Private Passenger Automobile Insurance Coverages

Transcription

1 Private Passenger Automobile Insurance Coverages An Actuarial Study of the Frequency and Cost of Claims for the State of Michigan by EPIC Consulting, LLC Principal Authors: Michael J. Miller, FCAS, MAAA Richard A. Smith, FCAS, MAAA Peer Reviewer: Klayton. Southwood, FCAS, MAAA July 2004

2 Foreword EPIC Consulting, LLC was retained to study the frequency and cost of claims data in Michigan for the private passenger automobile insurance coverages. The primary purpose of the study was to determine the degree of variation in losses by geographical area and, to the extent possible, determine whether the losses were primarily impacted by the frequency of accidents or the cost of the damage. The study and this report were sponsored by the Insurance Institute of Michigan and the Michigan Insurance Coalition. EPIC had the sole responsibility and the independence to prepare this report and to conduct the study in the way it considered to be actuarially sound. The opinions and conclusions expressed in this report are those of the individuals on EPIC s research team. In June 2004, EPIC published a an actuarial study of the frequency and cost of homeowners claims for Michigan. This auto study complements the previous homeowners study. i EPIC Consulting, LLC

3 About EPIC Consulting, LLC EPIC is a privately-held Illinois limited liability corporation. EPIC provides actuarial services to insurers, insurance regulators, and self-insured business groups. Many of EPIC s clients have been served continuously by its senior consultants for nearly twenty years. The authors of this report are principals of EPIC, Fellows of the Casualty Actuarial Society and Members of the American Academy of Actuaries. Each has been actively involved for their entire career in ratemaking for personal insurance coverages. The authors are available to answer questions about this report by calling (715) , or (309) , or by contact through the EPIC website at ii EPIC Consulting, LLC

4 Reliances and Limitations The authors have relied on the accuracy of the data provided by the ten participating insurers. The aggregate loss ratios in the study s database were compared to those published by the ational Association of Insurance Commissioners (AIC). The loss ratios in the two databases appeared to be consistent, except for the liability coverage loss ratios for 2001 and We were unable to reconcile the liability loss ratios in this study for accident-years 2001 and 2002 with the calendar-year loss ratios published by the AIC. However, this study s accident-year loss data were used for comparative purposes across geographic areas and across coverages, and for comparative purposes we judged these data to be reasonable. To the extent there are material, undetected errors in the database our conclusions could be significantly impacted. iii EPIC Consulting, LLC

5 Table of Contents Foreword...i About EPIC Consulting, LLC...ii Reliances and Limitations... iii Executive Summary...1 What the Study Is and Is ot...1 Conclusions of the Study...1 Description of the Study and Database...3 Definition of Important Terms and Concepts...4 Private Passenger Automobiles...4 Automobile Insurance Coverages...4 Comprehensive Cause of Loss...5 Claim Frequency...6 Average Cost Per Claim...6 Pure Premium...6 Premiums...7 Claim Losses...7 Loss Ratio...7 Expense Ratio...8 Profit...8 Insurance Rates...9 Analysis and Findings...10 Industrywide Data...10 Study Database Statewide...21 Geographical Loss Variation...27 Catastrophe Losses...28 Frequency, Severity and Pure Premium Bands...29 Population Density Bands...38 Territories by Coverage...41 Comprehensive Losses by Peril...41 Degree of Competition...42 Conclusions...44 TOC EPIC Consulting, LLC

