Commercial auto insurance displays all the signs of a troubled line. Unprofitable for eight years with an estimated combined ratio of 112.9% for 2018, the line’s residual market premium has grown 75% in recent years. In the marketplace, insurance agents and their clients are facing higher premiums, larger deductibles, lower limits and tighter risk selection.
The line’s predicament goes far beyond commonly cited claim trends — especially when other lines like personal auto and workers’ compensation are doing fine. A closer look also reveals that some commercial auto insurers are quite profitable.
For the entire line to become healthy, the oft-neglected commercial auto line begs for investment in risk mitigation, data, technology and predictive modeling. Rethinking the sale of commercial auto as a loss leader in bundled business insurance packages might help as well.
An Unhealthy Market
The commercial auto line is, in a word, miserable. Coverage is more expensive and harder to get. Residual market premium grew 75% from $100 million in 2014 to $174 million in 2017, with the pace increasing to $164 million for the first three quarters of 2018, according to the latest Automobile Insurance Plans Service Office data obtained by Actuarial Review April 2019.
According to “Commercial Property/Casualty Market Index,” 45% of brokers and agents expressed growing demand for commercial auto coverage from the third to fourth quarter 2018. This was likely due to less underwriting capacity, according to the quarterly report, which was published in March 2019 by the Council of Insurance Agents and Brokers (CIAB).
Agents and brokers characterize underwriting as “much more restrictive,” in the report. Insurers are also pushing for higher deductibles and premiums, which is making the line harder to place and price across the board. After peaking at an 8.2% average premium increase in second quarter 2018, commercial auto insurers premium rose another 7% in each of the third and fourth quarters, the report states. This is after more than eight years of consecutive quarterly increases.
Insurers are asking more underwriting questions, and some are charging prices high enough to discourage buyers, says Robert Klinger, president of Klinger Insurance Group. “Insurance companies are pulling out of the market altogether,” he adds.
One managing general agent, Energi Inc., is transitioning from offering traditional guaranteed cost insurance products to providing captive insurance programs through eCaptiv (an affiliated entity of Energi) for commercial auto and other business insurance lines. This allows members to have “skin in the game” and the firm to provide loss prevention training based on industry best practice standards, technology-based risk management services and products, such as telematics data capabilities and best-in-class claims management, says Energi’s president Tim Kolojay, ACAS.
According to the CIAB data, insurers started taking commercial auto premium increases in excess of inflation only in the last few quarters and even the latest average increases are less than 10%, offers Ken Williams, FCAS, staff actuary for the Casualty Actuarial Society (CAS). “Compare that to the price increases in the late 1990s and early 2000s, where CIAB data shows that commercial auto average premiums increased in excess of 10% for 20 consecutive quarters,” he observes.
The Rearview Mirror
A look at the rearview mirror reveals commercial auto insurer financials started tanking during the years 2011 to 2012. Commercial auto average insurance premiums, which had been declining for six years, began pulling back in first quarter of 2011, according to the CIAB report. A year later in the first quarter 2012, average premiums rose +3.15%.
Correspondingly, AM Best shows that the line’s combined ratio became unprofitable in calendar year 2011, according to its report “U.S. Commercial Auto Results Continue to Deteriorate” released in March. In 2011, the profitability measure climbed from a respectable 97.9% in 2010 to 103.5% the next year. (See Chart 2.)
Since then, AM Best reports that the calendar year combined ratio has gradually trended upwards to an estimated 112.9% in 2018. From 2008 to estimated 2018 figures, the loss ratio rose about 20% from 66.2% in 2008 to an estimated 84.1% in 2018. Thankfully, the expense ratio and loss adjustment expenses (LAE) remain stable at 28%-30% and 20%, respectively.
A few carriers are paving the way to 21st century rating by investing in technology and data collection — and closely guarding their secret sauce.
Other critical trend changes took place consecutively in 2012, observes William Wilt, president of Assured Research, LLC. The direct combined ratio, which does not include reinsurance, jumped 6.5 points from 94.8% in 2011 to 101.3% in 2012. (See Chart 3.) At the same time, reserve development was adversely deteriorating. Reserves dropped from a reasonable +1.9% favorable development in 2011 to -3.2% adverse development in 2012, bottoming at -8.6% in 2016. (See Chart 4.)
