For GEICO, which is owned by Berkshire Hathaway (NYSE:BRK-A) (NYSE:BRK-B), and Allstate (NYSE:ALL), the first quarter of 2015 was a surprisingly poor quarter for their auto insurance businesses. Claims-related losses reduced GEICO's first quarter pre-tax operating income by more than half, falling from $353 million in first quarter 2014 to $160 million this year. Meanwhile Allstate's underwriting income fell from $183 million to $76 million.
Both companies saw their auto loss ratios (the percentage of premiums paid out toward claims) rise above their historical norms. GEICO has typically operated with loss ratios in the 75%-77% range but reported a loss ratio of 80.1% this past quarter. In the case of Allstate, its main brand saw auto loss ratios increase from 67.9% to 71.7%.
With the largest auto insurers operating at pre-tax underwriting margins of 7%-8% of premiums earned, small percentage changes to the loss ratio have a dramatic effect on operating income. The main concern for investors is whether such shifts are a result of underwriting families broader shifts in consumer behavior. Auto insurance loss data is typically broken into two component parts: severity and frequency. Loss severity looks at the average dollar value of claims made, while loss frequency measures the quantity of claims as a percentage of policyholders.
During the two recent quarters both GEICO and Allstate experienced significant increases in loss frequency. Allstate saw increases in claims frequency across all its brands and lines of auto insurance business. The company's Allstate brand saw bodily injury claims frequency rise by 6.8% over the previous year. GEICO reported increases in claims frequency in every part of its business.
|GEICO Loss Experience||Severity||Frequency|
|Property and Collision||+3-4%||+4-5%|
The parallel exposure to claims increases across companies is a good sign for investors, indicating that the recent experience is less about an individiual company's underwriting process and more a result of broader trends. In the company's first-quarter call, Allstate attributed higher claim frequency to harsher than normal weather as well as greater driving behavior across all consumer segments.
Northeastern states suffered a particularly brutal winter as unusually harsh winter storms dumped multiple feet of snow in places like Massachusetts and New York. Increases in auto accidents and claims are not at all surprising given these conditions. Over the long run however, the weather-related impact on losses should revert to historical norms and should not be a major concern overall.
Lower gas prices leads to greater driving
For investors, a greater concern is the long-term trend in driving behavior. Through the company's Drivewise platform, which collects data on policyholder driving behavior, Allstate has indicated an upward tick in miles driven has been the second driver in higher frequencies. We find little fault in this argument as the improved economy and changes in currency and oil markets are starting to have an impact in U.S. household spending.
The largest factor pushing consumers onto the roads is the drop in global oil markets leading to multi-year lows in retail gasoline. The increased affordability has even driven consumers to opt for less fuel efficient cars, so it is no surprise to see an overall uptick in miles driven.
While oil prices have risen since the beginning of this year, investors and insurers alike should closely monitor where it goes in the next few months. The approaching summer months are generally the busiest for consumer travel. Road trips this year may be particularly appealing for families as the cheapest gas prices in recent years may push an even greater amount of families to take advantage of short term affordability. This could lead to an even greater than expected increase in auto claims during the summer months.
Fortunately, GEICO and Allstate have already indicated a proactive approach by actively increasing auto insurance rates in their operating markets. In many states however, increases in auto insurance premiums are reviewed by state regulators, and approval can take some time. While consumers should see rising car insurance quotes this we expect some lag in when these premium increase begin to take effect. This could prove to be problematic for the insurers if the rate hikes are inadequate or not in time to account for the summer travel season.
This article originally appeared on ValuePenguin.com.