6 Executive Summary What the Study Is and Is ot This is not a study of the adequacy or excessiveness of private passenger automobile insurance rates. A test of the reasonableness of rates is an insurer-by-insurer determination, because each insurer: has a unique group of insureds with unique expected losses; has unique methods of operation with unique operating expenses; and has a unique cost of capital and a unique investment portfolio which translate into a unique profit margin provision in its rates. The reasonableness of any rate schedule can only be judged on the losses and expenses which were expected at the time the rates were implemented. The reasonableness of rates cannot be judged by simply looking back at actual results for two or three years. This is a study of the private passenger automobile claim losses that actually occurred in 2000, 2001 and The goal of the study was to explain, to the extent possible, what the losses were, how often the claims occurred, where they occurred, and what perils gave rise to the losses. Conclusions of the Study The nature (i.e., claim frequencies and claim severities) of the private passenger insurance losses is significantly different for each of the seven auto coverages analyzed in this study. The claim losses vary significantly by geographical area within Michigan and these geographical variations are different for each of the seven coverages. As a general rule, geographical areas of high claim frequencies for one coverage are not areas of high claim frequencies for all coverages. Generally, areas of high claim severities for one coverage are not high cost areas for all coverages. The variation in losses by coverage and by geographical area means the private passenger auto losses and loss ratios will likely differ from one insurer to the next. Each insurer has a unique group of policyholders with respect to the location of its policyholders and the optional coverages purchased. Because of the uniqueness of each insurer s exposure to loss, judgment as to the reasonableness of rates can only be made on an insurer-by-insurer basis. The loss ratios in the study s database show little variation across the ten population density bands for the liability coverages and the physical damage coverages. The consistency in the loss ratios suggests 1 EPIC Consulting, LLC

7 that the variation in the premiums charged across the population density bands have been approximately in proportion to the variation of losses incurred. Michigan s private passenger auto loss ratio reached a high of 98.3% in 2001, ending a sustained increase since Michigan s sustained increase in the total auto loss ratio was the result of an increase in the loss ratios for the liability coverages, not the physical damage coverages. The increase in Michigan s liability loss ratios was the result of rising claim costs, rather than an increase in the frequency of claim occurrences. Underwriting profit/loss ratios in Michigan ranged from -13.1% to -35.0% during the period 1998 through Even when all investment income is considered, insurers realized only a 1.0% total return during 1998 through 2002 in Michigan. Such a return is less than an insurer could have realized had it invested its capital in a less risky business than Michigan auto insurance. 2 EPIC Consulting, LLC

8 Description of the Study and Database Data for the study were provided by the following insurers: Allstate Insurance Company AMCO Insurance Company Auto Club Insurance Association Auto-Owners Insurance Company Citizens Insurance Company of America Farm Bureau Insurance Company of Michigan Home-Owners Insurance Company orth Pointe Insurance Company Ohio Farmers Insurance Company (Westfield Group) State Farm Mutual Insurance Company The participating insurers write over 70% of Michigan s total private passenger auto insurance market, and as such, were able to provide a reliable and credible database for this analysis. Each participating insurer provided data for all its Michigan policies in effect during calendar years 2000, 2001 and The losses included in the data call were for all claims that occurred in 2000, 2001, or All losses were valued as of March 31, Data elements provided were written and earned premiums, earned car years, claim counts, and incurred claim amounts valued as of March 31, The data were summarized by coverage, zip code, limit of coverage and size of deductible. The comprehensive losses were identified by cause of loss (i.e., fire, wind/hail, vandalism, total theft, partial theft, glass, water/flood, animal collision, and all other). The three-year database included a total count of records equivalent to 12.9 million car years (i.e., one car insured for twelve months). 3 EPIC Consulting, LLC

9 Definition of Important Terms and Concepts Private Passenger Automobiles This study s database reflects only the experience of vehicles commonly referred to as private passenger automobiles. In the insurance business, private passenger automobiles include sedans, coupes, station wagons, vans, pick-up trucks, and panel trucks used for personal pleasure, family and business use. Some restrictions apply if the vehicle is used for business purposes. A vehicle used for retail or wholesale delivery, or a vehicle weighing more than 10,000 pounds, would not be included in the definition of a private passenger automobile. Also not included in the definition of private passenger automobiles are motorcycles, snowmobiles and other off-road vehicles. Automobile Insurance Coverages The following automobile insurance coverages are available in Michigan and included in the study s database. Bodily Injury (BI) liability protects the insured against monetary loss arising from legal liability for injuries to a person in an auto accident. Property Damage (PD) liability protects the insured against monetary loss resulting from legal liability for damage to property of others in an auto accident. Personal Injury Protection (PIP) pays to the insured the cost of medical, hospital, rehabilitation, loss of wages, or loss of services resulting from injury to the insured or family member in an auto accident. Property Protection (PPI) protects the insured from monetary loss resulting from his/her absolute liability for damage caused by the insured automobile in Michigan to property other than vehicles and their contents, except that it pays for damage to properly parked vehicles. 4 EPIC Consulting, LLC