Further, the industry missed the economic turn from 2013 to 2016 when personal VMT (vehicle miles traveled) was exploding, Wilt observes. (See Chart 5.) “The economy was expanding and that was not captured in the rating algorithms,” he says. There were also increases in transported tonnage, indicating more commercial vehicles on the road.
While it is understood that commercial auto is a medium-tail cyclical line, the most recent combined ratio upturn is different than the previous one during the late 1990s and early 2000s. Data provided by Assured Research shows the direct combined ratio of 119.8% (Chart 3) in 2000 while AM Best shows an after reinsurance combined ratio of 115.7% (Chart 2).
Both the AM Best and Assured Research charts not only show that the combined ratio from the last crisis was higher than the current crisis so far, but that results rapidly improved several percentage points in 2003. There is also a key difference with the line’s current crisis compared to the last one. Unlike the last crisis when claim trends were negatively impacting most commercial lines, commercial auto stands alone. (See Chart 6.)
Losses and premiums are both rising, which is not allowing the industry to catch up, explains Brian P. Sullivan, editor of the weekly newsletter Auto Insurance Report. He notes that paid losses increased10% in 2018, raising losses to a record-breaking $22.96 billion in 2018. In 2016 paid losses rose 2.2% to $19.12 billion.
The reasons behind the industry paying out another $3 billion in three years are difficult to quantify. Claims frequency, which presumably rises with exposure, does not appear to be increasing significantly. “After reviewing rate filings in several states, claim frequency for commercial auto specifically appears to be relatively flat,” Williams says.
“Frequency is not rising despite increasing vehicle miles driven,” explains Roosevelt Mosley, FCAS, a principal for Pinnacle Actuarial Resources. “Part of the reason is that safety features in newer vehicles are working,” he explains.
Severity in commercial auto, Williams observes, is increasing faster than the inflation rate, rising 7% to 9% in the most recent years. But once again, quantifying the contributors to severity remains elusive.
Some experts also point to growing investment in litigation and large settlements particularly for trucking accidents. Overall, litigation costs are not showing up as higher loss adjustment expenses (LAE), which have been neutral, Williams says. There is evidence that distracted driving, caused by cell phone use and feature-laden dashboards, affects personal auto frequency and severity. Since personal auto experience has limited application for commercial auto, its impact is difficult to quantify.
One severity contributor is the growing cost of vehicle repairs, especially those with safety technologies. Certainly, it is much more expensive to fix windows and mirrors with imbedded safety technologies than those without. But again, data on repair costs derive from personal vehicles, which are less expensive to fix than long-haul trucks.
For personal vehicles overall, the average repairable vehicle appraisal amount rose 11% since calendar year 2015 and 26% since calendar year 2010, according to data from CCC Information Services, Inc. The appraisal amount rose by 4% in calendar year 2018 to $3,053 after a 2.5% increase in CY 2017, according to the organization’s report, “2019 Crash Course,” released in March.
Despite claim trends, some commercial auto carriers are showing nice profitability. “If you look at the disparity of commercial auto across the industry, you can see who is doing a better job than others. The difference between the extremes is wide,” Mosley observes. The median combined ratio difference, according to AM Best data, is as wide as 60 percentage points.
Some commercial auto insurers are “growing quickly and profiting handsomely at the expense of poor-performing competitors,” according to the article, “Trouble in Big States Continue to Drag Down Commercial Auto” published by Auto Insurance Report in January. The article also points out that larger states, with the exception of Ohio, are showing poor returns in commercial auto.
Progressive Insurance, the nation’s largest commercial auto carrier, has a favorable loss ratio of 59.5% for 2018, according to the Auto Insurance Report’s April 22 issue. Progressive grew a remarkable 38.6% in premium from 2017 to 2018. Fifth-ranked Berkshire Hathaway posted a 61.4% loss ratio and grew 27.8%.
