We had a doozy of red ink recently that is now ready to be smothered in black.
As we get ready for 2Q2024 earnings season, which I expect to be a whopper for personal auto, let’s take a look at an excerpt from the NAIC March 4, 2024, news release focusing on personal auto: “Total private passenger auto insurance has the largest amount of direct premiums written reported as of March 4th, 2024, at $314,788,570,644, which is about 33% of all written premiums.”
That implies that at a 65% pure loss ratio target, there is more than $100 billion allocated to running the business and profits. After massive layoffs and writing restrictions in the past several quarters, profits will be eyepopping this summer, again.
It’s no secret that insurance companies are for-profit operations, whether they are organized as private companies, public companies, mutuals, captives or any other form of risk transfer. And anyone who makes a living on a percent-of-premium basis is wondering when there’s going to be a knock on their door, asking, “What are you doing for me next”?
[Full disclosure, I help insurance companies improve profits and experiences.]
See also: Modernizing Commercial Auto Insurance
As an industry veteran agent-of-change, my constant quest to unravel old ways of working, to hunt down and incorporate new data and to segment existing levels of analysis to create threads with deeper understanding and transparent explanation of contribution to loss has made me simultaneously respected and reviled, not always in equal parts. Everyone hates change, even when change is the only solution.
A big culprit in the red ink phase we have experienced was not so much that used car values soared. It is that the industry pricing for vehicle physical damage is uncoupled from the actual cash value of a vehicle while industry claims practices are tied to actual cash value.
Since the 1950s, the tradition has been to use the base value of the manufacturer’s suggested retail price (MSRP) for setting prices, using a starting suggested value at risk that treats all the makes and models (and more recently trim levels and other standard equipment) as though there are no possible upgrades.
The tradition goes on to predict the future value of every vehicle using a single depreciation factor table as though every vehicle depreciates in the same manner. That depreciation prediction slowly goes down from year 1 until flattening out typically between 45% to 35% of base price new between 10 and 15 years after the vehicle was originally available for retail sale.
After 10 to 15 years, that flat prediction of value will last as long as the vehicle is insurable, unless that specific vehicle becomes “collectable” and is required to be a scheduled valuable like a collector car.
We witnessed historic red ink when actual vehicle values sharply diverted from predicted values at risk - it was like a stock market meltdown where “naked call options” were suddenly cashed in and money to cover the spread was due on demand. The obvious analytic pursuit then is to question both the current process to set the value at risk and the way we predict the future value at risk.
Who would guess a $300 billion-plus industry with over 250 million vehicles under risk management would write insurance without keeping exacting tabs on the cash value of those assets? As we dig into the structure of the existing framework, we see many areas of being data poor (the 1950s era) and what that means in regard to recent rate taking and what comes next for the change agenda.
See also: Reducing Auto Claims by Embracing Sustainability
Spoiler alert:
- For newer vehicles with optional installed equipment, policyholders get “free insurance” -- the predicted scheduled insurance value is less than the actual value.
- For older vehicles still in operation at the flat part of the factor table, as the actual cash value trends to zero, the ratio of insurance value to actual value becomes large.
What this means in respect to the recent base rate increases:
- Vehicles with total MSRP above base MSRP still get “free insurance.”
- Older vehicles pay higher rates than their value suggests they should.
- Price accuracy declines as the predicted versus actual values diverge up/down.
- Price accuracy can be radically improved by just looking up the actual value as needed. (Homeowners carriers use insurance-to-value accuracy methods already).
What’s next?
- Breakthrough innovations revolve around using data more than technology.
- Every data process can be segmented for capturing more value -- more accurate predictions, easier task accomplishment, improved choices, cheaper costs and improved margins.
- Newer data frequently creates the largest scalable impact, but deeper levels of refined analytics are the catalyst for the most rapid value creation.
No good deed goes unpunished when there are hundreds of billions of dollars in play, yet ultimately what is good for customers ends up being good for companies and shareholders. Especially at auto insurers -- they have unique traditions from other lines of insurance, but 100 years of tradition unhampered by progress is coming to an end.
