For those in the insurance industry and those who observe it, the reasons behind the poor results for personal auto in recent years are no mystery: more cars on the road driving more miles, higher medical costs, higher repair costs for newer vehicles and — while difficult to estimate its precise effect — distracted driving.
The degree of impact these factors have had on frequency and severity trends, however, has perhaps caught many insurers off guard. Jim Lynch, chief actuary and vice president of research and information services at the New York City-based Insurance Information Institute, says the industry enjoyed a long period of low claims frequency and mild severity. As the U.S. emerged from the Great Recession, claims frequency began to increase. Insurers reacted by raising rates, but then, more recently, severity spiked.
Frequency & severity punches
As Lynch puts it, the industry was “hit from the left” on frequency, began to recover, but then hit with a “big roundhouse from the right” with severity.
The increase in frequency stems mostly from people returning to work in the (albeit slow) economic recovery. Lynch notes about 40 percent of miles driven occur during daily commutes, with many accidents occurring during rush hour. During the recession, as people lost jobs, fewer cars were on the road — a trend that's reversed in recent years. Lower gas prices have also encouraged drivers to hit the road more often. The result: frequency increased by more than 7 percent in the three years from 2013 to 2015, according to an October 2016 Insurance Information Institute (I.I.I.) white paper, “Personal Automobile Insurance: More Accidents, Larger Claims Drive Costs Higher.”
Lynch and others note the rise in frequency has moderated since 2015, but even if insurers could take some solace in that, the more recent uptick in severity causes concerns of its own. Tyler Asher, president of Safeco Insurance, says severity for the industry is up by about 5 percent annually over the past two years. He cites a jump in fatalities (the I.I.I. white paper notes an 8 percent rise in fatalities in 2015), higher medical costs and costlier vehicle repairs as reasons.
On that last factor, Liberty Mutual, in its Q4 results presentation, compared repair costs for minor front-end damage on the same make and model 2014 and 2016 entry-level sedan. The 2014 model cost $1,846 to repair, while the 2016 model cost nearly twice as much at $3,551.
Tracy Dolin-Benguigui, director at S&P Global Ratings, discussing the Liberty Mutual comparison, says the issue isn't just the higher costs to repair new technology in cars such as sensors and other systems, but also the need for specialized labor as technology becomes more sophisticated.
Of course, all of the new technology is designed to save lives and avoid crashes, which in theory should lower costs for insurers. “Long term, we do believe there are tremendous benefits,” says Asher. But in the near term, he says there are escalated costs associated with new technology in vehicles. Speaking strictly from a claims-cost perspective, he says the tipping point at which savings from safety improvements outweigh the higher cost of technology may be years away.
Less safety, increased severity
Dolin-Benguigui says the new safety features have not necessarily translated into safer driving in the U.S.; she says that could be because drivers may be circumventing these features through distractions and perhaps not paying as close attention to the safety features as they should.
It would be a challenge to find anyone among industry professionals, lobbyists and observers who doesn't believe distracted driving is contributing to the frequency and severity environments — not just from texting and driving but from the increasing number of gadgets in vehicles. As Asher notes, though, it's difficult to estimate the exact cost. But, he adds, “We believe it's on the rise and is adversely impacting trends.”
Neil Alldredge, senior vice president, Corporate Affairs, for the National Association of Mutual Insurance Companies (NAMIC), notes that despite the vast majority of states having some kind of distracted driving law on the books, the problem is increasing. “At the same time,” he adds, “more people are driving more miles, so there are more distracted drivers for longer periods of time on the road.”
The net effect of these frequency and severity trends is a personal auto market that, according to Moody's 2017 personal lines Outlook, hasn't had an accident-year combined ratio under 100 since 2008. It climbed to its highest point over that span in 2015, at 104.5, and is estimated to be 104 in 2016, Moody's Personal Lines Outlook shows. That high combined ratio is not for lack of rate increases, at least when considering the industry as a whole. Moody's, citing SNL Financial data, shows insurers in personal auto have steadily raised rates since 2010, even taking a higher percentage increase than the homeowners line in 2015, when auto rates climbed 5 percent.
2015 results worse than anticipated
When asked why the rate increases up to now have not gotten the industry out in front of the loss trends, Fitch Ratings Managing Director Jim Auden says, “We thought they would have caught up a bit in 2016,” and he adds a few factors worked against insurers. He says somewhat higher cat losses in personal auto this last year may have added about a point to the industry loss ratio. He also says 2015 results turned out worse than anticipated, with some companies reporting adverse development in the line.
