DRAMA in the Nonstandard Arena: The NONSTANDARD AUTO MARKET gets ready for action that will include


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The nonstandard auto market enjoyed above-average growth and profitability across the country through much of the 1990s. In fact, by the late ’90s, low entry barriers, including modest surplus levels required to support low-limit/short-tail policies, made the segment so attractive that players large and small joined the boom.

The seeming over-abundance of new capital committed to the market in a relatively short time, combined with aggressive marketing to spur growth, created some of the softest pricing in recent history. Underwriting results often suffered, causing reinsurers and larger companies to start tapping the brakes.

The result has been a recent return to more stringent underwriting guidelines and, in some cases, non-renewals. Over the last year or so, these bottom-line efforts have caused the market to harden rapidly, increasing premiums and culling some of the smaller players who, some say, were only in the business for a quick profit anyway.

A.M. Best’s Feb. 5 report, “Nonstandard Auto: Exit Ramp Just Ahead for Many Insurers,” pretty much sums it up: “Much has been said of the personal segment’s market concentration. The nonstandard auto segment is even more concentrated than the broader personal auto sector, with the top five insurance groups commanding more than 60 percent of the segment’s available premium dollars. Increasingly, this concentration of power has put less efficient, second-tier companies under increasing financial pressure as they compete for diminishing available market share. In addition, A.M. Best also has consistently seen a difference in operating earnings between nonstandard auto market leaders and followers.

“The disparate operating results between the two groups are driven by fundamental differences in the use of technology, pricing segmentation sophistication and expense operating platforms. A.M. Best expects the segment will experience a considerable shakeout over the near term, with high-cost operators burning capital, seeking merger partners or shutting down.”

The dress rehearsal The Best report contains no surprises for those in the industry who have already witnessed the beginnings of the market turn. Over the last year, numerous small players have already pulled out of some of the country’s largest markets, such as California, Texas, New York and Florida.

Lorelle Kitzmiller, executive director of the American Agents Alliance, said she has seen numerous companies pull out of California’s nonstandard auto market over the last year, and she expects many more to follow as the market continues to harden. In her opinion, there is still an overabundance of carriers. “Over the past few months…some producers have said their phones have dramatically dropped off,” Kitzmiller explained. “One agent said his calls were down at least 20 percent.”

With several reinsurers canceling their renewals, Kitzmiller believes the show is just about to start. “We’ll start to see a full-out market hardening in the next month or two,” she said. “I think it’s going to be pretty dramatic.”

By mid-year 2000, the industry was beginning to see the handwriting on the wall, predicting a dramatic market shift in California. Companies were already making adjustments by tightening underwriting guidelines or forcing mileage on their customers. Others were already pulling out of the market. One such casualty, Deerbrook, stopped writing nonstandard business in several markets, including California and Texas “for the time being.”

The survivors have made efforts to remain nimble, most increasing their premiums on a gradual scale rather than taking a 10- to 12-percent hike all at once, which could ultimately scare many customers away. The bottom line is covering rising loss costs, according to John Andre, vice president of A.M. Best’s property/casualty division. “Auto results in 2000 were probably the worst since the mid-’80s, the last time we had a true hard market and a rash of insolvencies,” Andre said, adding that most of the problem was mismanagement and poor reserving.

Did companies learn from that experience? We’re about to find out. “Many companies have implemented rate increases, but that’s not easy in every state,” Andre said. “We don’t see 2001 as being any better than 2000.”

The main act Lucio Lefante, a senior financial analyst in A.M. Best’s property/casualty division, said a key factor as to what will drive the market over the next year or so will be the results of one company: State Farm. “State Farm is at the top right now,” Lefante said. “They posted a nine-month combined ratio of 118 and were still able to make a profit. As long as they’re able to do that, it’s going to mean trouble for the rest of the market.”

A.M. Best reports that the nonstandard auto segment is more concentrated than even the personal auto sector, with the top five insurance groups commanding more than 60 percent of the segment’s available premium dollars. Increasingly, this concentration of power has put less efficient, second-tier companies under financial pressure as they compete for diminishing available market share.

Compared to other segments, nonstandard auto is particularly prone to pricing cycles led by market leaders whose rate changes can dictate overall market actions. In particular, Progressive and Allstate Indemnity have tremendous pricing power, according to A.M. Best, heavily influencing both soft and hard cycles.

From 1998 through late ’99, nonstandard auto was experiencing a significant soft cycle, and several companies compromised rate adequacy to gain market share. As loss costs increased rapidly and unexpectedly—with regard to personal injury protection coverage in certain large states—several companies, including market leaders, were caught off guard. As a result, nonstandard auto insurers began to report a significant deterioration in underwriting results beginning in late ’99 and continuing into 2000.

