What AM Best Says
AM Best: Higher Rates Drive Nonstandard Auto Underwriting Profitability

• John Weber
• February 2021
• 

U.S. nonstandard auto insurance is a niche market that offers coverage to drivers who present the highest risk of loss—adding complexities that the larger personal auto market doesn't necessarily have to face. These drivers may have been hit particularly hard by the pandemic, though a clearer picture will develop when third-quarter and year-end premium numbers come in, said David Blades, associate director, AM Best. Blades recently spoke with AM Best TV about recent sector results found in the Best's Market Segment Report Events of 2020 Impacting Nonstandard Auto Market Performance. Following is an edited transcript of that interview.

What impact is the pandemic having on the nonstandard auto insurance line?

Similar to the case with other lines of coverage, the bottom-line impact of the economic hardships that have been brought on by the pandemic are still playing out. Typical nonstandard auto customers can include recent immigrants and individuals that have financial difficulties, or have a history of financial difficulties.

We're seeing that it's possible that a meaningful number of the individuals that have been laid off, for example, after the onset of the pandemic could be, or may have been, nonstandard auto insureds. Again, that's going to play out, but we'll see how that affects year-end premium numbers.

We could also end up seeing a number of policy cancellations that affect top-line premium revenue for nonstandard auto insurers. Again, we're going to continue looking at that, but that's something, from a pandemic standpoint, that could impact bottom line and, therefore, the profitability of nonstandard auto insurers.

On the positive side, with many state departments of insurance implementing moratoriums on the cancellation of insurance policies for nonpayment, nonstandard auto insureds may benefit from those actions. Look at a state like California, for example, which generates more than 22% of the total direct premium written in the nonstandard auto market, so it could be very meaningful. To the extent that in any state the insurers were ordered to refund premiums to drivers that were affected by COVID-19, that's going to have some impact, we think, on nonstandard auto premiums and on the ability of nonstandard auto insureds to maintain their insurance. Also, some of the states that didn't initially issue formal mandates encouraged their insurance companies to work with their insureds on payment issues, etc. That should also have some benefit for nonstandard auto policyholders.

How had results been over the past few years going into 2020?

The operating performance of AM Best's Nonstandard Auto Composite had actually been improving notably in the last couple of years. Improved rate adequacy was the key driver for the improvement in underwriting income. That improvement in underwriting income had helped improve overall operating profitability for the nonstandard auto insurers.

Net premiums earned for the nonstandard auto composite increased in both 2018 and 2019, and they increased by more than the incurred losses that we'd seen.

So the loss ratio for the nonstandard auto composite had gone down, and that had really driven the improvement in the overall underwriting profitability for nonstandard auto insurers. The other component of the overall combined ratio is the expense ratio.

Nonstandard auto insurers generally operate at a little bit higher expense ratio than private passenger standard auto insurers. It had really been the loss ratio and the impact of rate increases and focusing more on good risk selection that nonstandard auto insurers had been employing, that had driven the improvement.

Those improvements in key underwriting fundamentals and the increasingly aggressive rate actions that nonstandard auto insurers had taken had really driven the improvement in the results.

Pretax income for nonstandard auto insurers has also consistently improved or [been] augmented by finance and service charges that are paid by policyholders. That's unique to nonstandard auto insurers when you compare them to private passenger standard auto insurers. That fee income gives a boost to the overall pretax income, and that's still something that continues to play out.

Nonstandard auto insurers get more of a boost from that fee income than they do from their actual investment income. Those are some of the factors that have improved the results in recent years.

We'll see if results continue to trend in that direction, with the pandemic and fewer cars on the road, especially during the shelter-at-home mandates. We do expect that to have some benefit by in terms of the loss ratio and the underwriting profitability.

Does the nature of the risk and the potential for loss make it difficult for smaller insurers to participate in this line of business?

Large and national private passenger insurers, those that have more technologically advanced platforms and more voluminous sets of credible data, can actually improve their risk selection, maybe even more so than some of the smaller, nonstandard auto insurers that don't have technological platforms at the same levels.

Those are definitely capabilities where the nonstandard auto insurers may be a step behind or at somewhat of a disadvantage in terms of playing against some of the larger insurers. The larger insurers with the more sophisticated, but efficient, systems can benefit from a lower expense ratio. That can also give them somewhat of an advantage over the smaller nonstandard auto insurers. That definitely plays a part.

In addition, single-state regional private passenger nonstandard auto writers that lack scale or effective risk and expense management capabilities, those companies are probably going to find it more difficult as the market continues to go forward.

They may find it more difficult to compete against those other insurers, and especially the degree to which the larger national insurers get more involved in nonstandard auto underwriting. Those smaller insurers with the lesser risk management systems, lesser expense management systems, could find themselves at a greater disadvantage going forward.

That's something that AM Best analysts will continue looking at.

Looking ahead to the rest of 2021, then, what does AM Best expect?

One of the things we're looking forward to is the impact of the recent acquisition of nonstandard auto insureds by national private passenger auto insurers. For example, in July, Allstate Corp. announced it would be acquiring New York-based National General Holdings Corp.

Auto insurance accounts for about 60% of National General's overall business, and they have a significant presence in the nonstandard auto market. Even though they're much smaller than Allstate, they have one of the largest networks of independent agents selling their products. I think over 42,000 agents countrywide, and that will markedly expand Allstate's independent agency business.

State Farm actually announced in mid-September that it was acquiring Gainsco, which is another large nonstandard auto insurer. Actually, the insurance company for Gainsco is MGA Insurance Co., but this was the first acquisition by State Farm in their 98-year history.

While Gainsco is expected to continue operating as a separate brand and a separate company, the plan is for State Farm agents to be able to distribute Gainsco products and services as well.

I think that's going to help propel Gainsco and enhance their operations even more so in the nonstandard auto marketplace. Those are things that our analysts are definitely going to continue paying attention to and monitoring in [2021].

The last thing I'd mention is that fraud continues to be a major issue for nonstandard auto insurers. Considering the economic hardships because of the pandemic, and the reality that more and more people are struggling financially, it bears watching whether nonstandard auto insurers report an uptick in vehicle dumping, arson, or any other types of fraudulent claim activity.