The nonstandard automobile insurance sector is cyclical in nature, characterized by periods of severe price competition and excess capacity followed by periods of high premium rates and shortages of underwriting capacity, according to an A.M. Best study. In the late 1990s, many nonstandard auto insurers attempted to capture business by reducing rates. These industrywide rate reductions, combined with increased severity trends, contributed to the deterioration of industry loss ratios in the years 1999 through 2001.
Since that time, most nonstandard auto carriers raised rates and tightened underwriting standards to address poor results. Some insurance companies withdrew from the market because of their inability to compete successfully, impaired capital positions, or because of a decrease in the availability of reinsurance.
Following the events of Sept. 11, 2001, and in an attempt to resolve constrained capacity and take advantage of the hard market conditions, many nonstandard auto insurers resorted to reinsurance solutions to help alleviate concerns about the spike in underwriting leverage. However, during a time when reinsurers disappeared as quickly as new ones were formed, companies faced not only tighter reinsurance contract terms, but also Best’s negative view of excessive dependence on reinsurance. Collectively, these issues made extensive utilization of reinsurance a less attractive capital-management tool.
The hard-market conditions during 2002-2003 created opportunities for many companies to move rates toward adequate levels, as well as increase growth of new business because of market disruptions.
As a result of these growth opportunities, there was an unfavorable impact on the nonstandard auto segment’s capital adequacy and underwriting leverage. However, the benefits of returning to underwriting fundamentals were evident during this period, when the nonstandard auto segment generated favorable operating performance and improved its overall financial strength, despite escalating loss-cost trends, reinsurance pressures and increased weather-related events. This improvement was even more impressive considering the depressed investment yields and unsettled equity market conditions during this period.
Nevertheless, because of higher reinsurance pricing and the drop in interest rates, A.M. Best observed an increase in the use of surplus notes and trust-preferred securities, as well as several nonstandard auto initial public offerings to support growth.
The nonstandard auto sector has rebounded considerably over the past few years. Evidence of this can be found in Wall Street’s confidence and several successful IPOs. But again, insurance is cyclical in nature. As the industry continues to fall down toward the trough of the pricing cycle, the combination of a flattening rate environment and expanding capital levels brings to light concerns about when competition will emerge wholeheartedly within the industry.