What s Driving Auto Loss Experience?

Transcription

1 What s Driving Auto Loss Experience? Exploring Contributing Factors and Offering 6 Strategies for Improved Profitability American Agricultural Insurance Company

2 2016 American Agricultural Insurance Company, Schaumburg, IL The contents of this publication are intended only to provide a general understanding regarding the topic provided and not intended to provide legal advice. It is imperative that each reader conduct a thorough, specific analysis of the law as it applies to the subject before taking any action. The information provided and law, as set forth in statutes and court rulings, change over time. Please consult with your attorney about these summaries before relying on them in any way. The information compiled in this material is the valuable work product of American Agricultural Insurance Company (AAIC) and was prepared by AAIC for the internal use of its client customers only. AAIC grants its client customers the limited right to use this information for their internal purposes only. Other reproduction or dissemination of this material or the information that it contains is strictly prohibited. By accessing this material, AAIC's client customers agree to be bound by the terms of this disclaimer. July 2016 American Agricultural Insurance Company Page 2 of 30

3 INTRODUCTION In 1891, engineer and inventor James Lambert drove one of his new inventions, a gasolinepowered auto, in Ohio City, Ohio, with his passenger James Swoveland. When Lambert started out on his excursion that day, he did not see a tree root sticking out of the ground which would cause him to swerve and crash into a hitching post. Luckily, only minor injuries were sustained by Lambert and Swoveland. But just as Lambert did not see the tree root, he surely could not foresee that his auto accident was the first of millions that would occur in the United States over the next 125 years. 1 Today, the National Highway Traffic Safety Administration (NHTSA) reports that car accidents occur every minute of every day with a total of six million car accidents occurring in the U.S. every year. From those accidents, three million people sustain injuries, including not only the drivers and passengers, but pedestrians as well. While only a small percentage of total auto accidents involve fatalities, approximately 90 people die in car accidents every day. 2 Auto insurance is not only imperative for drivers, but it serves as an important and necessary role in the U.S. economy. It allows Americans to drive on roads knowing they are protected against the financial impact of auto accidents as well as theft or damage to their autos due to events other than traffic accidents, such as collision with an animal. Some auto policies provide roadside assistance or towing services. Some insureds receive the benefit of payments for medical expenses and reimbursements of rental car expenses after their cars are disabled due to covered events. Without auto insurance, car owners responsible for an accident could become financially ruined. The auto insurance industry is currently in transition. Insurance carriers are faced with multiple challenges and opportunities. This white paper identifies several trends that are impacting the auto insurance market and provides strategies for improved profitability when it comes to auto losses. By educating insurers on the hurdles ahead, they can make informed decisions on future market strategies. July 2016 American Agricultural Insurance Company Page 3 of 30

4 CURRENT STATE OF AUTO INSURANCE INDUSTRY Since 2014, concern over increased claim frequency and severity prompted many insurance companies to raise prices in order to maintain margins and offset low returns on investments. Significant increases in both claims frequency and severity have posed a challenge for insurance companies. From 1996 to 2013, the industry experienced a steady rate of declining claim frequency. Factors such as aging population, fewer miles driven, graduated driver s licensing programs for teens, higher deductibles, and more vehicles than drivers were all positive indicators for the auto insurance industry. The cost of vehicle repairs were increasing steadily, but were manageable. After the recession, new car sales increased, gas prices decreased, and more people returned to work; all indicators of growth for the industry. Chart 1 shows the growth in Direct Written Premium for the Total P&C industry as compared to Private Passenger Auto. Since the beginning of the economic recovery at the end of 2009, DWP growth for the entire industry and PPA has been 23.1% and 21.8%, respectively. Chart 1: Direct Written Premium Total P&C Industry vs Private Passenger Auto ($000) $700,000,000 $600,000,000 $500,000,000 Three year dip during recession From , growth in DWP: 23.1% Total P&C 21.8% PPA $400,000,000 $300,000,000 $200,000,000 $100,000,000 $0 DWP P&C DWP PPA Source: SNL, P&C Underwriting Analysis July 2016 American Agricultural Insurance Company Page 4 of 30