10 Uninsured Motorist (UM) coverage protects the insured and family members against loss if injury is caused by an uninsured motorist. Underinsured Motorist (UIM) coverage protects the insured and family members against loss if injury is caused by a negligent insured driver with bodily injury limits lower than the limits provided under this coverage. Comprehensive coverage pays for all losses to the insured vehicle, other than damage arising from an auto accident. Examples of perils covered are theft or damage by fire, flood, hail, vandalism, or collision with an animal. Collision coverage pays for repairs to the insured vehicle if it is damaged in an automobile accident. There are three kinds of collision coverage available. Limited collision pays only if the insured is 50% or less at fault. Regular collision pays regardless of fault, with a deductible that always applies. Broad collision pays regardless of fault, but the deductible does not apply if the insured is 50% or less at fault. The BI, PD, PIP and PPI coverages are referred to as mandatory coverages because all auto insureds in Michigan are required to purchase these coverages. All other coverages are purchased at the option of the insured. In this report, references to the liability coverages are consistent with how that term is commonly used in the insurance industry. Liability coverages include BI, PD, PIP, PPI, UM and UIM. In this report, and commonly within the industry, the term physical damage coverages refers to the comprehensive and collision coverages. For simplicity of analysis, we have combined the three collision forms of coverage (i.e., broad, regular and limited) into a single collision coverage. Comprehensive Cause of Loss Insurers commonly code their comprehensive loss data so as to identify the cause of loss. This study provides separate analyses of the comprehensive losses for nine groupings of perils: fire (total and partial fire damage), total theft, partial theft, vandalism, wind/hail, water/flood, animal collision, glass/windshield, and all other. 5 EPIC Consulting, LLC

11 Claim Frequency Claim frequency is the ratio of the number of insurance claims to an exposure base. In this study the selected exposure base is one car insured for one year (i.e., earned car year). For example, a claim frequency of.150 means there were 150 claims for every 1,000 cars insured. A claim frequency of.150 can also be interpreted as a 15% chance, or likelihood, that a particular insured will incur a claim. Average Cost Per Claim The average cost of a claim is calculated as the total dollars of incurred claim losses divided by the number of claims. This value is also commonly referred to as claim severity. Pure Premium The pure premium is the average cost of claims per insured car. It is calculated as the total dollars of incurred claim losses divided by the number of insured cars. As shown in the following algebraic formula, the pure premium is the product of the claim frequency times the average cost per claim. Let: C D C/ D/C D/ = number of insured cars = number of claims = dollars of claim losses = claim frequency = average cost per claim (i.e., claim severity) = pure premium. Then: (C/) x (D/C) = D/ = Pure Premium. Since the pure premium is a combination of the probability of a claim occurring (i.e., claim frequency) and the average cost of a claim once it occurs (i.e., claim severity), it is considered as the best measure of risk for an individual insured, or for a group of insureds. An insured with an expected pure premium of $450 would be considered a higher risk than an insured with an expected pure premium of $ EPIC Consulting, LLC