Dolin-Benguigui questions whether enough insurers are pushing for the rate increases they need, perhaps fearing that they will lose customers in what remains a highly competitive environment. She points to the popular strategy of bundling auto and homeowners coverages, noting that if an insurer loses a personal auto customer because of higher rates, it may also lose that customer's more profitable homeowners business. The reluctance by these insurers to push for needed increases prolongs the time it takes to get on top of the loss trends. “It could take as long as the next three years,” she adds.
Wide disparity in results
Auden notes there is wide disparity in company results, with some major insurers holding strong with combined ratios under 100, while others stray well above that mark. He says the more successful companies are leveraging technology to stay ahead of competitors on both the claims and underwriting sides of the business.
Some agent representatives question whether those companies’ lower combined ratios can be attributed solely to superior underwriting. In an age where auto insurance is largely perceived to be mostly about price, some agents wonder whether companies’ combined ratios may benefit from the sale of cheaper policies with lower coverage limits, thereby limiting how much those insurers pay out in claims even if the loss event itself is costlier.
Chris Boggs, executive director of the Big I Virtual University at the Independent Insurance Agents and Brokers of America (IIABA), declines to speculate, but notes there is not much difference in premium between a minimum-limits policy and a policy with higher limits. Essentially, insurers sacrifice only a bit of premium by selling policies with lower limits but could potentially save a lot on claim payments.
Lynch points out the industry's combined ratio as a whole is going up, rather than down. For those companies achieving more favorable results, he says one factor could be the markets in which they operate. “If a company is under 100 consistently with the way the market is today, that they’re doing something to create a superior underwriting result,” he says.
Farther on up the road
Meanwhile, conditions are expected to remain challenging for insurers in the near term. Dolin-Benguigui says the market is in a classic hard cycle now, with rate increases of 8 percent to 12 percent expected in 2017. Some insurers — those that have been increasing rates for a while — may have weathered the worst of the storm, she says, but she also notes some of the adverse trends may not be just short-term blips or cyclical in nature. She expects the poor personal auto environment to continue pressuring broader industry results — perhaps pushing the industry's overall combined ratio above 100.
Auden says Fitch likewise sees further rate increases coming in the near term. “We would attest there could be some improvement in 2017 results, but it's from a very poor level in auto.” He says insurers may encounter some regulatory pushback in certain states as they try to take more rate increases. Alldredge says regulators are “more rooted in this mentality that insurers must be doing something wrong, or insurers must be trying to disadvantage their policyholders by raising their rates rather than looking at what is actually driving the rate side of this.”
Getting on top of loss trends
Lynch takes a more optimistic view, saying he believes insurers are getting on top of the loss trends. “They’ll get there,” he says, noting it might be in 2017. “I’d like to think that's when things will calm down on the loss-cost side. When that calms down — when frequency peaks out — you’ll see a much tamer situation.”
If there's one certainty for personal auto, it's that technology will continue to play a major role, both on the insurance side and with respect to the vehicles covered. Additionally, insurers will find new ways to underwrite risks and insure and engage with customers.
With respect to policy innovations, Asher expects telematics-based policies to play a bigger role in the near term, while Dolin-Benguigui says pay-by-mile coverage that incorporates mobile-app technology could gain more traction.
On the distribution side, speed continues to be the name of the game. For independent agents, some experts say comparative raters could help them stay competitive with direct writers and captive agents as far as how quickly they are able to turn around quotes, especially in a landscape where faster and cheaper appear to reign supreme, even if agents wish that was not necessarily the case. “As much as I hate to say it, I think auto insurance has become a commodity,” says Boggs. He stresses, “It is not a commodity, but it has been forced into that hole.”
Use of tech in underwriting
With respect to underwriting, Auden, who cites the use of technology in underwriting as a reason why some insurers have outperformed peers, also sounds a note of caution on over-reliance on such technology. Personal auto, he says, is the most sophisticated line from a pricing perspective — using advanced modeling and comprehensive data. But auto continues to struggle with profitability despite that. “The models aren't the end-all,” he says.
“That's a caution flag for other segments too,” he adds, particularly in longer-tail lines. In workers’ comp, for example, he says there is growing use of predictive modeling. “But if you get claim trends wrong in a longer-tail line, and there's more volatility in that line, you can have bigger swings in performance despite the advanced automation.”