5 INCREASED CLAIM FREQUENCY AND SEVERITY In our complex environment, it has been difficult to hone in on what s driving increased claims costs over the past few years. Typically it has been attributed to higher severity; however, the third quarter of 2015 also indicated higher frequency. Before diving into factors that may be driving this phenomenon, it s important to take a look at the frequency and severity by coverage type. Auto Collision Coverage All four quarters of 2013 experienced steady increases in claims frequency for collisions when compared to the same quarter in the prior year. Chart 2 illustrates an almost 9% year-overyear increase for the first quarter of 2014 compared to the first quarter of Chart 2: Private Passenger Auto Collision Coverage Percentage Change in Paid Claims Frequency and Severity From Same Quarter Prior Year 10.00% 8.00% 6.00% 4.00% 2.00% 0.00% 2.00% 4.00% 6.00% Significant Increase YOY Frequency Severity 8.00% Source: ISS/ISO/NISS Private Passenger Fast Track Data Auto Bodily Injury Coverage Bodily injury claim frequency and severity are shown in Chart 3. After demonstrating yearover-year decline in frequency from 4 th quarter 2013 to 3 rd quarter 2014, bodily injury claims began to climb starting with the 4 th quarter of The increases continue throughout July 2016 American Agricultural Insurance Company Page 5 of 30

6 Bodily injury severity rebounded from 2013 increases during each quarter of 2014, but 2015 spiked upwardly again. Bodily injury premiums will likely increase if bodily injury frequency and severity trends continue. Chart 3: Private Passenger Auto Bodily Injury Coverage Percentage Change in Paid Claims Frequency and Severity From Same Quarter Prior Year 6.0% 5.0% 4.0% 3.0% 2.0% 1.0% 0.0% 1.0% 2.0% 3.0% Frequency Severity Source: ISS/ISO/NISS Private Passenger Fast Track Data Auto Property Damage Coverage There were significant severity increases in property damage claims over a 16-quarter period as shown in Chart 4. Frequency also increased, but not at the same high rate as severity. Chart 4: Private Passenger Auto Property Damage Coverage Percentage Change in Paid Claims Frequency and Severity From Same Quarter Prior Year 8.0% 6.0% 4.0% 2.0% 0.0% 2.0% 4.0% Frequency Severity Source: ISS/ISO/NISS Private Passenger Fast Track Data July 2016 American Agricultural Insurance Company Page 6 of 30

7 Auto Comprehensive Coverage The year-over-year change in frequency and severity for comprehensive claims are depicted in Chart 5. Weather conditions impacted volatility for comprehensive claims. Severity trends were favorable throughout 2015, but 2016 may see increases again if the U.S. experiences adverse weather events. Chart 5: Private Passenger Auto Comprehensive Coverage Percentage Change in Paid Claims Frequency and Severity From Same Quarter Prior Year 20.0% 15.0% 10.0% 5.0% 0.0% 5.0% 10.0% 15.0% 20.0% Frequency Severity Source: ISS/ISO/NISS Private Passenger Fast Track Data Many insurance companies responded to unfavorable frequency and severity trends by filing rate changes and by implementing underwriting adjustments. However, regulatory opposition, technology challenges, and competing operational objectives can slow down the process. Furthermore, it may take several renewal cycles for the new rates to bake-in and have an affect on profitability. The industry data confirms that the industry as a whole has experienced greater than expected claim frequency and severity increases. But what are the reasons for the increases? It s likely several different causes occurring simultaneously contributed to the results. The next section will explore some of those contributing factors as well as possible solutions. July 2016 American Agricultural Insurance Company Page 7 of 30

8 ECONOMIC ANALYSIS During the recession, consumers spent less which translated to lower new car sales. Consumers also drove less as gas prices rocketed and there was less money to devote to discretionary spending like vacations and entertainment. Also, fewer people were driving to work as unemployment rose. The combined effect of these discouraging events was fewer vehicle miles driven. Some people chose to forego driving altogether and switch to carpooling or public transportation in lieu of maintaining their own vehicles. Economic Recovery and the Comeback in Driving The U.S. economy began to show signs of recovery in late One leading indicator of economic recovery is retail sales. An increase in retail sales shows improved consumer confidence and also strengthens the value of the U.S. dollar. Chart 6 illustrates that starting in late 2009, new auto sales spiked considerably followed by a large decrease. Both Charts 6 and 7 show a significant increase in new car sales in This rise is attributed to the Car Allowance Rebate System (aka cash for clunkers ), a federal program which provided consumers with as much as $4,500 each to trade in an old gas guzzler for a more fuel efficient new model. 3 The Brookings Institution reported that the program created more sales but those sales were simply pulled ahead from the next 10 months and would've happened without the stimulus. Gross domestic product growth was "negligible" and employment increases were "minimal," according to the analysis. Chart 6: New Auto and Light Truck Sales, (in millions) Source: Macrotrends.net, Auto and Light Truck Sales Historical Chart The year-over-year change in vehicle miles traveled, number of registered vehicles, and miles traveled per vehicle from are displayed in Chart 7. Gas prices were still high in July 2016 American Agricultural Insurance Company Page 8 of 30

