In early June, the Consumer Federation of America sent lettersto every governor and state insurance regulator, calling on them toundertake a review of auto rates to determine if price reductionswere due as a result of large gasoline price increases.

Even though the cost of crude oil has fallen of late, and theprice of gas along with it, any number of events or circumstancescould send the price of both soaring again overnight. Plus,actuarial studies indicate that even after gas prices startfalling, people do not return to their old driving behavior, sothat miles driven does not automatically rise in response. Bothpoints mean this question remains relevant.

Back in June, we informed New York Governor David Patterson that“with gasoline at $4 per gallon, New Yorkers are driving less,which will reduce auto insurer losses. We urge you to order thestate insurance department to act now to ensure that drivers see acommensurate reduction in their premiums.”

We also asked that the New York Insurance Department “convene animmediate rate hearing to require leading insurers to show causewhy rates should not be immediately lowered.”

In mid-July, Insurance Superintendent Eric Dinallo announcedthat, due to New York motorists' cutback in miles driven as aresult of soaring gasoline prices, GEICO had agreed to withdraw arate hike request for most of its companies.

The superintendent said also that other auto insurers with ratefilings before the department would be required to assess theimpact of reduced driving on their rates and rate requests under abulletin the department had just issued.

However, some in the industry warned regulators not to jump toany conclusions about gas prices, miles driven and insuranceexposure. National Underwriter reported on Aug. 13 that theProperty Casualty Insurers Association of America disputed Mr.Dinallo's determination that lower claims costs would result fromfewer miles driven.

PCI's assertion flies in the face of well-established researchindicating that driving behavior changes somewhat when gas pricesincrease, and that these behavioral changes lead to a decline innumber of auto insurance claims that are filed.

Consumers respond to economic incentives and disincentives byreducing their driving as gas prices rise. As a result, autoinsurance claim frequencies drop. Consequently, higher gas priceslead to lower auto insurance claim costs.

Leroy Boison, a Fellow of the Casualty Actuarial Society,studied this effect in 2005. (“Will Post-Katrina Gas ShortagesImpact Auto Claim Frequencies?”–Pinnacle Actuarial Resources Inc.,December 2005.)

After studying the 1979-to-1980 energy crisis, Mr. Boison found:“The crisis did not just contribute to short-term reductions inauto claims frequency; it also contributed to a long-term decline.For several years after the political crisis had passed andgasoline prices declined from their historic highs, claimsfrequency failed to return to pre-crisis levels.”

One of the reasons for this development, he noted, was that“…drivers found other ways to get around and stuck with them. Theseother factors include carpooling, public transportation andconsolidating errands, which reduced drivers' exposure to theperils of the road.”

Mr. Boison concluded: “Since increases in gasoline pricescontributed to a long-term decline in claims frequency as driversopted to [spend] fewer miles on the road, it is reasonable toassume the same could have happened after this crisis if theincrease in gas prices was significant and remained at a highlevel.” Other studies have also confirmed this effect.

Auto insurance rates are based on the trends regarding the costand frequency of claims. The cost of claims is not affected by gasprices, except very indirectly.

However, if the cost of gasoline makes people change theirdriving behavior, then the frequency of accidents–and thus,claims–is directly affected.

Using the most common actuarial method, the Washington-basedConsumer Federation of America found the annual rates of change inclaim frequency indicated by Fast Track data through September 2007to be as follows:

o Comprehensive: 8.2%

o Bodily Injury: 5.2%

o Property Damage: 2.4%

o Collision: 1.8%

In other words, claim frequencies were dropping by significantpercentages per year nationally even before the most recent sharpincrease in gasoline prices. These trend factors must be altereddownward to reflect current conditions and the mounting evidence ofsignificant changes in the driving behavior of Americans.

Federal Highway Administration data shows that passenger automiles driven dropped by 0.7 percent from 2005 to 2006–well beforethe latest spike in prices.

In March, the U.S Department of Transportation reported thatAmericans drove 11 billion fewer miles than the same month a yearago–”a month-on-month percentage decline [which] is the largestsince record-keeping began in 1942.”

It is incumbent upon each state's insurance department to testthe current pricing structures in auto insurance to determine ifthe changes in driving behavior are at least partially to blame forthe excessive profits of property-casualty insurers in recentyears.

Regulators should also evaluate whether higher gas prices leadto further windfall profits for insurers, as drivers alter theirdriving habits to ease their financial pain.

The commissioners should consider if any cost might rise fromthe use of smaller, more fuel-efficient cars that produce somewhathigher claims for bodily injuries, which might slightly offset thedrop in claim frequencies we will observe. However, the InsuranceResearch Council's claim that this effect might more than offsetany savings is demonstrably false from analysis of previous gascrises.

It would be a mistake if, in performing this analysis,regulators relied only on long-term trend factors, withoutadjusting claim frequency expectations downward to reflect thedriving behavior changes induced by the sharp gas price increasesthis year.