With any new rating variable, you have early adopters and late adopters.
The early adopters use the new variable and gain advantages over the late adopters.
The late adopters can’t price appropriately compared to early adopters. Late adopters price the safest drivers too high. These drivers end up going to the competition. Late adopters also price the riskiest drivers too low. These risky drivers get a good rate, so they stay. And drive up losses.
Eventually the late adopters become the victims of adverse selection. Their loss ratio goes up. They see a decrease in profits. They need to raise prices to cover their costs. This makes the situation even worse.
A great example of adverse selection in action is credit score in the 90s.
Using credit to price insurance is an old story. Insurers have been using it for years. But it’s worth revisiting to show why it was powerful and what happened to late adopters.
Take a look at this chart. It shows that if you had bad credit you were more likely to have a claim. As a result, insurers found that credit score was a powerful predictor of driving behavior and losses. The early adopters of credit as a variable thrived. The late adopters struggled.
This is what happened with Progressive and State Farm in the late 90s. Progressive adopted credit. State Farm didn’t. Progressive priced their customers appropriately. State Farm didn’t. Progressive got the safest drivers and shed the worst. The worst drivers went to State Farm and others.
Progressive’s loss ratio advantage over State Farm started at 4.2 when it adopted credit. Five years later its advantage was over 20.
A lot of insurers were the victims of adverse selection because of credit. And because of this, 95% of US auto insurers use credit today. The lesson here is that if there’s a new powerful variable, you need to use it to stay competitive.
Let’s turn to today, where telematics is disrupting the market. Is telematics the new credit score? And is history repeating itself?
Adverse selection says it is.
Progressive adopted telematics and UBI back in 2008. They’ve amassed over 25 billion miles of telematics data. They’re growing at 20% a year. And they’ve managed to do this with a loss ratio in the low 60s.
They’re up against a strong competitor in the chart above. It tracks their loss ratios from 2008 through 2018. In 2008, Progressive’s loss ratio lead was less than three. By 2018, Progressive’s lead grew to 12 points.
Telematics isn’t the only reason, but it’s a big reason.
And, today, every top 10 insurer has a telematics program.
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