9 2012 with some areas of the country paying more than $4.00 per gallon. Not until 2013 did the country start to enjoy cheaper gas prices which resulted in more driving. Chart 7: Vehicles Miles Traveled, Number of Vehicles, Miles Traveled Per Vehicle Percentage Change, YOY 8.0% 6.0% 4.0% 2.0% 0.0% 2.0% 4.0% 6.0% 8.0% Great Recession of 2008 Economic Recovery Miles Traveled Vehicles Miles Traveled per Vehicle Source: U.S. Department of Energy, National Transportation Research Center, Oak Ridge National Laboratory, Transportation Energy Data Book, Ch. 8 Household and Vehicles and Characteristics, Table 8.1 Population and Vehicle Profile, Vehicle Miles Traveled, , Federal Highway Administration. Households, , U.S. Census. As the economy recovered, more vehicles were on the roads thus impacting accident frequency. Also, miles traveled per vehicle were increasing. This indicates an increase in exposure per vehicle. Contributing Factor to Increased Claim Frequency Economic recovery after recession resulting in more miles traveled and more cars on road. July 2016 American Agricultural Insurance Company Page 9 of 30

10 More People Translates to More Accidents The U.S. population has grown over 100% since The number of licensed drivers from 1950 to 2013 more than tripled from 62 million to 212 million. In addition, the number of vehicle miles driven has increased substantially over the last 60 years with the number of miles driven per licensed driver increasing by 75% during that time period. Not only has the number of people driving increased, but drivers today are driving more than ever. Both of these indicators point to an increase in congestion and accident frequency. Chart 8 shows the trends in population, vehicles, households, and licensed drivers from These are all positively correlated events with a slight decrease in the number of vehicles from recession years Around 1985, the U.S. saw the number of vehicles surpassing the number of licensed drivers. From that time until the recession, the industry benefited from lower frequency on average. Chart 8: Population Data, , , , : Year Number of Vehicles = Number of Licensed Drivers per Household (000) 200, , ,000 50, U.S. Population Number of Households Number of Vehicles Number of Licensed Drivers Source: U.S. Department of Energy, National Transportation Research Center, Oak Ridge National Laboratory, Transportation Energy Data Book, Ch. 8 Household and Vehicles and Characteristics, Table 8.1 Population and Vehicle Profile, Contributing Factor to Increased Claim Frequency Increase in population, increase in licensed drivers, and increase in vehicle miles driven per vehicle. July 2016 American Agricultural Insurance Company Page 10 of 30

11 Gasoline Prices Impact Vehicle Miles Traveled Another trend to observe is the correlation between the changes in miles traveled and gas prices. Gas prices are very volatile and vary greatly from state to state, city to city, and even gas station to gas station. It s not unusual to see gas prices change within the same day in some cases. Chart 9 shows the annual price of a gallon of gas across select U.S. cities compared to the change in the vehicle miles traveled from Chart 9: Average Annual Gas Price vs Change in Vehicle Miles Traveled, per gallon $4.00 $3.50 $3.00 $2.50 $2.00 $1.50 $1.00 $0.50 $ % 3.0% 2.0% 1.0% 0.0% 1.0% 2.0% 3.0% 4.0% 5.0% YOY Percent Change Gas Price Miles Traveled Source: CPI Average Price Data, U.S. Department of Energy Since the early 2000s, we see a clear inverse correlation between the direction of gasoline process and the change in vehicle miles traveled. Prior to that period, this inverse correlation was not as obvious, but still existed. The U.S. Energy Information Administration provided information in Chart 10 which shows the forecasted price of gas over the next year. The price of crude oil will continue to be low; therefore, the price of retail regular gasoline will be low with only a slight increase in the summer months. If the U.S. continues to enjoy low gas prices, the insurance industry can expect to experience similar levels of claim frequency and severity. July 2016 American Agricultural Insurance Company Page 11 of 30

12 Chart 10: Forecasted Price of Gas Over the Next Twelve Months Contributing Factor to Increased Claims Frequency Decrease in gasoline prices contributes to increase in miles traveled. July 2016 American Agricultural Insurance Company Page 12 of 30

