Favorable trends have allowed leading auto insurers to produce strong earnings, but winners and losers in the sector will soon be decided by economies of scale and strong marketing, a new report says.

According to the analysis from Fitch Ratings, factors helping earnings grow include a positive rate environment, declining claim frequency, and, to a lesser extent, favorable loss cost trends. These strong earning are especially high in comparison to historical averages, Fitch said.

At the same time, the rating firm found that insurers that lack scale, underwriting sophistication, and brand awareness were largely unable to benefit from these positive trends to the same extent as better positioned peers, and that could eventually hurt them in the long run.

One of the factors that will begin to separate the winners from the losers is that, while auto premium rates are unlikely to fall materially in the near term, "Fitch believes a steady, calculated decline in rates is currently underway and will continue into 2007," the report said.

"As a result, Fitch believes this latter group will be disadvantaged as competitive and regulatory pressures increase in response to the strong profitability enjoyed by leading auto insurers in recent years," its report said.

Significant trends affecting the auto industry include the sector's growing market concentration, heavy advertising spending, direct distribution's heightened popularity, and consistently declining loss frequency throughout the sector.

"Fitch also views the auto insurers' return to the New Jersey auto market--where insurers historically have found it nearly impossible to underwrite profitably-- as further evidence of a healthier auto insurance marketplace," the firm reported.

Fitch said it believes auto insurers' risk segmentation capabilities, scale and expense efficiency, and success in maintaining underwriting discipline will separate the auto market's winners and losers going forward.

The report added, "While these characteristics have arguably always been factors of success or failure in the auto insurance sector to some degree," the firm believes "their near-term importance will increase as cyclical conditions deteriorate."

Regarding trends in the industry, Fitch analysts explained that as competition heats up, more companies use high-tech, high-touch strategies to win and keep more business. As a result, Fitch said, advertising spending is at a record high among auto insurers.

Fitch's study found that GEICO currently leads the auto insurance industry in advertising expenditures, with more than $500 million budgeted to be spent this year. It also noted the insurer's strong online presence.

"The company's strategy seems to be paying off, as its premium growth rate remains strong while many of its competitors' growth rates have begun to stagnate," Fitch reported. "A number of insurers, including Allstate and State Farm, have increased their advertising budgets and investments in technology in order to retain market share," it added.

Another trend Fitch found is that direct writers are becoming increasingly "prominent" in the auto insurance market by growing their market share, and because they are generating strong financial results.

Fitch said it expects direct writers to continue to grow market share by taking advantage of their low cost structure and ability to adjust premium rates, and to enter and leave markets without worrying about the effects such actions might have on their distribution system.

That said, Fitch's report advised that the firm believes agency distribution "will continue to play a prominent role in the auto insurance market for the foreseeable future, since a large number of consumers prefer agency distribution's service methods and multiple product offerings."

Special Reports /

Fitch: Auto Insurance Rates To Fall Through '07

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