12 Premiums Premiums are recorded as written premiums at the beginning of the policy term. The written premium is earned pro rata during the policy period. For example, an insurance premium of $500 for an annual policy written on December 31, 2003 will be recorded as $500 of written premium for year By June 30, 2004, the insurer will have earned one-half (i.e., $250) of the premium and will have recorded $250 of earned premium during the first six months of Claim Losses Claim losses include actual payments made to the claimants, plus amounts held in reserve for future payments on claims that have already occurred. Most private passenger auto claims are quickly paid and settled. But some claims, especially the liability claims, may not be completely settled for five years or more. The loss reserve amounts are estimates of future payments. Loss reserves change as more information becomes known and as partial payments on the claims are made. There are a variety of accounting protocols for recording claim losses. Losses can be accounted for according to the year in which the policy is written. These losses are referred to as policy-year losses. An example would be a policy written in December 2003, with a claim occurring in January In this case the loss would be considered a policy-year 2003 loss because that was the year in which the policy was written. Losses can be accounted for according to the year in which the claim occurred. These losses are referred to as accident-year losses. An example would be a policy written in December 2003 with a claim occurring in January In this case the loss would be considered an accident-year 2004 loss, even though the policy was written in Another common accounting protocol for recording claim losses is referred to as calendar-year losses. In this case any claim payments are recorded to the year in which the payments are made and any changes in the reserve for future payments are recorded to the years in which the reserve changes occur. Loss Ratio Claim losses are often expressed as a ratio to premiums. The total dollars of claim losses divided by the total dollars of premiums is a loss ratio. For example, a loss ratio of.70 (i.e., 70%) means that 70% of the premium dollars were needed to fund the payment of claim losses. 7 EPIC Consulting, LLC

13 For most rate analyses, the accepted loss ratio to analyze is an incurred loss (usually on an accidentyear basis) divided by earned premiums. A ratio of incurred losses to written premiums is hardly ever used because such a ratio will reflect a mismatch of the claim losses to the premiums used to fund the losses. An example may help clarify the mismatch problem. All policies written in 2003 will have the written premium recorded to 2003, but some claims on those policies may not be incurred until All policies written in 2004 will have the written premium recorded to 2004, but some claims on those policies may not be incurred until If one were to relate accident-year 2004 incurred losses to 2004 written premium, there would be two sources of mismatch. There would be accident-year 2004 losses in the numerator that properly tie to 2003 written premium, not to the 2004 written premiums in the denominator. There would also be 2004 written premiums in the denominator that tie to accidentyear 2005 losses, not to the 2004 losses in the numerator. Expense Ratio Expenses are often expressed as a ratio to premiums. Claim settlement expenses (e.g., legal or claim investigation expenses) related to premiums is commonly referred to as a loss adjustment expense ratio. Operational/underwriting expenses related to premiums are commonly referred to as an underwriting expense ratio. Profit There are three types of profit ratios commonly used in insurance rate analyses. Each profit measure relates to a specific portion of an insurer s overall return. The underwriting profit represents that portion of the premiums which remain after funding the claim losses and expenses. For example, if claim losses in a particular year constituted 70% of premium and all expenses totaled 25% of premium, the insurer would have experienced a 5% underwriting profit. If claim losses constituted 80% of premium and all expenses totaled 25% of premium, the insurer would have experienced a 5% underwriting loss. In addition to the underwriting profit/loss, an insurer also earns investment income while the premiums are being held to pay future claims and expenses. The investment income from premiums, 8 EPIC Consulting, LLC

14 plus the underwriting profit/loss, is commonly referred to as the operating profit. The operating profit represents the return generated by the insurance operations. Insurers are required to commit sufficient capital to guarantee the availability of funds to pay claims. These capital funds also generate investment income. The investment income from the capital funds, plus the insurance operating profit, represents the total return to the insurer. The total return must be sufficient to compensate the insurer for placing its capital at risk in the insurance operation. Insurance Rates Insurance rates are established so as to be sufficient to fund the claim losses and the expenses expected to be incurred during the time the insurance policy is in force. Expected future claim losses and expenses cannot be determined by merely looking at what actually happened in the past. For example, the fact that a house has not burned in the past does not mean the chances of a fire in the future are zero. Or, just because an insured has not experienced an automobile accident in the past several years does not reduce the likelihood of future accidents to zero. Determining these future probabilities is an actuarial process. The future likelihood of losses, as to both the expected frequency and the expected severity of claims, is the only basis for determining the reasonableness of insurance rates and the only basis for determining if rates meet the Michigan rate standards of neither excessive, inadequate, nor unfairly discriminatory. In addition to the losses and expenses, insurance rates provide for a reasonable margin for underwriting profit. The underwriting profit provision is determined so that the insurer s total expected return is consistent with the degree of risk to which the insurer s capital is exposed. Reasonable profit provisions, expense provisions and provisions for expected claim losses vary significantly among insurers, thereby making insurance ratemaking an insurer-by-insurer calculation. 9 EPIC Consulting, LLC

