charged by surveyed insurance providers for insuring a vehicle in different locations around New Zealand for indemnity policies.

For vehicle insurance, surveyed insurance providers are given a number of vehicle and driver criteria and risk factors to ensure the same level of coverage is maintained from quarter to quarter. Such criteria and risk factors include:

• driver (main policy holder) characteristics (age, location, gender) and excess level
• policy characteristics (eg claims history, additional policies held and driver exclusions)
• vehicle cc rating and sum insured
• vehicle security measures (eg car alarm or immobiliser).

Health insurance

The health insurance survey collects individual and group policy (the latter are usually arranged by employers and might be partially or fully subsidised by the employer) premiums for a range of types and levels of cover. Surveyed insurance providers are given a number of personal criteria and risk factors to ensure the same level of coverage is maintained from quarter to quarter. Such criteria and risk factors include:

• excess level
• type of cover
• family characteristics (eg age, relationship and parental status).

Life insurance

The term life insurance survey collects individual premiums for different amounts of cover for various personal criteria and risk factors to ensure the same level of coverage is maintained from quarter to quarter. Such criteria and risk factors include:

• characteristics of policy holder (eg age and gender)
• health status (smoker/non-smoker).

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Quality control and adjustment

As discussed above, each survey asks for the premiums for a fixed set or criteria and risk factors to ensure that the policies priced provide the same cover quarter after quarter. Quality adjustments are made for if the level of service being provided by the insurance company changes. In practice, if there were greater use of insurance services, such a greater incidence of car theft or a greater take-up of hip replacements, these would be shown as price change (if the greater claims led to increased premiums) even though these might be considered to be a change in risk factors.

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Estimation

National average prices are calculated for each type of insurance by combining the premiums for each policy and surveyed insurance provider. It should be noted that price changes are shown in full at the time that these are reported, even though most individual households would not face the new premium until their next annual reviews.

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