Unpacking the Truth Behind High Auto Insurance Premiums

Recently, a local television newscast ran a short report on the current high price of auto insurance. After recording one or two predictable complaints from the general public, the reporter ascribed the high prices to the high cost of “labor and materials.”

This is certainly, at best, a partial and very superficial explanation–one that provides little insight into the dynamics and specialized nature of the insurance industry and marketplace.

Those of us who have devoted much of our careers to the insurance industry understand the existence of such things as the insurance price cycle, and social inflation.

How do these industry nuances fit into the current auto insurance situation? There are a number of factors that have combined to drive auto insurance costs higher over the last decade:

• Vehicles have become more technologically sophisticated, making repair or replacement of electronic and computer-based components much costlier. Also, there is now more multi-component manufacturing, which promotes cost-effectiveness and efficiencies in the building process, but also results in greater costs associated with repairing or replacing a damaged component, since often the entire structure around that component must be replaced.
• Social inflation is a long-recognized tendency for insurance loss costs to increase at a rate exceeding general consumer inflation. This effect is largely due to the increasingly litigious nature of our society, resulting in greater numbers and sizes of tort awards and settlements.
• Behaviorally, distracted driving is becoming an increasing problem. Advancements in available technologies–phones, GPS, and other electronics–tempt drivers’ attention away from focusing on the road.

The above are factors resulting in general upward trends in auto insurance costs, and certainly there is a need to recognize and address these causes of increasing losses. But why the abnormally large jumps over the last year or two, when recent annual increases in auto insurance premiums are said to have reached 20%?

Related: Social Inflation Fix: Insurers Can’t Be Out Front, Chubb’s Greenberg Says

Actually, from a long-term perspective, current auto insurance premiums now are relatively consistent with historical levels. Prior to 2017 and 2018, premiums tended to increase at a 5-6% annual rate.

During the pandemic, largely because of the reduction in risk exposure due to less driving, premiums decreased, and insurers often returned part of the auto premiums to their policyholders. When driving returned to more traditional exposure levels, auto insurers found that rates were inadequate and needed to be increased to produce a reasonable return on equity. Hence the spikes in premiums during the last couple of years. Now, we’re essentially back to rate levels that would have prevailed if rates had continued to increase at 5-6% per year–levels with which insurers seem more satisfied.

Related: U.S. P/C Underwriting Results: Two Years in a Row Over $20 Billion in the Red

The good news is that there is evidence that auto insurance prices are stabilizing a bit. In the last two months, the auto insurance component of the Consumer Price Index has risen about 0.80%, which corresponds to roughly 5% per year. This is a significant moderation relative to the 20% annual increase that the data were suggesting just a few months ago.

Gorvett is a mathematics and actuarial science professor in the Department of Mathematics and Economics at Bryant University in Smithfield, R.I.