15 Analysis and Findings Industrywide Data The ational Association of Insurance Commissioners (AIC) annually publishes loss, expense, and profit data for each state and for each line of insurance. The AIC data for Michigan are derived from all insurers doing business in Michigan. The AIC loss ratios are calendar-year incurred losses divided by earned premiums. The premium and loss data are combined for all liability coverages and for all physical damage coverages. The sum of the liability and physical damage data are also shown as an all auto coverage total. Exhibit I shows that Michigan s private passenger auto loss ratio for all coverages combined reached a 23-year high of 98.3% in 2001, ending a sustained increase following the relatively low loss ratio of 53.1% in In a companion study of Michigan homeowners loss ratios, EPIC found exactly the same pattern of increasing loss ratios from 1993 through Total Auto Michigan Loss Ratio Exhibit I 100.0% 95.0% 90.0% 85.0% 80.0% Loss Ratio 75.0% 70.0% 65.0% 60.0% 55.0% 50.0% Calendar Year Michigan Michigan Average 10 EPIC Consulting, LLC

16 Exhibit II shows the AIC countrywide private passenger auto loss ratios for all coverages combined. The countrywide loss ratios reached a relative high point in 2001, after relative lows in 1997 and The countrywide 2001 loss ratio was 72.7%, compared to the Michigan 2001 loss ratio of 98.3%. The increase in the countrywide loss ratios persisted only from 1998 through 2001, whereas the Michigan increase persisted from 1993 through Total Auto Countrywide Loss Ratio Exhibit II 78.0% 77.0% 76.0% 75.0% 74.0% 73.0% 72.0% Loss Ratio 71.0% 70.0% 69.0% 68.0% 67.0% 66.0% 65.0% 64.0% 63.0% 62.0% Calendar Year Countrywide Countrywide Average As shown in the following Exhibits III and IV, the increase in Michigan s total auto loss ratio which persisted from 1993 through 2001 was the result of an increase in the loss ratios for the liability coverages, not the physical damage coverages. Publicly available loss trend data indicate this increase in Michigan s liability loss ratios was the result of rising claim costs, rather than an increase in the frequency of claim occurrences. 11 EPIC Consulting, LLC

17 Auto Liability Michigan Loss Ratio Exhibit III 140.0% 130.0% 120.0% 110.0% 100.0% Loss Ratio 90.0% 80.0% 70.0% 60.0% 50.0% 40.0% Calendar Year Michigan Michigan Average Auto Physical Damage Michigan Loss Ratio Exhibit IV 90.0% 85.0% 80.0% 75.0% Loss Ratio 70.0% 65.0% 60.0% 55.0% 50.0% Calendar Year Michigan Michigan Average 12 EPIC Consulting, LLC

18 Exhibits V(a) through (h) show the average claim severities and the claim frequencies for the BI, PIP, comprehensive and collision coverages in Michigan. These data are generated through the Fast-Track Reporting System and represent data from a significant portion of the private passenger insurance business written in Michigan. As shown in Exhibit V(a), the frequency of BI claims in Michigan is very low compared to the countrywide average claim frequency. This is because of the strength of the no-fault threshold in Michigan. There has been a decline in Michigan s BI claim frequencies since 1997 from about 3 claims per 1,000 insureds to about 2 claims per 1,000. While Michigan s BI claim frequencies have not recently changed dramatically, the average cost of BI claims has increased dramatically. Over the last three years the average increase in claim costs for BI have been approximately 5% annually. Exhibits V(c) and (d) show that the increase in PIP losses has been due to a sharp increase in the average cost of claims. While claim frequencies have remained relatively stable over the last three years, the average increase in claim costs for PIP has been approximately 12% annually. Exhibits V(e) through (h) show that average claim costs have been rising over the long term for the physical damage coverages (i.e., comprehensive and collision). However, the increase in average claim costs has been offset by a decrease in the frequency of physical damage claims. Overall, we find that the sustained increase in Michigan s total auto loss ratio from 1993 through 2001 was primarily due to an increase in the liability loss ratios, which were impacted primarily from an increase in average claim costs, rather than any increase in the frequency of claim occurrence. 13 EPIC Consulting, LLC