Responding to these declining margins, market leaders, led by Progressive, began sacrificing premium volume by implementing significant rate increases to compensate for increasing medical inflation and run-away personal injury protection claims severity. Key differences between market leaders and followers, A.M. Best reported, lie in the sophistication of underwriting tools that facilitate more accurate risk-pricing segmentation. Essentially, those insurance groups utilizing advanced technology typically have been able to identify their underwriting shortfalls and rate needs in advance of their peers, limiting further deterioration in earnings and surplus.

The encore A.M. Best reports that significant operating and premium volatility for nonstandard auto insurers has been seen, particularly in New York and Florida. As Progressive and other market leaders raised rates and withdrew market capacity, there was explosive growth—from 30 percent to 50 percent during the second and third quarters of 2000—among what A.M. Best termed “less-sophisticated competitors.” The rating company expects these competitors to show increased operational strain and diminished financial strength during 2001.

As a result, above-average consolidation activity is expected by A.M. Best. Some of the key consolidation factors outlined in the report include:

• Rising loss costs, particularly medical inflation and an unusually high level of run-away claim severity in personal injury protection coverage. • Lagging price increases, particularly for followers that are more prone to accept inadequate prices. • A widening gap in expenses and operating scale efficiency between market leaders and followers. Market leaders enjoy a seven-point expense ratio advantage over second-tier competitors. This expense disadvantage, combined with consistent underpricing, is a financial problem for some naive nonstandard auto insurers. • A widening technology gap affecting differences among companies concerning their relative ability to accurately segment and price risks. Small companies cannot justify required capital outlays for technology systems to support claims and underwriting functions, or online agency interface. • Top-tier companies have invested significant financial and managerial resources in sophisticated systems to support their claims departments. Because of their limited scale, those benefits are not available to the same degree for smaller companies. • Second-tier companies are generally confined to one distribution source, most often the independent agent channel. Investing in a direct distribution channel requires expensive financial and personnel commitments, effectively serving as a barrier for those organizations that cannot readily achieve the necessary scale to compete effectively. In addition, these insurance groups will be denied access to a growing portion of insurance consumers. • As the reinsurance market hardens, many weakly capitalized nonstandard auto companies are losing their reinsurance support and could be forced to reduce direct writings, further increasing their expense ratios and retentions.

Other acts to follow Topping off these issues is a general sense of dread among producers. Jack Ellis, former president of the National Auto Agents Alliance and owner and president of Auto Advantage Insurance Agency in Houston, Texas, said he fears a return to the market of the early- to mid-1980s when the assigned risk pool dominated Texas’ nonstandard auto segment.

“I’m so deathly afraid we’re going back to those days when…the liability in the pool was the cheapest bar none,” he said. “I’m already seeing…where the best rate for liability is in the Texas assigned risk pool.”

The fear of losing more business to state-assigned risk pools was articulated by Peter van Aartrijk Jr. in an article (Insurance Journal, Jan. 29) which quoted Martin Feinstein, CEO of Farmers Group, as saying the assigned risk pools in both California and Texas are increasing. The data is compelling, though it could be too soon to tell just what will happen.

In California, assigned risk pool volume has steadily decreased over the years, according to figures provided by the California Automobile Assigned Risk Plan (CAARP), with 30,133 applications filed in 2000, down from nearly 48,000 in 1999. That compares to a peak in 1989 of more than 1.23 million.

Despite those rosy annual figures, monthly applications, as well as assignments, have increased significantly over the last seven months. Just 151 applications were received at CAARP in July 2000. Since then, applications have increased steadily and exponentially, with 942 received in January—an increase of 84 percent.

As the curtain rises… Andre and Lefante don’t see improvements coming to any market in the country anytime this year, and possibly not even next year. In fact, A.M. Best predicts that the number of companies doing business in nonstandard auto could continue to drop off for the next five years.

Meanwhile, the segment is expected to record a combined ratio of roughly 110 for the full year 2000—higher for market followers—led by rising medical inflation against the backdrop of prior rate decreases.

Based on aggressive rate increases filed by several market leaders during 2000—some as high as 12 and 15 percent—results are expected to improve during 2001, although the market will still be challenged by rising loss costs. Beyond 2001, A.M. Best expects modest exposure growth in the nonstandard auto segment in the absence of additional states adopting compulsory auto insurance legislation, and a dramatic slowing in the depopulation of involuntary state pools.

Buy your tickets now, because this show should be one worth watching.


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