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Auto insurance proves to be a
stable but competitive sector

Lower premiums are being urged by regulators in several large states, but they are also being used aggressively by underwriters to build market share.

Competition has been heating up in the auto insurance sector for several reasons. The robust economy has boosted underwriting margins, and this has encouraged insurers to cut prices to attract business. Lower premiums are being urged by regulators in several large states, but they are also being used aggressively by underwriters to build market share. This is a logical business strategy in an otherwise mature market with little year-on-year growth. Established players are aiming for higher growth rates while new market entrants try to carve out product and distribution niches.

While competition means lower rates and greater choice for insurance buyers, it also may bring confusion. The auto insurance industry is relatively easy to enter, because it has fairly low capitalization requirements. But consumers and agents may not always know the newer market players very well, so they may be wary of doing business with these unfamiliar names. Standard & Poor's Insurer Financial Strength Ratings provide a clear, concise, and up-to-date snapshot of an insurer's ability to pay-now and further down the line. To help buyers make a more informed choice, a list of the 100 largest personal auto insurers is available.

Car sales and risky drivers fueling growth

Although recent global economic weakness and volatility in equities markets are a cause for concern, they occur against a backdrop of sustained U.S. economic growth. This broader trend has supported growth in revenues from auto premiums. Higher auto sales are behind the aggregate dollar increase in auto premiums. At the same time, many companies have reclassified their business between standard (average risk) and non-standard (higher risk) drivers. They have enjoyed double-digit growth in the latter segment. Although this segment will reach maturity eventually, for now it's still growing rapidly. Prospects in this segment are so attractive that many larger insurers — including Allstate and GEICO — have increased their presence in this area.

Auto insurers have gotten better over the past few years at holding down loss costs. In part, they've been helped by factors outside their control. Baby Boomers are turning 50, a demographic group which historically has fewer accidents. Airbags, seatbelt requirements, and drunk driving laws have also cut down on liability and damage claims. Medical cost and auto parts inflation have become more benign over the past few years. And some of the premiere insurers are achieving success with a kind of "managed care" system for car repairs, negotiating terms with auto body shops to reduce high repair costs. The regulatory and political environment during the 1990s has also been favorable for insurers. While auto insurance may become a political football in some states, including California, New Jersey, Massachusetts, and Florida, government-imposed requirements haven't recently sparked volatility or cut profitability within the industry.

Auto insurers have also been cutting costs by rethinking distribution models.

New ways of selling helping to lower costs

Auto insurers have also been cutting costs by rethinking distribution models. The traditional independent or captive agent model has high commission costs, but offers better retention rates. This is important in an industry where the average policy becomes profitable only after being in place for 18 to 24 months. To reduce commission costs, companies marketing through independent agencies are increasingly driving for closer, more exclusive relationships with their agents, which has increased pressure on marginal companies.

Meanwhile, players like GEICO are selling directly to consumers over the phone, and other providers are moving toward Internet-based transactions. This model can circumvent agent commissions but has higher barriers to entry in the form of technology and other infrastructure costs.

Some companies, recognizing that there will always be constituencies for different distribution models, are using both systems, although pushing forward with direct sales without alienating an existing agent force can be difficult. To avoid this conflict, some companies are implementing different distribution methods in different regions. Other companies, like Progressive, use the Internet to provide quotes, but give the customer a choice between going direct or through an independent agent. Currently, the market is evenly divided between captive agents (such as State Farm and Allstate), independent agents (such as Nationwide), and direct writers (such as Liberty Mutual).

Auto insurance industry competition is heating up as established insurers seek to grow market share, vying with each other and with new players, who are attracted by the industry's relatively low capital requirements and short liability tail. Other insurers are getting into the auto line to diversify their business. Many companies are making acquisitions to improve efficiency. Larger players benefiting from economies of scale will increase pressure on the smaller and marginal insurers to reduce their own costs.

Competition is good for consumers, but it can also be perplexing. Many new players may have unfamiliar names. Even established companies may trade under a different name when using a new distribution method. When consumers buy insurance directly, without an agent to aid decision making, it's important to research the ratings of the company. Standard & Poor's sees a mostly stable ratings picture for auto insurers, supported by strong capitalization within the industry. But individual players may see ratings downgraded if they can't weather increased competition, so it's crucial for consumers to do their homework. Standard & Poor's ratings take into account a company's current competitive positioning and prospects. Insurers rated BBB and higher are secure, while those below BBB are vulnerable.


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