Auto insurers are embarking on a ride into the unknown as motorists clock record mileage on U.S. roads and insurer underwriting results start to reflect a surge in driving.

The Great Recession of 2008 pushed mileage downward as never before, until driving started to rebound and the negative trend reversed in 2012. Today, an improving economy and falling gas prices have more people driving more often.

Miles driven set new records in 2015, and seasonally adjusted mileage continues to increase. Americans drove a combined 3.2 trillion miles during the 12 months leading up to July 2016, according to the U.S. Federal Highway Administration.

But this sign of economic recovery carries a downside for road safety in general, and for auto insurers in particular.

At Berkshire Hathaway's 2016 shareholders meeting, Chairman and CEO Warren Buffett was asked about Geico's declining financial performance. In response, Buffett pointed to frequency and severity of claims rising "quite suddenly and substantially" in 2015.

Accidents increase

In strong correlation with the spike in mileage (see Figure 1), accident frequency is at a 10-year high, having risen steeply in 2014 and 2015. This, in turn, may shrink auto insurers' margins.

Verisk Analytics examined two common types of property damage loss — liability property damage and collision physical damage — and found that for both categories, the rise in frequency tracks closely with the increase in miles driven.

Figures 2 and 3 show that property damage frequency climbed to 3.59 percent in the first quarter of 2016, while collision frequency was 5.95 percent. Many auto insurers found that the recession and the resulting drop in miles driven, which persisted through 2011, drove average frequency almost 0.19 percent lower than today's rates for property damage and 0.34 percent lower for collision. This dip in frequency — combined with lowered severity — was multiplied across millions of policies and helped insurers keep premium increases relatively flat in a competitive market, according to data from Fast Track Monitoring System.

Severity soars

During the recession, depressed auto sales led to aging of the nation's vehicle fleet, and new car sales took seven years to rebound. The average age of light vehicles in the United States increased to 11.4 years at the end of 2012. With fewer new cars being driven, accidents, on average, were less costly for insurers.

As better economic conditions boosted sales of new cars from 2012 to 2015, the trend toward older vehicles slowed. Therefore, severity is setting new records, in part because repairing modern safety technology tends to cost more. Since 2007, the average annual increase in collision severity is 1.68 percent, but that rate has been accelerating since 2012.

Between 2007 and 2011, during the auto sales slump, average annual severity for collision increased only 0.27 percent. As more new vehicles were sold between 2011 and 2015, average annual severity jumped to 3.10 percent (or 1.75 percent adjusted for inflation, while severity in 2015 dollars actually declined during the recession). Similarly, average property damage severity increased 1.26 percent between 2007 and 2011, but rose to 3.93 percent between 2011 and 2015, or 2.57 percent adjusted for inflation, while severity in 2015 dollars declined during the period between 2007 and 2011.

Technology is creating more distracted drivers, resulting in more frequent and severe accident claims. 

Bodily injury trends

A number of factors can affect the likelihood of bodily injury.

For example, bumpers of sport utility vehicles can override those of passenger cars, increasing the risk of injuring passengers, while improved safety features of modern vehicles often mitigate exposures. The frequency of bodily injury claims has been relatively stable before and after the recession, but severity is still increasing. While bodily injury has long been a significant drag on profitability, the growing frequency and severity of physical damage is tightening the squeeze on industry margins.

Deaths per 100 million miles driven had been declining steeply since the mid-1930s, from a figure of 15 to just slightly more than one. In 2015, this trend reversed, and the National Safety Council reported that road fatalities jumped 8 percent between 2014 and 2015, the largest increase in 50 years. While it remains difficult to pinpoint a precise cause of the troubling spike, potential contributing factors include:

    • Density: Miles driven are at unprecedented levels, correlating with more accidents, but the effect on risk is not necessarily linear. More driving also puts more vehicles in proximity to one another, producing a further multiplier effect.

    • Distracted driving: Figure 4 documents that many drivers admit to engaging in unsafe driving behaviors. Pervasive interactive technology brings distractions behind the wheel that may be increasing frequency and severity for insurers.

    • Defective vehicles: Despite the rebound in auto sales, a dichotomy remains between new and old vehicles. Newer cars tend to drive up property damage claim severity, while a small but increasing number of unsafe older vehicles may partially explain the growing number of severe accidents. Verisk's analyses of data supplied by three large insurers show branded titles (prior total-loss vehicles and vehicles deemed beyond their mechanical limits) have more than doubled over the past five years.

car driving on the highway

The increase in claims and their costs has lead many insurers to raise premiums. New technology and data analytics will help insurers identify mileage 'leakage' and other factors that increase costs. (Photo: Shutterstock)

Where the road leads

Auto claims frequency is back at pre-recession levels, and severity has reached record highs — which may explain why many insurers are raising premiums.

But these trends are ill-timed when considered beside broader disruption in the industry.

Advances in technology and analysis are placing competitive pressure on insurers to improve the customer experience and refine underwriting and rating as never before. And simply raising prices may fail to mitigate the frequency and severity squeeze.

Premiums for personal auto insurers grew 5.5 percent in 2015, but that has been insufficient to compensate for rising losses. Data reported to A.M. Best shows auto insurance adjusted loss ratios up a half percentage point in 2014, and almost two-and-a-half percentage points in 2015. Further, a Verisk analysis of this data over the past three years shows that only one in five premium dollars belongs to insurers that are hitting the sweet spot of profitable growth.

Verisk estimates the cost of premium leakage — revenue lost through misreported or omitted underwriting information — at 10 to 15 percent of annual direct written premium. The 2016 Verisk Auto Insurance Premium Leakage Survey found more than 80 percent of insurance leaders at least "moderately concerned" over premium leakage. But insurers can access tools to achieve and maintain better alignment between risk and premium over time.

    • Mileage: Because underestimated mileage accounts for more than 18 percent of leakage and mileage strongly correlates with frequency, accurately capturing mileage over the life of a policy can help refine rating and stem rising losses. Many new tools, including sophisticated analytics, smartphone apps and vehicle telematics can help empower insurers.

    • Rating symbol models: Using predictive modeling that accounts for frequency and severity by make and model can help insurers adjust to the higher costs of repairing the newest vehicles.

    • Loss history indicators and driver monitoring: The increase in frequency and severity means that in a hardening market, customers who are dissatisfied with rate increases will shop more. Loss history indicators and driver monitoring are cost-effective ways to identify recent claims or violations early in the quote workflow.

    • Prioritized pursuit: At point of sale and renewal, insurers can use sophisticated risk scores and projected losses for drivers and vehicle types — for example, a safe driver with a minor infraction or a vehicle with a branded title — and help inform decisions that balance short-term premium pursuit against potential lifetime policyholder profits.

A novel combination of factors is influencing trends in auto frequency and severity — although what's novel now may become normal in the future. The trends remain a puzzle and a challenge, but they can be managed with the right tools that help break down data to reveal underwriting insights. Insurers should act to get ahead of the changes, or they may find they can only react.

John E. Cantwell is vice president of product management at Jersey City, New Jersey-based Verisk Insurance Solutions. Dorothy E. Kelly is director of product management for personal underwriting at Verisk Insurance Solutions.

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