Let’s say you’re a first-time car buyer this month, preparing to move outside of a major US city*.
Your used car isn’t as cheap as it was six months ago, but that’s okay. You made a very large and inconvenient down payment due to high interest rates. Before you leave, you just need to sort out the insurance.
Usually this is an afterthought. But not this year.
In fact, your car may have to sit in the parking lot for a day or two while you shop for a policy that costs less. It’s not that you’re uninsurable, but US auto insurance companies have been losing money on underwriting policies, and prices are rising fast.
Shares of companies with major auto insurance businesses — which trade without imprimatur Warren Buffett’s cover, to say the least — are already starting to reflect the problem. Take Allstate and Progressive:
It’s not total market chaos, but it’s not copacetic either. Auto insurance losses are part of the reason Fitch Ratings downgraded Allstate’s credit rating to BBB from A- this week, as auto policy underwriting is the insurer’s largest line of business by premium collected. Allstate also sold $600 million of preferred stock earlier this month for a yield of 7.375 percent, a relatively wide spread to Treasuries. That shows management is “comfortable at [a] lower rating”, BMO analysts wrote after the sale.
Progressives hold up better, say analysts at CreditSights. But they are still optimistic across the industry. “After enjoying enormous profitability towards the start of the pandemic with substantial reductions in mileage, inflationary pressures have become especially acute,” they wrote.
The pressure on auto insurance profitability is largely due to unexpected “severity” rather than “frequency”. That means insurance companies don’t pay out on policies more frequently, but they do is pay a higher amount.
Simply put: It’s not that more car accidents are happening, it’s that the average cost of auto accident insurance insurers (both those already paid for and those they expect to pay) is higher.
Here’s what Tricia Griffith, chief executive officer of Progressive, told investors and analysts in the company’s first-quarter earnings call. With our emphasis:
We are seeing a trend towards higher-than-expected severity in previously closed claims on private cars especially in improving vehicle coverage. While I won’t speculate on why this trend is changing, I can tell you that we reacted swiftly and decisively to match our reserves for this short-tailed coverage. I have confidence in the people and processes we have in place to ensure we are sufficiently protected. . .
Now, there is a lot to do in fixing the car. And some things. We’re really — and I think as an industry, struggling with store capacity. So our ability to enter the car and the throughput to get it out, which of course affects length of time, rent, and so on. Parts prices are up a little under 3%, and labor rates, so think about the unemployment rate and how there’s a hiring problem everywhere. The same thing with the mechanics in the body shop. But that repair rate goes up to between 4.5% and 5%. So, those are some contributions.
Rising car prices and high demand have indeed played a big role in the long-term trend of higher car insurance costs.
The Manheim Used Vehicles Index shows used car prices will be 8 percent higher on average in 2022 than the previous year, although prices have stabilized more or less since December. Not only is total vehicle replacement more expensive, repairs are also more expensive, as the cost of car parts and service also increased last year, according to BLS data.
However, there may be more than just supply chain and labor cost issues.
Progressive’s largest first-quarter increase in severity came in the “bodily harm” and “damage to property” categories, according to its 10-Q. Both categories appear to be for accidents in which the covered driver is found to be at fault:
Mario Rizzo of Allstate said in the company’s 1Q earnings call that the stabilization in auto prices was more than offset by the higher share of cars that were completely damaged. He said that the severity rate is expected to be 9 to 11 percent higher in the first quarter than in the full 2022:
Actually, used car prices or total used car value actually fell a little bit in the first quarter in our numbers, but we had a higher total loss frequency percentage impacting the mix, so that’s really the drivers. And on bodily injury, it’s the same thing that we’ve talked about, medical inflation, medical consumption, attorney representation.
So I think the severity driver is holding up. In terms of where they’re going to go, that’s really anyone’s guess, but I think our perspective is, and we’re pretty consistent on this, we’re going to continue to drive up prices. We’ve been doing it since the fourth quarter of 2021 all last year.
The insurance company must also reassess its reserves (amount expect to pay claims) in the fourth quarter of 2022 to reflect the following, inter alia:
The increase in injury coverage reflects the most recent data and the most recent assumptions regarding the severity of third party bodily injury claims, increased claims with attorney representatives, litigation costs, increased utilization of medical care, and higher medical inflation.
So car crash victims and their attorneys are getting more aggressive (can’t imagine why), and they might even make a big push in the first quarter (confusing). Or shipwrecks are getting rarer but worse for no apparent reason.
Whatever the cause, executives at Allstate and Progressive have spoken at length about increasing prices. Allstate touted a 22 percent drop in newly published apps in its Q1 presentation, with sharp declines in three states where it faces a challenge to increase rates.
However, the metric used to evaluate the profitability of auto underwriting, the “combined ratio”, shows that Allstate continued to lose money on its auto underwriting in the first quarter, while Progressive was just gaining.
In other words, it doesn’t look like a “greed” story for auto insurance companies just yet.
*This hypothesis may or may not have anything to do with current events in the life of this correspondent.