13 Deteriorating Infrastructure We ve seen significant increases in the U.S. population, licensed drivers, vehicles, and miles driven; however, we have not experienced a similar increase in the number of miles of roadways in the U.S. In fact, as the number of vehicle miles traveled has increased 39% from 1990 to 2013, the number of U.S. roadway miles has only increased 5% during that same time period. The result is our roads are getting more use and our maintenance of the roads has not kept pace. Chart 11 confirms that each unit of roadway (i.e., each mile or road) has more miles driven on it which leads to greater wear and tear. Chart 11: Miles Traveled per Each Mile of U.S. Road, Source: U.S. Department of Energy, National Transportation Research Center, Oak Ridge National Laboratory, Transportation Energy Data Book, Ch. 8 Household and Vehicles and Characteristics, Table 8.1 Population and Vehicle Profile, The quality and condition of U.S. roads and streets continue to deteriorate. The American Society of Civil Engineers published a Report Card for America s Infrastructure in 2013 giving roads a grade of D for poor. At of the time of their report, 32% of America s major roads were in poor or mediocre condition. This translates to a cost of $67 billion a year or $324 per motorist in repairs and operating costs (such as gasoline wasted while in traffic). This is in addition to the taxes motorists already pay. Newly constructed road miles only increased 4% from 1990 to 2009, although vehicles miles traveled increased 39% during that same period. 4 The American Recovery and Reinvestment Act of 2009 provided improvements in pavement conditions, but they were not long-term sustained investments. In December 2015, President Obama signed into law a five-year, $305 billion highway bill. The new law, paid for with gas tax revenue and a package of $70 billion in offsets from other areas of the federal budget, calls for spending approximately $205 billion on highways and $48 billion on transit projects over the next five years. The measure is the first long-term national transportation spending package in a decade. It follows a string of temporary patches that began before Obama July 2016 American Agricultural Insurance Company Page 13 of 30

14 entered office. 5 This law promises to be a step in the right direction for sustained improvements to the nation s roadways. Contributing Factor to Increased Claims Frequency Increased vehicle usage on deteriorating roadways. July 2016 American Agricultural Insurance Company Page 14 of 30

15 NON ECONOMIC FACTORS Changing Demographics: Older Drivers Another key contributing factor to evaluate is the age of drivers. The two age groups that receive the most scrutiny are youthful drivers and older drivers, especially those senior citizens over the age of 70. The oldest baby boomers, those individuals born between 1946 and 1964, are reaching the age of 70 in By 2025 there will be more than 60 million Americans who are 65 years old or older, more than twice the number in 1990, representing 17% to 20% of the population. 6 The skill of driving relies on a driver s physical and mental alertness as well as good vision. Starting in one s 40s, vision may start to decline. Mobility and flexibility starts to diminish after age 50 for many people. Mental cognition can decrease after the age of While this generation, more so than those before them, has placed increased emphasis on improving their health and well-being through fitness, exercise, and nutrition, the aging process cannot be prevented. Per population, fatal crash rates increase noticeably starting at age and are second highest among drivers 85 and older. This is mainly due to increased risk of injury and medical complications, rather than an increased tendency to get into crashes. As Chart 12 shows, only fatal crash rates at age are higher. Chart 12: Number of Persons Killed and Fatality Rate per 100,000 of Population by Age, 2012 Number of Persons Killed Fatality Rate 20.00% 18.00% 16.00% 14.00% 12.00% 10.00% 8.00% 6.00% 4.00% 2.00% 0.00% < >74 Age Source: National Highway Transportation Safety Administration, U.S. Department of Transportation, Traffic Safety Facts 2012, Table 57. July 2016 American Agricultural Insurance Company Page 15 of 30

16 An increase in fatalities in car crashes increases claim severity in several ways. Victims of fatalities in car crashes are not always the drivers themselves. Passengers, occupants of other vehicles, bicyclists, and pedestrians are also at risk. Fatalities to non-drivers may trigger large bodily injury claims which would influence claims severity. Increases in fatalities to drivers may contribute to increases in claims severity for both personal injury protection (PIP) and medical payments coverages. Data shows that older drivers are more likely to be victims of fatalities in fatal car crashes than drivers under the age of 30. Chart 13: Percentage of Persons Killed by Person Type, 2009 Drivers Age Persons Killed Over 70 Under 30 Drivers themselves 60% 42% Passengers 16% 24% Occupants of Other Vehicles, Bicyclists and Pedestrians 22% 34% Source: Facts & Research, SeniorDriving.AAA.com. NHTSA s Fatal Analysis Reporting System (FARS) figures for 2014 show that 32,675 people died in motor vehicle crashes in 2014, a 0.1% decrease from the previous year. The fatality rate fell to a record-low of 1.07 deaths per 100 million vehicle miles traveled. But estimates for the first nine months of 2015 show a troubling increase in the number of fatalities. The 2015 fatality estimate is up 9.3% from the same period last year. 8 While fatal crash rates increase noticeably starting at age 70-74, research suggests that senior citizens tend to drive during daylight hours and when the roads are less congested. Older drivers can self-limit their driving by avoiding highways or congested intersections; traveling shorter distances; making fewer trips; avoiding night driving; and limiting driving in rain, ice, and snow. Contributing Factor to Increased Claims Severity Fatal crashes increase with elderly drivers. July 2016 American Agricultural Insurance Company Page 16 of 30

