Some Ways to Think About Virus’s Long-Term Impact on Insurer Profitability

How will the COVID-19 pandemic affect auto insurers in the longer term? No one knows for sure, of course, but a new McKinsey study provides a framework for considering the question.

Fewer people are driving due to business closures and work-from-home practices. This could lead to fewer accidents and claims – but evidence suggests severity of the claims generated may worsen. Speeding has increased in several states – in some cases, leading to fatal accidents.

In the longer term, McKinsey suggests, the pandemic could precipitate structural changes in the market for car insurance: “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…. Historically low oil prices will make driving much more affordable.”

On the other hand, if car purchases decrease because of economic uncertainty and unemployment, insurance sales could decline, hurting revenues. The industry already has returned more than $10 billion to policyholders through premium relief during the crisis, which also could affect insurers’ bottom lines.

Four scenarios

The McKinsey report lays out four scenarios to help insurers think about how the economic impact may play out in the longer term.

Pause and rebound. This scenario supposes the economic slowdown will end rapidly and the rebound will occur as quickly as the contraction. Consumers’ behavioral changes are assumed to be limited. Drivers might be a bit more conservative after the shutdown, exhibiting more caution, leading to fewer accidents which would help insurer profitability.

“Pent-up demand, supply-chain innovation, and infrastructure commitments would pull the economy to near pre-COVID-19 levels within weeks,” McKinsey writes.

YOLO (You Only Live Once). This scenario is defined by a rapid economic rebound but also more aggressive driving behaviors: “Fueled by cheap gas and a disdain for shared mobility, the roads and highways would become more crowded.”

Under this scenario, McKinsey writes,  accident severity would continue to climb, putting pressure on insurers to raise rates. The sudden drop in accident frequency during the pandemic, followed by a rapid escalation, “could strain the accuracy of actuarial techniques and regulatory expectations.”

Retrenchment. Difficulty managing the virus and complications from the business shutdown lead to a lengthy economic downturn: “As in the pause and rebound scenario….new behavioral norms would result in less travel, redefine entertainment, and contribute to a more cautious outlook on life.”

Favorable trends in claims frequency would continue, and claims severity would moderate in line with the more conservative behaviors.

But, McKinsey writes, “consistent with economic conditions, a surge would occur in the nonstandard market and state risk pools. Fraud would also spike as a by-product of economic pressures.”

Insurers could face consumer and regulatory pressure to return more premiums or reduce them further and expand coverage. Profitability would suffer.

Black swan. Worst case for economic contraction and behavioral changes. New behavioral norms  generate a YOLO outlook and compromise policing capabilities. Accident frequency would rise sharply. Claims severity would continue to climb.

“In addition,” McKinsey writes, “regulatory pressure could push rates down further or force expanded coverage,” exacerbating worsening profitability.

McKinsey analyzes the potential impact on auto insurers under each of these scenarios and associates each with a projected combined ratio – the most frequently used measure of insurer profitability.

Resources:

With Less Freeway Traffic Due to Coronavirus, There’s More Speeding and That Worries CHPLos Angeles Times, March 19, 2020

Statistics Show Speeding is Out of Control During Corona CrisisStreetsblog NYC, March 24, 2020