Personal automobile insurance is one of the most well known forms of insurance in the U.S. as it is mandatory in most states of the country. Vehicle insurance companies like State Farm Insurance (19% market share) and All State Insurance Group (10% market share) charge monthly premiums from insured parties with rates depending on the profile of the individual and the vehicle being insured.  Rates also depend on the underwriting practices of the insurance companies.
Personal automobile insurance premium volume has grown 5% from $164 billion in 2010 to $172 billion in 2012, accounting for 35% of Property and Casualty (P&C) premiums in the U.S. This growth has been driven both by strong car sales as well as price hikes by insurance companies looking to offset low yields from their investments. Vehicle sales in the U.S. went up 11%, year on year in 2011 and further increased 13% in 2012, as improving economic conditions lifted consumer sentiment.  However, a study by AAA showed that average auto insurance costs for sedans also climbed 3.4% in 2011, followed by a 2.8% increase in 2012. 
We currently cover two companies involved in personal automobile insurance in the U.S. : The Travelers Companies, Inc. (NYSE:TRV) and The Hartford Financial Services Group (NYSE:HIG). Travelers has a market share of nearly 2% and earns 16% of its premiums from the division. On the other hand, Hartford has a market share of 1.3% and earns a quarter of its P&C premiums from its personal automobile insurance operations.
Why Have Premium Rates Gone Up?
Insurance companies collect premiums from clients in exchange for coverage, and the income from these premiums is invested to generate returns. These investments are crucial for insurance companies. The combined ratio, a key measure of profitability taking losses, claims and other underwriting expenses per premium dollar, was around 108% for the industry in 2011 and 103% in 2012.  This indicates that without investment income, the property and casualty industry would actually be running on losses with a negative margin of 3% last year. However, after accounting for investment results, the industry actually reported a net income of $33.5 billion for 2012.
Insurers prefer to invest in “safe” securities like government and corporate bonds; close to 80% of the P&C industry’s asset base is invested in bonds.  The yields from these investments have been low in the last few years, influenced by the Fed’s monetary policies like the Quantitative Easing (QE) program. The ongoing QE3 program involves $85 billion in monthly purchases of assets such as long term treasuries and mortgage-backed securities from commercial banks and other financial institutions, thereby increasing liquidity and reducing long term rates. The 10 year Treasury bond yield, which can be used as a benchmark for bond yields, was around 5% before the financial crisis and fell to 1.5% in 2012.  Short term rates have also been affected by Fed policy; the U.S. Federal Funds Rate, the rate at which banks borrow from each other to maintain capital reserves, is currently less than 0.1%.  As a result, the P&C insurance industry saw its yield from investments drop from 3.8% in 2011 to 3.6% in 2012. This has forced insurers to resort to price hikes to maintain margins.
Where Do We Go Now?
Bond yields have been climbing this year since Federal Reserve Chairman Ben S. Bernanke first suggested the possibility of the Fed cutting back on the pace of the QE3 program back in May, with the 10 year Treasury bond yield now around 2.8%.  The Fed has not given a timeline for tapering but has suggested that it will analyze economic data, giving a threshold of 6.5% unemployment rate and an inflation rate target of 2% before it increases interest rates.  The unemployment rate has improved from 7.9% in January to 7.3% in October this year.  This would indicate that the Fed might start tapering the QE3 program in the near future.
However, the labor force participation rate is at a 35-year low of 64% suggesting that the decline in unemployment rate might be due to people opting to stay unemployed.  The Fed might take this into account before deciding future monetary policies aimed at improving the U.S. economy. Also, Mr. Bernanke is likely to be succeeded by Federal Reserve Vice Chair Janet Yellen, who is perceived to be more dovish, favoring lower interest rates to promote development.  There is a distinct possibility that the Quantitative Easing program might continue longer than the market currently expects. In this scenario, we can expect insurance costs to rise further in the coming years. With auto sales still trending upwards, the personal automobile insurance market could continue to see growth. We presently expect the total personal automobile insurance premiums in the U.S. to cross the $200 billion mark by 2018.
In our next article, we analyze the impact of personal automobile insurance on Hartford and Travelers.Notes:
- NATIONAL ASSOCIATION OF INSURANCE COMMISSIONERS PROPERTY AND CASUALTY INSURANCE INDUSTRY 2012 TOP 25 GROUPS AND COMPANIES BY COUNTRYWIDE PREMIUM [↩]
- GENERAL MOTORS COMPANY AND SUBSIDIARIES, Form 10-K [↩]
- Auto Insurance, Insurance Information Institute [↩]
- P/C Insurers’ Profits Rose in 2012, but Profitability Lagged Long-Term Norm as Sandy Losses and Drop in Investment Gains Hit Results [↩]
- Analysis of Insurance Industry Investment Portfolio Asset Mixes, National Association of Insurance Commissioners [↩]
- Daily Treasury Yield Curve Rates, U.S. Department Of The Treasury [↩]
- U.S. Federal Funds Rate, Bloomberg [↩]
- U.S. 10-Year Yield Tops 2% as Bernanke Says Fed May Taper Buys [↩]
- Bernanke Offers Possible Timetable for Tapering [↩]
- U.S. Department of Labor, Labor Force Statistics from the Current Population Survey [↩]
- Labor Force Statistics from the Current Population Survey, United States Department Of Labor, November 21, 2013 [↩]
- Treasuries Rise as Pimco Says Summers Withdrawal Is Supportive, Bloomberg, September 16 [↩]