17 Changing Demographics: Youthful Drivers Life would be infinitely happier if we could only be born at the age of eighty and gradually approach eighteen - Mark Twain According to the NHTSA s Traffic Safety Facts 2012, based on police-reported motor vehicles crashes, persons 21 to 24 years old (per 100,000 population) had the highest fatality rate and the highest injury rate (see Charts 12 and 14). Persons ages are not that far behind. Chart 14: Number of Persons Injured and Injury Rate per 100,000 of Population by Age, , , , , , , , , ,000 50,000 < > % 1400% 1200% 1000% 800% 600% 400% 200% 0% Number of Persons Injured Injury Rate Source: National Highway Transportation Safety Administration, U.S. Department of Transportation, Traffic Safety Facts 2012, Table 57. In the insurance industry, youthful drivers are generally considered those drivers under the age of 25. Insurance companies may break out that group into smaller segments by gender and marital status and more refined age groups for rating and underwriting purposes. Such groups may include: less than 16, 16-19, and Youthful drivers are less experienced behind the wheel and therefore are charged more for auto insurance coverage than older and more experienced drivers. Graduated Driver Licensing Programs Reduce Crashes The driving statistics when a teen passenger is present are staggering. Two or more peer passengers in the car more than triples the risk of a fatal crash with a teen at the wheel. 9 With peer passengers in the car, male teen drivers were almost six times more likely to perform an illegal maneuver and twice more likely to act aggressively before crashing than when driving alone. 10 Likewise, teens driving at night is an increased risk. According to the Insurance Institute for Highway Safety (IIHS), 58% of teen crash deaths occur between 6pm and 6am. July 2016 American Agricultural Insurance Company Page 17 of 30

18 Because of the higher risk of car accidents involving teen drivers which cause injury or death, most states now have Graduated Drivers Licensing (GDL). GDL systems are intended to give novice drivers experience in less risky driving situations such as driving only during daytime hours and driving with only family member passengers. Over time, as drivers gain more experience and maturity, driving situations become more risky and the drivers adapt to the new situations. Two studies by the IIHS and the Highway Loss Data Institute show that strong restrictions on nighttime driving and teenage passengers, as well as delayed licensing age, reduce fatal crashes and insurance losses for teenage drivers. 11, 12 Chart 15 shows the positive results of GDL since its inception in the 1990s. Chart 15: Percent Change in Collision Claim Frequencies (95% Confidence Interval) Based on Poisson Regression Analyses of GDL Components, Source: Highway Loss Data Institute, Graduated licensing laws and insurance collision claim frequencies of teenage drivers, R. E. Trempel, 2009 July 2016 American Agricultural Insurance Company Page 18 of 30

19 Since 1975, the number of teenagers (ages 13-19) who died in motor vehicle crashes decreased by 70%. While this is a significant improvement, motor vehicles are still the leading cause of death among teenagers. More progress can be made as 56% of teenage fatalities in passenger vehicles occurred in vehicles driven by another teenager. Contributing Factor to Increased Claims Frequency Graduated Driver Licensing Programs reduce the number of teenager deaths due to motor vehicles, but more improvements are needed to make teenage driving safer. July 2016 American Agricultural Insurance Company Page 19 of 30

20 Distracted Driving Everyone has heard that distracted driving is dangerous and increases the chance of getting into a car accident. Drivers and their passengers are at risk, but so are pedestrians who may be distracted while walking. The U.S. Government website for distracted driving distraction.gov provides resources to learn about the dangers of distracted driving and the solutions that are under consideration. The site provides some key facts to consider: Source: Distraction.com Teenagers are not the only ones who are texting while driving. A report done by the AAA Foundation for Traffic Safety revealed that adult drivers are by far the likeliest age group to admit to using their phone while driving. Eighty-two percent of adults ages reported using their cell phone while driving as did 72% of adults between The use of smart phones by adults in the U.S. has increased from 35% in 2011 to 64% in More and more people are becoming dependent on their smart phones for near constant connectivity to online information. Smart phone applications developed specifically for non-gaming use are prevalent. Companies are using technology as a marketing opportunity to engage adult consumers. Apps such as Google Maps and Waze provide drivers with instant mapping July 2016 American Agricultural Insurance Company Page 20 of 30