19 Exhibit V(a) Bodily Injury Liability Claim Frequency per 1,000 Exposures Paid Claim Frequency Period (Year Ending Quarter) Source: ISO/AII Private Passenger Fast Track Data Michigan Countrywide Exhibit V(b) Bodily Injury Liability Average Claim Severity $35,000 $30,000 Average Claim Severity $25,000 $20,000 $15,000 $10,000 $5,000 $ Period (Year Ending Quarter) Source: ISO/AII Private Passenger Fast Track Data Michigan Countrywide 14 EPIC Consulting, LLC

20 Personal Injury Protection Claim Frequency per 1,000 Exposures Exhibit V(c) Paid Claim Frequency Period (Year Ending Quarter) Source: ISO/AII Private Passenger Fast Track Data Michigan Countrywide Personal Injury Protection Average Claim Severity Exhibit V(d) $25,000 $20,000 Average Claim Severity $15,000 $10,000 $5,000 $ Period (Year Ending Quarter) Source: ISO/AII Private Passenger Fast Track Data Michigan Countrywide 15 EPIC Consulting, LLC

21 Comprehensive Claim Frequency per 1,000 Exposures Exhibit V(e) Paid Claim Frequency Period (Year Ending Quarter) Source: ISO/AII Private Passenger Fast Track Data Michigan Countrywide Comprehensive Average Claim Severity Exhibit V(f) $1,200 $1,000 Average Claim Severity $800 $600 $400 $200 $ Period (Year Ending Quarter) Source: ISO/AII Private Passenger Fast Track Data Michigan Countrywide 16 EPIC Consulting, LLC

22 Collision Claim Frequency per 1,000 Exposures Exhibit V(g) Paid Claim Frequency Period (Year Ending Quarter) Source: ISO/AII Private Passenger Fast Track Data Michigan Countrywide Collision Average Claim Severity Exhibit V(h) $3,000 $2,500 Average Claim Severity $2,000 $1,500 $1,000 $500 $ Period (Year Ending Quarter) Source: ISO/AII Private Passenger Fast Track Data Michigan Countrywide 17 EPIC Consulting, LLC

23 Exhibit VI presents the underwriting profit ratios published by the AIC. As previously described, the underwriting profit is equal to earned premiums minus incurred losses and minus incurred expenses. In 1993, when Michigan s auto loss ratio was at its lowest, the Michigan auto earned premium exceeded the total of incurred losses and expenses by 18.8% (i.e., underwriting profit ratio of 18.8%). In each year from 1993 through 2002, the Michigan auto earned premiums were insufficient to fund the incurred losses and expenses. The underwriting losses were especially significant from 1998 through 2002 (the latest available data). Underwriting profit/loss ratios ranged from -13.1% to -35.0% during the period 1998 through As shown in Exhibits VII and VIII, the auto underwriting loss has been primarily a result of losses on the liability coverages. In the period 1998 through 2002, the liability coverages in Michigan were especially unprofitable with underwriting loss ratios ranging from -37.9% to -81.2%. Total Auto Michigan Underwriting Profit Exhibit VI 25.0% 20.0% 15.0% 10.0% 5.0% Underwriting Profit 0.0% -5.0% -10.0% -15.0% -20.0% -25.0% -30.0% -35.0% -40.0% Calendar Year Michigan Michigan Average 18 EPIC Consulting, LLC

24 Auto Liability Michigan Underwriting Profit Exhibit VII 30.0% 20.0% 10.0% 0.0% -10.0% Underwriting Profit -20.0% -30.0% -40.0% -50.0% -60.0% -70.0% -80.0% -90.0% Calendar Year Michigan Michigan Average Auto Physical Damage Michigan Underwriting Profit Exhibit VIII 20.0% 10.0% Underwriting Profit 0.0% -10.0% -20.0% -30.0% Calendar Year Michigan Michigan Average 19 EPIC Consulting, LLC