COVID-19 and Auto Insurance: What Can We Learn from History?
Actuarial work is never simple, but when the economy is stable it can become routine. It is when disruptions occur that the need for analytical skill and new data is ratchetted up. The lockdown necessitated by the COVID-19 pandemic is such an occasion. It affects all kinds of insurance – workers compensation, business interruption, and auto, just to name a few. The effect on auto insurance will be complex, both in the areas of pricing and reserving. History speaks to these challenges, but not necessarily in ways that make it easier. It is logical to think we can study similar events in the past to guide us. As you can see from the graph below, there have been several stretches during the past 50 years where driving has declined. The vertical gray bars denote recessions, so clearly miles driven has a relationship with the health of the economy. In my opinion, there are two intervals that are especially interesting: the 1973 oil embargo and the 2008 recession. Both produced significant changes in driving behavior. But there are significant differences in the reason for the change.
A Tale of Two Cities
In 1973, the reason for the recession was specifically related to driving. There was an international oil shortage driven by an embargo, producing sharp price increases and higher demand at the same time. Gasoline was scarce, and lines were long. So, the effect on driving was direct, and this fact was not lost on regulatory bodies. There were calls for reductions in auto insurance rates, and it was at the time that the Fast Track reporting system for frequency and severity was created. It was designed to collect data to demonstrate whether or not the recession had caused claims to decrease for the industry and therefore whether money should be returned to the consumer. A (possibly) unintended consequence of the crisis is that we now have a source for industry claims data used by actuaries for deriving trend factors. In 2008, on the other hand, the country experienced a sharp recession based on a crisis in the housing industry. Despite the lack of a direct economic connection to driving, the drop in miles was about 2.6%, a half point deeper than the oil embargo. It also took much longer to recover the original level. There are likely at least two reasons for the decreased driving: 1) Unemployment eliminates the need to drive to work, and 2) Families are much more judicious in travel decisions. Differences Matter It may seem that less driving leads directly to decreased claims, and that we could reduce resulting premiums proportionately. But since every event is different in cause and therefore in reactions, the questions that need to be answered are complex. For example,
• Is the effect from employment greater than the effect from family decisions?
• If so, does less driving to work mean lower frequency but higher severity (since a larger portion of accidents will be on the highways)?
• Does less highway driving lower severity but lead to more fender benders (increasing frequency)?
• Are the effects temporary, or does the event produce a permanent effect (a “new normal”)? These of course are not binary questions. Each one has a spectrum of possible answers and every combination will produce a different total effect on the appropriate adjustment to auto insurance rates. Not only that, but the answers are likely different by segment, and so indicated adjustments will not be across-the-board for a book of business.
So What Do We Do?
The COVID-19 crisis is still in the early stages and data is just beginning to emerge. As it does, insurance companies need to use what they have to determine the unique characteristics of the current driving behavior. For example, it is likely that there will be permanent effects if companies determine that a larger portion of their work force can work from home. The answer to this one question determines whether a one-time rebate or a rate reduction is more appropriate. While history’s main lesson is the variability in the scenarios and the uniqueness of each crisis, there is one thing that seems to be a common theme. When driving decreases, it does take a while to return to former levels. So, I think we can count on the mileage driven to stay at lower levels for a long time. As actuaries work to help companies determine the correct rates and reserves, they will need to work through changes in trend data, classification data, and payment patterns. It is challenging – very challenging – but this is what we were made for. As an industry, we will work through these issues to better serve the customer. And as a result, we will be better prepared for the next crisis.