21 capabilities. SpotHero provides users with access to parking spots near their location. RepairPal gives drivers access to nearby mechanics, including price information for common repairs. GasBuddy is one of many gas station locator apps available to drivers in need of a quick tank fillup. In theory, drivers can use these apps when parked, but the purpose of these apps is to aid drivers while driving. Contributing Factor to Increased Claims Frequency Increased use in cell phones while driving at all age levels. July 2016 American Agricultural Insurance Company Page 21 of 30

22 Driving Behavior: Under the Influence of Alcohol, Prescription Drugs, or Marijuana Alcohol-impaired driving fatalities accounted for 31% of all motor vehicle traffic fatalities in the U.S. in While those deaths are completely avoidable, this is a decrease of 27% from 2005 to (See Chart 16.) Chart 16: Fatalities and Fatality Rate per 100 million VMT in Alcohol-Impaired-Driving Crashes, Source: National Highway Transportation Safety Administration, U.S. Department of Transportation, Traffic Safety Facts 2012, Table 57. The drivers most at risk for alcohol-impaired-driving are young people and drivers with a prior driving while impaired (DWI) conviction. Among drivers with blood alcohol content (BAC) levels of 0.08% or higher involved in fatal crashes in 2014, three out of every 10 were between 21 and 24 years of age (30%). The next two largest groups were ages 25 to 34 (29%) and 35 to 44 (24%). Drivers with a BAC of 0.08% or higher involved in fatal crashes were seven times more likely to have a prior conviction for DWI than were drivers with no alcohol in their system. 14 Driving under the influence of drugs, either illicit drugs or misused prescription drugs, can impair driving as well. Depending on the drug, different drugs cause different reactions in the brain. Marijuana can slow reaction time, impair judgment of distance and timing, and decrease coordination. Drivers under the influence of cocaine or methamphetamine can be aggressive and reckless. Certain kinds of sedatives called benzodiazepines can cause dizziness and drowsiness. 15 However, people tend to mix substances so it s difficult to determine the affects of a specific drug. Alcohol is just one of many drugs that can impair driving. Nowadays, many people are taking multiple drugs: alcohol, marijuana, prescription drugs, and other illicit drugs. As shown in Chart 17 (next page), the number of drivers with three or more drugs in their system nearly doubled during 1993 to July 2016 American Agricultural Insurance Company Page 22 of 30

23 Chart 17: Number of Drugs Detected Among Drugged Drivers Involved in Fatal Motor Vehicle Crashes, % 70.0% 60.0% 50.0% 40.0% 30.0% 20.0% 10.0% 0.0% One Drug Two Drugs Three or more drugs Source: National Highway Transportation Safety Administration, U.S. Department of Transportation, FARS analytic reference guide Contributing Factor to Increased Claims Frequency Driving while under the influence of multiple drugs. July 2016 American Agricultural Insurance Company Page 23 of 30

24 Vehicle Factors The iphone was first introduced in 2007 and in less than a decade, the smart phone has changed the way we live. Consumers are now expecting more connectivity out of their new cars, similar to what they experience through the use of their smart phones. As the auto industry merges with the technology industry to provide a better in-car experience, the auto insurance industry must adjust with these changes and, more importantly, be prepared for the negative effects such as rising costs of vehicle repairs. Autonomous safety features like collision avoidance and automatic braking are already in vehicles sold today. Some luxury vehicles also warn drivers if they are getting drowsy and alert them with a beep or message. Another feature uses infrared cameras to alert nighttime drivers of potential hazards, including detecting animals or pedestrians in the car s path. These safety features are already showing value with improved safety and crash avoidance. An IIHS study of police reported rear-end crashes in 22 states between 2010 and 2014 compared crash rates for Acura, Honda, Mercedes-Benz, Subaru, and Volvo vehicles that were equipped with automatic braking and front-collision warnings to the same models without those technologies. Rear end crash rates for the study showed vehicles that struck the other vehicle (excluding vehicles hit from behind) were 39% lower. If all vehicles were equipped with both automatic braking and collision warning, IIHS estimates 13% of police-reported crashes could have been averted in The IIHS estimates that nearly half of all model year 2015 vehicles have front crash prevention as a standard or optional feature. Given that the average age of the vehicle fleet in the U.S. is 11.5 years, the percentage of vehicles on the road with this crash prevention is quite small. IIHS/HLDI predicts the entire U.S. fleet of cars will have front crash protection starting in the year All of these safety features are creating a safer driving experience which should lead to lower claims frequency. Unfortunately, car crashes cannot be avoided altogether, and vehicles with advanced safety features are more expensive to repair. Not only are repair costs for vehicles with advanced safety features rising, but so are vehicle repair costs in general. But what s driving these increases in repair costs? And if repair costs were properly adjusted for inflation, would that affect the results? Mitchell International, a leading provider of technology and information solutions to the auto insurance and collision repair industries, released their 1 st quarter Industry Trends Report which included a study of vehicle repair costs. They identified the three main components that drive repair severity as parts, labor, and paint. Comparing the model year 2010 and 2015 Toyota Camry and Chevrolet Malibu and adjusting the 2010 figures for inflation, they found that the average number of parts replaced actually declined in the Malibu from 2010 while the Camry s average increased. Adjusted for inflation, the overall repair severity increased at more than double the rate for the Malibu over the Camry despite the Malibu s labor hours staying the same. The differences in labor dollars ($64 for the Malibu and $45 for the Camry, adjusted for inflation) contributed slightly July 2016 American Agricultural Insurance Company Page 24 of 30