Other carriers did not fare so well. Second-ranked Travelers Insurance saw its loss ratio spike to 74.5% but sustained market share. Third-ranked Liberty Mutual Group experienced a 79.3% loss ratio, which is better than its 93.5% loss ratio in 2017. Zurich Insurance Group, which is the seventh largest commercial auto insurer, posted a loss ratio of 79.8%, according to the publication.
“Claims costs go up and down all the time,” writes Sullivan in an email. “The problem is that so much of the business is baked into other parts of the coverage, rather than standing alone.” As a result, he continues, “Insurers have not managed the line as closely and are willing to use it as a loss leader. What has surprised everyone is how long insurers were willing to let that happen. I thought, and most insurers told me, that they thought it would improve long ago.”
Williams says that some large writers who offer other commercial coverages and cover larger trucks showed poor commercial auto results. These include Zurich, Liberty, AIG and Hartford, companies AM best listed in the top 15 largest writers in 2017. The AM Best report states the fourth quartile of commercial line insurers are showing combined ratios around 138%.
However, the top quartile has an excellent median combined ratio of 77.7%. The two best performers of the 15 largest commercial auto insurers are Progressive, which writes vehicles fleets of one or two, and Berkshire Hathaway. Both carriers just offer vehicle coverage, so the product is sold unbundled. And not surprisingly, Progressive, is considered a leader in commercial auto predictive modeling for rating and pricing.
21st Century Rating
Another contributor to the disparity among insurers is the vast differences in how commercial auto insurers rate coverage. Mosley explains that some insurers use straight Insurance Services Office (ISO) information with some ability for schedule rating, some use ISO with some deviations and others have completely broken away from ISO.
While a few insurers are incorporating more granular rating plans, it remains common to use broad risk classifications such as long versus short haul, vehicle weight and class. “Once we get more detailed information about the exposure you can understand the risk better,” Mosley says, which should lead to better class plans. “The ultimate application,” he explains, “is to develop new rating factors and relativities, and/or a more refined rating and underwriting approach based more on science than intuition.”
A few carriers are paving the way to 21st century rating by investing in technology and data collection — and closely guarding their secret sauce. Much of the commercial auto industry, however, is not there yet. Like workers’ compensation in the early 1990s, the overall poor performance is motivating some of the industry to get serious about risk management. Current data collection is primarily safety-focused as evidenced by the multiple vendors offering products that include cameras and sensors for that purpose.
Even though insurers understand that “who the driver is matters,” they are slow to adapt to technology in general, Mosley says. That might sound strange when telematics technology is successful for identifying and correcting unsafe driver behavior. The dongle devices are expensive, Mosley explains, especially when installing them in large fleets while insurers are “already dealing with profitability issues related to expenses.” Phone apps can also be effective, but it depends on the use.
For example, technology that can track vehicles in real time, such as the navigation service OnStar, have existed for years. “Insurance companies are not ready to consume, analyze and act on data in real-time yet,” he explains, which would provide new insights on a more frequent basis.
Commercial auto insurers are finding useful sources of outside data. Since a vehicle’s condition is associated with safety, commercial insurers are using CarFax data to learn miles driven, repair records and other vehicle history information, says Dan Hill, national sales director for CarFax’s Banking and Insurance Group. The data also helps to reveal fraud, such as previously flooded cars on the market and misrepresentation of the number of miles driven, Hill says. CarFax is also collaborating with Pinnacle on a free contributory data bank for personal and commercial insurers that will allow insurers to compare benchmarks with other insurers. For commercial auto, “the data is the story,” he observes.
Despite several years of premium increases, the commercial auto insurance line continues to grow more unprofitable. A combination of competitive pricing, adverse reserve development and missing major economic growth made the line vulnerable when vehicle repairs and other costs began increasing losses. As a result, the line is still playing catch up. But there is more to the line than it appears. A few commercial auto carriers are managing to be quite profitable.
Future success depends on everything from how the product is sold to the mix of covered vehicles and investment in risk mitigation, data collection and predictive analytics.
The condition of commercial auto should be the wakeup call. An industry commitment to invest in risk prevention and research to understand the line’s unique macro and micro challenges are two places to start.
Annmarie Geddes Baribeau has been covering insurance and actuarial topics for nearly 30 years. Her blog can be found at www.insurancecommunicators.com.