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How the coronavirus could change US personal auto insurance

McKinsey 22 Apr 2020 12:00

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The COVID-19 pandemic continues to expand, and the United States has now surpassed all other countries by number of cases. Few anticipated the pace at which the US economy would shut down and physical distancing would become so pervasive. Like all industries, insurance has been materially affected: since the onset of the pandemic, it has lost $760 billion globally in market capitalization, the third highest among all industries.

Across the US insurance industry, the impact will be uneven. Life and annuity carriers will be the hardest hit because of lower interest rates. Some segments will be affected by rising mortality rates. Commercial property and casualty (P&C) businesses will shrink because of the economic contraction and rising unemployment. Some P&C lines will experience spikes in losses from business interruption, directors and officers, event cancellation, medical malpractice, and trade credit, among others.

At first glance, the impact on US personal auto insurance appears to be more muted. The segment’s growth and performance have been mostly impervious to recessions over the past 20 years. However, the pandemic could precipitate structural changes in the market. For instance, mobility trends may pause if more people choose to own a car and drive everywhere because they think ride sharing and public transportation are too risky during a pandemic. Historically low oil prices will make driving much more affordable. And, while less driving during the shutdown period will result in a lower frequency of accidents overall, cities may see higher frequencies, as less congestion could lead to increased speeding.

There remains much uncertainty about the full impact of COVID-19. In this article, we explore four scenarios (including a “black swan” worst-case scenario) based on several unknowns: What if the economic impact is worse than anticipated, caused by longer lockdowns or more difficulty restarting the economy? What if trauma associated with the pandemic leads to fundamental behavioral changes? There is a chance that personal auto insurance will experience the same volatility seen in the 1970s and 1980s, when nonstandard risk segments, assigned risk pools, and uninsured motorist surcharges threatened the industry’s viability. Indeed, in 1985, one of the leading auto insurers nationally was a state underwriting plan with a 140 percent loss ratio. Could the current pandemic lead to similar levels of strain on the industry? The answers will have implications for how insurers move forward.

In 2019, the US personal auto combined ratio was 98.3 percent, an improvement from a peak of 106.3 percent in 2016. From 2009 to 2018, personal auto insurance grew roughly in line with the economy, with some additional growth from improved rates. Loss ratio has been trending slightly downward, from 70 points in 2009 to 68 points in 2018 (Exhibit 2). Lower claims frequency has resulted from continued improvements in safety measures and vehicle technology, but this drop has been partially offset in states that have legalized cannabis. Higher severity reflects a continued increase in medical inflation for bodily injury, higher repair costs for cars with expensive sensor technology, and several years of “social inflation,” when verdict awards have trended upward across the US legal system.

COVID-19 will likely affect US auto insurance in two ways.

The recent experience in several European countries in March 2020 illustrates this pattern: within less than 20 days of the pandemic reaching 100 cases, driving decreased by 50 and 80 percent in Germany and Iberia, respectively (Exhibit 4). When there is less driving, there is a lower frequency of auto accidents.

Second, insurance companies will face top-line pressure. As new-car sales decrease, auto insurance will slow down. The impact on insurance revenues will not be one-to-one, since most new-car purchases represent a replacement of a currently insured vehicle. The United States is home to approximately 280 million cars, and annual car sales total about 17 million. Top-line revenues will be strained by any drop in new-car sales, although the impact will be moderate relative to the overall volume of insured vehicles. In addition, given the unprecedented exponential increase in unemployment, missed premium payments and policy lapses are likely to increase. The biggest impact could come from insurers returning or reducing premiums for lower usage (an issue further explored later in this article).

Another potential shift is in driving behavior. Public sentiment can be widely altered by traumatic events: the Vietnam War and the attacks of September 11, 2001, were examples of such events. Recent polling by the American Psychiatric Association found that 36 percent of Americans say the coronavirus is having a serious impact on their mental health, and 59 percent say it is seriously affecting their day-to-day lives. 1 1. “New poll: COVID-19 impacting mental well-being: Americans feeling anxious, especially for loved ones; older adults are less anxious,” American Psychiatric Association, March 25, 2020, psychiatry.org. As populations react to trauma, some cohorts become more risk averse and cautious, while a smaller, secondary cohort engages in more risky behavior—a classic symptom of post-traumatic stress disorder. 2 2. Carol S. North and Betty Pfefferbaum, “Mental health and the Covid-19 pandemic,” New England Journal of Medicine, April 13, 2020, nejm.org.

Our analysis used a projected combined ratio of 99 in 2020–21 as the starting point. Depending on the scenario, the projected combined ratio ranges from 97 (reflecting a slight improvement) to as high as 120 (reflecting a rapid and significant deterioration) (Exhibit 7).

1. Pause and rebound (combined ratio of 98)

This scenario is defined by a relatively rapid economic rebound but also more aggressive driving behaviors. Some cohorts in the population may exhibit a YOLO outlook on life, similar to the que será, será (whatever will be, will be) exuberance of the 1970s after US soldiers returned from the Vietnam War. Fueled by cheap gas and a disdain for shared mobility, the roads and highways would become more crowded.

Implications for carriers

As the economy faces the pandemic head on, the impact on the industry at the other end of the tunnel could be marginal or seismic. US auto insurers must engage in rigorous scenario planning for multiple outcomes over the next 12 to 18 months and evaluate investment priorities. Executives should be forceful about reallocating capital and continuing—perhaps accelerating—the transformation activity in pricing, marketing effectiveness, customer experience, and product innovation that may have been underway before COVID-19. 4 4. Alex D’Amico, Mei Dong, Kurt Strovink, and Zane Williams, “How to win in insurance: Climbing the power curve,” June 2019. Insurers must also appreciate the longer-term changes that this pandemic may precipitate in the industry.

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