25 to the increases, as do the paint and materials differences; but parts costs represent the biggest component of the increase. The study concluded that new passenger cars cost more to repair now than they did five years ago. The rising cost of parts has had the biggest impact on collision costs overall. Mitchell International then sought to determine why are the repair costs rising? They concluded it is due to the following reasons: The rising demand for trendy and more expensive headlights, like LED halo lighting drives costs up. Original Equipment Manufacturer (OEM) car parts are more expensive in 2015 than they were five years earlier, even when adjusted for inflation. Note that this study focused on vehicles that were appraised as new vehicles which use more OEM parts as opposed to less expensive after-market parts which are typically available in vehicles older than five years old. 17 Contributing Factor to Increased Claims Severity The average age of vehicles on the road is increasing thus delaying the expected benefits of safety features. Vehicle safety features are improving, but repair costs have increased for new cars. Original Equipment Manufacturer (OEM) car parts are more expensive today, even taking inflation into account. July 2016 American Agricultural Insurance Company Page 25 of 30

26 6 STRATEGIES FOR IMPROVED PROFITABILITY While there s no silver bullet to solve the frequency and severity challenges of the auto insurance industry, companies may want to consider these ideas as possible strategies for improved profitability. Advanced Ratemaking Techniques The ability to accurately match rate with risk for private passenger auto policies is of utmost importance to insurers. Due to advances in technology and innovation, companies can complement traditional actuarial methods of ratemaking with data mining and analytical techniques to produce more stable and accurate rating plans. Many U.S. insurers have adopted multivariate analysis (MVA) as part of their rate making practices. MVA focuses on individual level data to determine the risk at a granular level and takes into account the interactions that many different variables of a risk have on one another. Companies using predictive modeling (a type of MVA) to identify the characteristics that best predict the risk, produce a scoring equation and calculate a score that represents the expected losses for each risk in the book of business. Insurers not employing these advanced methods may be adversely selected against and may see poorer performance than their more technology-savvy counterparts. Precision in pricing may help combat increases in claims. Risk Tolerance and Mix of Business In the highly competitive private passenger auto insurance market, companies work to attract the most profitable mix of customers consistent with their business goals. For instance, an insurer may want to focus on growth by seeking drivers categorized as high-risk. They may be willing to take on the risk of higher claims from those drivers because they may be offset by higher premiums. Companies may consider reviewing their underwriting standards to determine a profitable strategy for business mix based on their risk tolerance and business objectives. Direct Repair Programs (DRP) DRPs, which are networks of auto repair shops and dealerships approved by an insurer, help auto insurers provide their insureds with quality repairs at a reasonable cost. 18 While insureds have the right to go to any repair shop to repair their vehicle, insurance companies that offer DRPs are providing a value-added benefit to their customers which could also help reduce repair costs. Internal Process and Systems Improvement As companies look to outside factors for an explanation of higher claims frequency and severity, part of the problem may be in their own backyard. An audit of IT systems and other processes may uncover errors which could possibly result in mistakenly issuing policies or paying claims incorrectly. By reviewing processes and systems, companies may find that their results are partly due to poor internal controls which can be corrected relatively easily and inexpensively. July 2016 American Agricultural Insurance Company Page 26 of 30

