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
CHP
Los Angeles Times, March 19, 2020

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