27 Diversification in Product Mix Diversification of the product lines offered may provide companies with a method to offset some of the negative results in the private passenger auto line. Whether it s other personal lines of business such as homeowners or getting into or increasing commercial lines policies, companies may want to consider the cost and benefits of moving into new lines of business. Break the Commodity Myth More so than other financial instruments, personal lines property and casualty insurance products, especially auto, foster less loyalty. Private passenger auto insurance is highly sensitive to price fluctuations and has a low level of customer interactions, acting much like a commodity. Customers have few opportunities to interact with their insurance companies which makes it much easier for them to search for less expensive insurance and leave their current carriers. To change this model, companies may want to consider what differentiates them from their competitors. Perhaps improving customer-agent communications or appealing to a specific market segment that has been previously overlooked is one solution. For example, companies may want to consider providing Internet quoting capabilities to appeal to social media-savvy drivers. July 2016 American Agricultural Insurance Company Page 27 of 30

28 CONCLUSION While private passenger auto insurers struggle with increased claims frequency and severity, the answer is likely not just one factor but a mixture of several events combined. Each company must evaluate how this perfect storm of circumstances has affected their financial results so they can determine the proper mix of possible solutions. While the current auto insurance industry is facing many uncertainties, insurers have many opportunities. Advanced methods of ratemaking and digital technologies, such as reaching customers through the Internet and social media, continue to transform the industry. Companies that can position themselves by focusing on their strengths may reap the benefits of growth in new business and higher retention. Providing insureds with a more personalized experience, tightening internal systems and processes, implementing strategies to optimize mix of business, and executing product diversification are possible ways to improve results. Unlike James Lambert who could not foresee the tree root protruding from the ground, the insurance industry is armed with the tools it needs to steer clear of unexpected bumps in the road. July 2016 American Agricultural Insurance Company Page 28 of 30

29 Endnotes 1 (2016, June 2). Retrieved from Ohio History Central: (2015, February 11). Retrieved from Certified Paralegal Community: 3 Cash for clunkers opened up the floodgates. (2014, July 27). Retrieved from Automotive news: for clunkers opened up the floodgates Curry, A., Mirman, J., Winston, M., & Durbin, D. (2012, January 24). 4 (2016, June 8). Retrieved from American Society of Civil Engineers: /#p/roads/conditions-and-capacity 5 Goad, B., & Laing, K. (2016, February 4). Retrieved from The Hill: obama signs 305b highway bill 6 Cobb, Roger W., & Coughlin, Joseph F., (1999, June 1). Retrieved from North Jersey Transportation Planning Authority: 7 (Cobb, Roger W., & Coughlin, Joseph F., 1999) 8 U.S. Department of Transportation, National Highway Safety Administration. (2016, January). Early Estimate of Motor Vehicle traffic Fatalities for the First Nine Months 9Jan Sep) of Traffic Safety Stats, Crash Stats. 9 F.K. Winston, e. a. (2008, March). Risk Factors for Death Among Older Children and Teenage Motor Vehicle Passengers. Archives of Pediatric Medicine. 10 Curry, A., Mirman, J., Winston, M., & Durbin, D. (2012, January 24). Retrieved from Journal of Adolescent Health: 139X(11) /abstract 11 McCartt, A. T., Teoh, E., Fields, M., Braitman, K., & Hellinga, L. (2010, June 1). Graduated licensing laws and fatal crashes of teenage drivers: a national study. Arlington, VA: Insurance Institute for Highway Safety. Retrieved from Insurance Institute for Highway Safety: 12 Trempel, R. (2009). Graduated Licensing Laws and Insurance Collision Claim Frequencies of Teenage Drivers. Arlington, VA: Highway Loss Data Institute. 13 National Highway Transportation Safety Administration. (2015, December 1). Retrieved from Traffic Safety Facts, Alcohol Impaired Driving, 2014 Data: nrd.nhtsa.dot.gov/pubs/ pdf 14 (2016, April 15). Retrieved from Centers for Disease Control and Prevention, Injury Prevention & Control: Motor Vehicle Safety, Impaired Driving: Get the Facts: drv_factsheet.htm 15 National Institue on Drug Abuse. (2016, June 1). Retrieved from Drug Facts: Drugged Driving: driving 16 Insurance Institute for Highway Safety. (2016, March 1). Retrieved from Crash Avoidance Technologies: avoidance technologies/qanda#crash avoidance technologies July 2016 American Agricultural Insurance Company Page 29 of 30

30 17 Horn, G. (2016, January 1). Retrieved from Industry Trends Report: The High Cost of High Tech: trends/itr vol 16 no 1 winter 2016 apd.pdf 18 Insurance Information Institute. (2016, July 19). Retrieved from What Are Direct Repair Programs and Generic Auto Parts?: are direct repair programs and generic auto parts July 2016 American Agricultural Insurance Company Page 30 of 30